The Market Panic Playbook

As long-time readers are no doubt aware, I spend a healthy amount of my day trying to decipher the drivers of the daily market action. In short, whenever markets start to move quickly, I make it my business to understand why. My thinking is if I can stay in tune with what markets are doing and why they are doing them, it is easier to stay on the right side of the primary trend - and I am unlikely to be surprised when trends and/or market regimes change.

This is especially important when big moves happen fast. Experience has taught me that downside volatility from a few sell programs during the day doesn't usually mean much. But when volatility suddenly surges and prices move down in a violent fashion, there is usually a reason.

It doesn't matter "what" the reason is. And I most definitely don't feel a need to agree or disagree with said reason. For me, since markets are an "it is what it is" business, my opinion is not needed or warranted. I simply must be able to understand why the bots are doing what they are doing.

I find this approach is especially helpful when the market gets into a panic, such as we saw last week. Suddenly and without warning, stock prices were plunging, and bond prices were surging. This combo was like a beacon requiring my immediate attention.

So, it was time to implement my "panic protocols" - I.E. my playbook for big, bad events in the markets. Here's the way it works. Step one is to identify the cause of the volatile movement. Step two is to determine if the cause is fundamental or technical. And from there, we have to decide if there is any change to the macro picture. Finally, you need to watch the price action and be ready to identify a wash-out phase.

In this case, there was no obvious news to react to. No inflation report. No surprise Fed announcement. Nor any new wars cropping up. Not even a big miss by a company such as NVDA. So, we had to dig deeper.

What stood out quickly was an historic plunge in Japan. The major indices fell 12.5% overnight and were down around 20% in three days. What the heck? Hadn't Japan just made fresh new all-time highs for the first time since 1989? Things were supposed to be going well in the land of the rising sun.

Naturally, the next question was, why were Japanese stocks crashing? Sure, the Bank of Japan had surprised everyone with a small rate hike, but that by itself didn't seem to warrant a 20% decline.

So, we looked around. And before long, there it was. The Yen. More specifically, the Yen-Carry trade. The surprise rate hike had ruined a "trade" that the hedgies had been using for ages in a VERY levered way. You borrow in Yen and buy the mo-mo names. But with the BOJ move, all of a sudden, the no-brainer trade was a loser. As such, it was an "EVERYBODY OUT OF THE POOL!" moment.

Yes, there were other factors involved such as the jobs report stinking up the joint and new tensions in the Middle East. And with prices crashing, the bears started singing their recession song again. But anybody with a brain knew this was silly. Thus, at least early last week, there didn't appear to be anything "fundamental" happening. Traders were simply dumping the leaders (aka selling what was easiest to sell) in what felt like an indiscriminate fashion.

So... Given the inputs, we decided this was a "trading" or technical situation, not folks changing their macro or fundamental outlook. For example we didn't feel there was anything happening that would negatively impact Microsoft's (MSFT), Alphabet (GOOGL) or Meta's (META) earnings.

This brings us to the final rule of big, nasty market events, which is an oldie but a goodie: "Panic early or not at all!"

Since we deemed this not to be a fundamentally based event and nothing had happened to change our big-picture outlook, we chose the latter. And despite some technical levels breaking down and momentum sell signals, I felt it was best to largely stand pat.

At times like these, it is important to remember that pullbacks/corrections are a normal part of a bull market's stair step march higher. Two steps forward, one step back. And according to BofA, history shows the S&P 500 pulls back by 5% or more three times a year on average. And the S&P falls by 10% or more about once a year. As such, one should keep in mind that pullbacks are part of the game.

It is also important to recognize that stocks were already primed for a pullback, a correction, or what I like to call a "sloppy period." The market was very overbought. Sentiment had become entirely too rosy - especially regarding those much-loved AI names. Seasonality tailwinds had turned to headwinds as historical cycles favor the bears at this time of year. Systematic strategies needed to rebalance. The AI trade was stretched and fully owned by individuals and hedgies alike. The corporate buyback window was closed. And both the S&P 500 and NASDAQ 100 indices had run an awfully long way in a short period of time, putting them well above their normal trend lines.

Thus, the setup was there - and everybody knew it. So when the first wave of selling hit, anyone in a position to buy simply sat on their hands and waited. Waited for the forced selling to end. Waited for the "unwind" to be complete. Waited for the dip to become large enough to buy.

Although the jury is still out whether or not this "sloppy period" will last a while longer, it does appear that the dip buyers (including yours truly) are alive and well. For now, anyway.

Thought for the Day:

Kind words can be short and easy to speak, but their echoes are truly endless. -Mother Theresa

Wishing you green screens and all the best for a great day,

David D. Moenning Founder, Chief Investment Officer Heritage Capital Research, a Registered Investment Advisor

Market Models Explained

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: NVDA, MSFT, GOOGL, META - Note that positions may change at any time.

NOT INDIVIDUAL INVESTMENT ADVICE.?IMPORTANT FURTHER DISCLOSURES

?