Published December 7, 2018
We are now deeply in the middle of serious US Stock Market slide with all indices down viz. Dow, NASDAQ, S&P 500 and the stocks in firm correction territory. Based on where we are, it appears that the Bears have invaded Wall Street and the Bulls are in full retreat. The TV and Financial Press is full of analysts and experts providing various reasons for this correction.
The initial cause attributed by experts to this stock market slide may be characterized as a Global Synchronized Slowdown as opposed to Global Synchronized Growth that led to frothy levels of Market Indices in Summer and early spring. Another cause for this could be the Hiking of Interest Rate by the Federal Reserve gradually from 2017 with five 25 basis point hikes — we had called this out with a request to the Fed to hold off on further Rate Hikes until the 2% Inflation Target was reached in our earlier Blog Entry (in Dec 2017) but that was not to be!
Of course there are other factors that have been weighing the markets down such as escalating Trade Tensions all summer first with North American Allies viz. Canada and Mexico and more importantly with China. Of course news headlines emanating from these discussions and other events nowadays lead to significant Upswing or Downswing due to Algo-Trading i.e. Algorithm based Automated Trading Systems that execute buy / sell and call / puts based on current events and there has been no shortage of headlines to fuel this type of trading. We understand from some reports that at least 50% of all executed order on all US Exchanges originate from these Algo-Trading Systems which makes upswings and downswings very accentuated.
However, in our opinion, this Stock Market Slide can be attributed to one very significant Geopolitical Event in the last couple of months viz. Sanctions against Iran Oil. It is our view that once this appeared imminent, a number of Energy related firms went ahead and bought significant amounts of Crude Oil Futures expecting that Iran Oil, whose output is significant, will go offline and will result in a huge spike in Crude Oil Prices due to significant shortage. However, the Trump Administration’s actions to keep Crude Oil prices in check and also help allies resulted in US waivers to eight countries to keep purchasing oil from Iran. Consequently, the expected shortage of Crude Oil did not materialize and there has been a glut in supply resulting in significant price reduction of crude oil.
This has resulted in margin calls against a number of firms, hedge funds and other traders which created a huge liquidity crisis. It is also well known that these entities hold significant assets in Stock Markets (Equities, ETFs etc.) to diversify their portfolios. Consequently, these margin calls have forced them to liquidate these Stock Market assets to pay off their margin requirements, which has resulted in significant selling pressure in the Stock Market. Once these large Sell orders were executed, the algo-trading systems kicked in their sell orders resulting in a steeper sale and flight to safety such as Bonds which has seen a flattening of the yield curve. Hence, the marked is still unwinding some of these positions as there are now redemptions also by large institutional investors to pay off their obligations which is part of a vicious cycle. We believe that this will probably continue till 1Q 2019 and there will be flight to safety.
Therefore, in our opinion, it is time to do your homework and make strategic acquisitions on the long side in shares of companies with strong balance sheets and positive cash flows. However, we do not recommend, in this blog, strategies to go on the short side as it fraught with risk for individual investors. It is worth noting that we have seen numerous corrections over the last 20 years like Russian Default, Dot Com debacle, Financial Crisis of 2008, Flash Crashes in the early 2010s and the market has bounced back each time! Hence, it is our view that the Stock Market is an engine for Financial Wealth Creation and this correction is temporary and can be used to rebalance and deleverage risk for increased gains when the markets go up.