The Next Catalyst
On Friday, September 19, the S&P 500® Index (SPX) traded to an all-time high of 2019.26. Since then, a 9.8% correction has unfolded, with the SPX at a six-month low of 1820.66 on October 15. Several key technical levels were breached along the way, including the 200-day moving average of 1905.75.
Figure 1: SPX, Year to Date
Besides the SPX, other capital markets have experienced volatile trading. Crude oil futures have fallen from $95 to slightly below $80 as of October 15. The yield on the 10-year U.S. Treasury also declined from 2.65% to 1.86% during the correction. These are the types of volatile moves that generally unfold over a multi-month period, not three weeks. The fact that the declines happened so rapidly gives me confidence that they can be defined as “liquidations.”
On Wednesday, October 15, as the Dow declined nearly 500 points intraday, CNBC asked me to appear at the New York Stock Exchange for the final few hours of trading. I enjoyed the opportunity to offer insight as to why the liquidation was occurring and the impact on investors.
Typically, the hedge fund community has a list of VIP equity names that they are confident are best in breed and thus heavily owned. In fact, the research divisions at investment banks actually create a hedge fund VIP list. As I commented on CNBC that day, there are “not many VIP’s remaining on the hedge fund VIP list.” The current liquidation is largely due to the hedge fund community neutralizing risk in cyclical global growth assets found on those VIP lists.
For the retail investor, this is a liquidation that should be observed, not actively participated in. To their credit, passive investors never wagered against the fixed income market as some in the hedge fund community have. Municipal bonds, Treasuries, other select fixed income products and proxies, have performed well year to date, and the passive investor has enjoyed ownership during the recent correction. They have understood the importance of “striking a balance” in their portfolios.
Interesting to me are those who would suggest allocating toward hedge funds is fruitless, citing the recent headlines about CALPERS’ reduction in hedge fund exposure and the current hedge fund-driven liquidation. As I told CNBC’s Kelly Evans on Wednesday, I actually expect these events could initiate a much needed consolidation and phase out process in the hedge fund community. There simply are too many talent-starved hedge funds in operation currently. That has branded the entire asset class incorrectly; the best in breed, when they are properly identified, are those whom I would invest alongside, especially after this washout. Next Tuesday, October 21, I will be at the JP Morgan Robin Hood Investors Conference in New York; and I consider the women and men who will be presenting at that conference as the type of talent that best characterizes the hedge fund community.
Lastly, in order to arrest the current correction and resume the prevailing bullish trend, the most important condition the capital markets need is a strong fundamental catalyst. Markets are void of any currently. Please keep two things in mind as you consider what that catalyst could be:
- I suspect the Republican will make gains in Congress on November 4, and that the potential shift in the Senate to a Republican majority of possibly 53 seats will be symbolically positive for markets. Whether the reality of these actions is positive or not remains to be seen, but the simple perception of much needed D.C. change should be applauded.
- In previous corrections, SPX corporate activity in the form of share buybacks buffered the downside. Unfortunately the correction unfolded at an inopportune moment, as SPX companies are restricted from buybacks due to the current earnings season. The majority of SPX companies release earnings during the weeks of October 13, 20, and 27. As of Monday, November 3, approximately 375 out of 500 SPX companies will have reported earnings. As the calendar flips over to November, markets will enjoy the return of corporate buybacks. Goldman Sachs, in a recent note, highlighted that since 2007 the month of November is the most active month for buybacks.
Most likely, the flip of the calendar at the end of October will present the next catalyst.