The coronavirus is the catalyst, not the cause, of the market crash
Wall Street blames the coronavirus for the current crash for the same reason the Democratic Party blames Russia for losing in 2016: to avoid responsibility.
A month ago I said: "the stock market is massively overvalued. Right now the stock market is a bubble in search of a pin."
If you want to know what's actually going on then you need to dig deeper than the headline.
Let's start with what traders are saying.
Fund managers are being faced with a collapse of liquidity as they try to handle record market moves...
“I have yet to find liquidity,” said Richard Hodges, a money manager at Nomura Asset Management, whose bets on Italian and Portuguese bonds last year put him in the top 1% of money managers. “There is none.”
The dry up in liquidity was seen across markets.
Why is there no liquidity (i.e. buyers in a down market)?
That comes down to three reasons:
“The liquidity in the Treasury market is bifurcated: sometimes very good, but when volatility picks up the high-frequency traders step away,”
Imagine that. The guys who front-run the markets are all gamblers, not investors.
#2) the Fed has crushed the short-sellers:
For the last 12 years, every time the stock market threatened to correct, the Federal Reserve printed mountains of money. In a normal market, short-sellers would provide liquidity in a downturn by buying back their positions (at a profit). After 12 years of having their faces ripped off by the Fed, professional bears are almost extinct on Wall Street.
#3) You. Yes, you, the retail investor:
The idea of "passive indexing" sounds harmless enough - buy an "index" and be an "average" investor.
However, it isn't as simple as that, and we have spilled a lot of ink digging into the relative dangers of it. Last week, investors saw those risks first-hand.
The biggest risk to investors is when "passive indexers" turn into "panic sellers."
Risk concentration always seems rational at the beginning, and the initial successes of the trends it creates can be self-reinforcing.
Until it goes in the other direction.
While the sell-off last week was large, it was the uniformity of the price moves, which revealed the fallacy "passive investing" as investors headed for the exits all at the same time...
For example, out of the 1750 ETFs in the U.S., there are 175, or 10%, which own Apple (AAPL). Given that so many ETFs own the same company, the problem of "liquidity" is exposed during a market rout.
If you want to know why stocks are having such wild swings, look no further than these three reasons.
But stocks isn't the whole story.
A much more important story was happening in the bond market.
In a week that has already been record-setting in financial markets by any number of measures, the moves in the 30-year U.S. Treasury bond stand alone as jaw-dropping and unprecedented.
On Monday, the long bond opened at a yield of 0.99%, down 30 basis points from where it closed the last trading session and the first time ever it fell below 1%. About seven hours later, a relentless rally would push the yield to as low as 0.6987%, a drop of 59 basis points that Bloomberg News’s Elizabeth Stanton noted was the largest intraday drop on record.
...All told, in the span of roughly 36 hours, 30-year Treasury yields surged 62.5 basis points from trough to peak. Measuring from the intraday high on March 6 to the low on Monday, the drop was a staggering 85 basis points.
Those sorts of rapid swings don’t happen to long-term Treasuries. I mean that literally. Two-day moves of such magnitude have never happened before since the Treasury Department began issuing the 30-year maturity in the 1970s.
To give you an idea of the magnitude of the moves in the Treasury market, consider these two things:
#1) the S&P 500 dividend yield just crossed above the 30-year US treasury by more than 10 basis points. In the last 60 years this has happened just once before: in 2008.
#2) even Wall Street banks are questioning the safety of Treasuries.
It's important to put these markets in perspective.
The stock market reflects the value of corporate America.
The treasury market reflect the value of the actual economy.
A stock market crash would cause a recession.
A treasury market crash would cause a depression, if not a revolution.
Finally, last week I said this about Trump's response: "We are on track to record the first $1 trillion deficit since 2012, and this is before a recession hits. And you want yet another tax cut for the rich?"
Both the dollar and treasuries dumped on Trump's tax cut plan.
This wouldn't have happened if our deficits weren't already so large due to Trump's tax cut giveaway to the wealthy in 2017.
That it is having a negative impact on the strength of the dollar is not a surprise.
The U.S. dollar is set to lose a bit more ground against other major currencies next year, challenging a view among most foreign exchange dealers that aggressive tax cuts just passed by the Senate will have a positive effect on the currency.
Typically traders sell stocks and buy bonds in bad times, and do the reverse on good days. This works 99.9% of the time.
Today was that 0.1% day.
The stock market’s faithful hedge failed when investors needed it the most.
As the Dow Jones Industrial Average plunged into a bear market and the S&P 500 approached that threshold with a 4.9% drop, longer-dated Treasuries were battered too, with the yield of 30-year bonds surging to 1.39% from Monday’s record low of just under 0.70%.
That produced a combined rout of 8.6% for long-dated bonds and U.S. equities on Wednesday, measured by adding the losses on BlackRock Inc.’s long-dated Treasury exchange-traded fund and the drop in the S&P 500 -- their worst combined daily drawdown since the ETF was created in 2002. For balanced portfolios, this session was worse than any during the financial crisis.