"The Real Reason the Market’s Crashing"
by Brian Maher
"832 points the Dow Jones lost yesterday — its third-largest point drop in history.The S&P and Nasdaq were also knocked flat. Markets peeped out of their foxholes this morning, apprehensively… like battle-shocked troops after an artillery siege. Down rained another barrage...
The Dow Jones was down another 546 points today. The S&P, another 57. The Nasdaq, which showed some fighting elan early this morning, ended the day 93 points lower. The commander in chief has stepped forth to assign blame: “The Fed has gone crazy. I think the Fed is making a mistake. They’re so tight,” he added in targeted criticism.
Just so. But the Fed’s mentation has been a long-standing question. And its tightening is far from news. So… why exactly did the Dow Jones take a 1,378-point trouncing these past two days? Where are the reinforcements? Why no cavalry to answer the desperate bugle? Today we penetrate the fog of battle… tune out the deafening din… and seek our answers outside official channels…
The story by now is familiar enough. In response to (apparently) strong economic data recently released, long-dated Treasury yields increased too much — too fast. The market was taken unawares, its trousers wreathed around its ankles… and stocks sold off in red-faced panic. Explains Michael Farr, CEO of Farr, Miller & Washington: "Clearly, stocks are spooked by higher rates and maybe some inflation that seems to be creeping in. That suggests the Fed will keep raising rates, and that’s taking the wind out of the stocks that have done the most, particularly in the tech sector."
Charlie Ripley, senior strategist at Allianz Investment Management, in confirmation: "[Yesterday’s] equity sell-off is a reaction from investors finally realizing we are in a higher interest rate environment, and given the elevated level of stocks, market participants were likely looking for a reason to sell. Higher interest rates typically bring on tighter financial conditions, which could dampen growth going forward, and equity markets are reacting to that."
Yes, but returning to our previous question: Why the severity of the sell-off? Why no late cavalry charge to turn the battle? Scratching his head, for example, is Mark Stoeckle, CEO of Adams Funds: "It really doesn’t make any sense to me that some of these stocks are getting beaten up as much as they are."
In search of clues, we thumb the calendar back to February… and the 11% correction that shook the stock market. We stumble upon an immediate likeness. February’s sell-off also came during a similar “blackout period” that obtains today. MarketWatch, dated Sept. 18, citing research by Goldman Sachs: "If stocks do become volatile in the coming month, that wouldn’t mark the first time in 2018 that blackout periods have coincided with market declines." In fact, the issue was cited as being a contributing factor to sell-offs in early February. At the time, Goldman wrote that the blackout issue was “likely intensifying the decline” in the major averages, which resulted in corrections... for both the Dow Jones industrial average and the S&P 500."
We find The Wall Street Journal trumpeting a similar alarm, dated Sept. 17: "Because major indexes have been unusually calm lately, sudden outsized market moves during the blackout period could sour investor sentiment toward stocks, some analysts say. That occurred when the market tumbled in February. Scott Glasser, CIO of ClearBridge Investments, also warned in early September: "[These] provide a tremendous amount of support to the market, and with blackout season coming, we won’t have that added measure of support."
To what strange blackout period do we refer? A blackout on stock buybacks. Earnings season unofficially begins tomorrow. Regulations generally forbid corporations from conducting buybacks the month prior to releasing earnings — lest they face suspicion of insider trading. Hence markets have lately groped in the darkness of a "blackout period." Some 86% of S&P components were under blackout as of Oct. 5, according to Goldman Sachs. That is, 86% of S&P components have been unable to conduct buybacks this past week. And by some occult, midnight turn of fate markets have gone to pieces this past week... while the blackout has been in effect. Coincidence? Not according to Jasper Lawler, head of research at London Capital Group: "The timing of the sell-off just days before U.S. earning season unofficially kicks off on Friday is more than a coincidence." More than a coincidence... we must agree.
In reminder, corporations buy back their own stocks to increase their stock price. Buybacks reduce the amount of shares outstanding and artificially inflate earnings per share. Buybacks have provided much of the helium that has levitated markets to dizzied heights. Corporations, in fact, represent the largest source of demand for U.S. stocks.
Goldman Sachs estimates S&P buybacks this year will exceed last year’s by a thumping 44%. And buybacks remain on pace to exceed $1 trillion this year — a record. “The impact of buybacks is so profound,” argues CNN Business, “that some worry about how stocks will hold up without them.” February provided one answer. These past two days may be providing another…
But now that earnings season is upon us, the blackout is drawing to a merciful end. A blizzard of fresh buybacks is likely on tap — and none too soon. If markets find their legs in the upcoming days, you may therefore have your explanation for the past two days. If stocks continue into the depths regardless, we suggest you drop to two knees… lower your chin to your chest… and pray."