Crashes, Liquidity and Unicorns

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Happy August!

The S&P 500 was down 3.2 percent on Friday and 5.8 percent for the week; the last time it fell more than 100 points in a week was in October 2008. Futures were down more than 2.2 percent as of last night; as of 8 a.m. they were down about 3.6 percent. The Dow, meanwhile, is off more than 10 percent from its May high, "taking it into correction territory," which is at least a delightfully soothing expression. Nothing's wrong: It's just that the previous prices were not quite correct, but now they've been fixed. Everything's great. Better than ever really. Here is Neil Irwin at the New York Times arguing that everything's great: "If you step back just a bit, what has happened in financial markets this week looks less like a catastrophe in the making and more like a much-needed breather when various markets had been starting to look a little bubbly."

Should you panic and sell all your stocks? Don't ask me! Maybe ask your financial adviser?

On days like Friday, Michael Smith, president of STA Wealth Management in Houston, said, a financial adviser’s role “is kind of like becoming a psychologist.” It is all about reminding people to stay calm and not to let emotions lure them into making mistakes, he explained.

The best argument that I've heard for retail investors getting expensive financial advice, as opposed to cheap indexing, revolves around those reminders: The psychological tendency to sell low and buy high is strong and destructive, and if advisers can talk clients out of it that can be good for the clients and also more broadly volatility-dampening. Though then there is this:

Rachel Shasha, 34, a New York-based retail trader, picked a good time to stay out of the market. “A lot of funds are on vacation right now,” she said, herself enjoying the beach this week in Miami, Fla. “I expect they’ll come back after Labor Day and start buying again when they see everything on discount.” 

I don't think that's how fund management works, but I like her style. Elsewhere, was poor stock-market breadth a warning sign of the crash? The VIX was up almost 9 points to close above 28, its biggest one-day jump in four years, with an inverted curve that "generally indicates a heightened level of risk aversion." Valuations still don't seem all that cheap. And: "Dow 5,000? Really?"

China.

It could be worse, and is, in China, where "the Shanghai Composite racked up its worst day since February 2007, wiping out all its gains of 2015, in a tumultuous session that even Xinhua, the official Chinese news agency, dubbed 'Black Monday.'" And in Hong Kong, the Hang Seng's relative-strength index is at 15, "the lowest since the Black Monday rout almost 30 years ago," if that is the sort of thing that matters to you. "China has set the cat among the pigeons," says a guy. The government "is planning to flood its banking system with new liquidity," and has "allowed pension funds managed by local governments to invest in the stock market for the first time." But the People's Bank of China "is the last major central bank that has not embarked on an ‘all-out’ nuclear-tipped bazooka tactic," which is quite an escalation of the metaphor. Hank Paulson once asked for a bazooka to keep in his pocket unused; now the bazookas have lost their effectiveness through overuse and have had to be retrofitted with nuclear tips.

Elsewhere in China, "The head of a Chinese exchange that trades minor metals was captured by angry investors in a dawn raid and turned over to Shanghai police, as the investors attempted to force the authorities to investigate why their funds have been frozen." I hope he patiently explained to them that their funds were taking a much-needed breather after getting a little too bubbly.

People are worried about bond market liquidity.

Here's a New York Times story focused on emerging markets bonds and the mutual funds that buy them:

What worries many regulators and economists is how much mutual fund money is now tied up in these hard-to-sell bonds — an amount that far exceeds the exposure investors had to these markets in earlier emerging-market crises.

And:

If investors ask to be repaid all at once — as happened in 2008 — a run-on-the-bank scenario could unfold because funds would have difficulty meeting the demands of people wanting their cash back.

So this week should be a test of the bond market liquidity worries, no? The Pimco Total Return and Unconstrained Bond Funds, mentioned in the article as having big emerging-markets exposure, were down 0.19 and 0.45 percent on Friday; Pimco's Emerging Markets Bond Fund was down 0.41 percent. If emerging-market credit continues to widen, will all those funds make it worse? Or will the illiquidity-driven bond crash remain in the hypothetical future?

Elsewhere in liquidity, here is a story about how investors are scrambling to buy Treasuries because of the rout in equities. Fine, that's the flight-to-safety move, arguably a bit odd when everyone thinks a rate increase is coming, but still pretty traditional. But one of the bond-market-liquidity-worry stories was that if things went wrong, bond investors would dump Treasuries first, because Treasuries are still pretty liquid. That story struck me as nicely volatility-dampening, since the rush to dump Treasuries for liquidity purposes would offset the rush to buy Treasuries for flight-to-safety purposes. So far the safety story seems to predominate.

And here (and here) are some worries about "risk parity" investing, which is a bond-liquidity-adjacent set of worries:

Analysts worry about the possibility of contagion, given that risk parity funds automatically pull their horns in — or “rebalance” — when markets are turbulent, which means problems in the asset class can swiftly be transmitted elsewhere. The AllianceBernstein report pointed out that because they are highly leveraged “bond market losses could force a broad sell-off in equities and other asset classes as managers rush to meet margin calls”.

Elsewhere, Gretchen Morgenson worries that loan mutual funds may not be properly disclosing that they are not trading on inside information. 

The food top.

Here's an op-ed from a former waiter at (apparently) Eleven Madison Park about how "serving elaborate meals to the super-rich left me feeling empty" that contains the following sentence:

Grown men wearing Zegna and Ferragamo would sit at the bar chanting, “We are the 1 percent!”

Really though? I feel like this op-ed is a more bearish indicator than anything the VIX or the relative-strength index could get up to. Elsewhere in signs that food culture is a little bubbly and could use a breather, here is Matt Buchanan on Major Food Group: "Every MFG restaurant since, while producing food that ranges from merely good to astounding, has been designed around maximum capital extraction from their guests." And here (via Tyler Cowen) is Eugene Wei on food culture

Food has replaced music at the heart of the cultural conversation for so many, and I wonder if it's because food and dining still offer true scarcity whereas music is so freely available everywhere that it's become a poor signaling mechanism for status and taste. If you've eaten at Noma, you've had an experience a very tiny fraction of the world will be lucky enough to experience, whereas if you name any musical artist, I can likely find their music and be listening to it within a few mouse clicks. 

Elsewhere, food truck name ideas.

Zombie unicorns.

Oh hey super:

Early this year, Mr. Gurley said there would be “dead unicorns” in 2015. Now, he says, “zombie unicorns” would have been a more accurate term, since struggling companies rarely fail outright. Instead, they labor privately and are often forced to raise money or sell themselves for less than their previous valuations.

I have complained before about the unicorn terminology but at this point Silicon Valley commentators seem to have evolved a whole elaborate mythology that is beyond my grasp. The picture at the top of this article is a bunch of dudes sitting around their Mac laptops and one of them is wearing a Transformers mask. I assume he's been anointed the high priest of some chthonic deity of the Santa Cruz Mountains. Later there'll be a ritual human sacrifice, followed by a hackathon and then foosball.

Trump vs. Wall Street.

One sort of annoying thing in journalism is when a leading presidential candidate announces a Very Serious Plan to make some sort of big change to the tax code or financial regulation or whatever, and then everyone has to pretend that it might happen and analyze what it might mean, even though everyone basically knows that the odds of that person being elected and then actually trying to make that change and then getting it passed in anything like its proposed form are essentially zero, and that the Very Serious Plan is all for show, even though no normal people are actually paying attention to it anyway. Anyway here's Republican presidential front-runner Donald Trump on hedge funds:

"Half of them, look, they're energetic, they're very smart, but a lot of them, it's like they're paper pushers. They make a fortune, they pay no tax. It's ridiculous, OK? This—and some of them are friends of mine. Some of them, I couldn't care less about. It's the wrong thing," Trump said. "The hedge fund guys are getting away with murder. They're making a tremendous amount of money. They have to pay taxes. I want to lower the rates for the middle class. The middle class is the one, they're getting absolutely destroyed. This country doesn't have—won't have a middle class very soon."

Here's his plan to fix that:

I want to make it very simple. And we can leave the tax code the way it is and simplify it, or you could go to a form of a flat tax. You could go to a fair tax. There’s a lot of things you could do.

Stay tuned for what that might mean for the hedge fund industry.

Things happen.

Brad Katsuyama’s Next Chapter. Bank of Internet. Southern Co. to Buy AGL Resources for $8 Billion in Cash. John Carney is still bearish on Fannie and Freddie. U.S. banks moved billions of dollars in trades beyond Washington’s reach. WhatsApp pump-and-dumps. Monies – Joining Economic and Legal Perspectives. What Makes an Analyst Report Influential? Ads on the moon. Why Can't We Bet On Elections? Stock Market Investment: The Role of Human Capital. 16 Startup Metrics. McKinsey Project Report on My Dating Life. The reading list for my financial journalism cliché book club.  Beer Mile World Classic. Pooductive.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net