"Any man's death diminishes me, because I am involved in Mankind; And therefore never send to know for whom the bell tolls; it tolls for thee."
-- From "Devotions upon Emergent Occasions" by John Donne (1624)
A Simple Introduction to Complexity Theory
Some call them "Black Swan" events. I call them non-linear outcomes. Let's talk.
Every once in a while, in the life of a professional trader/investor, the individual is forced to watch events unfold in real time, and ,even if seemingly well-prepared for what appears to be unfolding (we did talk about significantly reducing long-side exposure to the banks earlier this week), to wonder. Wonder about just how complex all systems truly are that might create interlocking environments, environments that might otherwise, in a more logical world, appear unrelated. One must wonder about linear or logical outcomes, and, of course, one very carefully must consider the probability or likelihood of non-linear or what should be (but might not be) illogical outcomes.
The Silvergate Capital (SI) news seemingly came about due to a collapse in valuations across the universe of cryptocurrencies. What else is out there? SVB Financial Group (SIVB) , the parent of Silicon Valley Bank, is suddenly forced to sell assets at substantial losses due to declining deposits and the poor composition of its balance sheet. Credit Suisse CS is, well, a slow-moving train wreck decades in the making.
Are they all related? In a somewhat simple, explanatory way, yes. Are any of these three dependent upon the others? Probably not. Not to an especially high degree. anyway.
Do any of their tentacles extend to other banks? Other companies? Government agencies? International organizations? Your neighborhood? Your household? What kind of unwelcome exposure lurks in the shadow of misunderstood structure? How can one possibly answer those questions? Very few can answer even one or two of those questions with any certainty.
"Complexity Theory" has become a term used to explain the inter-environmental relationships between a probably close-to-infinite number of systems that themselves, even in isolation, have become quite complex in nature. All complex systems have some kind of structure. As the parts of one system fail or that individual structure takes on damage, or perhaps even collapses, its impact upon structures apparently adjacent, meant to withstand external pressures might be pressured in such a way as to present vulnerabilities that had been unforeseen and hence unprepared for. The simple system such as the household economy, dependent upon saving for retirement and carefully managing family expenses, might fall victim to the already mentioned non-linear outcome elsewhere that those managing the household economy had never heard of, or even thought of.
As problems and relationships become better understood, these systems must adapt and evolve. The results of these changes have the potential to create disturbances that themselves create unexpected adaptations, unprepared for evolution, and "out of left field" results elsewhere. Understand that the more leverage inherent in any system at the onset of a crisis, the more probable that any series of unexpected outcomes becomes visible in a non-linear fashion over time. Time itself might be required to forensically discover where errors in judgment or errors in assumed firewall-like protection or a dreaded lack of systemic independence might be determined. All while environmental adjustment and cooperation between parties involved continues in real-time, thus further enhancing the complexity of it all. Let's move on.
Late Wednesday, SVB Financial Group revealed that the bank had lost about $1.8 billion in making sales of a portfolio of securities valued at roughly $21 billion. The bank dumped these securities on the market in response to a decrease in customer deposits. By Thursday, as investors turned equity holdings of SIVB into a fire sale, attention turned to other banks, even large banks. What kinds of bond portfolios are held by all of these institutions? They were merely reacting to an influx of those same customer deposits during the pandemic response, right? Another victim or more victims of overtly irresponsible fiscal policy? In a way, yes. Blame the legislature for the absurd growth in money supply and the inflation that it has created. Blame the central bank for enabling such irresponsible behavior.
Investors took a hatchet to all US banks. On Thursday alone, during the regular session, the Big Four -- JPMorgan Chase (JPM) , Bank of America (BAC) , Citigroup (C) and Wells Fargo (WFC) -- lost approximately $52.4 billion in market capitalization. The KBW Bank Index gave up 7.7% on Thursday, while the Dow Jones US Select Regional Bank Index surrendered 8.21% and the S&P SPDR Regional Banking ETF (KRE) lost 8.11%, all in a matter of hours. Yes, someone had opened up a can of you know what on the banks.
SIVB itself lost 60.14% during Thursday's regular trading session as SI gave up 42.16%. Then it got worse. On Thursday evening, Bloomberg News reported that Founders Fund, the San Francisco-based venture capital fund co-founded by Peter Theil, had advised clients to pull money out of Silicon Valley Bank. Separately, it was reported that Coature Management and Union Square Ventures had advised clients similarly. It's early (very early) and SIVB has been trading all over the place overnight, but as I write this I see that name down another 45% since Thursday's closing bell. SIVB traded as high as $348 in early February. I see it trading with a $57 handle here on Friday morning.
There won't be too many surprises here. The S&P 500 gave up 1.85% on Thursday as the Nasdaq Composite slid 2.05%. Among the indexes I watch closely, the top performer was the Dow Jones Industrial Average at -1.66%. The Russell 2000, which is home to many regional banks, lost 2.81%. Losers beat winners by almost 7 to 1 at the New York Stock Exchange and by almost 4 to 1 at the Nasdaq market site. Advancing volume took a 7% share of composite NYSE-listed trade and a 20.9% share of composite Nasdaq-listed trade.
Across the 11 S&P sector SPDR ETFs, the top three performers were all defensive in nature, with the Utilities (XLU) on top at -0.8%. The Financials (XLF) took a 4.06% beating on Thursday, followed by the Materials (XLB) sector at -2.57%. Composite NYSE-listed trade increased by a whopping 25% on a day-over-day basis, indicating that real portfolios sold large exposure across (obviously) the US banking space. Trading volume moved sideways (actually down small) for Nasdaq-listed stocks.
The only winners, as absurd as it sounds, were Treasuries as traders started to price in a more serious recession than many had considered only a few weeks earlier and the inevitable response that will be required politically.
Technically, though, some serious problems have been created for equities...
Readers will see that on Thursday the S&P 500 met resistance at both its 21-day exponential moving average and 50-day EMA and was soundly rejected at both levels. The index made short work of surrendering its 200-day simple moving average (SMA), making only one half-hearted attempt to form support at that level with about 80 minutes left in Thursday's regular session. The level easily broke upon a second attempt to crack support and that was all there was. Relative Strength is suddenly relatively weak, while for the index, the daily moving average convergence divergence (MACD) suddenly shows all three components in negative territory.
Readers will also note that while the Nasdaq Composite also failed at its 21-day EMA and 200-day SMA, this index actually found support precisely at its 50-day SMA. Indeed, the spot was tested with about 30 minutes left in Thursday's session, support was discovered and the spot was not tested again for the day.
Reader: Sarge, are you going to buy back the banking exposure sold earlier this week in order to book a nice capital creation trade?
Me: I have no plans to, at this time. In fact, I am kicking myself a little for not selling more of my overall exposure than I did, which was 50%. This was foreseeable. Maybe not to this degree, but the fact that the banks were not acting correctly was becoming visible.
As if the trader's life could not get more complex right now, today is February "Jobs Day." Expectations are for a "hot" print for year-over-year wage growth and sustained levels of elevated demand for hours worked per week. Have a nice Friday, gang. Wear your helmet, buckle your chinstrap, two sources of water, and clean socks. Now, move.
February Employment Situation (08:30 ET)
Non-Farm Payrolls: Expecting 207K, Last 517K.
Unemployment Rate: Expecting 3.4%, Last 3.4%.
Underemployment Rate: Last 6.6%.
Participation Rate: Expecting 62.4%, Last 62.4%.
Average Hourly Earnings: Expecting 4.7% y/y, Last 4.4% y/y.
Average Weekly Hours: Expecting 34.6, last 34.7 hours.
Other Economics (All Times Eastern)
13:00 - Baker Hughes Total Rig Count (Weekly): Last 749.
13:00 - Baker Hughes Oil Rig Count (Weekly): Last 592.
14:00 - Federal Budget Statement (Feb): Last $-39B.
The Fed (All Times Eastern)
No public appearances scheduled.