The story on the Street: 'People sell what they can sell, not what they want to sell'

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A man in a surgical mask walks by the New York Stock Exchange (NYSE) after more cases of coronavirus were confirmed in New York City, New York, U.S., March 10, 2020.

Andrew Kelly | Reuters

The easiest thing is to blame the computers and the algorithms that keep them going, propelling the market ever lower in a death spiral that doesn’t seem like it will end.

But that’s only part of the story that has churned out the most violent bear market in Wall Street history. 

At the epicenter of the slide is an effort to sell anything that can be sold. It’s about de-risking at breakneck speed, getting rid of anything standing between investor portfolios and solvency. The rush for the exits is breathtaking and feverish, brought on by a biological threat whose ultimate reach remains uncertain.

And as long as that unknown persist, as long as the coronavirus maintains its shroud of dark mystery, the gravitational pull of the market is going to be to the downside.

“If you need to raise cash, you do that immediately,” said Jim Caron, head of global macro strategies in fixed income for Morgan Stanley Investment Management. “What people are doing is looking at things that they can sell to raise crash, and that’s part of the crisis market situation. When these things happen, people sell what they can sell, not what they want to sell.”

In Caron’s part of the market, that most recently has meant a fire sale of bonds across multiple categories — U.S. Treasurys and German bunds, corporate debt of all stripes, particularly on the lower end of the quality scale, and a variety of other fixed income instruments that buyers are generally shunning. 

Low demand for these products sends prices falling and rates climbing, which was a toxic potion Wednesday for a market that saw major stock averages fall so far that the New York Stock Exchange had to stop trading briefly.

By the end of the day, the Dow Jones Industrial Average fell 6.3% and had erased almost all of the gains it had made since President Donald Trump took over in 2017.

While many retail investors watch stocks as a barometer for financial market health, it’s actually been bonds that have told the story lately. The fixed income market is much larger than the one for equities, and when buyers and sellers are as far apart as they’ve been lately, that creates major ripples through the system.

“The trend is lower. At some point we need to see the market start to base at a certain level,” Caron said. “The place you need to look at is the bond markets. When the bond markets start functioning properly and you get liquidity restored and fungibility of assets restored, everything will behave a little more normally.”

In the stock market, the selling has been staggering. The bear market — defined as 20% down from the 52-week high — arrived without warning and the usual peaks and valleys accompanying a downdraft. Yes, there have been some strong up days. But the rush lower has been by far the stronger move.

Order in the markets

It seems odd to discuss an orderly sell-off under such conditions.

Yet most industry veterans who spoke to CNBC over the past several days described just that — an unmitigated stampede out of positions yet amid a fully operational market that is doing what it’s supposed to, no matter how much pain it causes.

“Markets have functioned. We’ve not had dislocations where market function has broken down,” said Mike Ryan, chief investment officer for the Americas at UBS Global Wealth Management. 

What has been out of the normal realm is how “almost routine” daily moves of 5% or 7% have been in the market, he added.

“These are extraordinary swings,” Ryan said. “There so much uncertainty about the path of the outcome. It’s not surprising that as the market processes new information and incremental information that you just get these dramatic shifts in market pricing. The market is trying to come to terms with what the virus fallout will be and what values do we assign to that.”

The value of spreads

There are abstract corners of the markets to look where it becomes apparent how bad the dislocations are. One such measure is the difference in yield between the three-month Treasury bill and the three-month Libor rate, an international benchmark for what banks charge each other for loans.

That gap, known in the market as the TED spread, bottomed at 0.11 on Feb. 26 and zoomed all the way to 0.45 on March 5 and has stayed elevated since, representing a surging rate of risk in the bank credit markets. 

At the same time, comparisons of Treasury Inflation-Protected Securities to their counterparts of similar duration have fallen through the floor. That spread is considered a useful indicator of inflation expectations ahead, and the gap now has narrowed almost to zero. 

The moves have befuddled market participants as seemingly divorced from reality in an economy humming along nicely only a few weeks ago. But they remain the market’s take on where things are headed, at least for now.

“The market is just trading off a sci-fi movie where it’s a viral pandemic and we’re all going to die,” said Nancy Davis, founder of Quadratic Capital Management. “The market’s are not being rational now. They’re trading off fear, not off data. There isn’t the data to look at to see how bad things really are.”

‘Do your best every day’

Absent any current data, markets are looking to policymakers for help and selling until it arrives.

“You’ve got a combination of panic, margin calls and fear,” said Joseph Brusuelas, chief economist at RSM. “They’re selling what they can sell and heading for the doors as quickly as they can.”

The Federal Reserve already has stepped in by slashing its benchmark interest rate to zero and instituting programs aimed at juicing the credit markets with more than $1.5 trillion in liquidity, plus another $700 billion in asset purchases.

Congressional leaders and the White House also are at work on a stimulus bill that is expected to be announced any minute.

Still, the market slide continues until there is a greater sense that either a bottom has been hit, or the coronavirus situation is under control.

Nathan Sheets, chief economist at PGIM Fixed Income, is familiar with such uncontrolled selling as he ran the foreign currency operations for the Fed during the financial crisis.

He said a degree of patience is warranted now as the central bank’s policies take root and start alleviating some of the conditions leading to the panic selling.

“I was not that surprised or that discouraged that the Fed’s big package did not immediately turn the markets. Many of the interventions during the crisis that were powerful didn’t turn the markets when they were announced,” Sheets said. “It’s a building block in the solution. Just do your best every day, and always be prepared for the eventuality that you’re going to have to do more.”

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