Wild Action In Markets Gets Wilder

Another Huge Decline

Lately we have been seeing stocks do the opposite of what they did the previous day. Stocks fell Thursday, were up on Friday, fell on Monday, were up on Tuesday, and fell on Wednesday. Wednesday was another steep decline. But stocks managed to just barely avoid a new bear market low as they increased sharply at the end of the session. 

From 2:25PM to the close they rose 5.18%. S&P 500 was down 5.18% which made this the 8th straight day where the S&P 500 moved at least 4%. Previous record was 6 straight days in 1929. VIX closed at 76.45 which was its 5th highest close ever. March 2020 has the 1st, 5th, 6th, and 7th highest VIX closes ever. 

This Bear Market In Context

For most of the past few weeks it's been amazing how quickly this decline has been. But that it wasn’t as bad as the average bear market. With the latest declines, it is getting closer to that marker. Average bear market has a 30% drop and the average bear market in a recession has a 37% drop. The market is down 29.2% so far. If you think this will be the average bear in a recession, it makes sense to start buying now. 

The table below shows the worst drawdowns since the 1920s. 2008 and 2000 busts were the 2nd and 4th worst bear markets since the ‘20s. This bear market is already the 13th worst. It needs to get to -32% to be in the top 10. Forward returns are always hugely positive off the trough. 

Average 1 year gain off the low is 52.2% for these bear markets. An obvious catch is timing the bottom. Good news is gains are usually so powerful that you don’t need to time it perfectly to make money soon after the end of the bear market.  

Details Of Wednesday’s Wild Action

Wednesday was the craziest day in market’s I’ve ever seen in my life. A muni-bond ETF called MUB fell 6.15%. You’re starting to see ETFs decouple from their underlying assets. The ETF, which rarely moves much, is down 11.65% since March 9th. It doesn’t help that New York and Los Angeles which are 40% of the ETF are in dire financial straits. 

Russell 2000 was down an enormous 10.42%. It’s down 41.6% from February 20th. Forward PE ratio for the S&P 600 is 10.5 which is very close to the trough in 2008. Small caps are dirt cheap. We don’t know what the forward earnings will be, but we didn’t know what they would be in 2008 either. Earnings were terrible in 2009 and will be terrible in 2020 especially for small caps.

Let’s look at the best and worst sub-industries in 2020. 3 worst are oil and gas equipment; oil and gas drilling; and hotels, resorts, and cruise lines. They are down 71.19%, 70.53%, and 66.81% year to date. They will rally the most when the stock market bottoms, but some have bankruptcy risk. 

It’s also possible that the oil price war continues after COVID-19 is fought successfully. There are only 3 sub-industries that are up this year. They are food retail, water utilities, and hypermarkets & super centers. They are up 16.97%, 5.89%, and 3.79%. 

Implied correlation of the S&P 500 defied the laws of statistics by reaching an intraday high of 101.25%. Panic can’t be louder than that. The chart below shows the correlation closed the day at 86.35%. Correlations rise during panics because people sell out of everything. Funds de-risk their portfolios, retail traders puke their positions, and funds face redemptions after blowups.

Credit market is in big trouble as firms lack easy access to capital. Financial conditions are tightening rapidly. JNK junk bond ETF is down 18% since February 20th. As you can see from the chart on the left, firms that are highly profitable have been outperforming the S&P 500 dramatically in the past few weeks. 

On the other hand, firms with high leverage are underperforming. Underperforming a market that’s down 29% is disastrous. After the market bottoms, the high leveraged stocks will do the best.

Restaurant & COVID-19 Update

Let’s review the data on restaurant bookings, COVID-19 tests, and COVID-19 cases. Restaurant bookings on March 17th were the worst of this recent stretch. Yearly growth was -84% in the U.S. and -90% in Germany. There have been 76,495 tests so far in America. 

As you can see from the chart below, the number of tests per day has been ramping up considerably. America still isn’t close to where it needs to be, but it will likely make big progress in the next few days. Number of confirmed cases is going to explode in America as the number of tests ramps up.

Wednesday was a horrible day for COVID-19 news. Italy had a big spike in cases to 4,207 as its stretch of new cases being range bound ended. It had 475 deaths which was the most by far. Spain looks disastrous as well as it had 2,943 new cases and 105 new deaths. America had 2,954 new cases and 44 new deaths. There have now been 219,067 total coronavirus cases globally and 8,961 deaths. The number of cases will grow to a quarter of a million in 2-3 days.

Conclusion

S&P 500 just barely avoided making new cycle lows. But this was still the weirdest day we've ever seen in markets. Small caps are almost as cheap as they were in the fall of 2008. A muni-bond ETF cratered. 

S&P 500’s implied correlation got above 100%. Stocks ignored the fiscal stimulus passing the Senate. They are also ignoring the possibility that a cure will be discovered in the next few months. Personally, I believe one will be found this year because I believe in humans when they work together. 

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