December 9, 2018
It was a busy, on-the-whole-gut-wrenching week for most of us, but we’ll get to all of that shortly. First, and perhaps for the (let’s at any rate hope) final time, I will take this opportunity to pay tribute to a Great American. Scion of an elite political family, Ivy League-educated, accomplished college athlete, legislator, two-term Vice President and top vote getter in a presidential election.
We could, of course, be referring to Poppy Bush, who was laid, amid much pomp and circumstance, to rest this past week. Except we’re not. Instead we pay our respects to the irrepressible, still-able-to-fog-a- mirror Albert S. Gore. Unlike Bush 41, he never fought in a war, failed to win his presidential bid, and ultimately divorced his long-suffering, rock and roll hating wife Tipper. Yet he still, somehow, manages to permeate the ionosphere. As everyone knows, he invented the internet, and managed to put himself front and center in the Climate Change debates – while cashing in, among other projects, on his sale of a flailing Cable TV enterprise to the Petro-oligarch-controlled, America-hating Al Jazeera.
Also, if you add the word “rhythm” to his name, you arrive at a homonym for the ubiquitous for model- driven methodologies. The Al Gore Rhythm has a nice ring to it, the double entendre so compelling that (on my immortal soul) without prompting, I suggested to my son that he name his band The Al Gore Rhythm. He rejected the idea, and, in retrospect, I can hardly blame him.
Among other reasons because I was not the only one who came up with this clever mash up of nomenclature. Al Gore Rhythm has even been enshrined in the Urban Dictionary, which defines it as an individual or object with annoyingly stiff, robotic motions. Y’all can decide for yourselves, but as for me, I think the Urban Dictionary nailed it.
I reckon that’s about it with respect to A.G. – except for one thing: his mash up homonym pair – algorithm -- is starting, in my judgment to do real damage to the markets. Now, please understand me, I hate to do so, but see no alternative other than to opine that market algorithms are starting to wreak real havoc on investment portfolios. In fact, it may be more than coincidence that these programs, with their heavy reliance on connectivity, actually bear the name of the internet’s self-anointed founder.
I have resisted blaming the algos for market causing carnage for many years now, and this for a number of reasons. The excuse of their presence is just too convenient. Algos are entirely too available as a justification for losses. No one really knows how they operate (including, presumably in many cases, the operators themselves). Most importantly, no one can prove empirically that their presence is problematic.
All of these issues persist, my friends; indeed, they do, but my mind is changing about them. I’m not sure that risk factors would be configured much differently if algos didn’t dominate market proceedings, but I think that a lot of investment pools would be better off if they weren’t around.
But let’s first take a look at the markets as a whole, and acknowledge, yet again that my own particular compass has been way off since before Thanksgiving. After reaching the time-honored state of being unable to choke down even one additional morsel of turkey, I welcomed in the following week with a real concern that equities were going to blow out to the downside. And I was wrong. Dead wrong. As everyone knows, they rocketed up across the entire sequence.
The improbable, insulting assault on my prognostications was due and owing to a couple of heaven-sent catalysts that came our way during the last week of November – ones that ran in direct refutation of my most pressing market concerns. For context: 1) Fed Chair Powell assertively calmed our interest rate fears by stating that his rate hiking work was nearly done; and 2) the Trump-Xi summit concluded with the only positively-shaded outcomes that were feasible – the postponement of the next round of tariffs and a promise to sit down in earnest and begin to hammer out a deal.
Number 2 was, of course, mostly pure political posturing; I have long believed that our trade issues with China are too complex and obtuse for accurate information to be delivered to the public. But there was every chance that the sit-down could’ve produced widely socialized incrementally negative outcomes, and when it didn’t, I felt that a significant short-term risk had been removed from the markets.
The news for the Fed, I felt and still feel, was more impactful. I have believed for some time that we’re in the wrong time and wrong place for rate normalization. Though he’s annoyingly self-serving, Gundlach is dead on when he suggests that contemporaneous central bank balance sheet reduction and policy rate increases is a counterproductive, counterintuitive exercise. Throw unmistakably slowing global growth into the mix, and you really have to wonder about those Fed hawks.
While it was only one speech, I think Powell painted himself into a corner in which unless the economy shows renewed, sustained vigor, he cannot move his policy rate upwards more than a small fraction without looking as unstable as the guy who appointed him. And that, mis amigos, was cause for celebration – the fact that – true to script – Powell and all his minions began immediately walking back his comments notwithstanding.
So by all accounts, we entered last week with two visible, short-term risks having removed themselves from the equation, but what did the market do? It sold off. Hard. All week. When the dust settled on Friday, the SPX closed with in a microscopic ½ index point from where it landed on Thanksgiving Friday
– a punishing two-week round trip as ever I can remember. Govies rallied across the globe, with the U.S. 2’s/5’s spread actually negative, and those hard-nosed Swiss now again charging investors 20 basis points per year for the privilege of lending to them until 2028. Given what is transpiring in these economies (and indeed) worldwide, I fail to see how long-term rates anywhere can achieve much uplift.
Private debt was an entirely different story, with High Yield securities selling off in sympathy with their equity brethren to beat the band:
The dumping of less than impeccably credit-worthy debt obligations is a clear sign of a rising risk premium, and, connecting the dots, it must be acknowledged that over the last couple of weeks, said premium fell when I expected it to rise, and rose when I expected it to fall. I reckon that’s what makes this the great game it is.
Now, clearly, it didn’t help matters that while the world’s two most powerful leaders were breaking bread and drinking toasts to a bright collaborative future, our Canadian friends, at our request, were busy arresting, a nepotistic senior executive of a Chinese technology company long suspected of purloining our technology and using it for various nefarious purposes. But though the long arm of international law reached out on Saturday, the news didn’t break until late Monday, by which time the markets had already begun its week-long descent. Published news reports suggest that Trump didn’t even know this was going to take place, but: a) this is laughable; and b) we should all hope and pray it’s a lie. I shudder to contemplate a domestic governance structure under which while a president was in the midst of perhaps the most important meeting in many years with his Chinese opposite number, he was uninformed that his own G-men were arresting a Chinese executive.
Either way, it’s not the best footing upon which to commence critical trade negotiations. Moreover, while I won’t venture too far into this undesirable territory, I will also suggest that the market may be justifiably spooked by a scene in Washington that appears to be near breakdown. Mueller is starting to drop his bombs, and it’s not pleasing anyone. The adult in the West Wing, Chief of Staff John Kelly, was (as was inevitable) given his walking papers. Meanwhile, the President was busy taking shots at his once-highly lauded/now former Secretary of State. It unfortunately appears, my loves, that the Russia debacle is coming to a head. One thing is certain: Trump is about to receive that punishing sequence of body blows that was always in the offing with this here mess. As a matter of pure substance, it looks to me to be a survivable event – both legally and politically. But it will require careful, disciplined management: a) which was never his strong suit; and b) which whatever meager gifts of this nature the Good Lord bestowed upon him appear to have dwindled to insignificance. I won’t lie: this makes me very nervous.
On a more encouraging notes, arrest notwithstanding, the U.S. China negotiators are making encouraging noises, interest rates are trending downward and I don’t see this trend reversing itself anytime soon. While the domestic economy may be feeling some gravitational pull, from what we know, it’s still humming along. Meanwhile, equity valuations are approximately 12% below where they were 2 ½ months ago.
And at least in part, I blame the algos. Sell programs were in full force all week, but that’s just one factor. Open interest in important risk benchmarks like crude oil is bouncing around like they are immersed in a particle collider. Individual, macro-neutral equity names are down 30%, 40% or more – all on no news.
Using deductive reasoning, I think that the quant programs are at their misbehaving worst, and here’s the thing: they’re not even benefitting from the damage they’re causing. My anecdotal information indicates that quant funds are having both their worst quarter and worst year in several. I won’t lie: this frustrates me, because hard experience has taught me that when individuals and entities are doing harm to others, they should at least benefit from their transgressions – at least in the short term. Otherwise, why bother?
Overall, my sense is that equities are pretty oversold here, and I expect them to bounce – perhaps significantly, perhaps as soon as tomorrow. The “sell everything” elements of the algos will certainly take more shots at the market, but I think they’re running out of gas. Moreover, with all of the insanity going on everywhere one cast one’s eye, I believe there’s limited upside to the equity tape over the next several quarters, and if I’m right, then these look like pretty good entry points to me.
Of course, the algorithms may disagree and probably will, but Al Gore and the Al Gore Rhythm abides. According to published reports, the former is now a billionaire, and has reasons to be glad, on balance, for those hanging chads that took him down in ’00. My son’s band picked the name of The Jays (in tribute to the first initials of 75% of their favorite ensemble: Led Zeppelin). But cruel fate intervened and The Jays are no more.
Their surviving members carry on, though, as do Al Gore, the Al Gore Rhythm, and, of course, market algorithms. There’s really not much else to do, now, is there? So hang in there my friends; when good stocks in your portfolios get crushed, when you lose Florida by 500 votes, when problems arise as they always do, if you hang in there, perhaps there’s an Al Jazeera out there for you as well, just aching to take your troubles away. Stranger things, in fact, have happened you know….
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