By mid-afternoon yesterday, the S&P 500 Index had fallen to 3,858…within spitting distance of the 3,800 level that so many people (including ourselves) have been saying was a good target for a short-term bottom for the stock market. (Some people think it will be THE bottom for this decline.) In other words, the index pretty much got there yesterday…before the market was able to put in a nice late-day rally. This morning, the futures are trading higher (over 1% higher on the S&P 500 and almost 2% higher on the NDX Nasdaq 100 Index). Thus, it looks like this bounce just might have some legs.
One reason to think that this rally could indeed last more than just a day or two is the action we’ve seen in the crypto markets since Wednesday. On that day, the crypto market got absolutely crushed…on the news that Terra had lost its 1 for 1 peg to the dollar. The problem was that many of those cryptocurrencies are not very liquid. Even the market liquidity for bitcoin has shrunk substantially this year. As these cryptos were getting hit hard of Wednesday, a lot of leveraged investors started getting margin calls. However, since the crypto market is not as liquid as it once was, it is very likely that these leveraged investors could not sell enough of those assets to meet their margin calls. Therefore, they had to go to assets that ARE quite liquid…and they sold those to raise enough money to meet those market calls.
We believe it is likely that these crypto investors turned to the big cap tech names to raise the money they needed…..Let’s face it, t he common stocks that these cryptocurrency investors own are very unlikely to have big positions in “old economy” stocks like GE and U.S. Steel. Instead, it is likely that they own tech stocks…including the big cap names…which are VERY liquid. In other words, we believe that the HUGE declines we’ve seen this week in several of these big cap tech names were caused by investors dumping their most liquid tech names to meet their margin calls in the crypto. (This is very reminiscent to what Long Term Capital Management did in the late 1990s. The fixed income investments which they had highly leveraged bets in…were VERY thinly traded. Therefore, when the problems with Russia’s debt cause these instruments to collapse, LTCM had to dump one of their few stock holdings to meet their margin calls. In this case, it was GE…which was the biggest/most liquid stock in the market back then.)
Anyway, the crypto markets stabilized yesterday, so it is not a big surprise that we got a late day rally in the stock market. Since these crypto investors were no longer involved in the “forced selling” in the stock market to pay for their margin calls, it helped the supply/demand equation in the stock market normalize quite a bit yesterday (as a big source of “supply” faded). That is why we got the late-day rally in our opinion.
The question now is whether the crypto markets will remain stable. If it can, there is a good chance that a lot these mega cap names…which have been absolutely clobbered this week (without any big negative news or any of them)…should be able to bounce nicely in the coming days. That, in turn, should help the stock market bounce nice…at least over the near-term…….…When “forced selling” abates, it is usually followed by a strong rally…even if it’s not a lasting one.
Longer-term, we still believe that inflation is going to remain a big problem…EVEN if we see peak inflation soon. Due to the war in Ukraine…which has become a war of attrition and will thus last for a long time…we believe that inflation will stabilize at a level that is much higher than anything we’ve seen since the 1970s. That will create the kind of further headwinds that will keep any rally (even a sharp one) from gaining a long-term foothold.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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