Morning Comment: So Many Holes in the Dike

We all know that the big story in the market place yesterday was the crash in WTI crude oil for May delivery. There is no question that there were some key technical issues that were involved, but the move into negative territory (deeply negative territory) had to do with the fact that some traders did not want to take delivery of oil. The simple reason for this is that they had no place to put it. The reason they had no place to put it is that demand has completely fallen off a cliff. In other words, to some degree, the explanation for yesterday’s historic decline was quite complicated…but to another degree, the explanation was relatively simple.

Very simply, the action in the oil market yesterday was an important signal of how much the global economy has shut-down. No, oil should never trade below zero, but the fact that it can (and the fact that Brent crude has fallen significantly this morning) shows just how much demand has collapsed.

However, yesterday’s action in WTI goes well beyond that. It also tells us how many different markets have become incredibly fragile. Actually, the fragility of the global market-place first started to become evident several months before the healthcare crisis began. This took place when the Fed had to come-in with their “not QE” QE program…in order to stabilize the repo market. Since then, we’ve seen an assorted number of markets act in a way that made them seem at least somewhat broken. This was especially true in several credit markets before the Fed came to the rescue (once again) with a variety of programs last month…and it became evident once again yesterday in the oil markets……We just believe that when so many different markets are disrupted in such a meaningful way…so close together…it’s not a good sign at all.

Therefore, it is our opinion the huge moves we’ve seen IN MANY DIFFERENT MARKETS over the past few months is a significant reason for concern. On top of the signals they’re sending, we also worry that the major declines we’ve seen in so many different markets will cause more problems down the road….and history tells us that this is almost always the case.

Think about it, when the stock market declines 15%-20%, only the investors who were wildly leveraged feel serious pain. Everybody else does feel SOME pain, but nothing they cannot bounce-back from. However, when an asset falls 25% or more, it not only inflicts serious pain on all leveraged investors, it also inflicts it on non-leveraged investors. More importantly, it inflicts severe pain on leveraged companies as well.

The biggest problem is that the pain is SO serious when these mega-declines take place that many of the leveraged investors and leveraged companies cannot recover from the fallout from the massive declines. However, those repercussions tend to come at some point AFTER the initial decline. In the initial decline (the first “wave” that we keep talking about), it’s the highly leveraged investors who get clobbered. The next wave lower comes when the companies and their lenders get whacked. It takes a little time for this to happen, but when it becomes obvious that these highly leveraged companies (and investors) cannot patch all of the holes in the dike, the next wave hits. Again, this take time, but there always seems to be a second wave of selling when the first wave of selling is something more than just a deep correction (when the initial sell-off is more than just 15%-20%).

That second wave of selling includes some more leveraged investors (the ones who weren’t as wildly leveraged as the first batch we talked about)…as well as the investors who tried to bottom fish after the first wave of selling. It also includes the ones who never sold on the first decline…and finally decide to throw-in the towel. However, the catalyst tends to be the realization that the initial sell-off…the one that was much more than just a deep correction…did a lot more damage to the foundations of many companies (and thus the economy & the markets) than people originally realized. Therefore, it becomes inevitable that another wave of selling takes place.

What we’re trying to say here is two fold. First, when many different markets become very volatile at the same time (or at a time very close to one another), it signals that something is wrong in the system. Frequently it means there is too much leverage in the system which needs to be unwound…..Second, when the markets fall hard…in a way that can be seen as something more than just a correction…there is almost always another shoe to drop…once it becomes obvious that leverage used by too many investors and too many companies had made it impossible to fix their problems.

Therefore, yesterday’s historic crash in crude oil…even though it only took place in the front month…is another example of how the markets today are very much like a “weak dike” during a flood. It keep springing leaks in a new place……..Like those weak dikes, it sure seems like the financial markets are very weak right now. In other words, even though there are some very legitimate reasons why the crash in the oil prices for May delivery yesterday did not reflect the real situation in the oil market right now, the real situation in the oil market right now is still dismal! Therefore, the action in WTI yesterday is yet another example of just how messy the current financial situation is around the globe!!!

When it comes to the significant declines we have seen in so many different markets, there are only so many times when you can say, “yeah but,…….” Yes, maybe the Fed’s massive stimulus programs and Washington’s fiscal measures can plug all off the holes. However, if history is any guide whatsoever, there are going to be a lot more holes that spring leaks before this crisis is over…and many of those holes will be bigger than some of the ones we’ve seen so far. In other words, caveat emptor.

Matthew J. Maley

Managing Director

Chief Market Strategist

Miller Tabak + Co., LLC

Founder, The Maley Report

275 Grove St. Suite 2-400

Newton, MA 02466


Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.

Posted to The Maley Report on Apr 21, 2020 — 8:04 AM
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