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Gut-Wrenching Volatility and Credit Facility Panic

publication date: Mar 25, 2020
author/source: Brian Nelson, CFA

Image shown: Stock markets have never been this volatile in history.
By Brian Nelson, CFA
The markets are gyrating again Wednesday morning, March 25, as investors digest the passing of a stimulus package to mitigate the dire impact on the U.S. economy of the COVID-19 outbreak, which continues to run rampant around the world, with the World Health Organization pointing to the United States (New York) as the next epicenter of the virus. We'll have more to say about the stimulus plan later today, but there are a few things I wanted to make you aware of in the meantime.
The Dow Jones Industrial Average registered its largest one-day point gain during the trading session March 24 (one of its highest percentage gains since the Great Depression), and this market continues to be dominated by price-agnostic traders (quant/indexing), with momentum and volatility strategies exacerbating upward and downward moves. Including futures market activity, the daily trading swings have been unprecedented as the markets eclipse volatility levels last witnessed during the Great Depression.
We're not out of the woods yet, as price-agnostic trading (quant/indexing) continues to run wild. According to CNBC, during this month through March 24, the Dow Jones Industrial Average has fallen 8,288 points, there have been 13 moves of 1,000 points or more, the average daily move has been 5.1%, with an average daily point range of 1,183. These are not healthy-functioning markets, and the machine-driven rally toward the close March 24 was not encouraging at all. Read more about why in Value Trap.
We're still digging into the details of the stimulus plan, but to this point, the Fed has launched unlimited QE and the Treasury seems to be on board with unlimited bailouts and Congress seems to be fine with all of it. An incredible $4 trillion of a $6 trillion package may be earmarked to "allow the Federal Reserve to make huge emergency bailouts of whatever entity it chooses." We're now in an environment of significant moral hazard, and the market may be starting to factor in an unlimited Fed/Treasury/Congress put.
There's still a growing probability of another Great Depression (think massive GDP declines and large unemployment, not necessarily bread lines, though the stimulus package may be in some way the modern version of this). We continue to witness a "revolving credit facility panic," with dozens of companies drawing down their corporate credit cards, and the Fed is taking actions to limit bringing attention to weakness in the banking system by reducing bank examinations at the smaller lenders, perhaps to stem the possibility of bank runs amid weakness. We reiterate our view that financials and energy equities should be avoided in this tumultuous market environment.
Our 2,350-2,750 fair value on the S&P 500 remains unchanged, and we could see aggressive panic/forced selling to 2,000 on the broad market index (the S&P 500 closed at 2,447 on March 24). Long-term investors with time horizons greater than 10 years may have already been nibbling at this market, using dollar cost averaging strategies and may benefit from any bear market rally. These long-term investors have a keen eye toward retaining dry powder in the event the worst of the swoon is still ahead. Our additional options commentary can be added to your membership here.
Some businesses drawing down revolvers: BA, HLT, WYNN, KHC, CEC, DRH, TLRD, JILL, BYD, EYE, APTV, WSM, WRI, GLPI, RCL, OHI, CTRN, GM, SSD, VALE, AIV
Please be sure to ask your financial advisor if options may be right for you. Derivatives trading is risky, can result in complete loss of premium (capital), and most options expire worthless.


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Brian Nelson owns shares in SPY and SCHG. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.

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Ben Pedersen (New York)

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