It is safe to say that we have made history in the last two weeks and broke several records, not that this is about that. In just 15 days, the S&P 500 is down 16%, and the Dow down 15%, only five two-day periods in the past 124 years have been worse. We moved from all-time high bull markets to a bear market in this time period, with the S&P 500 now down 29%, Eurostoxx down 36% and Emerging Markets down 27%.
It is not the collapse, but the speed at which it is falling.
Even if prudent risk management took hold over the last few months, even a gentle dip in the market in the last 24 hours would have cost one a collapse of 10% before one could refresh risk screens. During the Global Financial Crisis in September 2008, it took the market two months to go down 30% and in bits and pieces. If that does not say it all, I'm not sure what would explain what we have witnessed.
Thanks to the globalization of asset classes -- and the free money, cheap carry, that ties them all together -- cross assets share a very delicate relationship with each other. There is a pattern, a theme, a story to be told and an ending to be chosen.
From being driven up by copious amounts of free liquidity and non-QE quantitative easing, and valuations stretched, the coronavirus was an exogenous event that called into question the demand side of the equation. And so risk was taken down as bonds were well bid and equities sold off, as the slowdown theme traded to recession, and then potentially even to deflation when Saudi Arabia threw their oil bomb over the world and flooded the market with 3mln bpd of oil when it needed it the least.
As risk unwound and the corporate bond debt bubble was slowly getting to the verge of bursting, equities had to come back to more "normal" valuations. In the blink of an eye, we were dealing with a global pandemic mixed with Fed taking its foot off the pedal at the same time; the market lost all support, the music stopped and everyone scrambled to grab the last chair. But something changed towards Wednesday afternoon: The formulas and correlations broke down. Asset classes were not making sense despite central bank measures.
Bonds started selling off, higher yields. Usually that would mean some support coming in away from the deflation theme. The Dow puked, Small-Caps and Transports have basically been under water since Trump got elected in 2016. The FTSE has fallen 11% -- the worst fall since the 1987 crash. Banks were obliterated, and the Volatility ($VIX) curve is the most inverted it has been since Lehman crisis. The High Yield and Investment Grade market have been hammered, with record outflows. And it is not even worth mentioning the carnage in cryptocurrencies.
The model 60-40 equity/bond asset allocation risk parity funds has blown out to 3-standard deviations wide. Both bonds and equities have been selling off. As the world grappled with deflation, bonds should have been going higher. And Gold, too has been selling off.
Over the past two weeks, these safe-haven asset classes have been in-the-money and generated heaps of profits for those who held them. But even they are being sold down relentlessly. That can only mean one thing: margin calls.
As the model broke, VAR at banks and funds started flashing red, means it is game over, they have to close all positions, no arguments. The tail events were hit in most models when the Energy sector blew up on Monday, as stocks were down 40% on average, on the open. It would have been impossible for any fund to hedge or manage risk. Some Energy and/or Macro funds blew up. And due to those margin calls, they were leaning on the market relentlessly on Wednesday -- and even Thursday, despite the Fed's gargantuan liquidity injection announcement to start from today, Friday.
On Friday, the Fed will offer $1 trillion in the form of $500 billion in each of 3-month and 1-month repos. And next week, it will offer another $1 trillion. This will go on until April 13. That is a gigantic $4 trillion injection in one month.
In addition, the Fed will still be buying $60 bln worth of Treasury securities, including all types and maturities not just T-bills. That means a total of $4.5 trillion can come in the next month, if all the repo auctions are submitted. In 2008, it was all about the Mortgage Subprime Bubble, this past decade it was the "Everything Bubble". And now the Fed, to contain the economic and financial damage, has opened the flood gates to support just that, everything.
Next week is the all-important Options and Index expiration on March 20, where $VIX and equity options expire. Given the scale at which we have declined breaching strikes we never thought we would hit this month, there is a lot of derivative exposure here that needs to be considered. Between 2500-2700, the market is vulnerable -- hence the volatility as we breach those levels as market makers have to hedge their delta, but just have no clue where it is going and how fast. All this means that we have bazookas firing from everywhere. So how is one meant to remain calm and logical and try to make sense of these moves?
One thing is certain, coronavirus is the catalyst that rocked a very delicate boat, which came across an oil tornado's path. To sell off 30% in 15 days is jaw dropping. The Fed, other than monetary easing, needs to provide a fiscal stimulus package to aid the health care and medical systems, to ease worries about the pandemic. This virus is infectious, but if draconian measures are taken as in South Korea, Wuhan and Singapore, this situation can be resolved a lot sooner than just dismissing it. After the carnage witnessed, there will be aftershocks, as the system needs to come back into equilibrium.
Rest assured, it will. And this time inflation, hyperinflation will come. Commodities will be the biggest beneficiary of that turnaround, at some point. It seems we witnessed the last stage of the selloff, the utter capitulation and panic. There is great value out there, in Technology and in Commodities. Oil will perhaps take a bit of time to recover, as it works through the massive oversupply, but value is also there. Copper will be the most vicious on the upside on this turnaround -- don't forget China has announced 20 trillion yuan of infrastructure-related projects for 2020, and it is starting to stabilize as the rest of the world goes into panic mode.