Uncategorized, Weekly Update

The Fear Trade

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Published February 28, 2020


The old market adage that stocks take the stairs up and an elevator down was on full display this week. After months of marching ever-higher, with investors becoming more and more complacent about ANY risk, stocks finally found something to be truly concerned about. The complete uncertainty surrounding the potential spread and impact of the coronavirus is exactly what the stock market hates. See the chart below showing the precipitous declines in some stocks that pay huge dividends, which should insulate them from such declines, shouldn’t they? Prospect Capital pays more than a +10% dividend from its bank-like lending. In three days, this company has given up almost a year’s worth of gains; and having occurred on no news specific to the company. This is pure fear!

Precipitous declines in stocks that pay huge dividends

Pure fear or something else?

And this week that fear has shifted notably. On Thursday, as the S&P 500 tumbled -4%, the Chinese large-cap ETF (FXI, trading almost 50M shares), dipped less than -1%. Fear has made its way across the pond from Asia to the U.S. With U.S. stocks trading at ever-lofty levels over the past several weeks, you could argue that U.S. markets were due for a slide. But this slide has been historic in its swiftness leaving investors few places to hide and scarce little time to react as stocks violently move from losses to gains and back within a couple of hours.

When people are selling in a panic, they don’t negotiate the price.

The VIX “fear index” approached 40, a level rarely seen outside of the sheer bedlam of the financial crisis (see green line below).

The VIX “fear index” approached 40

This, too, shall pass. And the good corporate earnings that ruled the market only a few days ago might be the focus again. For now, Wall Street’s worst enemy – fear and uncertainty – are in charge.

Our models, which are trend-following, will catch up quickly to this sudden turn of events. Then, they will work to build profits in what might be a new investing landscape where elevated volatility offers opportunities for our type of trading.

Market Update

Stocks were rocked this week as coronavirus fears reached a fever pitch in U.S. markets. News of virus cases in South Korea, Italy, and Iran forced investors to consider a possible pandemic scenario which might seriously impact global economic growth. That scenario sent stocks tumbling -3.4% Monday. The selling was unrelenting, with another -3% slide Tuesday. Wednesday brought a bounce higher at the market open, only to see selling drive stocks back down, this time to a modest -0.4% slip. Brazil and Pakistan announced their first coronavirus cases, while companies began announcing the suspension of employee travel. The bottom dropped out of stocks Thursday in a -4% rout. Microsoft (MSFT) told investors the company would no longer be able to meet sales targets this quarter, another concrete sign of the business hit from the virus. Stocks declined yet again through most of Friday’s trading with indexes sliding around -3% before a late buying spree brought the Nasdaq all the way back to breakeven. 10-year U.S. Treasury yields fell to their lowest levels ever at 1.15%. The VIX fear index spiked all the way to near a 50 reading at Friday’s worst levels, heights rarely seen (and a level often marking a short-term bottom in stocks). Shares in travel-related companies were decimated with cruise line Royal Caribbean (RCL) falling -25% in a week and American Airlines (AAL) suffering its worst weekly loss in history. Oil prices have fallen over -30% since early January. They have been perhaps hinting at slowing global economic growth for weeks. Nevertheless, U.S. stocks have seen an extraordinary six days. The S&P 500 has given up the entirety of the October-January rally in those six days, completely discounting all the goodness of a rebound in corporate earnings. It’s been quite a week.

Stocks suffered their worst losses in years this week. The S&P 500 (SPY) fell -11.16%. The Nasdaq 100 (QQQ) slid -10.63% to its 200-day moving average before finding support. Small-cap stocks (IWM) were in free fall, closing lower by -12.43% on the week. All three indexes now post losses year to date, though the QQQ is only down a modest -3% so far in 2020, even with this week’s carnage.

Warm wishes and until next week.