Brian McMorris

Contrarian, long/short equity, deep value
Brian McMorris
Contrarian, long/short equity, deep value
Contributor since: 2009
Company: Wealth-Ed
Volatility is concurrent, not predictive, as you have observed. The exception is that very high volatility has a hard time staying extreme for any length of time (more than a few months) as panic eventually subsides.
So a spike to 50 or more is not sustainable and can be seen as capitulation. That does not always mean a bottom, however. The volatility in 2008 spiked to 55 (on the SP500) October 10 after the Lehman failure. It was the end result of a huge selloff in markets and SPY, from 127 on Sept 19 to 88 on Oct 10. Many investors, private and professional, were buying puts to stem the bleeding (some might say too late, especially as premiums spike on volatility).
But it did not signal the end of the bear, only the beginning. There were subsequent recoveries and additional selloffs cascading to the market low on March 9, 2009. VIX spiked to 80 no Oct 27 and again on Nov 20 as the market worked its way lower. In fact, at the bottom, volatility was subsiding from the 60s and 70s. It only reached 49.68 on March 9 2009
A single spike in volatility (VIX) is not definitive, certainly not a spike to a mere 32 as on last Wednesday, Jan 20.
fallacy in this logic is that companies with "strong buyback programs" have any money left to do buybacks when the market craters and the economy turns to recession. Very few companies were able to execute big buybacks at the bottom in 2009. They were trying to survive
agreed....buybacks are a good contrarian signal. When Apple engaged in massive buybacks, it was near the top of its price range. Has gone nowhere since. Shows it was out of ideas. Microsoft, same thing under Ballmer. He had no ideas, so he manipulated the stock with buybacks. Not surprising for a CFO kind of guy. MSFT did not get better until they dumped Ballmer
me too....waiting to reload my puts on a 5% pop (1950 on SP500).
Ray Dalio also agrees. Never bet against Dalio, manager of largest hedge fund in world, Bridgewater.
Hussman is a very credible economist and not so much a behavioral analyst. Hussman is ruled by numbers. He is VERY good at the numbers. But most of us know that the market is a voting machine and ruled by mass psychology in the shorter term (and yes, 7-8 years is short term for markets). In the long run, it is an earnings weighing machine.
Hussman is able to mathematically demonstrate that the Fed can only use smoke and mirrors for a short time (he uses the term "the Fed painted itself into a corner"). At some point, the chickens come home to roost. Are we there? Sure seems like it. When a 0.25% rate increase after none for 8 years, can panic the market, that says to me we are at the termination of artificial market manipulation by the Fed.
Please tell me, what is the Fed going to do now to stop the decline? They could reverse their measly 0.25% FF increase. Will that shock and awe teh market into buying vs selling? Will that cause the dollar to dramatically weaken, saving the commodity based economies from debt default?
Reminder to all your readers, FNG: the 2008-09 crash was reversed by some seriously artificial stimulants, care of the Fed. They had 5 percentage points on the Fed Funds rate to work with at that time. Monetary mechanics allowed the Fed to print $4T of money (create a lot of liquidity administered through the primary banks) in driving down interest rates from 5% to 0.25%.
As we now know, most of that printed money, and then some through the magic and leverage of lending, ended up in the stock markets. THAT is the proximate cause of ramping up the stock market to SP500 of 2100, NOT earnings. PE expanded from 9 to 22 on trailing earnings, worth 150% increase on the indexes. Earnings themselves were also positively impacted by the Fed printing machine (debt funded buybacks, commodity and energy company earnings strength due to a weak dollar, infrastructure spending, broker margin, etc), running from $50 in 2009 to $100 in 2015 on trailing earnings. That was worth another 100% for a total of 300% increase on the SP500 (from 666 to 2100) based almost entirely on QE.
With no QE available with the FF rate at 0.50%, how does the Fed plan to kite the stock market once more? Until I understand that, I am staying on the sideline
Maybe too late to sell. But then that is what I told myself in January 2008 with my portfolio down about 12%. I had only liquidated about 25% of my portfolio based on Sept - Nov 2007 volatility. When the big drop came in September, I was trapped. Ended up down 55% (since I normally hold a lot of higher beta small caps). Won't repeat that mistake.
I already sold throughout 2015 closing out everything (except some index puts) by January 5. No pain for me here. No panic
Agree Hendrick3....but for sake of argument, what happens at $10 oil. I think that is a great outlier forecast, but I have seen it made recently. At that price there would be no option but to shut the doors on most oil producers. How many can even come close to break-even at that price. I know PWE can't. Its transport costs are too high.
As for the oil sands plays. Lights out. I read this morning that Flint Hills Refining in Minneapolis is paying $ -0.50 per barrel of sour crude. You got that right, if you are a producer you have to pay them to take it. Negative pricing coming to the oil market. Doesn't look too good for the near term which is why I am staying low for now.
DVL...PWE is a much more efficient oil producer now than in early 2014. There are many metrics that prove that. So $10 will come at a lower oil price than before. But otherwise, you are right, this could very well be 1986 all over. And that is why I am not re-upping my positions after expiration. But I will hold my very cheap 2500 shares as a marker. No point in selling them now. Maybe the oil market will miraculously bounce back. At $0.55 it is a fairly cheap and infinite option.
This is hardly a "darkest time". The current market is like 2007 with the SP500 having fallen from 1546 on Oct 11 to 1400 November 26. Yes, there were rebounds along the way, but the first phase of the Great Recession was nothing like what was to come. Volume and volatility would go much higher over the following 14 months.
Still have a couple thousand shares, but let 50 call contracts expire on Friday without rolling them. I need to see some proof the oil bust is over before I come back to any energy name. If PWE is still around when the supply situation is straightened out, I will come back to PWE
DVL...PWE is not "messed up". They were 2-3 years ago. But the story on PWE stock price the past 18 months is about the price of oil, not the management of PWE. If oil had stayed around $80-100, the stock would be over $10 right now and maybe over $12 with no dividend cut. Management was well on the way to fixing PWE's problems. But no management can solve this set of problems (Saudi and global over-production).
The only reason the integrateds will survive is their refining, transport and distribution businesses. Their production business is just as screwed as any mid-tier E&P like PWE.
Adec....I did not "get out". I just chose to use options on PWE a few months ago when oil kept drifting lower. I let them expire on Friday and won't come back until there is some technical progress on the chart of WTI. When I do come back, it will be with PWE. And I will be buying stock as if it were options unless they do a major reverse split
This is not about PWE, it is about massive global over-supply and a proxy war between the Saudis and Iran fought through oil production. This could end with oil at $10. That will lead to the demise of many energy companies likely including PWE and also a major recession or even depression that will cause most stocks to crash
Excellent post....or, we could have a bear market that causes a recession which is exactly what happened in 2008. The economy is heavily influenced by the equity markets, especially with debt so important to our modern economy and what happens to bank lending when equities are hammered.
DVL...that 12 month negative EPS number is pretty misleading. While I am almost out of PWE now that January options have expired, it still is as good a producer as any. If trends continue, the entire industry will be wiped out and it won't really matter which energy name you own.
As of Q3, PWE was operating cash flow (EBITDA) positive ($520MM) according to their latest (January 4) presentation. Reported earnings are not the way to look at energy producers due to all the depreciation and amortization write-downs. Cash flow, either Free or Operating, is a much better way to evaluate.
That said, until I see some change in supply commitment by the Saudis, Russians, and other middle east countries, I am staying clear of energy. Some who post here have bashed PWE. But they were no worse and in many ways better than their peers the past couple of years. Once the Saudis dug in determined to destroy the North American energy industry at all costs, it didn't really matter which name you owned. They are all going down, including some very big cap names like FCX and CHK. They will take the global economy and markets with them, I am afraid. I am currently nearly all cash.
FNG....not sure why you say the energy crisis is not as severe as the mortgage crisis. The IMF is very concerned and been issuing warnings for a year. Here is an article on the subject from Sept 2015 in the FT.
Fact is not only banks are at risk due to energy and commodity company failures (FCX will likely fail) but entire countries and their debt are at risk. Banks stand behind commodity company and country debt, so banks are also at risk. The problem is well into the $ trillions. It is fully capable of repeating 2008 and with global central banks out of ammunition to stop the descent.
Many consider the current setup more dangerous than at this point in 2008
TBC..."[T]otal U.S. market short interest is the highest it's been since September 2008.... In the aggregate, the last time investors were this convinced that stocks were due to decline ... we were in the depths of the financial crisis.""
Isn't that the point of expressing caution? September 2008 was a very good time to become cautious, if one wasn't already (I certainly was!!) I don't consider AAII to be a contrarian indicator. This is a fairly enlightened investor class. They are more likely a leading indicator. True, at some point after the Red warning lights come on from the AAII survey readings, it will be a time to buy. But if the Sept 2008 sentiment reading was a contrary indicator, it was 6 months early, with much more pain to follow!!!
Based on my own market experience and research, we are now in a 2008 scenario with almost a perfect overlap from 2007-08. The recent warnings were the selloff in August-September, same as in 2007. The proximate cause, or at least poster child, then was the blowup of a two well-known Bear Stearns hedge funds which led to the demise of Bear Stearns in March 2008. This destabilized the markets' belief in the imperviousness of major American banks.
In 2015 the trigger may be the collapse of revered Third Avenue Funds mutual fund TFCVX. How many more of those emerging market and commodity fund failures are to follow? (this collapse is really a by-product of Fed policy, which was salubrious for emerging markets including China, and their debt during QE expansion and will be just as deleterious during QE contraction).
It is also interesting to note the eerie similarity of the Dallas Fed suspending Mark to Market for Energy futures markets: This may slow the selling, but won't solve the supply-demand imbalance. Echoes of 2008 suspension of mortgage fund "mark to market" requirements
What will be the March 2008 equal to Bear Stearns and the September 2008 equal to Reserve Primary Fund breaking the buck, Fannie and Freddie Mac collapse? AIG failure? Lehman failure? Stay tuned.
Great observations and can easily be backtested in previous major selloffs like monthly volatility in July 1998, July-August 2002 and September October 2008. (I do find interesting that the 2000-01 selloff was without much volatility, but the drip-drip type you describe, until 9/11)
Here is a great piece on historical market volatility that goes back 150+ years. Unfortunately, it was written in 2000 prior to the market events to come. But one can clearly see the volatility spikes on page 5 in 1929, 1937, 1974 and 1987. 2008 would be even an bigger spike and stand out on this chart.
True...I will keep reading you, FNG. Even though I disagree with your patience (complacence?) in the current circumstance, you seem thoughtful and prepared to take action at some point. You are watching the correct technical indicators. To me they flash red right now, to you yellow.
You may want to rethink your long term thesis that the past is prologue. I completely disagree. The post WW2 Baby Boom is the single biggest factor in the global economy and markets and what was a long term tail wind is becoming a long term head wind. It will require different thinking. Gross and Grantham have been thinking hard about this and are worth considering.
TBC....While I appreciate your disdain for buybacks and agree that if done at firesale prices, there might be some justification (unfortunately, they rarely are), I completely disagree that buybacks are not "historically alarming". Indeed, they are. I contend, buybacks are primarily responsible for the stock price recovery since 2009. There is much proof of this if one is to look online. Worse, those buybacks are not done with profitable cash flow. They are done with (Fed provided) debt which compromises the company's future survival.
Here is but one of many articles on this subject, including recent writings in the Harvard Business Review:
Jeremy Grantham is very focused on demographics. This is the same Jeremy that I followed to huge returns on his February 2009 call to get long the markets in a big way. He is certainly no perma-bear but is very reasoned and rational. He also publishes his views for free on a quarterly basis, which is a generous public service (other "greats" should follow his example, James Grant).
Jeremy's 4th Quarter newsletter should be out shortly. Here is his 3rd Quarter letter which warns of things to come:
I do not offer investment advice, but I do suggest reading that might cause readers to think. The biggest factor any investor should ponder is global demographics. It is surely long term in nature, but it is also insidious. It makes mincemeat of historical comparisons developed in a time that is not only different, but the polar opposite of what is to come.
In a nutshell, the biggest economic and then market boom in recorded history occurred over the past 60 years. The primary cause of global economic expansion was the "baby boom", not just in America, but all developed economies. Now with that boom ripening to old age, what are the economic and market effects? Not good, if one is long equity markets. So, while people can remain glib about the future based on the past, if they so desire, it may not be good for one's economic well being. Economic growth north of 4% in developed economies with market returns north of 10% will be far and few between.
Here is a little reading from Bill Gross's January missive. Yes, he may have gone cold the past couple years, but only because even he, the Bond King and one of the greatest investors in modern history, hung onto hope too long:
"The first two weeks of this year have been driven by emotion (Fear)".
Market action cannot be diminished by making this point. The Market, in the short term, is ALWAYS driven by emotion. That is the source of Bernard Baruch's "Voting machine" analogy for short term markets. Were you saying the same last year when the market was being drive by Emotion (Greed)?
Same is true for your statement that the market is "oversold" implying there is a bottom. It is always oversold after a selloff. That is stating the obvious. It has nothing but very short term value, as in a few days of trading. Same can be said after a multi-day rally when the markets always become "overbought" and subject to a corrective selloff. Overbought does not mean the market will not go higher in the longer term.
In a declining market, the market becomes oversold, as measured by an indicator like MACD. There will be a 3-4 day "relief rally" to allow buying and selling to balance, and then there is another decline into "oversold" territory. It is disingenuous and misleading to imply that "oversold" is sign of a bottom. It will be at some point, but no reason to believe it is now.
Is that what the American markets have come to: the Bulls need corporate buy-backs to make their case? Pathetic. Financial engineering is the bane of American capitalism and is what is wrong with our economy. No reason to grow the business when earnings can be inflated by reducing share count which is financed by issuing cheap bonds. Well done Federal Reserve! You have achieved what we thought impossible, a mortgage crisis redux, migrated to corporate balance sheets
"There's no reason to believe that QE and company stock buy back ruled this bull"
Really? Actually, QE driven liquidity explains almost all of the runup from 2009. The increase in QE debt times legal bank leverage (reserve ratio) is almost exactly the increase in the value of American equity markets. Bank lending is the intentional mechanism for Fed QE to get transmitted to the economy. That is its purpose. Bank lending has been directed at liquid assets like stocks via investment bank margin or company buy-backs. This is provable by tracing fund sources, not just speculation.
So, if QE is reversed, which is indicated by its new commitment to higher interest rates (money supply expansion / contraction is how the Fed lowers or raises interest rates), then assets must be liquidated in some fashion. Some of those assets (or many) will be equities
Lets see how brave you are when the major indexes are down 20% and the minor (IWM) are down 50% (already down 30%, of bought IWM at the top, vaporized a lot of wealth, holding). We will see who has the cajones, then.
IWM (small cap stock index) already down 30% from peak. No one talks about that. We are already in the depths of a Bear market with global all shares market down 25%.
It is only the new "Nifty Fifty" embedded in the DJI, QQQ (containing FANG) and SP500 that are holding up those indexes. They are a crowded trade and should be shorted as down only 11-15% with a lot further to fall to catch the rest of the global equity market.
"(NYSEARCA:SPXU), closed at $31.84 on July 20th. The August 25th close for SPXU was $45.65, or a gain of 43%. If held for a relatively short duration, there is no penalty, and in this case, it actually fared better than the three to one ratio. That was primarily due to the swift nature of that decline."
Leveraged ETFs pay off big when you get them right because volatility spikes concurrent with the theme (Short or Long) as investors crowd into the underlying puts or calls. That is how ETFs constructed for "triple" return produce quadruple return. The opposite is true if buying a put or call or ETF containing same at a moment of great volatility. Better to be a seller of puts or calls at that point in time to allow volatility be your friend.
So here we are one week later, and the summer swoon levels did NOT hold. So what is the new advice FNG? The S&P500 is at its "neckline" going back over 2 years. The decline today was on relatively low volatility at 27. Not the panic whoosh that ends bear markets >50, like in October 2015 when it hit 50, before that the panic in August 2011 or in October 2008 when it hit 100.
With VIX still low, China and commodities continuing to plummet, and weak Q4 earnings coming up suggesting potential recession later this year, there is not much to stop this decline. Next stop after piercing the neckline is a 20% decline to 1700, but it is still not strong support with 20% somewhat arbitrary, though the classic "bear" threshhold. There is really nothing solid until 1100 or thereabouts, from sell off in August 2011, a very strong "V" bottom. It was the Fed that turned around the market at that time with QE3. Maybe the Fed will need to come to the rescue again. But how?
This is not a prediction, just a range of possibilities. But better to be on the sideline while waiting to see how it works out. As the sages say: never catch a falling knife.
Another analogue: "Fed action backstopping every major market decline" = "investor complacency". At one time, the term "moral hazard" was used frequently in respect to Fed over-action / bailing out the banks. Guess this is what that looks like.
I guess I missed the part where managing equity markets was the Fed's congressional mandate.
FNG...if you are wondering the proximate cause for the record year-opening market declines, it may not be China or Oil (though those surely don't help). It is likely the revisions to Q4 Earnings Forecasts which are now dropping like a rock on the eve of earnings season.
The most recent print from Factset (Friday) shows the newest consensus forecast is -5.3% for Q4 YOY. Since Q4 2014 was weak, this is really negative news. This will make three quarters in a row with a negative print on earnings YOY. Wall Street is missing badly on its earnings guidance on which stock prices are based. Price must fall a long way (20%) to catch up with earnings reality.
As for advice, I don't offer other investors any but will share my experience. I have gotten flat in 2015 by selling and going to cash and by hedging using puts. I am not a big fan of the leveraged short funds. They are not very efficient. Most would be better served by just buying ATM puts on an index to cover some percent of their long positions. That has been my approach. I bought the Jan 16 puts on EEM the middle of 2015. I have actually been able to trade that position during the August downturn, but went to an even larger position on the October bounce. I am now liquidating my EEM puts as they expire this week and are up over 100%. My timing has been good so I will wait for another bounce in EEM or IWM before reloading with put LEAPs (Jan 2017). In the meantime, I have been selling my long positions to stay neutral.
Amazing how this big economic machine works, isn't it? Very high demand for cars and phones, fueled by cheap and easy loans (like houses in 2006) sow the seeds of their own destruction. They pull demand forward (as pointed out by Richard Fisher on CNBC) and encourage excessive plant and production (also built cheaply and easily this go-round with CB money). Once the supply is in place and when demand is met (all that want it have purchased it) the end is near. Demand collapses, price crashes as suppliers dump inventory and run plant at break-even. Earnings crash. Stock prices follow. Amazingly, they hardly ever lead on the way down as complacency ALWAYS sets in to hot markets.
Rinse and repeat