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The Real Reason the Fed Cut Rates Again (And Why It’s NOT the Time to Start Buying)

3 | By Shah Gilani

The Forecast for this week is “dire.”

Investors have been sold a bill of goods by most analysts and the media, and worse, by their brokers and financial advisors.

The Capital Wave Forecast’s been warning subscribers that “this time is different,” and rallies, especially big jumps like we saw on Friday, are nothing but “dead cat bounces.”

It’s not just bad, it’s worse than people realize.

Futures this morning were “down limit,” meaning they were down more than 5%, and stopped trading.

When exchanges opened at 9:30, they hit their first circuit breaker, which is a tumble of 7%, in a minute.

Think about that. The S&P 500 fell more than 7%, it fell more than 9%, in seconds after markets opened, and it’s because there were no bids, or very few bids (bids are prices buyers are willing to pay, at lower levels) and tons of offers, meaning sellers flooding exchanges with market orders, which pushes stocks down to wherever those few bids are. Since there were no bids, or only a few at much lower levels than where stocks closed, the drop was literally “indeterminable.”

Think flash crash, only it could be a series of flash crashes we might have to endure in the weeks, maybe months ahead.

I hope that’s not what happens, but, based on the internal mechanics, meaning how exchanges actually process orders, how orders come and go, and the net effect of years of mechanical changes, there are almost no “standing orders.” Standing orders are bids (important because bids represent levels where investors are willing to buy and stem falling prices). No waiting bids means falling prices.

Exchanges halt trading for 15 minutes, then they open again. The next circuit breaker is 13% down, if, when, we get there, exchanges halt trading for another 15 minutes.

If stocks drop 20%, exchanges stop trading for the rest of the day.

What’s bad, obviously all predicated on the economy in the U.S. slowing and probably coming to a stop, a la China, which closed down cities and quarantined more than 46 million people (probably a lot more), like Italy and Spain, and elsewhere, is that no one knows when this will end, no one knows how bad the virus’ impact is going to be on humans and markets.

Last week was frightening.

Everything bad that could happen in markets, essentially happened.

While it looked bad on the surface, with equity markets down about 10% on the week even after Friday’s almost 10% dead cat bounce, underneath, things were worse.

Bonds were all over the place, dangerously so.

They traded as if they were penny stocks. They jumped then collapsed. Yields on Treasuries went down then exploded higher, that’s crazy. The 30-year Treasury bond’s yield went from below 1% to 1.79%, seriously, that’s insane. The yield fell back down to end the week at 1.35%. It would take an entire article to explain how actually insane that is, how devastating that is for bond traders, for institutional investors. Crazy.

High-yield bonds collapsed. They’re not done going down, by a long shot.

Gold collapsed. Why? Because instead of being a safe-haven, gold assets got sold by investors because they had to sell to meet margin calls, and gold was just another “asset” that had to be sold. As its price fell, more investors who thought it would hold up, sold.

Bitcoin, and the other silly cryptocurrencies that are nothing but speculative vehicles, got hit too. That’s proof that these cryptocurrencies are nothing more than toys at this point in their short lives.

Oil collapsed. And it’s not done tanking. What’s scary there is how governments are affected, entire countries, regions, not just companies.

The biggest hit to markets, and that means all of them, equities, bonds, commodities, was selling by massive risk-parity funds.

Risk parity is a portfolio management system, usually a computer programmed system, that weights portfolio assets by their volatility, by how risky they are based on their volatility. Portfolios are stuffed with less risky investments, where less risky also means less volatile, where volatility actually means the possibility of greater loss and the possibility of greater profit, because volatility goes in both directions.

Since risk parity portfolios are designed to be less risky, in order to make better returns they leverage up their holdings of less risky assets with borrowed money, a lot of borrowed money. By leveraging their portfolios, managers reap better returns.

But, when volatility explodes, across all asset classes, as it has been, as it did especially last week, risk parity funds automatically start “rebalancing” and sell assets whose volatility is increasing. If everything’s volatility is increasing, these giant fund managers are selling all kinds of assets. And they’re not done.

Their selling knocked down prices, caused margin calls, and ignited a negative feedback loop that’s far from over.

The real reason the Fed lowered the fed funds rates again, this time to zero, is big, leveraged funds are in trouble. Banks that lent to them are in trouble.

There’s trouble everywhere.

This is NOT the time to start buying.

That time will come. But probably not for a couple of weeks or more likely, months.

Sincerely,


Shah

3 Responses to The Real Reason the Fed Cut Rates Again (And Why It’s NOT the Time to Start Buying)

  1. randy a says:

    maybe years. u may not think bitcoin is such a toy if people lose faith in the dollar & it becomes dethroned as the worlds reserve currency. everybody gets wet in a tsunami.

  2. John Purinton says:

    Shah, Thank God you are there with your great explanations ! Everyone else is trying to sell me something.

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