It’s a financial cliché that bull markets end with a bang, not a whimper.
Like a rollercoaster taking a dive after it’s reached its highest point, markets past their peak can drop hard and fast.
Once the market sells off, investors scramble for the exit as they all hope to get out as close to the top as they possibly can.
Then other investors panic. They see their assets rapidly lose their value and want to get out too. This only serves to reinforce the downward pressure on the market.
But, to utter the four most expensive words in the English language according to Sir John Templeton, this time it’s different.
The longest bull market in Wall Street history doesn’t seem to end with a bang. The market resembles a balloon that slowly deflates rather than one that goes pop.
Even though 40% of S&P 500 stocks are already down more than 20% from their peaks, there’s no real panic. It seems plenty of investors still think it’s a bull market blip instead of a bear market.
The absence of panic is why we might have to call this year’s sell-off a stealth crash.
For the past 10 years, Tina was queen of the stock markets.
Tina, you say?
“There is no alternative.”
Ideally investors diversify their portfolios so there’s a good mix between risk and reward.
Tina shows up when there aren’t many good investment options around. Investors don’t diversify as much as they’d like. They might heavily tilt their portfolios towards stocks because other asset classes offer much worse returns.
The Tina effect is when stocks rise only because there’s no viable alternative. It’s one of the reasons why stocks have done so well over the last decade.
Lower-than-low interest rates made cash yield next to nothing. Bonds offered worse returns. Investors were held hostage in a low-return environment with stocks the best option on offer.
That’s changing now. Alternatives to stocks have become more appealing of late.
It’s not such a bad thing that investors get more options to invest their money and don’t inflate the stock bubble any further.
Bond yields have gone up because the Federal Reserve has been hiking interest rates. Government bonds in general, and US Treasuries in particular, are considered a relatively safe investment.
People are getting worried about stocks because the bull market has never lasted this long, precisely at a time when returns on bonds are going up…
It’s not so strange, then, that investors are taking some money out of the stock markets and put it into bonds. They’re diversifying rather than panicking about stocks.
Another explanation for the stealth crash in stocks (a sell-off minus the widespread panic) is that not every investor is convinced yet that we’re headed for a bear market.
Yes, markets have fallen. But as long as they haven’t breached the psychological barrier of a bear market yet (a 20% drop from the market’s peak), plenty of investors will still believe/hope/pray it’s just a temporary setback.
The biggest losers in the market over the past weeks have been technology stocks. But it’s precisely the stocks in this sector that reached dazzling heights earlier this year.
The argument that this is merely an overdue correction of overvalued stocks is not so crazy.
An unkindness of ravens
An alternative reading of the signs, however, leads to a more troubling conclusion…
It’s fine for investors to diversify if other asset classes get better returns. But if investors are dumping stocks because stock yields are getting worse, that’s worrying.
For about a decade, cash hasn’t been popular with investors because it had no yield.
That might change soon, notes CNBC:
“Investors can now turn somewhere they have not been able to for a long time as stocks stall out: cash.
“Yields for cash are higher today than for 60 percent of S&P 500 companies.”
Cash outperforms more than half of America’s 500 biggest publicly listed companies? Uh-oh.
US Treasuries, too, are getting more popular for the wrong reasons.
Rather than diversifying, there’s reason to believe investors are losing confidence in the markets. That’s why they’re fleeing to a safe haven asset, like US government bonds.
What makes me say that?
Well, economists are getting nervous because the yield on short-term bonds is edging closer to the yield on long-term bonds. This is called an inverted yield curve.
The bigger the yield gap between two-year Treasuries and 10-year Treasuries the better. If this gap narrows, it means investors are growing pessimistic. They think risk in the market is going up so they demand a higher reward.
Recently spreads between short-term and long-term Treasuries shrank to lows not seen since before the 2008 crisis. An inverted yield curve is a sign that the winds are turning. It’s typically followed by a recession.
Investors increasing their cash position and narrowing spreads between short-term and long-term bonds are the market equivalent of a flock of ravens – an unkindness – crossing our path.
Still, the stealth crash of 2018 implies there are still plenty of investors around who won’t panic until the stock market officially wanders into bear territory.