How does it work? How do we break down this badly? What's really going on short-term?
I told you earlier about what happens in the economic world short-term versus long-term. But how about the actual mechanics of a decline. What's it really like in the trenches.
Fortunately I have been in the trenches and let me tell you, on days like today, it is nasty as all get out. In fact, on days like today you need to know how much tension the actual sellers of merchandise can put on your stocks and why you need to pay more attention to the sellers than you do the companies.
First, let's go over some proximate causes, shall we? Let's revisit the last 24-hour beginning after the close of last night's trading after what, in retrospect, was a remarkably placid day. We had just been given a nice upside surprise from Intel (INTC) and a very strong quarter from CSX (CSX). These two companies -- the largest semiconductor company in the world and one of the big three railroads -- give you remarkable reads of the world's and the nation's economies.
I found myself truly liking the Intel quarter. The company continues to put money in the right places, namely personal computers and tablets, both of which showed strong growth. The company's minting money. CSX told you that almost all of its lines of cargo were strong, even coal, and gave you a very positive outlook for business, both in its coverage area and the world.
I left the office feeling pretty good given that today has always been a day that takes its cue from those two companies' earnings.
Sure enough, when I awoke the futures looked flat, and the overseas markets were quite strong, particularly Asia. Alas, though, that was at 4:20 a.m. It was placid enough that I actually had time to adjust my fantasy football line-up as I read over the bank earnings from the previous day to prep for Bank of America's (BAC) quarter today.
But after a quick workout I came back to see all hell had broken loose. Remember, I have a checklist of what has to go right in order to get an investable bottom and it was almost as if the fates took the list and turned it upside down with pain.
First, rather than Ebola being contained, a second health care worker had contracted the disease. That in itself sent the futures tumbling. But then out of nowhere, I mean, literally out of nowhere, AbbVie (ABBV), a very good drug company that was trying to take advantage of the tax inversion rules, let it be known that it was close to dropping its bid for Shire (SHPG).
I don't think people realize how vicious this market can be behind the scenes. There are many firms that borrow huge amounts of money to buy stocks that are being taken over by other stocks to make a little money between when a deal is announced and when a deal closes. Hedge funds had borrowed billions of dollars to buy Shire, a deal that was almost certainly expected to close, especially because AbbVie had recently reiterated the importance of the acquisition.
With the deal breaking down you could expect colossal losses by hedge funds, and judging by the price of Shire, down 30% or $73, we got them. Now Shire's a terrific company, but AbbVie management apparently felt that the new rules from the U.S. Treasury made the deal unworkable. So it isn't like there were people who wanted to scoop up Shire with the hope that another buyer comes along.
You have to understand what happens when you get a breakdown like this. The firms that lent the money to the hedge funds immediately call the hedge funds when they see Shire drop and say "you need more collateral because the asset you have borrowed against is falling apart." These are very clinical phone calls. No cajoling. Just "you send the money in or we are going to sell whatever we have of yours to raise it." I have both made those calls and had those calls made to me. They are monstrous. Sometimes so many funds are involved with these deals that when they fall apart they can take down the whole market.
I remember on Friday Oct. 13 in 1989 we had an almost 7% decline in the stock market because a deal to bring United Airlines private broke down. I remember it well because we bought a ton of stock at my old hedge fund at the end of the day because we knew how the mechanics worked because of my training in the Goldman Sachs margin department and the margin calls I made there as a broker. I knew there was nothing fundamental wrong with the economy so it was worth buying.
But this time is different. Because at the same time we were assessing the deal and the impact of the new Ebola victim we also got retail sales that were weak. Next thing you know interest rates on the 10-year Treasury are plummeting below 2%, a huge move we haven't seen since last year. That freaks people out in itself, because we had thought the economy was getting better. When you lump in the plummeting price of oil with the slow retail sales and then you overlay the Ebola fears you get a picture of economic activity screeching to a halt.
There are many sectors that get clobbered when we have a revision of views about economic activity. The industrials get hammered, but so do the financials. At the same time, with visions of Walking Dead dancing in our heads, we envision a world of empty planes and malls, so even though gasoline is down, because of low oil it doesn't matter.
So while Shire led the hedge funds down, those who still clung to the idea that our economy might be doing better got crushed, too.
It looked like we could rally just because everything seemed so overdone and oil, which is now leading the S&P down or up, was actually going higher. But then mid-day we got the incredibly stupid news that the second stricken health care worker had actually flown commercial on a Frontier Airlines plane and we realized, once again, that we have no real protocols in this country for health care workers who handle Ebola patients.
Now we have to wait 21 days until we find out who was infected on the plane, if anyone, and that means we will find it really hard to bottom until we get past this three-week period. Remember, Ebola represents the top of mind concern and we saw a total breakdown of travel and leisure stocks anticipating airline, hotel, cruise line and theme park cancellations.
Now, ironically, some of the worst hit stocks from the previous days started to rally while the safest stocks people have been hiding in, the ones that I said had to get hit before we got a bottom, were beginning to go down.
That's a welcome sign.
But if you go over the list of what needs to happen before we bottom all we got, frankly, was a worsening of almost each one. Yes, all stocks are now being hit, even the safe ones. But Ebola's anything but under control, the big speculative stocks haven't all surrendered their gains, and I can't say oil has found its footing -- the futures were down today after all.
Tech hasn't stabilized. The sanction war remains on. We didn't get that many beats and raises on earnings. The technical are in tatters. China's doing nothing good and ISIS is still on the move. Plus now we have an eleventh, the breakdown of the big hedge funds that levered up is just now happening. That, too, has to run its course.
So, in the end, we didn't make any progress on the list, except all stocks getting hit. And we know that there are possibilities of many Ebola victims lurking, just like SARS, which was supposed to be in control, but didn't get in control until we had huge selloffs in anything travel and leisure. That scenario now must play out.
We aren't done. We are oversold. I see bargains, particularly in 3%-yielding safe stocks now that oil's come down and the 10-year Treasury is under 3%. But I think it's safe to say that we will have more selling until we reach that elusive bottom, and any lift will, once again, be a chance to lighten up, not buy more stock.