VIX: A Correction Fireside Chat by Jared Dillian, Mauldin Economics
I don’t really enjoy these things like I used to. Keep in mind, I’ve traded through a lot of blowups, going back to 1997.
They all kind of feel the same after a while.
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Nobody wins from corrections except for the traders, which today mostly means computers. I forget who said this: “In bear markets, bulls lose money and bears lose money. Everyone loses money. The purpose of a bear market is to destroy capital.”
And that’s what is going on today.
For starters, long-term investors inevitably get sucked into the media MARKET TURMOIL spin cycle and puke their well-researched, treasured positions at the worst possible time.
But I’m not trying to minimize the significance of a correction, because some corrections turn into bona fide bear markets. And if you are in a bear market, you should get out. If it is only a correction, you probably want to add to your holdings.
How can you tell the difference?
My Opinion: This Is a Correction
So what were the two big bear markets in the last 20 years? The dot-com bust, and the global financial crisis. Two generational bear markets in a 10-year span. Hopefully something we’ll never see again. In one case, we had the biggest stock market bubble ever and in the other, the biggest housing/debt crisis ever. Both good reasons for a bear market.
What are we selling off for again? Something wrong with China?
Again, not to minimize what is going on in China, because it is now the world’s second-largest economy. Forget the GDP statistics. After a decade of ridiculous overinvestment, it is possible that they’re on the cusp of a very serious recession, whether they admit it or not.
But the good news is that the yuan is strong and can weaken a lot, and interest rates are high and can come down a lot. China has a lot of policy tools it can use (unlike the United States).
Let’s think about these “minor” corrections over the last 20 years:
1997: Asian Financial Crisis
1998: Russia/Long-Term Capital Management (LTCM)
All of these were VIX 40+ events.
In retrospect, these “crises” look kind of silly, even junior varsity.
The Thai baht broke—big deal.
Russia’s debt default was only a problem because it was a surprise. And the amount of money LTCM was down—about $7 billion—is peanuts by today’s standards.
After 9/11, stocks were down 20% in a week. The ultimate buying opportunity.
And in hindsight, we can see that the market greatly underestimated the ECB’s commitment to the euro.
So what are we going to say when we look back at this correction in 10-20 years? What will we name it? Will we call it the China crisis? I mean, if it’s a VIX 40 event, it needs a name.
I try to have what I call forward hindsight. Like, I pretend it’s the future and I’m looking back at the present as if it were the past.
My guess is that we will think this was pretty stupid.
What to Buy
I saw a sell-side research note yesterday suggesting that this crisis is marking the capitulation bottom in emerging markets. I haven’t fully evaluated that statement, but I have a hunch that it is correct.
China is cheap, by the way. But if China is too scary, they are just giving away India. I literally cannot buy enough. And I have a hunch that Brazil’s president, Dilma Rousseff, is going to be impeached and the situation in Brazil is going to improve relatively soon.
Think about it. The most contrarian trade on the board. Long the big, old, bloated, corrupt, ugly, bear market BRICs.
Also the scariest trade. But the scary trades are often the good trades.
There’s more. If you think we’re in the midst of a generational health care/biotech bull market, prices are a lot more attractive today than they were a few weeks ago.
I also like gold here because central banks are no longer omnipotent.
That reminds me—there was something I wanted to say on China. The reason everyone hates China isn’t because of the economic situation. It’s because they made complete fools of themselves trying to prop up the stock market. So virtually overnight, we went from “China can do anything” to “China is full of incompetent idiots.” Zero confidence in the authorities.
You want to know when this crisis is going to end? When China manages to restore confidence.
When they have that “whatever it takes” moment, like Draghi.
If they keep easing monetary policy, sooner or later there will be an effect.
I Am Bored
I used to get all revved up about this stuff. That’s when I made my living timing tops and bottoms. I don’t do that anymore. I do fundamental work, and I go to the gym and play racquetball. The mark-to-market is a nuisance.
Also, if you can’t get excited about a VIX 50 event, you have probably been trading for too long.
There is a silver lining. The disaster scenario, where the credit markets collapse due to lack of liquidity, isn’t happening. Everyone is hiding and too scared to trade.
Honestly, high-grade credit isn’t acting all that bad. And it shouldn’t. I don’t see any big changes in the default rate.
Anyway, if you want to go be a hero and bid with both hands, be my guest. It’s best to be careful and average into stuff. These prices will look pretty good a couple of months from now, I think.
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