There are many reasons to get a little bullish today.
Let’s talk first about where we are and then talk about where we are heading.
So, why did the market drop? The recent market blow-off has been quite breathtaking: the S&P was down -10% in 2 months. Facebook down -35%! Amazon down -22%.
I still don’t know what triggered the drop. It seemed more technical based instead of fundamental based.
That is to say, yes, the market was overbought and ripe for a pullback… but a drop of 9%?
You may cite the trade war, tax loss selling come early, some disappointing forecasts… but most of that was already priced in.
One thing I do know: this was a massive margin call. And it appears to be over.
In a previous report, I walked through the use of margin (aka debt). Basically investors borrow from investment banks using their current assets as collateral.
This is a good thing in a bullish market: the underlying collateral assets rise in value – enabling more borrowing – and the newly purchased assets also rise in value.
Investors can borrow at 1% per month and watch their portfolios grow 3% or more. (This is simplified, but it’s basically 2% on the underlying asset and 2% on the assets bought on margin, minus the 1% borrowed). This is market beating that makes for big bonuses yearend by Wall Street and hedge funds.
But being over-leveraged is bad when the market turns bearish. It forces fire sales at prices the holder didn’t want to sell at. But their brokers are forcing them to sell to meet the margin calls.
Which then pushes the market down. Causing more margin calls. Rinse and repeat. Banks are calling in IOUs and the borrowers must cover them immediately.
Evidence of extreme margin calls
When you have to sell, sell your most profitable assets to lock in gains.
Amazon was up 80% for the year before this October-November drop. Apple was up over 30%.
In other words, the companies that seem to have been most decimated are also the companies that had some of the biggest runs.
Bitcoin (BTC) was another target for slaughter.
Demand for BTC has been steadily falling – if demand is defined as volume purchases. Worse, anyone who bought and held BTC in the last 16 months is now losing money. Not a lot of people are buying into it. And that makes a sell-off more powerful.
But the biggest evidence of margin calls is in the margin debt data itself.
Margin debt is tracked by FINRA and it peaked in July. It pulled back a bit before outright collapsing (-6%) in October. November was probably more of the same (waiting for the data).
It’s very simple: buyers had turned into net sellers.
I don’t know if we have bottomed. But I know we’re at or close to a short-term bottom. The markets are up 4% since November 23rd.
There are finally more buyers than sellers.
With the margin calls over, the worst of the selloff is here. (There could be more as year-end approaches, but that’s more individual than institutional.)
I think you’ll see pension funds and other big institutional buyers jumping in at this time of year.
Remember, a bull market is simple. There are more buyers than sellers.
Another reason to be thinking bullishness: future prospects look brighter.
China still hasn’t capitulated, which has added risk to the markets. But they will. And when they do, it’s back to business and a serious market surge.
Editor of Moneyball Economics
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