WASHINGTON, February 9, 2018: We’re beginning to get it. As February began, Mr. Market decided to get bipolar. Really bipolar. In fact, Mr. Market has totally flipped out this week, entering into an extended, self-destructive manic phase so violent that brought, and continues to bring, everyone and everything right down along with it.
The financial geniuses that love to get interview spots on CNBC to talk up their own books have variously attributed Wall Street’s now week-long and still-continuing bloodbath to the latest government shutdown (which ended as quickly as it had commenced); spiking interest rates (which seem to go up as quickly as they go down); declining oil prices (which, in a few dollars more, will bounce right back up again); overly generous stock prices based on historically high PE ratios (which we’ve actually had for nearly a decade); the threat of protectionism (which most other countries vigorously practice against the U.S.); and, you name it.
Bipolar Market Actions
This violent, irrational and hugely bipolar market action is being driven by a huge unwinding of positions. More specifically, an unwinding of positions.
The current market decline has really been caused and continues to be led by a Confederacy of Dunces that invested heavily in short instruments (such as ETNs) that profited from a benign VIX (volatility) environment.
This phalanx of ever-so-smart trading geniuses – including increasingly wrong-way hedge funds, supercomputer programs that sell massively and mindlessly when targets are hit, greedy Wall Street hotshots and individual investors who love to day trade for fun and losses – put massive bets on a continuing benign investment environment via leveraged, short ETFs and ETNs that seemed to make money for them regularly. Until they didn’t.
Worse still, they, and thousands of funds, institutions and individual investors alike, employed more and more leverage (borrowed money or the use of credit) to accumulate all the stock their portfolios could hold in order to magnify those “guaranteed” returns.
The problem is, when leveraged share purchases, short sales and VIX hedging strategies go wrong, markets can plunge, which leads to mass quantities of those dreaded broker margin calls. Back when I was doing this for a living, that meant calling my clients and telling them that if they didn’t bring or wire X amount of dollars to their accounts immediately to cover what were now effectively bad loans, I’d have to start selling out stocks in their portfolios to cover the difference.
You can imagine how those phone conversations went. And remember, this was the early 1980s, and accounts didn’t come with linked bank accounts, credit cards, or instant electronic transfers of money from various bank accounts. Clients had to pony up the actual cash. It was panic time.
We have plenty of easier money-transfer methodologies these days.
But when a market crash gets completely out of hand, as it has during this horrible week, mass dumping of shares gets underway and it quickly comes at you hard and fast. It’s like a bipolar manic phase running completely out of control and destroying everything in sight.
No stock sectors will be spared. This bipolar market has run entirely amok. It’s sell, sell, sell, the hell with the price, I want out. Or, worse, I have to get out because I have a massive margin call. This stuff just feeds on itself, and no one knows when it will stop.
We referred to CNBC’s Bad Boy stock market expert and showrunner Jim Cramer in one of our articles yesterday. Let’s return to him today. Having actually worked in the trenches as a hedge fund manager for years, he provides the kind of insight you generally won’t get from your full-service broker and that you will never get from your discount broker – mainly because that’s why he’s a discount broker.
Here’s Cramer’s take on Mr. Market’s violently manic bipolar phase, via a recent CNBC report. Cramer provides greater detail on this sadly familiar scenario that plays out time and again in different ways and when you least expect it. (Our comments appear in parentheses.):
“In 2017, a record year for the stock market, the bet against volatility served investors well. Shorting the placid VIX through levered trading instruments like the XIV, the VelocityShares Daily Inverse VIX Short-Term exchange-traded note, was a lucrative way to play the low-risk environment.
“But now, with volatility spiking, trading products like the XIV are coming back to bite.
“Worse, Cramer figured that most of those owners bet against the VIX with borrowed money, meaning they would have to sell S&P 500 futures to raise cash and cover their losses. (I.e., margin calls.)
“To his surprise, the ‘Mad Money’ host found 17 different trading products like the XIV that allow people to make leveraged bets against volatility. (We had no idea there were actually so many of these dangerous vehicles available to the average customer.)
“‘Now they’re all imploding,’ he said. ‘I swear, some of these dopes never learn. The current situation is like a similar version of what happened in 2008 after hedge funds levered up — borrowed money — to bet on mortgage-backed bonds.’
Very few stocks can withstand hedge-fund-led pain like this, Cramer warned. Big dividends don’t help because the market is declining all at once, valuation is no defense because stocks can always go lower and stock buybacks only help “sop up” the shares being sold, he said.
The only stocks that really work are ones that are able to deliver drastic surprises to the upside, like Twitter after its Wednesday earnings report or GrubHub and Nvidia after their Thursday reports.
“‘Here’s the bottom line: we’ve seen this movie in bear markets before. When the market breaks down like this, the culprit is forced selling. … This time, it’s caused by the breakdown of these leveraged bets against volatility, and it won’t stop until the bets are unwound,’ Cramer said. (In other words, even level-headed pros have no clue as to when it’s safe to come out of our fallout shelters.)
“‘We don’t know when things will get placid again, but until these traders get wiped out, finding winning stocks will be like finding a needle in a haystack. (Italics ours.) That’s why I say you want to identify high-quality companies and use the weakness to scale into them gradually on the way down, betting that the VIX madness will end at some point. But the key is that you need to leave room to buy more at lower levels … because where this thing stops, nobody knows, although if you stick with me and this show, I’ll give you the best clues I know at least to try to find out.'”
That concluding paragraph contains some genuinely sensible advice.
No one is safe from this bipolar market
BTW, our own relatively conservative portfolios are dying in this bipolar market along with everyone else’s. We will even admit to a certain nervousness at this point. But, aside from trimming positions that won’t come back for a long time now, markets and stocks have been whipsawing up and down so fast that we’ve been absolutely unable to put on our usual ETF hedges, the short S&P 500 ETF (symbol: SH) and the double-short (leveraged) S&P 500 ETF (symbol: SDS). We just don’t know when – or if – to put them on to hedge (protect) our large portfolio in particular.
As we write this article, the Dow Jones Industrial average has gained over 300 points, lost over 350 points, and is currently off by 340 points as of approximately 11:15 p.m. Friday, as stocks once again swing wildly and totally without meaning. The trend remains clearly and viciously down. But heaven only knows where our hyper-manic, bipolar, dysfunctional Mr. Market will end up at the end of the day. We sure don’t.