It’s been a long time coming but finally, over the last few days, we’ve had the first hints of a market shakedown. A big sell-off in US stocks was followed by a substantial uptick in volatility measures. Suddenly everyone is asking whether this is the ‘big one’?
There are certainly lots of obvious warning signs, not least in valuations and jitters in the bond markets. Analysts at SocGen have also pinpointed an interesting idea – whether increased volatility amongst distressed stocks is the ‘canary in the coal mine’. In a note today the SocGen quant team wonder whether a big uptick in vol amongst ‘low-quality stocks’ might be a useful indicator. Their conclusion?
“ …a high reading on this metric has historically been followed by negative equity returns, while low readings are followed by stronger performance (see left figure). A parallel credit-market analogue to quality is the spread on high yield bonds issued by firms of poor credit ratings, and as a market timing device, both the volatility of our Quality style and High Yield Spread appear to provide superior performance to the Fear Index.
End of January readings provided a worrying mix of signals and it is a big shame given recent market declines that we didn’t manage to publish this note on a timelier basis! End of month readings saw rapidly rising quality volatility (at 70 percentile) combined with an extreme level for VIX, but with the High Yield credit spread remaining extremely low (at 4 percentile). The rising volatility in distressed stocks, in particular, should be of a cause for concern and we’d remain cautious despite the still benign signals from credit markets as we are unclear of how much of a dampening effect will be a function of the extraordinary liquidity from quantitative easing.”
My own hunch – and that’s all it is – is that this is Not the end of the great bull market of recent months. I can entirely believe that the S&P 500 might touch a low of 2600 and that the FTSE could also slip down to as far as 7200 but that’s at far as I’d go. This feels more like the markets taking some profits and allowing itself something of a breather. Crucially I’ve run into countless numbers of investors who’ve been looking for a buy on the dips opportunity. Arguably this might that moment. If on the other hand, you think this really is the start of something much bigger, have a look at SocGenis Infinite Turbo ticker MF60 which has 12 times leverage on the downside. Over in their covered warrants side, SC11 with 25 times leverage on the downside is probably worth a look although personally as the week drags on I’d be more tempted by SC14 with its 25 times upside leverage.
Looking back to the core 12 months view, I’m still cautiously bullish with a target of 3000 for the S&P and 8000/7800 for the FTSE 100, with a proper slowdown and financial panic set for some time in 2019 – probably caused by some completely unforeseen political crisis.
Talking of buying on the dips, I’ve found myself drawn to PayPal. Its had a bad few days after eBay announced it was dropping the payment platform. I can’t say I was entirely surprised by this and I’ve long wondered why the auction platform gives PayPal such a prominent position now that it is a separate business. But I’d be tempted to buy at this point because I think it will make zero long-term difference to the PayPal model. It’s nicely positioning itself as the payment platform of choice globally with a host of extra features for both sellers and buyers. In my view, it’s the premier global fintech payments platform that everyone has to beat. Although I think we’d struggle to regard its shares as cheap, it is an obvious global tech leviathan with a deserved premium rating. Buy on the dips as they say.
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