The Anticipated “Waterfall Decline” Has Begun
A “Waterfall Decline”, in Markonomics lingo, refers to a drop of AT LEAST 15% within a few weeks. A “Crash” is a one or two day event in which the imbalance of sellers over buyers requires extraordinary measures such as trading halts. Major indexes lose at least 10% in one session.
An example of a Crash is the 22% loss in the Dow Jones Industrial Average (Dow) on October 19, 1987. That Crash marked the LOW of a roughly 40% Waterfall Decline starting back in mid-August. Another example of a Waterfall occurred subsequent to 9-11.
One can think of a Waterfall Decline as a Crash in slow motion.
The case for an imminent Waterfall decline was made here: “Stock Markets Poised For Waterfall Decline?” (https://markonomics101.com/2018/12/09/stock-markets-poised-for-waterfall-decline/).
Market Index Dec. 1st High Dec. 21st Close Loss Loss Per Day
Dow Jones Industrials 26,000 22,446 13.7% 1.05%
S & P 400 Mid Cap. 1,900 1,611 14.2% 1.09%
Nasdaq 100 7,100 6,046 14.8% 1.14%
New York Composite 12,600 11,035 12.5% 0.96%
Russell 2000 Sm. Cap. 1,550 1,292 16.6% 1.28%
S & P 600 Sm. Cap. 970 810 16.5% 1.27%
S & P 500 2,800 2,417 13.7% 1.05%
Dow Jones Transport. 11,000 8,875 19.3% 1.48%
As you can see from the table, the market loses about 1% per day on net during the decline.
The Credit Crisis of 2019?
Evidence continues to mount that the core of the Christmas Crash is both a sudden economic slowdown and deterioration of Corporate credit quality. Financials are “Ground Zero” for this growing Crisis and Panic possibly resulting from a growing impairment in their portfolios of Loans. “Collapsing Financials Lead Stock Market Lower”. (https://markonomics101.com/2018/12/08/collapsing-financials-lead-stock-markets-lower/).
The Slide Show below shows the beating of the Financials most susceptible to credit deterioration:
These are the key takeaways:
- Financials, but most specifically Commercial Banks, appear to be in SERIOUS trouble. The Bank Index (BKX) is at multi-year lows and the group has lost nearly 20% in just 3 Weeks!
- Less than Investment Grade Corporates, aka Junk or High Yield Bonds, have become illiquid, and are beginning to reflect deteriorating credit quality. Presumably, this is a result of the oncoming Recession.
- ETF’s which hold BANK LOANS specifically, such as FTSL and SRLN, are making new lows DAILY. In just the last couple of weeks, an entire year’s worth of return has been wiped out. The implication is that investors perceive a substantial reduction in credit quality of the Funds’ holdings.
Out Come The Bottom Fishers
A very good synopsis of the “Bull” case is presented in this very recent piece: (https://seekingalpha.com/article/4229814-abysmal-investor-sentiment-market-bottom-might-near).
The “Core” of this particular argument, is that the Market has reached EXTREME readings of FEAR and PANIC. If true, that might support equity value. It isn’t true, though. See below.
Market psychology IS critical to the formation of Tops and Bottoms. In general, once too many participants become PESSIMISTIC, the available SELLERS have sold out. Tops are accompanied by extreme complacency or GREED and when everyone has bought in.
For a good refresher on Investment Psychology: “The Psychology of Investing”. (https://markonomics101.com/2018/10/08/the-psychology-of-investing/).
FEAR? Yes. EXTREME FEAR? Maybe not.
A very good Market measure of investor sentiment is the Volatility Index (VIX). Also known as the “Fear Index”, it measures investors’ expectation of the dispersion, or variability, of future returns. Higher Volatility suggests that investors are fearful of a large, adverse market move.
The level of Volatility is THE MOST IMPORTANT factor in determining the cost of “insuring” a portfolio holding against loss using options. A high VIX means that investor demand for insurance is high and, accordingly, so is the cost.
A 20 year history of the VIX is presented in the chart below. Note that readings higher than 30 are COMMON! The Chart DOES NOT indicate EXTREME FEAR, just FEAR.
The February, 2018 lows occurred with a VIX at 50. Readings nearly as high as 90 occurred during the 2008-2009 Financial Panic. At the height of the Crisis, the VIX remained ABOVE 30 for EIGHT STRAIGHT MONTHS.
What If You’re Stuck In the Middle?
We’ve repeatedly recommended that anyone stay OUT of this market and observe from the sidelines. In other words, “Capital Preservation” is critical and risk mitigation key. A great beginning guide to dealing with the new reality, a BEAR MARKET can be found here: “How To Survive, Prosper and Thrive in the Coming Bear Market”. (https://markonomics101.com/2018/10/09/how-to-survive-prosper-and-thrive-in-the-coming-bear-market-part-1/).
What if you’re still invested? From my own personal experience, and having learned some of the lessons the hard way, I found the following to be true during EXTREME and RARE periods like now:
- BEAR MARKETs behave entirely differently than the slight dips traders and investors have previously experienced. Quantities of stock BID for or OFFERED become MUCH SMALLER. It takes longer to execute an order and BID/OFFERED spreads WIDEN substantially.
- Markets can grind lower in an atmosphere of BEARISH sentiment for months. During these periods, I’d constantly hear markets were “Oversold”. That keeps only false HOPE alive while your portfolio goes lower every single day.
- It is critical that new information, like the kind we present, not be ignored because it doesn’t fit your world view. We learn more from the views of those who see things differently.
- View LOSSES AS LOST. If information should change, you can always put your positions back on. From the Charts, this Waterfall may have ANOTHER 20% to go if we bounce at the next logical support levels. “The Bear Market For Equities Shifts Into High Gear”. (https://markonomics101.com/2018/12/20/the-bear-market-for-equities-shifts-into-high-gear-charts-of-the-day-5/)
The Psychology of A Waterfall
Holding during a Waterfall is psychologically easy because it’s so deceptive. Once a market has fallen a certain amount, say 20%, the traders who can’t admit to being wrong, tell themselves they have become “long-run” investors. Or, they tell themselves it’s “too late” to sell.
In addition, Waterfall’s may bounce, reverse or rally sharply for any reason at any time. This too, can provide false hope and make holding all the way down to the bottom deceptively logical.
Right now, only RISK REDUCTION matters.
As markets decline, opportunities will begin to emerge. The key to taking advantage of opportunities is to be liquid when others are not. The other key is to have superior information. That’s where Markonomics 101 comes in. Be Informed Not Misled!