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Fiscal Hopium Rally Brings Another Opportunity To Reduce Risk

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Includes: BNDX, BWX, DDM, DHF, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FSD, GDO, GHY, GHYG, GIM, HIO, HUSV, HYB, HYI, HYXU, IGOV, IHY, IVV, IWL, IWM, JHA, JHB, JHD, JHML, JHY, JKD, OTPIX, PGHY, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTA, VTWO, VV
by: Danielle Park, CFA
Summary

Global risk markets have experienced the steepest 30 percent decline in history over the last month.

We should expect to see some big reversal rallies punctuating the downtrend – even while the trend continues down.

It took 12 years to make the mess that’s now imploding. We should not expect the clean up to be completed in a month.

Originally published on March 24, 2020

Global risk markets have experienced the steepest 30 percent decline in history over the last month. We should expect to see some big reversal rallies punctuating the downtrend–even while the trend continues down.

Today, as algos key on the promise of a big US federal aid package and a G7 pledge to do “whatever is necessary”, the bounce is big. This affords yet another opportunity to review risk exposure amid a global recession, liquidity crunch, and forced selling yet to come. The unravelling here is only just begun. See WSJ: The Hedge Fund trades going haywire:

The fact that many such trades are financed by leverage to juice returns has made the fallout worse. The use of debt to enhance yields is probably the reason why some theoretically more stable sectors like utilities have actually performed worse than the broader market in the current bear market, for example.

Some trades that make sense normally are turned upside down in a crisis, when traders don’t sell what they should but what they can.

As well as Bloomberg’s We’re looking at a system-wide margin call:

“he Federal Reserve ushered out a second wave of quantitative easing Monday. But the worst scramble for cash is happening in an opaque corner of the market, where Chairman Jerome Powell has little control. What we’re witnessing is a system-wide margin call.

With the coronavirus outbreak intensifying, asset managers are getting squeezed by a record outflow from bond funds and billions more from stock funds. Even bigger withdrawals are probably happening in the over-the-counter world, where trades are conducted out of public eye, through broker-dealers. When traders get margin calls, they resort to selling their most liquid assets, usually stocks and U.S. Treasuries. This only deepens the slide.

Consider OTC derivatives, which are mostly betting slips on the future movements of interest rates and currencies…As of June 2019, the notional amount of such derivatives rose to $640 trillion, the highest since 2014, data provided by Bank of International Settlements show.

For some perspective on this, the credit derivatives market was essentially non­existent in the early 1990s, and in 2008 had a notional value of about $50 Trillion. Over the last 12 years, these financial weapons of mass destruction have ballooned nearly 13x larger.

It took 12 years to make the mess that’s now imploding. We should not expect the clean up to be completed in a month. Open doors should be used as exits.

Disclosure: No positions

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.