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Another Rough Day For The Markets: Now What?


Monday seemed like it could have been a reversal day. After a big drop Thursday and a bigger drop Friday, stocks reversed hard on Monday. Sure, shares weren’t exactly higher on Monday, but they did post a solid recovery off the 1,000+ Dow drop in the morning. A -600 close wasn’t good, but it was a 50% recovery off the worse levels of the day. Adding to that…

The Dow opened up 400 and traded around there much of the day Tuesday, causing many investors to think the worst of this crisis had passed. After spending nearly all of the day up in this lofty range around 300-400+ on the Dow, shares started to sink around 3pm ET.

And then, they started to really plunge. Within an hour, all the gains of the day would be wiped out. The Dow, which had just recently been +400 found itself down more than 200 for the day. That’s right, shares utterly wiped out, dropping 600 big on

Yes in the pivotal final hour.

So what to do now? Is this the moment to throw in the towel to sell it all before things get even worse?

First off, why’d we crash at the end of the day? There’s no clear reason. There weren’t any foreign markets that collapsed in that span, and crude oil was well behaved. Nor were there any particular large-cap stocks leading the dive.

Yes, it does appear this 600 point rapid final-minutes Dow plunge was the work of unthinking computers rather than anything logical or explicable. So, if we dropped without a reason, should we be buying tomorrow?

Yes, probably, but it’s complicated. If you’re trading with a very short-term outlook, let’s say three days or less, then I can’t help you. The market may rocket, it may nosedive, or it could do a bunch of nothing tomorrow. Anyone promising to tell you what will happen on a short term basis is misleading you.

On a longer term outlook, yes, the market probably isn’t a bad buy here. To be clear, no the market isn’t “cheap” as value investors define it. The normalized PE is still well above “bargain basement” levels.

However, depending on the index, the US is down close to 15% over the last week. We’re way oversold, and a big huge bounce should come soon. Whether or not you think prices head lower into the holiday scene is hardly relevant.

The thing is, with shares down this hard, a bounce is nearly inevitable, regardless of the state of the broader economy. After plunges this big over the last thirty years, a big short-term recovery is almost inevitable.

Whether or not it sticks for the longer term is a different question. There were big bounces in 2000, 2007, and 2011. Given those economy crises, we know how those turned out.

Regardless, in general (and yes, this is general, this isn’t specific advice to buy or sell a security!) we feel that we’ve reached an attractive level here at sub-1900 S&P 500.

Could things go lower? You betcha, absolutely. Is it likely? No, no it isn’t. In fact, after the biggest one-day VIX spikes in history, returns are usually fantastic for stock buyers. According to that chart, a vast majority of buyers will enjoy a positive return 1, 3, and 5 days after a crash incident.

Since both Friday and Mondays were “crashes” according to that standard, we should be well primed for the inevitable recovery afterwards.

What are we to do? For one, you need to reconsider your portfolio allocation. If you are having trouble sleeping tonight, or you’ve had nightmares recently, you should probably sell some positions. Your health is more important than your net worth; pare your assets down to a level where they don’t cause you to lose sleep.

So yeah, if you’re already nervous, this isn’t the point to be trying to buy more. That said, don’t sell anything! Retail investors – smaller players – are famous for underperforming the market as a whole because they puke up their shares to the bigger boys during these sorts of market routs. I entreat you, don’t be that guy who sells out at the bottom.

If you’re feeling good about your position and asking how you can take advantage of the current downdraft – then yes, this is the time to be buying. What to buy? You can target particularly oversold stocks – there’s plenty of stuff down 20% or more over the last week.

On the other hand, you can buy your favorite stocks at a good price. They may not be smashed exactly, but the big-cap market leaders like Apple (AAPL) have indeed dropped far off their highs in recent days.

Regardless of what you do, the important thing is not to sell. If you own a well-diversified portfolio, you probably own mulitple stocks down 20-30%, if not more. And yes, it feels terrible! But don’s sell, things will improve.

Why ETFs Are Tricky In Times Of Turmoil

A large part of today’s money is invested in actively managed mutual funds or passive funds, known as Exchange Traded Funds (ETFs). In the recent years, in particular these ETF’s have made a stellar growth and are part of many investment portfolio and 401k’s. The 3 most liquid ETF’s have a combined Net Asset Value of USD 225bn. As such, these instruments play a significant role in the investment flows. This was underlined by recent developments, especially the early morning rout we witnessed this Monday.

Tracking the market

ETFs are a major driver of market direction. For example, when there are a lot of investments (‘inflow’) in an ETF, this fund has to invest these funds in the market. Its mandate obliges the ETF to be fully invested to be able to track the movements of the underlying as close as possible. As a result, for example an ETF which tracks an index, has to buy shares pro rato in the underlying index. On the other side, when a large number of investors are selling their ETF, the fund sees outflow and has to sell its underlying shares (see figure 1).


Reinforcing market movements

The dynamics of inflows and outflows have the potential to reinforce market movements. In upward trending markets, this is most of the time a steady process. As the saying goes, markets take the stairs up and the elevator down. When everybody wants to exit, things can get nasty with the ETF dynamics. A recent article in the WSJ pointed out to the fact that volume on stock markets tend to concentrate in the first 30 and last 60 minutes of the regular trading hours (i.e. 9.30 – 10.00 am EST and 15.30-16.00). This is also the time of day ETF’s are balancing their assets, based on the flows of the day. So in case investors turn bearish and are heading for the exit in the early phase of trading, matching of supply and demand will disrupt. This is what we saw yesterday at opening: since everybody is selling, ETFs and mutual funds have to join the pack, causing bizarre movements.

More ETF-driven turmoil to expect?

Although US-markets had a relative quiet first half of the year, ETFs were confronted with a steady outflow. For example, the largest and most liquid ETF, the SPDR S&P 500 ETF (SPY) saw it’s number of outstanding shares declining with roughly 20% (see chart below). The outflow implied that SPY had to sell part of its assets.

www.capitalistreview.com EFT

Investors should follow the ETF flows closely. For a part the flows are tracking the market. However, outflows indicate that money is going out of the market. Potential weakness may thus be spotted in an early phase. As for now, the trend for 2015 seems to be unfavorable. Be also prepared for extreme moves in the first 30 minutes of trading. Don’t place market orders pre-market, since these orders will be executed at very unfavorable prices. On Monday, a lot of shares and ETF’s showed abnormal price declines in the first minutes of trading, ETF’s were even traded with huge discounts to their Net Asset Value. Not soon thereafter, prices began to normalize. Don’t get caught in the wrong movement.

After the Plunge: Takeaways From The Recent Volatility

Last week saw the US stock market take some hits. The market was down sharply both Thursday and Friday. The continuing pressures from China’s slowdown and the continuing crunch in the energy sector finally came to a head Monday.

The stock market crashed Monday, with the Dow opening down a 1,000 points; a nearly unprecedented feat. Shares would recover, getting back to near breakeven around the lunch time, before lurching back into another nosedive at the end of the day.

It’s still too early to tell if we’re entering a new bear market or if this is another passing correction. Will this be another quick scare like the Ebola panic of October 2014, or is this the real deal selloff bears have been yearning for? Time will tell.

What we can take away from this has more to do with the specific market troubles this morning. The most important takeaway is that the market is still fragile, in fact, perhaps more fragile than it was in 2008.

Through lunch-time, before the market plunged again, it appeared we’d been victims of a flash crash in the morning. The sudden dumping of stocks into a bidless market really felt like some sort of high-frequency algo sequence gone bad. Were actual humans choosing to puke up stocks in the morning at such crazy prices?

Just to name a few, Baidu (BIDU), China’s $50bn internet giant found itself down more than 30% this morning. Baidu, which traded at $220 as recently as a month ago closed Friday at $150. Today, it opened way down and soon plunged to precisely $100.00 even, where it then turned on a dime and headed $40 back up an hour later.

Apple (AAPL) similarly crashed, falling as low as $92 before rebounding nearly 20% later in the day. That’s just crazy! The world’s largest company just shouldn’t see its value fluctuate anywhere nearly that much.

Other notable names included hospital operator HCA that plunged 50% in the morning, losing $30bn in value before recovering most of its losses. Mundane toothpaste seller Colgate (CL) saw shares decay 20% in mere moments. The US’ arguably leading biotech firm, Gilead (GILD) also enjoyed an inexplicable 20% collapse.

Things were equally bad, if not worse, in the ETF space. Rather vanilla theoretically low-risk ETFs such as SPDR Dividend ETF (SDY) collapsed more than 40%. Its underlying holdings weren’t down nearly that badly, but the algos got out of control and started dumping shares and hitting stop losses into a bidless vacuum.

Similarly, the S&P Buywrite ETF (PBP) also crashed more than 40%. Unlike SDY, there was no plausible explanation for this whatsoever. PBP simply owns the S&P 500 and sells call options against it. PBP, then, by definition is a slightly lower-risk investment that should just about track the S&P 500 tick for tick. And yet, when the S&P 500 was down less than 10%, PBP was on a nearly half-off sale. Pure lunacy.

What are we human investors to do in this computer algorithm-driven minefield? We need to have a plan in case of flash crash.

First things – it’s usually clear when there’s a high risk of flash crash. The market had been tanking for weeks before the big crashes started in 1929, 1987, 2000, and 2008. Even before the May 2010 flash crash, which wasn’t part of a big correction or wider economic problem, there was a solid 4% multi-day drop setting the stage for the ultimate washout.

Similarly, the large dives Thursday and Friday made it clear we were in the danger zone for a Monday nosedive. Once we were at risk of flash crash, that’s the time to consider your reaction in advance.

When you know that there’s a risk of flash crash, it’s a good time to reconsider your portfolio holdings. If you are on the fence about something, consider selling it before it potentially crashes. Better to make that decision calmly, not when you’re staring at a miserable 20% spike down on your screen.

On the flip side, consider which holdings you like most. What would you want to own more of? When Apple is at, say, 105, ask yourself, would I want to own more of this if it suddenly collapsed 10%? Set a limit order at 95, and boom, you got an awesome buy Monday morning.

Many people say it was hard to get fills buying stocks that were way down Monday morning. The people who did get the best order fulfillment were the people who had preexisting sitting buy orders on set prices. If the market trades below your limit, they have to fill you. If you’re trying to buy with the market constantly halting, unhalting, and gyrating, it is much harder to get an actual buy order concluded.

Put your buy order for Apple down 10%, Colgate down 10%, Baidu down 20%, and so on. If they hit, awesome, you got a steal and can either hold them or flip it hours later for some fast money. If the orders don’t fill, no cost to you.

And if you see ETFs that are trading below any logical price, as the dividend and S&P buywrite ETFs did this morning, buy a small amount and flip it later once the algos start pricing it right again. Just make sure you understand what’s actually in the ETF before you get into it.

To Hike or Not To Hike: The Fed’s Big Decision

This Wednesday, the Fed released its latest meeting minutes which give us a look into the their thinking on the state of the economy. Until recently, it had been assumed by most economists and analysts that the Fed would (finally) make its long-anticipated interest rate hike in this September’s upcoming meeting.

However, doubts have seeped in during recent days. First, China announced a surprise devaluation of their currency last week. While small in scale, the devaluation shows that the world economy is continuing to slow. Some are saying that China has fired the first shot in a “currency war”. Even if it’s nothing so serious, raising interest rates and applying contractionary pressure to the economy as China undermines the US’ economic position with a weaker currency could backfire.

Then, Wednesday morning, the government released new CPI inflation figures that showed inflation, contrary to expectations, had slowed substantially last month.

The Fed has a mandate to balance inflation and employment. It is supposed to encourage as much employment as possible without inflation overheating – generally a 2% inflation target is the standard. With inflation cooler than expected and below the Fed’s target, that gives it more room to delay, potentially, the rate hike until December.

And the release of the Fed minutes Wednesday showed that the Fed is wavering on whether to hike or not. One member of the Fed board is ready to hike immediately, but was willing to wait one more meeting. The Fed committee as a whole though found that “economic conditions warranting an increase in the target rate for the fed funds rate had not yet been met.”

Given that the economic momentum since that meeting which generated the minutes has been negative, I’d be surprised if the Fed sees enough evidence to feel compulsion to hike in September. So, it’d seem like the play now is to position ourselves for a no hike in September, high probability of a hike in December outcome.

For traders with a shorter-term outlook, the play here is to buy assets with high leverage to interest rate changes. Many of these sectors have already been generally beaten down in recent months, in expectations of a hike, and could enjoy healthy bounces following a Fed no-move in September.

In particular, I’m looking at REITs – such as the iShares U.S. Real Estate ETF (IYR). This fund owns a basket of real estate investment companies that make their profits borrowing at (hopefully) low interest rates and collecting rent that exceeds interest and leaves plenty for substantial shareholder dividends. Their business model works better with low interest rates. The ETF’s shares are down close to 10% since their 2015 peak, and now yield a healthy 3.6% annual dividend.

A more conservative way to play the trend is to take a look at utilities. Unlike REITs, these businesses are not so sensitive to interest rates. However, many yield-hungry investors own utilities as a bond-like substitute, since utilities tend to pay more interest than bonds nowadays but remain low risk. Since utilities are regulated businesses and customers will keep using electricity regardless of how the economy fares, these are extremely reliable businesses.

However, utility shares have fallen on concerns that rising interest rates will encourage investors to dump their utilities and buy bonds in their place. This selloff has cause shares of the Utilities Select Sector SPDR ETF (XLU) to be down close to 10% from the year’s peak as well. At present, the ETF yields a solid 3.4%.

Finally for investors seeking a more aggressive Fed play, one should consider the most beaten-down assets. Oil in particular is one place that could benefit substantially if the Fed remains on hold. Oil prices, down 60% now from last year’s peak, could rebound smartly once selling pressure abates.

While a Fed no-decision wouldn’t change the underlying dynamics for the commodity itself, the adding of more liquidity into the capital markets would encourage more risk-taking, and give more margin for speculators to try to find the bottom on oil. Particularly with bets against oil hitting extremes, the stage is set for a share reversal in the oil pits should the Fed ease up on its monetary policies in September.

Finally, foreign stocks – particularly in smaller emerging markets – would benefit from a Fed no hike. The US dollar has soared this year, causing routs of foreign currencies. This has led to panic selling of foreign shares and triggered rounds of austerity and belt-tightening across the developing world.

One way to play this would be in the iShares Latin America 40 ETF (ILF). Its shares are down from 45 to 25 over the past year, and are down 20% just this summer. This ETF would likely see a sharp rebound should the Fed not raise interest rates.

The next Fed interest rate decision will be announced September 17th. Stay tuned, there will be plenty of opportunities in the wake of their move.

It’s Time To Take A Look At Barrick (ABX)


Barrick Gold (ABX) is the world’s largest gold mining company. Despite a tremendous drop in the past years, from its all-time high around $50/share in 2011 to $8/share, it remains the biggest player in its industry sporting a $9 billion market cap.

Gold has had a rough run of it lately, falling from its all-time peak of $1900/oz down to $1100/oz today. Barrick has dropped with the tide, its high debt load being a key problem for the company’s outlook. The company’s debt is a real concern, and until recently, I felt shares were not yet a bargain.

All that changed, however, in July, as Barrick shares plunged from $10 to $7 in the space of just three weeks.

Despite the latest plunge in the share price, the company’s core business seems to be stabilizing. The company produced 1.4 million ounces of gold in Q2, and is on pace to produce about 5.5 million ounces for the year. It is producing at $895/oz all-in cash cost, leaving significant space between the cost of production and the current $1100/oz gold price. And that cash cost was down smartly from the $927 it cost the company to mine an ounce of gold in Q1.

Barrick was profitable in Q1 and lost just one penny per share in Q2 of this year; its operations are going fairly well despite the low current gold price. And the company managed to put up $525 million in operating cash flow in Q2 – a solid jump from the $316 million it managed in Q1. The company ended the quarter with $2.1 billion in cash on hand, plenty to weather any near-term storms.

Furthermore, the company is continuing to execute on its long-term turnaround strategy that will ensure the company’s survival through the current doldrums.

This strategy is focused on several points, all of which will shore up the balance sheet. The company is selling off non-core assets, it reduced the dividend, it will be cutting the long-term debt load by $3 billion, and it is reducing expenses by a hefty $2 billion target for 2016.

The dividend cut was disappointing for long-term shareholders but for new owners, it’s a clear positive. The dividend going forward will be 2 cents per quarter/8 cents per year. This amounts to a 1.2% yield, and is reasonable given the company’s current headwinds. While a dividend is nice, the real upside here comes when the gold cycle turns upward and Barrick shares double off the bottom.

Barrick is selling off assets to raise cash. The cash is being used to reduce the debt load. Already, the company has paid off $250 million in debt during the first half of 2015. And this rate promises to increase, since the company just finalized a deal that will bring them a more than $600 million upfront payment for a royalty stream on their Dominican Republic-located Pueblo Viejo mine.

Barrick gets $610 million in cash now, plus a portion of the spot price for the gold and silver produced at Pueblo Viejo. In all, the deal gives Royal Gold (RGLD), the buyer, 7.5% of the gold and 75% of the silver from the mine for the first several years of production at a sharply discounted price, and then 3.75% and 37.5% of the silver from the mine thereafter.

While this deal may benefit Royal Gold in the long run, particularly if the prices of gold and silver rise substantially, it gives Barrick a large sum of capital now which it can use to shore up its liquidity and pay off a good chunk of debt.

This royalty stream comes on top of the company’s recent move to sell 50% of its Zaldivar Copper mine in Chile for $1 billion in cash. With the price of copper plunging (it has a much uglier chart than gold), this seems like another sound move.

While cutting the dividend, selling assets and reducing headcount seem like discouraging moves, it all makes sense with a long-term perspective. As the world’s largest gold miner, Barrick is taking the painful but necessary steps to ensure its survival.

When the cycle turns – rest assured, it will – Barrick will still be the world’s most important, turning out 6 million ounces a year at less than $1,000 per ounce. Should gold turn back up to say, $1,500/oz, Barrick would be positioned most favorably to capitalize. The asset sales and dividend cut may seem ugly in the present, but in the long run, Barrick is making exactly the right moves. Buy the shares now, when the gold sector turns upward, you’ll have a big winner on your hands.