October’s Market Rout Leaves Stock, Bond And Real Estate Investors With No Place To Hide (#GotBitcoin?)
Triple breakdown in stock, real estate and bond prices has upended investors’ traditional safety tool kit, leaving many with losses. October’s Market Rout Leaves Stock, Bond And Real Estate Investors With No Place To Hide
A brutal October selloff across stocks and bonds has tested investors’ resolve in a way not seen since the financial crisis.
Stocks around the world have lost more than $5 trillion in value in October, according to S&P Dow Jones Indices, putting shares in the U.S., Europe and Asia on pace for one of their worst months in years. Adding to the stock market’s anxieties has been a rare simultaneous drop in bond prices that has pushed yields near their highest levels in years.
The dual breakdown in stock and bond prices has upended investors’ traditional safety tool kit of buying Treasuries during periods of volatility, leaving many with losses.
Traditional investment portfolios of 60% equities and 40% bonds have fallen 3.5% in October and are down 1.5% this year, on pace for a rare annual loss that has only been seen during volatile periods in 1990, 2001 and 2002, said Luca Paolini, chief strategist at Pictet Asset Management, which manages $191 billion. Even investors who are heavier on fixed income would still be in the red, with allocations of 75% bonds and 25% equities falling more than 2% this month to drag their performance down 1.3% for the year.
“There’s no real place where investors can hide,” Mr. Paolini said. “This is one of the worst years in a long time for diversification.”
A laundry list of problems sent stocks reeling in October, erasing the hefty gains major indexes notched over the summer. Concerns that the U.S. economy is on the verge of overheating sent bond yields up, inducing the stock market’s first bout of volatility earlier this month as investors were forced to re-evaluate the rich valuations in some pockets of the market.
Then signs of slowing corporate growth among highflying companies like Amazon.com Inc. and Google parent Alphabet Inc., along with ongoing trade tensions between the U.S. and China, extended losses in stocks and bonds around the world.
The S&P 500 has fallen nearly 8% in October, its worst month in more than eight years. Shares in Europe haven’t fared much better, with the Stoxx Europe 600 declining nearly 6%. Several major indexes in Asia are down in the double digits this month, one of the worst being Japan’s Nikkei, which is on pace for its biggest monthly pullback since 2010.
With losses mounting, the MSCI world equal-weighted index, which gives the stocks of 23 countries the same amount of clout regardless of market value, is down more than 15% from its closing high in late January.
Declines in bond prices, meanwhile, have exacerbated investors’ pain. Annualized losses among U.S. Treasurys and investment-grade bonds are at 9.7% and 4%, respectively, the third-steepest declines since 1970, according to a recent Bank of America Merrill Lynch report.
“The market is convinced we’re at the end of the cycle,” said Steve Chiavarone, who runs Federated Investments’ global allocation fund. “Investors think fiscal policy is going to be less accommodative; therefore that’s going to lead to inflation picking up and the [Federal Reserve] is going to be more aggressive.”
The Federated fund, which owns stock and bonds in developed and emerging markets, has fallen 7.7% so far this month. Although that slide knocked Mr. Chiavarone’s fund into negative territory for the year, the fund manager remains bullish on equities and bought depressed shares of growth companies during October’s harsh selloff.
“We would be more concerned if equity volatility was confirmed elsewhere, such as with rising jobless claims or inflation surging,” he added.
Some investors have been unwilling to wade into the volatility to buy depressed assets, whether they be stocks or bonds, several money managers said. Instead, October’s rough patch has pushed some investors to load up on cash.
Cash allocations among Bank of America’s wealth-management clients rose to 10.4% of assets in the most recent week, up from 10% at the end of September. Meanwhile, 174 fund managers overseeing $518 billion are, on average, holding cash balances of 5.1%, well above the 10-year average of 4.5%, according to recent reports from the bank.
Others have shifted toward gold and other assets, such as shares of utility companies and consumer staples that pay rich dividends and tend to hold up better during times of economic distress. Still, the sliver of gains among those assets hasn’t been enough to buoy diversified portfolios.
“We’ve been moving to be a little more defensive,” said Mike Balkin, a William Blair & Co. portfolio manager, who has pared back his fund’s exposure to technology and other growth stocks that had extreme valuations. He has shifted some of that money into shares of consumer and health-care companies. “In a downdraft like this, you’re not going to escape the carnage,” he said.
Even with the losses among bonds, several money managers have moved to increase their exposure to fixed income, willing to bear the declines over the short term for greater stability in their investment portfolio. Of the past seven bear markets, only two caused portfolios split 60/40 between equities and bonds to fall more than 20%, UBS Group AG said in a recent note.
The Swiss bank’s investment strategists has said to increase exposure to Treasuries and maintains a positive outlook on stocks. Mark Haefele, chief investment officer of the bank’s global-wealth arm, said in a recent note to investors that global growth will slow in 2019 as the Federal Reserve and other central banks unwind their balance sheets and the benefit of last year’s corporate tax cut fades. Wells Fargo Investment Institute has been also recommending investors stay diversified and continue to carry bonds despite short-term pain.
“This isn’t going to end tomorrow. If an investor can stomach another 5% to 10% drawdown, hang tight,” said Liz Young, a senior investment strategist at BNY Mellon Investment Management, which oversees $1.8 trillion. “If someone’s skittish and can’t handle it, rotate into those safe-haven assets where you can try to hide out.”
Home Prices Continue To Lose Momentum
Gains fell below 6% in August as slowdown in housing market becomes more widespread.
Annual home-price gains fell below 6% for the first time in a year in August, another sign that the slowdown in the housing market is becoming widespread and is likely to persist in the months to come.
The S&P CoreLogic Case-Shiller National Home Price Index, which measures average home prices in major metropolitan areas across the nation, rose 5.8% in the year ending in August, down from a 6% year-over-year increase reported in July.
Price gains accelerated for most of the last two years, growing significantly faster than both incomes and inflation. August marked the fifth straight month of decelerating price gains, as interest rates have risen and inventory in some markets has been growing.
Home buyers “must be breathing a collective sigh of relief that home price growth finally has slowed.” said Skylar Olsen, director of economic research and outreach. Ms. Olsen said the slowing appreciation “is a sign that fierce competition is dying down.”
The Case-Shiller 10-city index gained 5.1% over the year, down significantly for the second straight month from 5.5% the prior month. The 20-city index gained 5.5%, down from 5.9% the previous month.
Fourteen out of 20 cities are showing slower price growth than a year earlier.
Las Vegas had the fastest home price growth in the country for the third straight month, at 13.9%, followed by San Francisco, where prices grew 10.6%. Seattle, where realtors have reported a significant pullback in buyer demand in recent months, fell to third place with a 9.6% annual gain in prices.
David Blitzer, managing director at S&P Dow Jones Indices, said that even though there is a pullback in the housing market there are no signs that the current weakness will become a repeat of the crisis in 2008 because mortgage default rates remain low. “Without a collapse in housing finance like the one seen 12 years ago, a crash in home prices is unlikely,” he said.
More than five years of rapidly rising prices, combined with higher mortgage rates are making homes increasingly unaffordable for buyers. Rates for a 30-year mortgage averaged 4.86% last week, up nearly a full percentage point from the beginning of the year, Freddie Mac said last Thursday. Because Case-Shiller home-price data lags behind by a couple of months, it doesn’t yet reflect the most recent run-up in rates.
“Coupled with mortgage rate increases that picked up steam in September, higher prices are stifling home sales as more buyers are priced out of the market,” said Danielle Hale, chief economist for Realtor.com.
Most sectors of the housing market are slowing, including new home sales and housing starts. Sales of previously owned U.S. homes fell 3.4% in September from the previous month to a seasonally adjusted annual rate of 5.15 million, the National Association of Realtors said Friday.
Fewer people are attending open houses and inventory levels are rising, prompting Lawrence Yun, the group’s chief economist, to acknowledge there has been a “clear shift” in the market.
There’s No Place to Hide Anymore When the Stock Market Plunges
All the obvious hedges against stock-market volatility—Treasurys, gold, bitcoin and the VIX—stopped working in September.
September hurt shareholders, not only because stocks fell but also because the things they’d bought to protect their portfolios also fell. From the S&P 500’s high on the 2nd of the month, stocks, Treasurys, gold, bitcoin and the VIX volatility index all dropped.
This total failure of hedging is unusual, but investors need to get used to the idea that Treasurys no longer provide the ballast for a portfolio.
It wasn’t just the normal pattern of asset returns that broke down. Within the stock market the correction in Big Tech upended many of the reliable ways to minimize losses. High-quality stocks, companies with strong balance sheets and reliable profits, fell by more than the market. Smaller companies beat bigger companies.
Within the S&P 500, cheap or “value” stocks outperformed, although they still lost money. But while Big Tech-dominated growth stocks lost out among large companies, among small companies growth beat value. Sector performance followed no discernible pattern either. And stocks that normally rise and fall faster or slower than the market, known in market jargon as high or low beta, didn’t behave predictably.
Now the froth has been blown off the big disruptive growth stocks, we can hope that the normal market relationships will reassert themselves. But the biggest hedge against losses, Treasurys, probably won’t be back as a useful tool for years, if ever.
The problem showed up in Japan in the 1990s after the country slashed interest rates and government bond yields plunged. But it has become most obvious with Germany. In the eurozone crisis of May 2011 to July 2012, German 10-year bunds gained 25%, similar to the loss on eurozone stocks. But by this year the plummeting yield and already-negative interest rates meant there was little more to gain: Bunds made almost nothing from the February stock-market high to the low, and have provided essentially nothing since (Japanese bonds have lost investors a small amount).
Treasurys have now followed suit. In the first phase of the pandemic they made roughly 10%, before the brief period of chaos in the bond market. But since then they’ve been basically flat, giving investors little to no protection—including inflicting a small loss as stocks fell from the Sept. 2 high.
The problem is that, with yields so low, it is hard for them to fall much further, causing prices to rise. The Federal Reserve might still step in with a new Operation Twist to buy more longer-dated Treasurys, which could lower the 10-year yield a bit from its current 0.7%. But even if it was reduced to zero, that would offer a paltry potential price gain of just 7% from the bonds.
Of course, the Fed could follow Japan and Europe in taking interest rates negative, which would create more space for bond gains, but policy makers have repeatedly insisted that such a policy would be inappropriate for the U.S. It’s worth noting that the U.K. used to say the same, but is now openly contemplating the idea.
Even negative rates only provide a brief respite, though: The European Central Bank reckons it could in principle go as low as minus 1%, but if German bund yields followed suit, the price gain for investors would still only be 7%. That doesn’t provide much protection against stock-price falls.
“Fixed income is now 100% fixed and 0% income,” says Jan Loeys, long-term strategist at JPMorgan. He recommends investors give up on short-term hedging entirely and focus instead on how to make gains in the long run. This includes using more instruments that offer equity-like short-term volatility but more predictable long-run returns such as junk bonds or preferred stocks.
Investors are no more likely to be willing to endure short-term losses now than they were in the past, though, and the hunt for alternatives to Treasurys is strong. The problem is that many of the suggested instruments are also sensitive to the same things as equities.
Gold, for example, is touted as the ultimate defensive asset, but it shares the sensitivity of stocks to inflation. Both gold and bitcoin are also dominated by speculation, so when there’s a speculative bust—as in September—they can be expected to share in the losses of stocks being dumped by traders rushing for cash.
Put options should protect against falls in the market, but lose money when stocks are flat or up and so are an expensive hedge in the long run. Volatility trading is even worse, costing a lot for more than very short-term use, and being messed up when volatility rises or falls in line with stocks, as it did in August and September.
For those with enough savings not to need to increase their wealth, Treasurys still offer a small guaranteed income, albeit less than expected inflation. The rest of us should plan for a more volatile portfolio and lower returns in the future than the past.
Tech-Bubble Prophets Are Validated As Stock Rout Spares No One
For weeks, warnings that elevated tech-stock valuations could cause a violent selloff bubbled beneath the surface. On Wednesday, they looked prescient.
U.S. stocks tumbled the most since June with rising virus cases threatening the economic recovery. More than $2 trillion has been wiped from the value of American equities this week and Wall Street’s fear gauge spiked to the highest in four months.
Big tech companies from Apple Inc. to Amazon.com Inc. led the rout, their shares having gotten so expensive relative to expected earnings that further price gains became hard to justify. Software giant SAP SE set off alarms on future profit when it warned revenue would suffer well into 2021.
A day later, U.S. tech darlings exacerbated market volatility for the second time in two months after a summer of gains that outpaced the broader market’s advance by 10 times.
“There’s uncertainty around the coronavirus surrounding the impact of another wave of shutdowns,” Matt Maley, chief market strategist at Miller Tabak + Co., said by phone. “If one of these other tech companies talks about lockdowns affecting their earnings in 2021 the way SAP did, we’ll have a big problem.”
The S&P 500 fell 3.5% to close at the lowest in five weeks. Tech shares in the gauge sank 4.3%. Alphabet Inc. and Facebook Inc. lost more than 5%. The VIX jumped almost seven points to close above 40.
The worry over future earnings is spiking just as big tech lines up to report results. Investors punished Microsoft Corp. even though its third-quarter profit beat expectations and its forecast was mostly in line with estimates. The stock plunged more than 4%.
Up next are the other four of the market’s five biggest constituents that have a combined $5 trillion in market cap. Apple, Amazon, Facebook and Alphabet all report Thursday after the close. All are expected to show a strong third calendar quarter, but the focus will be on how they see the end of 2020 and the start of next year.
“Because tech has supported the market’s rally in 2020, the earnings of those big tech companies are going to really drive sentiment,” said Chris Gaffney, president of world markets at TIAA Bank. “The risk is that it could drive it in a negative way and add on like a snowball rolling downhill to this selloff.”
Buyers had piled into the tech giants for the safety provided by their strong balance sheets and products that cater to stay-at-home demand. They stayed with them as the economy rebounded because of their size advantage. But with the virus rampaging and Congress unlikely to shore up the economy with an aid package, speculation has mounted that tech earnings won’t be able to meet lofty expectations.
That’d be fodder for bears like David Einhorn, who called an “enormous” bubble in tech stocks and said his firm has added bearish wagers. The big top for tech stocks may have occurred on Sept. 2, according to the president of Greenlight Capital, who cited a surge in trading of call options and a growing industry concentration among signs of excessive euphoria. Since then, the tech-heavy Nasdaq 100 has plunged almost 10%.
“Bubbles tend to topple under their own weight. Everybody is in,” Einhorn wrote in an Oct. 27 letter to investors. Greenlight has adjusted the portfolio of companies it’s wagering against by adding a fresh so-called bubble basket of mostly “second-tier companies and recent IPOs trading at remarkable valuations,” he added, without identifying specific stocks.
Usually earnings tend to calm the market during periods of stress. But not this time. Among S&P 500 companies that have disclosed results, 85% beat analyst estimates and are on pace for the best showing since Bloomberg began tracking the data in 1993.
That’s doing little to excite buyers who have watched the index rallying as much as 60% from its March trough and valuations reaching levels not seen since the dot-com bubble.
On the contrary, traders are taking profits off the table. As a result, shares of companies in the S&P 500 reporting quarterly earnings have dropped 0.8%, on average, the next day. Tech shares have fared the worst, falling 2.7%, data compiled by Bloomberg showed.
“The stock reaction tomorrow from AMZN, FB, GOOG and AAPL will be telling as to whether tech can keep up this dramatic pace of outperformance,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group, referring to the tickers of the tech giants. “A regime change is at hand as valuations begin to contract.”
Tech firms have yet to prove that the boost in businesses during the pandemic is not fleeting. Microsoft gave a second-quarter forecast for revenue in some divisions that fell short of the highest analysts’ projections.
Earlier this month, Intel Corp. reported a surprise drop in sales of chips for data centers, potentially signaling a drop-off in demand for expansion of the server farms that underpin cloud-computing services.
Netflix Inc. missed Wall Street’s estimates for subscribers, renewing doubts about its ability to maintain growth as pandemic lockdowns go away and competition intensifies.
“There is no question that these companies have great business models, have executed well and stand to benefit from how the economy is reshaping itself, but there are questions about if they have gone too fast, too far,” Peter Tchir, head of macro strategy at Academy Securities.
“Parabolic valuation increases can only be justified by extremely strong guidance. A lot of great companies have seen incredible gains in their stock prices.”
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