There is blood in the streets in capital markets the world over. Bitcoin is down over 20% in less than one week. Long-term US Treasuries are now firmly entrenched in bear market territory. The stock market saw an incredible reversal last week after the FED's announcement with the S&P 500 closing Monday 7% below Wednesday's high. I read on CBS Marketwatch that last Thursday's reversal saw unprecedented damage to "market internals" suggesting more downside is possible - and today is confirming that.
The question I have heard several times is "what is behind the rapid and widespread decline in the markets?" Typically, when markets decline, there are three culprits: Deleveraging, Deflation/disinflation or Devaluation.
I am afraid the overwhelming evidence points to a bout of deleveraging. Deleveraging is a market state where anything that can "catch a bid" is liquidated to cover losses in the worst-performing sectors. As I watch the markets, I am seeing Safehaven plays like gold, corn, and oil move in lock-step with the US equity markets. And the most plausible explanation for this is deleveraging. There is plenty of evidence to support this development and plenty of evidence to rule out the other possibilities.
We can rule out Deflation or at least disinflation as the bond markets have continued to lead the stock markets lower. US Treasuries are experiencing a little bit of a reprieve today but only after suffering large losses last week. Further, corporate bonds, REITs, and other fixed-income plays are seeing big drops today following large declines last week thus suggesting the current market activity is not due to disinflation. Today alone, REITs fell over 4%. If the markets were looking forward to inflation pressures subsiding, interest rates would be falling and not rising.
Devaluation is obviously a potential cause for the market panic but this doesn't explain why counter-cyclical names are crashing right along with over-valued cyclical stocks. Devaluation is typically not broad-based. For example, as over-valued tech stocks started to crash in 2000, the rest of the stock market held up fairly well. Same in 2008. Housing stocks and financial institutions declined in 2006 well before markets experienced a widely felt deleveraging in the fall of 2008. The declines in the capital markets over the past few weeks have been very broad-based, maybe as broad-based as they have ever been. I cannot find a single instance in market history where stock market indexes, US Treasuries, and gold have all declined at the same time.
Only time will reveal the truth but for now, my take is the capital markets are experiencing a significant deleveraging event and "the baby is being thrown out with the bathwater." Some quality investments may continue to take a hit until a) capitulation takes place or b) the FED can releverage the capital markets. Once this phase is over, it will be time to jump back into counter-cyclical names that have been beaten up. And there may be some high-quality cyclical names that may take such an extensive hit that they become attractive as well. But discerning a low-risk entry point will be the ultimate challenge. No one wants to catch a falling knife and right now, practically every knife is falling.