I slept badly last night. I was worrying. Was I worrying about global stock markets crashing or about whether the robotic lawnmower was finally going to do the bits it seems to chronically forget? Actually, it was neither but then who cares either way? I spent 35 years at the sharp end of markets, and I have seen it all before. The problem when markets go haywire – as they are doing at present – is that most folks have never understood that they are not some abstract mythical monster with tentacles but are the reflection of the actions of the collective of people who trade them.
There is a huge difference between trading and investing, about whether one is a “real money” or a “leveraged” player. I am retired from the markets, have a few investments on which I intend to live until I shuffle off to the great hunting grounds in the sky. I am not a trader, have not borrowed any money in order to buy what I hold in my portfolios and am therefore reasonably sanguine about, pardon the pun, the blood on the streets. I spoke to one of my investment managers this morning – I have my SIP with one firm of pension managers and a small portfolio with an old-school London stockbroker. I say sanguine because even if I panicked and instructed my man to sell everything, I’d still be lumbered with a pretty chunky capital gains tax bill as most of my holdings predate the recent stock market rally which I, along with most of my peers, have for some time been eying with considerable suspicion.
Most investors, especially private ones, have the habit of believing that the highest price at which any one of their holdings was once marked has to have been the right one and that anything below that is a loss. It is not. Markets in all asset classes, but especially in equities, have the habit of overshooting to the upside as much as they overshoot to the downside. Meaning the reality of what an asset really is worth is most likely somewhere in the middle.
The problems occur when traders have borrowed to buy and have pledged the asset that they have purchased as security against the loan. Banks assess the price volatility of an asset and then decide what percentage of its purchase price they are prepared to lend. If, as and when the market price falls below the level at which the bank believes the security to no longer suffice to secure the loan, it will ask for either the loan to be immediately repaid or for more security to be posted against the loan. In the trade, that call for more security is known as a margin call. If the borrower who is also the owner of the asset doesn’t have enough cash to “post margin”, then either that stock will have to be sold or some other stock will have to be sold instead.
When everybody who is overleveraged has to sell into a market which is already replete with sellers and there is nobody there who wants to “catch the falling knife”, we get a sharp downturn, like the one we are currently experiencing. Markets had over the past months, and especially on the back of the AI frenzy, priced themselves to perfection. In other words, they had gone full-Panglossian in assuming that the AI revolution was going to make everything wonderful.
Warnings of the possibility – or even probability – of a recession in the US economy have been there for a long time but markets have an annoying habit of only focusing on the indicators that suit the mood in which they are. That interest rate policy is not only a function of inflation but also of the economic cycle was something that few in markets had been willing to see.
That said, the Global Financial Crisis was not accompanied by a recession and the one that should have followed from the Covid-19 pandemic was suppressed by the legendary ZIRP and NIRP, the zero and the negative interest rate policy period.
There has not been a natural cyclical recession since before the millennium as a result of which most market participants have never actually seen one. The current senior management generation is in its mid-40s and so only just in graduate training when the last big equity crash – the one that hit the dot.com bubble – last visited. They are the ones who rallied markets in the belief that it is central banks’ prime objective to keep stock markets buoyant. And who can blame them? For the past quarter of a century, that is all they have known.
There are dozens of explanations as to why we have suddenly found ourselves in this downdraft and questions abound as to whether this is the beginning of a prolonged period of declining stock markets. It’s the Bank of Japan tightening too late and the yen appreciating. No, it’s the Fed easing too late and the dollar declining. It’s public sector debt. No, it’s private sector debt. It’s the prospect of a Trump Presidency. No it isn’t, it’s the prospect of a Harris presidency. It’s too much AI. No it isn’t it’s not enough AI.
It is none of these and all of them. Above all it’s August. The markets are thin and relatively small amounts of selling can launch a disproportionately fierce avalanche. The tectonic plates are shifting and there are earthquakes and volcanoes breaking out. But the continents are not about to fall apart and sink into the sea. Some overleveraged and overly long portfolios are going to get badly beaten up, but the sun will continue to rise in the East and set in The West. We shall all live to fight another day.
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