Markets and Toilet Paper
3 18 20
Buddy, can you spare a square? The action in the Fixed Income and Equity markets is similar to the toilet paper shortage. Everything in one direction and indiscriminate of price. A person will act if they think you will act in the same manner and they will accelerate the action if they think you will accelerate your action. Think equity holders scrambling to sell securities or consumers lining up at the front door of stores an hour before the store opens. The fear of not getting something, an executable price or a product, no matter how irrational, forces actions.
High Frequency Traders (HFT), computer algorithms, and volatility hedging feed on each other in a vicious cycle. As volatility spikes, hedge funds are forced to liquidate positions and sell stocks. HFTs see prices drop and begin to pull back on their buy orders and increase their sell orders. Momentum algorithms see prices drop and exasperate the pressure by selling. Buy orders disappear whiles selling increases and the cycle expands.
These last two weeks have been a flush, bad pun intended. As I mentioned in an earlier commentary, the fear of the unknown unknowns is causing a panic. Few assets have been able to escape the carnage. The CRB Commodities Index, an index that measures the price of a basket of commodities, is back down to levels not seen since 2002. The oil market is being decimated from both the supply and demand side of the equation. Precious metals, long thought to be a safe haven in times of turmoil, has been driven lower after an initial rally to a 7 year high. When you have to sell and can’t sell what you want, you sell what you can.
Fixed Income markets are experiencing an extreme price dislocation. Initially, investors filed into US Treasuries, pushing yields to record lows on longer dated maturities. Last week, the 10 yr Treasury traded close to a 0.30% yield. Today it is trading close to 1.20% as the auxiliary markets that trade off of its price are being sold. Companies, fearing a repeat of 2008, have accessed their corporate lines of credit for funding. In 2008 the big banks closed those unused lines of credits and the companies saw their financial liquidity dry up. Now, as the lines are accessed, banks are forced to sell their commercial paper investments to fund them.
This is one of the reasons that has invoked the response from the Federal Reserve. It used its bazooka, 2 intra meeting rate drops that lowered the Fed Funds rate to 0% -.25%. The next day, the stock market experienced its largest point drop ever, telling the Fed that its actions weren’t enough. They began lending $1.5 TRILLION to the market to increase liquidity and reinforce the notion that they were there to be the lender of last resort to any bank that wanted or needed to borrow. The large banks lined up at the Discount Widow (Fed lending facility) to access that liquidity. The Federal Reserve, with the backing of the US Treasury, opened a facility to provide relief to the Commercial Paper market.
I believe that the action on both the Monetary (Federal Reserve) and the Fiscal (Washington) policy will be successful. Unfortunately, it takes some time to put it all into motion. I would not be surprised to see President Trump, House Speaker Pelosi and Senate Majority Leader McConnell stand together in front of the camera and state they are willing to do whatever is necessary. That’s not something I ever though would happen 2 months ago but the world has changed. America is at its best when it faces a common enemy. The response will be large, coordinated and stimulating.
The markets are heavy and I believe, oversold. The recent selling has wiped out market capitalization equal to 2/3 of annual US GDP. The economy should slow, possibly stall, but not falter. Even with people required to quarantine, there is still underlying economic activity taking place. There is a light at the end of the tunnel, just not quite sure how long the tunnel is. Coming out of this crisis, there should be pent up demand and activity. The government is attempting to keep citizens affected by this financially liquid and safe. Do your part, flatten the curve. Check on loved ones, maintain social distancing, don’wash your hands, be kind and we will get thru this together.
As always, please feel free to contact me with any questions.
Michael Marietti
The opinions expressed herein are those of Riverbend Planning Group. The data and opinions are furnished for informational purposes only and should not be considered a solicitation for an investment decision. Although it is derived from sources believed to be accurate, Riverbend Planning Group makes no guarantee to the accuracy of the information
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