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Here’s the Worst-Case Scenario

Yesterday, I listed my Five Surprises of 2019 which will play out during the first half of the year prompting stocks to take another run at the highs, and then fail.

What if I’m wrong? I’ve always been a glass half full kind of guy. What if instead, we get the opposite of my five surprises? This is what they would look like. And better yet, this is how financial markets would perform.

*The government shutdown goes on indefinitely throwing the US economy into recession.

*The Chinese trade war escalates, deepening the recession both here and in the Middle Kingdom.

*The House moves to impeach the president, ignoring domestic issues, driven by the younger winners of the last election.

*A hard Brexit goes through completely cutting Britain off from Europe.

*The Mueller investigation concludes that Trump is a Russian agent and is guilty of 20 felonies including capital treason.

*All of the above are HUGELY risk negative and will trigger a MONSTER STOCK SELLOFF.

It’s really difficult to quantify how badly markets will behave given that this scenario amounts to five black swans landing simultaneously. However, we do have a recent benchmark with which to make comparisons, the 2008-2009 stock market crash and great recession. I’ll list off the damage report by asset class. I also include the exchange-traded fund you need to hedge yourself against Armageddon in each asset class.

*Stocks – Depending on how fast the above rolls out, you will see a stock market (SPY) collapse of Biblical proportions. You’ll easily unwind the Trump rally that started at a Dow Average of 18,000, down 25% from the current level, and off a gut-churning 9,000 points or 33% from the September top. The next support below is the 2015 low at 15,500, down 11,500 points, or 43% from the top. By comparison, during the 2008-2009 crash, we fell 52%. Everything falls and there is no safe place to hide. Buy the ProShares UltraShort S&P 500 bear ETF (SDS).

 

*Bonds – With the ten-year US Treasury yield peaking at 3.25% last summer, a buying panic would spill into the bond market. Inflation is nonexistent, we are running at only a 2.2% YOY rate now, so widespread deflation would rapidly swallow up the entire economy. In that case, all interest rates go to zero very quickly. The Fed cuts rates as fast as it can. Eventually, the ten-year yield drops to -0.40%, the bottom seen in Japanese and German debt three years ago. Buy the 2X short bond ETF (TBT) which will rocket to from $35 to $200.

 

 

*Foreign Exchange – With US interest rates going to zero, the US Dollar (UUP) gets the stuffing knocked out of it. The Euro soars from $1.10 to $1.60 last seen in 2010, and the Japanese yen (FXY) revisits Y80. Strong currencies then crush the economies of our largest trading partners. Their governments take their interest rates back to negative numbers to cool their own currencies. Cash becomes trash….globally.

 

*Commodities

Here’s the really ugly part about commodities. They are only just starting to crawl OUT of a seven-year bear market. To hit them with another price collapse now would devastate the industry. Producer bankruptcies would be widespread. The ags would get especially hard hit as they have already been pummeled by the trade war with China. Midwestern regional banks would get wiped out. Buy the DB Commodity Short ETN (DDP).

 

*Energy

The price of oil (USO) is also just crawling back from a correction for the ages, down from $77 to $42 a barrel in only three months. Hit the sector with a recession now in the face of global overproduction and the 2009 low of $25 becomes a chip shot, and possibly much lower. Those who chased for yield with energy master limited partnerships will get flushed. Several smaller exploration and production companies will get destroyed. And gasoline drops to $1 a gallon. The Middle East collapses into a geopolitical nightmare and much of Texas files chapter 11. Buy the ProShares UltraShort Bloomberg Crude Oil ETF (SCO).

*Precious metals

Gold (GLD) initially rallies on the flight to safety bid that we have seen since September. However, if things get really bad, EVERYTHING gets sold, even the barbarous relic, as margin clerks are in the driver’s seat. You sell what you can, not what you want to, as liquidity becomes paramount. This is what took the yellow metal down to $900 an ounce in 2009. Buy the DB Gold Short ETN (DGZ).

*Real Estate

Believe it or not, real estate doesn’t do all that bad in a worst-case scenario. It is perhaps the safest asset class around if a new crisis financial unfolds. For a start, interest rates at zero would provide a huge cushion. The Dodd-Frank financial regulation bill successfully prevented lenders returning to even a fraction of the leverage they used in the run-up to the last recession. We are about to enter a major demographic tailwind in housing as the Millennial generation become the predominant home buyers. I’ve never seen a housing slump in the face of a structural shortage. And homebuilder stocks (ITB) have already been discounting the next recession for the past year. A lot is already baked in the price.

 

Conclusion

Of course, it is highly unlikely that any of the above happens. Think of it all as what Albert Einstein called a “thought experiment.” But it is better to do the thinking now so you can do the trading later. There may not be time to do otherwise.

Be Careful, They Bite!

January 11, 2019

Global Market Comments
January 11, 2019
Fiat Lux

Featured Trade:

(WHY THE MARKET CRASHED IN DECEMBER),
(SPY), ($INDU), (VIX)
(THE GOVERNMENT’S WAR ON MONEY),

(TESTIMONIAL)

Why the Market Crashed in December

Were you horrified by the market action in December? The next one could get much worse.

We are all used to market corrections. Live long enough and you will endure hundreds of them.

But December? That was a real first class crash, a four times a century event. And to see this occur in the face of solid economic data made it totally unexpected by all. The only analysts predicting a collapse like this one are the ones who have been expecting it daily for the past decade.

To see a 20% decline in NASDAQ and a 50% plunge in market leaders in the face of a 3.2% GDP growth rate and a 3.9% unemployment rate is a first. It makes no sense.

This wasn’t a correction. This was an instance where the market ceased to function and was effectively closed. In fact, it took a conspiracy of several independent forces to get the meltdown we got.

The bottom line here is that this is not your father’s stock market.

The low hanging fruit here is to blame in the high-frequency algorithms. But that is the cheap shot. Algos don’t care which way markets go. They take volatility up sharply, but they take it down as well, as any long-suffering vol player will tell you.

Over time, their market impact is neutral. And algo traders go home 100% in cash every night. That doesn’t explain opening meltdowns of 500 points a day or more. No, there was something much more structural at work.

Human emotions are easy to predict. Take the humans out of the equation and markets can only be read by mainframe computers, at least on a short-term basis. That’s why so many of these market traditions, like “Sell in May and go away,” and the “Santa Claus rally” have quit working.

Only about 10% of today’s daily traders are the breathing kind. The rest are all made of silicon. Even I have come to rely heavily on my own personal algorithms in the Mad Hedge Market Timing Index. It has been worth its weight in gold and saved my bacon many times.

There is no doubt that pure quant strategies have blood on their hands. These funds strictly adhere to rules that have identified the long-term relationships between different asset classes and act accordingly.

For example, when bonds go up, you sell them and buy more stock, but sell more foreign currencies as well, and perhaps pick up some copper as well. All of this is adjusted for risk and volatility. There is thought to be about $1.5 trillion committed to this kind of strategy.

Among these, you can include “risk parity traders” of the kind pioneered by my friend Ray Dalio in the 1990s. (Ray will tell you how he did it in his fascinating book, Principals, out last year). Ray, by the way, is one of the top performing money managers over the last 30 years.

Trend followers pour more gasoline on the fire. If you sell, they will sell more, creating these massive 100 handle days in the S&P 500 (SPY).

Heightening fears was a never-ending torrent of bad news out of Washington. Two out of three key cabinet positions were emptied by presidential firings and remain unoccupied. Trade talks with China came to an impasse. It was not what investors wanted to hear.

All of this set up the perfect storm for December.

Equity mutual fund redemptions hit a record $53 billion in early December. Market liquidity dramatically shrank as players took off for the holidays, as seen on the chart below. Liquidity during the second half of December was thinner than the worst days of the 2008 financial crisis.

A two-decade-long flight of capital from the floor of the New York Stock Exchange was also a factor. The inevitable result was for the Volatility Index (VIX) to take a run at its highs for the year.

If you wanted to sell anything in size, it could only take place at throwaway prices. It all culminated in the notorious Christmas Eve Massacre which saw a 1,000-point range day in the Dow Average in a holiday-shortened trading day. If it had been a full day it might have been down 2,000 points.

Don’t expect any respite from these strategies any time soon. In fact, we could see worse moves ahead. The current administration believes in a free market, non-interventionist approach to securities markets.  That means no new regulation.

The same thing happened in the run-up to the 2008 crash when Christopher Cox (brother of my old boss at Morgan Stanley, Archie Cox) was basically told to go play golf instead of regulate.

Welcome to the new age of investing. The bottom line for all of us traders and investors is that we are going to have to pedal a lot harder to earn our crust of bread….or become a computer.

 

 

 

 

 

Did you Say “Buy” or “Sell”

December 21, 2018

Global Market Comments
December 21, 2018
Fiat Lux

Featured Trade:

(WHY CASH IS THE BEST HEDGE)
(INDU)
(PRINT YOUR OWN CAR),
(TESTIMONIAL)

December 20, 2018

Global Market Comments
December 20, 2018
Fiat Lux

Featured Trade:

(THE GLASS HALF EMPTY MARKET)
($INDU), (SPY)
(HOW TO EXECUTE A VERTICAL BULL CALL SPREAD),
(AAPL)

December 17, 2018

Global Market Comments
December 17, 2018
Fiat Lux

Featured Trade:

(THE MARKET OUTLOOK FOR THE WEEK AHEAD, or THERE’S NO SANTA CLAUS IN CHINA)
($INDU), (SPY), (TLT), (AAPL), (AMZN), (NVDA), (PYPL), (NFLX)

December 12, 2018

Global Market Comments
December 12, 2018
Fiat Lux

Featured Trade:

(STANDBY FOR THE COMING GOLDEN AGE OF INVESTMENT),
(SPY), (INDU), (FXE), (FXY), (UNG), (EEM), (USO),
(TLT), (NSANY), (TSLA)

October 12, 2018

Global Market Comments
October 12, 2018
Fiat Lux

Featured Trade:

(WHY THE STOCK MARKET IS BOTTOMING HERE),
(SPY), (INDU),
(NETFLIX SAYS WE BECOME A NATION OF COUCH POTATOES),
(NFLX), (M), (AMZN), (TSLA), (DIS), (GOOG)

August 31, 2018

Global Market Comments
August 31, 2018
Fiat Lux

Featured Trade:
(MONDAY, OCTOBER 15, 2018, ATLANTA, GA, GLOBAL STRATEGY LUNCHEON),
(WATCH OUT FOR BEARS!), ($INDU),
(MORE BIOTECH AND PHARMA STOCKS TO SOAK UP)

August 28, 2018

Global Market Comments
August 28, 2018
Fiat Lux

Featured Trade:
(VERTICAL BULL CALL SPREADS REVISITED),
(HD), ($INDU),
(THE RECEPTION THAT THE STARS FELL UPON),
(TESTIMONIAL)