For much of 2018, the prevailing market theme was the one Morgan Stanley dubbed "rolling bear markets" when any time a given asset was hit, whether emerging markets, Italian bonds, or tech stocks, money would simply rotate from one place to another. However, at the end of September, when rates spiked amid concerns the Fed was prepared to push rates beyond neutral, things changed overnight.
Fast forward to now when what appeared to be somewhat orderly sequential blow ups have mutated into wholesale market panics in which everything starts to go wrong at once, or as Bloomberg describes it "everywhere you look, something’s blowing up."
In commodities, it’s the record plunge in oil. In equities, it’s six weeks of turbulence in the S&P 500. Debt markets have been rattled by the turmoil engulfing General Electric and PG&E. Bitcoin just plunged 13 percent. And Goldman Sachs, the storied investment bank, is having the worst week since 2016.
As Bloomberg correctly notes, by themselves these sudden asset air pockets would be enough to incite panic, "but have them erupt all around and even the most grizzled Wall Street types can start to sound paranoid. Does GE have something to do with Goldman? How does Bitcoin sway the stock market? Wildfires have nothing to do with crude’s convulsions, but both are bad news for banks."
“The risk of contagion is understood. What’s not understood is where and how connected things are,” Stewart Capital Advisors' Malcolm Polley said by phone. "Just about anything can create panic, create contagion, and it doesn’t have to be something that makes sense."
That bad things should congregate isn’t surprising to Donald Selkin, chief market strategist at Newbridge Securities, who sees it as a consequence of having it so good for so long. He’s waking up every night to check the futures.
“People are saying, ‘Get me out across the board,”’ Selkin said. “Everyone is anxious. I am anxious. You buy a good company and hope for the best and pray it doesn’t get destroyed. Look at Apple down $40. Look at some of the most well-known companies being decimated. I own Apple. I own Exxon. Of course I feel a lot of pressure.”
The biggest headache is plaguing investors is identifying the channels of contagion that are dragging seemingly disparate assets lower, and which for years remained dormant in the face of adverse stimuli. Some examples:
Bitcoin is viewed as an isolated ecosystem but it does have a bearing on chipmakers, a particularly speculative corner of the market that is watched to gauge investors’ risk appetite. The digital currency’s peak in December came two months before the S&P 500’s worst rout in two years.
The connection between GE and banks? After the debt downgrade made it harder for the manufacturer to borrow through commercial paper, it has turned to credit lines provided by banks to fund businesses. According to its quarterly filings, the industrial conglomerate has drawn on $41 billion in credit lines from more than 30 lenders.
Not everyone agrees, and the die-hard bulls are still hoping that there is no correlation between the now shrinking consolidated global central bank balance sheet, and these increasingly more frequent events. "We have seen a number of idiosyncratic stories going on such as GE, GS, PG&E which are not necessarily a signal of a market correction,” said NN Investment Partners money manager Dorian Garay. “U.S. credit and macro fundamentals are solid as reiterated by recent macro indicators and earnings.”
Perhaps Garay, like all the other millennials in the market who have never lived through a real bear, forgot that the market - when stripped of its central bank training wheels - is a discounting mechanism, and it's not about current earnings but the future cash flow streams. Although in a world dominated by central banks, one can see why people would forget this modest distinction.
Some have had no choice but to remember.
“We’re still focused not only on valuations but on the quality of balance sheets going forward,” said Joe Smith, deputy CIO at Omaha, Nebraska-based CLS Investments. Low rates have enabled borrowing to fund share repurchases and higher dividends, he added. “Some of those factors could likely translate as things that create more angst or anxiety for investors going forward as people start to think about whether those companies in effect overspent too much with their credit cards.”
He has a point: in fact, despite spending a record $800 billion on buybacks in 2018, US corporations have nothing to show for it. Take the US buyback index, SPBUYUP, which is down YTD.
Worse, the "king of buybacks", Apple, has spent $100BN on stock repurchases in 2018, and yet recently entered a bear market, down 20% from its highs, and also below its 200D Moving average.
It's no wonder that in this environment - where seemingly uncorrelated assets can suddenly collapse together for unknown reasons - traders are extremely nervous.
They will be even more nervous when they learn that according to Bank of America, even as the S&P is fading, the ingredients of a flash crash are rising as bond / FX / equity volatility is all trending up amid vicios deleveraging events - such as the recent plunge in oil offset by a record surge in nat gas. This is largely the result of divergent central bank policies and yield differentials, which manifest themselves via abnormal spreads.
To justify the controversial claim that a crash is coming - an prediction which will only assure guarantee even more sleepless nights for already worn out millennial "traders" who are still learning how to spell "sell" - BofA CIO Michael Hartnett shows the near record 295bps spread between Libor-Euribor which was last seen on two occasions: the first time in October 99, just before the bursting of the dot com bubble, and the second time in 2006 - just before the US housing bubble burst and ushered in the global financial crisis. It is this spread that is the "tell" that a flash crash is imminent.
So what will catalyze said flash crash? To BofA, triggers could be "violent US dollar move and/or shock macro data forcing abrupt GDP & EPS downgrades." Or, to quote Leuthold Weeden's CIO, Jim Paulsen, "When this thing finally finds a bottom, panic will be everywhere."