WASHINGTON, February 6, 2018: Could today be Turnaround Tuesday?
Investors big and small, including this writer, were largely a battered and exhausted lot during and after Monday’s closing bell on Wall Street. While futures continued to tank in after-hours trading action, the official closing figure for the Dow Jones Industrials put that widely followed average down nearly 1200 points on the day, its biggest numerical loss ever. This whole depressing, money-losing episode has left most investors longing for a real Turnaround Tuesday.
The big questions for U.S. markets today: Will Monday’s huge crash mark the beginning of a major market correction? Or will we have a great Turnaround Tuesday that saves our badly beaten portfolios from certain disaster?
As of 2 p.m. Tuesday, the answer to both questions seems to be “Yes.”
After an expected opening hit, the Dow soared for over half an hour this morning, taking an unexpected positive swing of over +350 points. Then, down it went again, then back up, having already traded in an astonishing 934 point range as we write this article. It’s reminds us of that old carnie barker’s “wheel of fortune” pitch: “Round and round and round she goes, and where she stops, nobody knows.”
Let’s see what kind of odds we might have for the wheel to stop on “Turnaround Tuesday.”
What happened to the stock market on Monday?
As investors guzzle Maalox and pop little Xanax pills, let’s step back and see what happened with Monday’s extraordinarily violent crash, a market hit so powerful that it swept nearly every stock of consequence down along with it no matter what the financial realities. That could help us understand just a bit why today might actually end up as Turnaround Tuesday.
From a number of usually reliable sources, I’ve gleaned the following potential reasons behind Monday’s Daisy Cutter action on Wall Street.
- Traders have been getting nervous about rising inflation expectations, which are generally attributed, in the main, to accelerating wage growth. Problem is, we haven’t had rising wage growth throughout the bulk of my adult lifetime, which is getting to be considerable. So what’s the problem?
- In case you haven’t looked lately, interest rates have been rising steadily and fairly rapidly. The widely followed 10-year U.S. Treasury note, a key number in determining real estate loan rates, has jumped from less than 2 percent to nearly 3 percent in a very short period of time.
- The interest rate jump has depressed bond prices and increased bond yields to the point where, for the first time in a long time, bond interest rates may start to compete at long last with stock dividend yields, particularly in the real estate and utility sectors.
- There’s been a growing consensus among analysts that the Federal Reserve may raise short-term interest rates more than the previously hinted at three times this year.
- Investor sentiment, which has favored exuberant stock market bulls, is so high, particularly among retail traders (like you and me) that a nearly always reliable contrarian indicator is coming into play. Among Wall Street pros, it’s generally accepted that the little guys start to pile in, it’s time to sell, since small investors “always” climb into the market when a bull run has nearly run its course.
- Harder to describe, a pair of trading phenomena I’ve often denounced in these columns – high-frequency trading (HFT) and algorithmic, machine-based and machine controlled trading, based on headlines rather than financials, has come into play big time over the last few trading days and particularly on Monday. When pre-programmed price points get hit, or when certain headlines are triggered, machines often go into overtime, either buying or dumping everything in sight, exacerbating normal moves in the averages, or, in the case of trading yesterday, catastrophically overdoing things in a cascading series of mass stock dumping moves.
Worrying about the VIX, something small investors rarely watch
Another big reason for yesterday’s YUGE mass-selling burst was a bit more esoteric, having to do with a popular measure of stock volatility that’s hard to explain to the man on the street.
But I’ll try.
We’re talking here about something that’s known to professional traders as “the VIX.” The VIX is a measure that charts what’s known as the volatility of the stock market. Created by the Chicago Board Options Exchange (CBOE), its Volatility Index (symbol: VIX, or $VIX)) is a proprietary measure of volatility expectations that’s often referred to as the “fear index,”
For much of the fall, the VIX measure was flat in the low-normal range. That means that, while stocks and averages go up and down every day, moves in general tended to be reasonable and not very big on a day-to-day basis. There wasn’t much of a “fear factor.”
But sometime last week, volatility and volatility expectations began to surge after hitting lows earlier in January as the market drifted relentlessly upward.
Between roughly last Thursday and yesterday (Monday of this week), however, volatility, and the VIX, began to surge violently upward.
All about VIX ETFs, more or less. Plus, the wonderful world of short-selling
Enter a small band of ETFs that mimic the VIX, giving hedge-funds and risk-happy investors a chance to make (or lose) money on the actual VIX index, which is not in itself a security.
There are long VIX ETFs and ETF style investments that are (in a way) like normal ETF investments. They trade like stocks and quantify the bet that trading volatility – and therefore the VIX – are both likely to increase. If that bet is correct, the trade isn’t much different from the average stock trade. The VIX goes up, the price of your VIX ETF goes up, you sell and make a profit.
On the other hand, for hedgers and risk takers, you can also make a negative bet on the VIX, just as you can be a short-seller of stocks. The bet here is that volatility, and the VIX, will DECREASE. As the VIX continues to drop, your reverse or “short” bet will go up as the VIX goes down, and your negative or “short” VIX ETF will make money the opposite way most investors are accustomed to thinking of investing.
In other words, if you’re optimistic about Company X, you buy shares of Company X, ride them up, and sell them for a profit, assuming your estimate was correct.
But if you’re pessimistic about Company X, you borrow shares of Company X and sell them first in your margin account. If you’re right about your negative bet, the stock will drop, you will then buy the borrowed shares back, and pocket the cash you made on the downside.
I won’t explain the mechanisms here because we’ll miss the point. Just rest assured people who do this do it all the time and it’s perfectly legal. But what it boils down to is this: As an investor, you can make wagers on the upside or the downside of a stock or other equity investment, and you can still make money either way. But for a variety of reasons, a bet on the down side, or short side, is far more risky than the way most people tend to invest.
Which gets us back to those VIX ETFs, or in this case, the VIX ETFs that are geared to the short side, mimicking bets that the VIX will decline, or get less volatile.
For a variety of reasons, for the last several weeks, investors and funds alike have been substantially increasing their holdings in short VIX ETFs, apparently reasoning that an already tame VIX index would get tamer and tamer and drift down even lower than it already was.
Problem is, by Thursday and Friday of last week, this bet was proving to be terribly wrong. But the wild action we witnessed in Monday’s U.S. stock market action blew the VIX spectacularly higher. And for each point higher, betters on the short side got clobbered harder and harder.
We figure that at some point, the majority of these holders either dumped their short VIX ETFs, or, even after dumping them en masse, still owed money to their brokerage houses, forcing them to come up with the cash by dumping mass quantities of stocks themselves, just adding to Monday’s bona fide selling panic.
According to Reuters London, the bloodbath in these ETFs (and stocks) got so bad going into Tuesday morning, that
“Three U.S.-listed inverse VIX ETFs were halted from trading on Tuesday after suffering heavy losses on Monday when a spike in U.S. stocks volatility caused a violent unwind of trades betting volatility would stay low.
“Trading in the VelocityShares Inverse Vix Short-Term ETN (XIV.P), ProShares Short VIX Short-Term Futures ETF (SVXY.K) and VelocityShares Daily Inverse VIX Medium-Term ETN (ZIV.O) was halted and all three products had a short sell restriction placed on them, Thomson Reuters data showed.”
Yeah, I know this is heavy going. But all that’s been outlined above contributed mightily to the horrendous 3-4 days of miserable downside trading that culminated in Monday’s explosive and hopefully 1-day crash. It was the worst one-day loss in the history of the Dow. The other averages fared just as poorly, BTW.
Odds for a successful Turnaround Tuesday
In a trading note from our own broker, Charles Schwab, we get a bit more perspective on the recent action:
“Do these losses put the long-running bull market at risk? Probably not, says Schwab Chief Investment Strategist Liz Ann Sonders.
“‘Pullbacks are normal,’ Liz Ann says. ‘While those exceeding 5% can be very stressful to long-term investors, we are still advising investors to stay the course at this time as long as they have a long-term investing plan in place.’”
That’s good advice, particularly if we end up higher on Turnaround Tuesday, or whatever we get today. As for my own battered portfolios, I’ve pretty much “stayed the course,” but have dumped 3 small positions in real-estate owning REITs, given that this sector is still likely to get beaten up, at least short term, by expectations (right or wrong) of wildly increasing inflation that will trigger wildly increasing interest rates that will kill REIT investments in short order.
I don’t think this is necessarily true at all. But if everyone else thinks such things are true, you’ll get killed by staying investments like REITs that Wall Street gurus have painted targets on. So we’re out. Otherwise, I’m hoping to get some portfolio relief from a real Turnaround Tuesday, even though Mr. Market might try to take it all back on Wednesday.
I actually did buy into a few smashed up positions yesterday that I think are long term winners. I’ve discussed them in my companion column, which I’m going to finish after today’s highly uncertain Turnaround Tuesday comes to a close.