3/15/2020
My take on the stock market
There are many similarities between the current downturn than the one in 2008. The market has declined at the similar pace (20%+ in 3 weeks) as in 2008, after the Lehman Brothers failed. The VIX (the fear index) index hit an intra-day high of 77 yesterday (3/13/20), before it settled at 57 after a late rally. I remember VIX hitting 79 in Oct. 2008 also. This time, VIX closed at 75 on Thursday, very close to the peak in 2008.
I think the current market downturn will create once-a-decade investment opportunities. I am planning to shift some of my capital intended for real estate to stocks now. After the market recovers, I can shift it back to real estate where more investment opportunities will come later.
My past experience tells me that the market turmoil will not be over for another couple of months at least. The more severe the decline the longer it takes to recover or repair the damage. The first priority is to preserve financial capital and emotional capital, so you can have a chance to capture the upside. Back in 2008, I did manage to preserve my financial capital, but I was too emotionally exhausted to invest in 2009, so I missed the 11 year bull market, where SPX went up 4-5X.
Market bottom
I believe the key is to look for signs of market bottom or the downside is limited before one can really put in a lot of capital. The future is unknown and there is no perfect method. It is going to be process of trial and error. It will have a few false starts before the rally becomes more sustainable. It is going to cost a few dollars in a process. From the past downturns, here are my observations:
1) VIX index: This index, to me, really measures the speed the market declines, or the second derivative of the market index. It usually peaks right after a period of the fastest decline. The market may still has more downside even after the VIX peaks because it may go down at a slower pace when VIX and market both decline. However, more than 75% of the damage should already have occurred when VIX peaked, according to the past 4 episodes (Aug. 98, Oct. 2008, Feb 2018 and Dec 2018, I didn't include the 2000-2002 ). With the exception of 2008, the market's (NDX) bottom coincided with the peak in VIX. There is a good chance the market already had its low, assuming VIX being 75 was the peak.
2) Leading stocks or indicators: Not every sector will hit the bottom at the same time. Some sectors are known to lag, such as the Russell 2000 index (or IWM) vs. SPX. For instance, as of 3/12/2020, NDX, SPX and Russell 2000 were down 22%, 25% and 33% respectively. The tech sector heavy NDX is outperforming SPX because it is weighed down by the energy sector, travel/service related sectors, and financial sector, which were the worst hit. In 2008-2009 crisis, Apple stock bottomed a few months before SPX did in March 2009. I am not sure what stocks will lead this time, but I do think QQQ will lead SPX and Russell 2000. In summary, a higher trend should be observed before one can deploy too much capital.
3) It is difficult to know how long it takes to contain the corona virus,
but the experience of S. Korea and Japan is encouraging: the spread of
the virus seemed to have peaked. Although we cannot trust the official
figures from China, but their measures should produce the similar
result: the virus has been contained. Since the numbers in the U.S.
would most likely to increase, given it is in the early stage. However,
the lock-down measures should yield encouraging results soon. If that happens, it should help the market. Again, I do believe the U.S. will lead the world in financial market.
What to buy
The most important factor is timing, what to buy is secondary. The most important consideration is about portfolio positioning: meaning your percentage exposure at a given point. This will determine 90% of your gain or loss. I prefer to stay with liquid instruments such as index related ETFs or large cap stocks because it is easy to be in and out of the market with less transaction cost because all instruments are high correlated.
It is very easy to fall in love with your own favorite stocks and expect them to outperform the market. In my case, my loved ones almost always are the last ones to rally. In my hedge fund days, I often found myself losing money from my long positions and short positions at the same time when the market started to rally. It is not what market likes matter, not you:).
1) Crude oil: The crude hit a low of $31.5 on 3/12/2020, which is the second lowest price ($26.66 in 2016, $31.5 on 3/12/2020, $33.16 in 2015 and $35.59 in 2008) since 2008. The oil demand will definitely be greatly reduced by the lock-down measures China, the US. and Japan, the top 3 economies in the world. So will be the supply at this price level where it is not economical for shale oil, tar sand oil or deep ocean to maintain the production. Assuming, the low of $26.66 holds this time, the downside is only about $6 (using $33 on 3/13/20). This is better than most stocks.
2) Leading sectors or stocks: QQQ and other tech stocks (such as AMZN, AAPL, etc), I believe, are good choices because they should have less downside than stocks in other sectors. Note that many of the large tech companies are virtual monopolies in their industry: MSFT, INTC, GOOG, FB, ORCL, CRM, ADSK, INTU, ADBE, etc. They are good candidates for long term holdings.
3) Lagging sectors: The sectors, which were the hardest hit, should have more upside when the market turns, but they will have more downside as well. I prefer not to touch them until I am convinced the market indeed turned. Here are some of the sectors, I see, were hit pretty hard:
- Travel/entertainment/service related:
- the cruise ship operators: RCL, CCL
- Casino stocks: LVS, MGM, BYD, CWN, VAC
- Newbies: UBER
- Airlines: UAL, etc
- Financial Sector:
- Investment Banks: JPM, GS (leaders)
- Banks
- REIT: One of the surprising things is that some specific REIT stock got hit hard. EPR properties, which specialize in ski resort, gaming, entertainment, and education segment of the market, came down more than 50% within days. It went down 36% on 3/12! The lack of travel, and school closures should affect their customer base, very significantly. Some other REITs such as the cell tower rental operators AMT and CCI have hardly gone down at all. Their business is probably the most recession proof because they have long term leases (5-10 years) with inflation escalations terms built in with major cell phone carriers.
- Energy Sector: After the sharp decline in oil prices of over 20% on 3/9/20, due to the disagreement of production cut between Russia and Saudi Arabia, the energy sector got hit hard, especially the shale producers and mid-stream master LP stocks. In general, resource stocks in energy, mining and ag sectors, in my opinion, are going to zero in the long term. As soon as their reserves are exhausted, they vanish. Politically and socially, they are pressured to keep the prices low so people can afford to live.
- CEFs: the Closed End Funds offer an unique opportunity to invest because some of them are trading at a significant discount to their NAV values. The challenge here is that they can be very illiquid. I believe the only sensible way of buying them is to have an effective to hedge the downside, should the market goes down hard. Here is a link where you can search and screen for CEFs: https://www.cefconnect.com/closed-end-funds-screener
Short term trading
There are some opportunities to trade if you are willing to counter the market trend in the very short term. For example, if the market has been going down for a day or two, it went down another 3-5% pre-open the following day, it is often worth taking a long position pre-open and exit 1/2 during the morning rally, the other 1/2 either at the close or next day, depending how the market acts. I traded QQQ this 4 times last week. So far, it was 4 for 4, capturing over 2% on average each time.
You can also use the rally to exit or lighten up your positions, and sharp down turn (after at least down two days).
https://www.thebalance.com/oil-price-history-3306200
