Total Capitulation

Total Capitulation

This has been going on for a while. US innovation stocks, Chinese tech stocks, and ultra-growth stocks have all been going down relentlessly for a year.

Have we reached capitulation?

If we haven’t, I think we’re close.

Monday was an interesting trading day:

  • Stocks were down
  • Bonds were down
  • Commodities were down
  • The dollar was down

Cash, of course, was unchanged on the day.

Usually, when you see stuff like this, you know we are getting pretty close to the bottom. That and all the pain and pleasure on Twitter.

As I am fond of saying in my newsletters, trends can continue a lot longer than you think, to the point where prices get ludicrous. I think we are there now with tech. We’re getting to the point where some of this stuff is legitimately cheap, which is hard to believe. Some of these names are trading at less than 50% of their 200-day moving averages, which is always a useful gauge.

I confess to dipping a toe in this stuff last week, and it hasn’t been fun so far.

But it is the move in the bond market that has me worried. Usually, when the stock market is under stress, bond yields drop. This time, they are rising. And we are experiencing the beginning of an echo of the 1970s, an environment of high inflation, where stocks and bonds were both big losers and commodities were big winners.

Commodity prices have gone ape in the last few weeks. Could they go even higher? I suspect it is possible.

You have probably heard of something called the economic misery index, which is unemployment plus inflation. Yes, that is a measure of economic misery, and we are experiencing it on the inflation side. But there is another way to measure economic misery—the ratio of financial assets to hard assets. Financial assets (stocks and bonds) are the things we want, and hard assets (commodities) are the things we need. When the price of things we want is going down, and the price of things we need is going up, I would define that as economic misery. We are becoming less rich as things get more expensive. To my knowledge, no one else has created such an economic misery index. I tried to construct one in 2008, without much success. But this is the source of the pain we are experiencing.

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But Is It Really Pain?

The CBOE Volatility Index (VIX), incredibly, is still in the low 30s, and while corporate bonds have experienced a small amount of selling, corporate credit remains incredibly tight. It is hard to call a bottom until you get some panic in volatility or credit.

Still, there is an exception to every rule.

Some people take solace in the fact that even though the S&P 500 is down about 10% and the Nasdaq-100 is down about 20%, a majority of names within the indices are down 50% or more. If you’re just looking at a chart of the S&P 500, you would never know we’re in a bear market. But if you look at the average hedge fund (or individual investor’s) portfolio, it’s much worse than that.

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One little-known fact about me—I am capable of withstanding an enormous amount of financial pain. Sometimes this is an asset, and sometimes it is a liability. If I am undisciplined about a trade, I can frequently wait it out until it goes in my favor, over a period of years, after taking a drawdown of 50% or more. This is true of most investments—if you wait long enough, they will eventually go in the money. Sometimes this is good, because I can give a trade time to work without panicking out of it after a 5% loss.

I think this comes from:

  1. Growing up poor, so money is an abstraction
  1. Working on the sell side, where taking losses is an art form
  1. Not really being motivated by money

I am forced to have more discipline in my newsletters because of the potential for reputational damage. I may be able to ride out a 50% drawdown, but I can’t ask my subscribers to do that—even if I think it makes the most sense.

Anyway, this is all a roundabout way of saying that I think we’re close to a bottom. I hope so, because I already dipped a toe. The irony of all of this is that the best place to be in the last few weeks has been cash. Even with 8% inflation.

Hey look, if the Fed really starts raising rates, you might be able to get some yield out of T-bills on Treasury Direct. Remember the days of 14% money market yields back in the late 1970s? We could be headed back there.

Jared Dillian


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