Last week we talked about the most important thing to master – your emotions.
This week’s lesson is…
…never be forced to act.
About 15 years ago, we were on the floor of the NYSE trading gold stocks. There was a CEO of a South African mining company who had gotten a bit out over his skis when it came to risk. His bankers were now demanding that he pony up more capital. Word got around the street that this chap was in dire straits and he had to offer 5 million shares of a rival gold company that he owned in order to raise capital. In the meantime, the price of the mining company had been driven down by short sellers who knew his situation. He was now forced to sell at an artificially low price. We were the lucky buyers that day as we bought 20% of his stake. Suffice to say that we were very happy over the next several weeks as the stake that he was forced to sell us tripled in price.
The mining CEO had over leveraged himself and was forced to sell at the lows. There are all kinds of ways we can get forced into action when investing. We never want to be forced into action. Chinese investors learned that lesson last week.
After the Lunar New Year, Chinese authorities shut down access to markets for 10 days due to the coronavirus. When markets did reopen, most stocks were Limit Down. Limit down means that for all intents and purposes only buy orders are accepted. You cannot sell below the prescribed limit down. What happens if you really need the money? You have to wait until the next trading day and hope they are not limit down again. The further the price falls, the more shares you, and everyone else, will need to sell. One thing we learned in the GFC of 2008 – anything is possible. Think the unthinkable. Markets could stay closed for days. ETFs could fall below the price of their value as sellers overwhelm buyers in search of liquidity. China’s lesson is our lesson.
Markets are not efficient. They do not seek price equilibrium. Markets seek extremes. Markets are like teenagers. They will seek the limits to which they can push. Market regulators seek to decrease volatility. Decreasing volatility only increases the chances of a Minsky Moment as markets, seeing little risk, push the outer limits. Much like a controlled burn helps limit forest fires moves lower in asset prices create a respect for risk. We haven’t had a controlled burn in some time. Markets are pushing limits, thanks to central bank policy from China to the US. This year’s action in Tesla (NASDAQ:TSLA) is one clue. Tesla is up 78% YTD! Tesla is now worth more than Ford Motor (NYSE:F), General Motors (NYSE:GM) and BMW (OTCPK:BMWYY) COMBINED!
Bonds and gold are still outperforming the S&P 500 YTD. We are watching copper and the debt markets. Copper is the global economic barometer and traded lower for 13 straight trading days. It has bounced off of its lows, but it indicates that there is a serious slowdown in the world economy. The coronavirus is having an impact on global GDP. Supply chains are being disrupted. If this goes on through next week, companies will begin to report problems. The market may very well ignore it as a onetime problem but debts need to be paid, and there is a large amount of debt needing to be rolled over in the next 24 months. Companies have taken on debt and used it to buy back corporate stock. They may have painted themselves into a corner. Never be forced to do something. The coronavirus may be what they didn’t see coming.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.