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Some Good Things About Crashes

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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The S&P 500 closed down 3.9 percent today, which is not great. But there seems to be a lot of very cheery news coverage of it? "Three cheers," says Felix Salmon. "A feature not a bug," says Tadas Viskanta. Bloomberg is "Finding the Silver Lining in This Stock Selloff." Maybe crashes are good? I have to say that the people now celebrating the crash are mostly not the people complaining about rising stock prices a week ago, but I guess the latter group of people are celebrating too, in their way.

Anyway I figured a soothing thing would be to list some positive aspects of today's crash, so here they are.

1. You can buy stocks cheap (1).

The important thing to remember is that most of us are structurally short stocks. We will retire with some pile of stocks, which we will have to buy, but we are still not that far along in accumulating that pile. Lower prices reduce the value of our current pile, but also cheapen the rest of the pile which we have to buy in the future. As Warren Buffett once said:

Practically anybody in this room is probably more likely to be a net buyer of stocks over the next ten years than they are a net seller, so everyone of you should prefer lower prices. If you are a net eater of hamburger over the next ten years, you want hamburger to go down unless you are a cattle producer.

Salmon echoed Buffett's point today: "Don’t think of this as a stock-market crash. Think of it as stocks going on sale." In the long run, for most of us, this is clearly correct.  Of course if you view the stock market as an accurate prediction of the future earning power of the American economy, this calculation gets more complicated, but there is no obvious reason to do that. Remember what Shiller said.

2. You can buy stocks cheap (2).

The above logic is less reassuring if you are in the markets business, in which case your ability to save for the future is tied not only to the price of stocks that you'll buy in the future, but also to your ability to remain employed and attract assets and earn money and so forth. So if you were long with client money this morning, sorry! On the plus side though, if you've been complaining about how hard it is to distinguish yourself in a generally rising market, congratulations, now you have an awesome opportunity.

There is also this from Josh Brown, recommending that you cope with downturns by viewing them as sales on stocks and putting in out-of-the-money good-til-cancel limit buy orders on stocks that you'd like to own if they fall even further below their current prices. This is a psychologically appealing strategy, but as someone who used to buy puts for a living I would make the following comments:

  1. If you're committed to buying those stocks if they fall further ("The important thing is that I put the orders in and I leave them alone," says Brown), why not sell puts and pocket some premium for that commitment? 
  2. "If you like your stock at 100, you'll love it at 80!" is a terrific pitch. But it is also misleading. If you like your stock at 100, it's because you haven't yet heard the news that pushed it to 80. That news is terrible!

3. You can stop worrying about quarterly capitalism.

The S&P 500 destroyed about $714 billion worth of value today, or almost nine months' worth of S&P 500 earnings. A market that was laser-focused on the next quarter's earnings wouldn't do that. The big swings represent changing views not about next month but about the long-term future. As James Surowiecki says:

Amazon, for instance, isn’t worth two hundred and thirty billion dollars because of how much money investors think it will make over the next five years, but because of how much money investors think it will make over the next thirty, forty, or even fifty years. And over that long a stretch of time, even small changes in how fast a company grows can have very big economic consequences. 

And:

This is the real paradox of big market moves like the one we saw on Thursday and Friday: while they’re often seen as evidence of investors reacting to short-term news, they’re more likely to happen when the market has a very long time horizon. The price of a long-term perspective, in that sense, is sometimes short-term turmoil.

This strikes me as entirely correct, and a nice corrective to worries about market short-termism. (Surowiecki is a skeptic.) Though, again, remember what Shiller said. And there is the fact that Apple's stock rallied dramatically after an unscheduled first-two-months-of-the-quarter earnings preview, so who knows.

4. You can stop worrying about bond market liquidity.

Remember how mutual funds would suffer panicked withdrawals, and bond managers who used exchange-traded funds as their liquidity instrument would dump those ETFs, leading those funds to dump illiquid corporate bonds, causing prices to gap down, leading to more withdrawals in a vicious cycle that would massively exacerbate any fundamental credit worries? At their lows today, the iShares Select Dividend ETF and First Trust Value Line Dividend ETF -- large-cap U.S. stock ETFs -- were down about 36 percent from Friday's close. JPMorgan's and General Electric's stocks were down about 21 percent, at their lows. (All of them got much better.) Meanwhile bond ETFs did fine. The New York Times worried about emerging-market bond fund liquidity on its front page yesterday. The iShares JPMorgan Emerging Markets Bond ETF was down just 1.9 percent at its lows today. The SPDR Barclays High Yield Bond ETF and iShares iBoxx High Yield Corporate Bond ETF were down about 2.4 percent at their lows, and recovered a bit later. The stock ETFs were nuts. The bond ETFs performed like ... you know, bonds.  Bonds on a bad day, sure, absolutely. But not bonds in a death spiral.

Here is Bloomberg's Lisa Abramowicz:

Call it patience, or lack of liquidity, or just paralyzing fear. Whatever it is, bond traders certainly seem immobilized amid the turmoil. Fixed-income trading volume remains about 60 percent of what would be expected in an accelerating decline, Jim Vogel, an interest-rate strategist at FTN Financial, wrote in a note Monday.

So perhaps that's an illiquidity story, but it is not the illiquidity story we were supposed to worry about. In the story we were supposed to worry about, the liquidity of bond funds would lead to disaster when it ran up against the illiquidity of the underlying bonds. The reverse seems to have happened: The limited trading of bonds is propagating back to bond funds and ETFs. Bonds are, relatively speaking, pretty chill. (Sorry, "immobilized.") Equities are where liquidity is crazy. JPMorgan destroyed, and then gained back, about $30 billion in five minutes this morning. That's a liquidity problem. 

5. Hedge funds look good.

One thing I learned on this Longform podcast with Carol Loomis is that she might have invented the term "hedge fund." Now Carol Loomis is great, but that seems like a terrible legacy. The problem with the term "hedge fund" is that it encourages knee-jerk etymological determinism, with people wandering around complaining that hedge funds don't hedge. But why should they hedge? I mean, some hedge, some don't, there is no particular connection between hedging and hedge funds, but we are stuck with the name and the facile complaints.

Except!

Hedge funds that aim to profit from global economic trends, a group that oversees some $550 billion, spent July putting on trades that profit from declines in equities, data from Credit Suisse Group AG showed.

And: "It’s welcome news to hedge funds that have trailed the market almost every year since the global financial crisis." If your thesis for investing in hedge funds was that they might miss some of the rally but would protect you from the downside, congratulations, that might actually be working out for you.

Cheer up, this bear is happy.
Illustration: Mary Childs/Bloomberg.

6. TD Ameritrade are heroes.

As anyone who's reading this knows, the single best thing that a broker can do for retail customers in a crash is just not answer the phone. Retail investors lose out by trading based on emotion, buying at highs and selling during panics. Financial advisers earn their living by talking their clients out of doing that, but not answering the phone is an even more reliable, and less emotionally taxing, way to achieve the same goal. 

Marvelously, this morning "many clients of the popular online brokerage TD Ameritrade said they can’t log on to its website to see their portfolio or trade," and Scottrade "also experienced problems with its site." I gather that those customers are unhappy. I also gather that Ameritrade and Scottrade saved them a lot of money. Let us salute their sacrifices on behalf of clients. Though:

Trading volumes were “up significantly” among clients of TD Ameritrade Holding Corp. going into the open of markets today, Kim Hillyer, a spokeswoman for the company, said in an e-mail. “Clients’ trades are still being executed,” she said.

7. The Fed.

I stay away from Fed prognostication, and obviously many people think that the Fed won't and shouldn't respond to moves in equity prices, but it seems straightforward to say that a big scary crash reduces the odds of the Fed raising rates soon, by at least some nonzero amount. One (anachronistic) way to interpret the Shiller overshooting of stock prices is just: If you overreact to bad news, that will encourage the Fed to think that there is something to worry about, and then it will loosen monetary policy to rescue you. It is hard to see exactly how markets could coordinate performatively worrying in order to communicate a plea for help to the Fed, but if you believe that then it should be doubly reassuring: One, because the Fed might help, and two, because part of today's crash is performative overreaction rather than genuine fear.

8. It solved inequality.

Look, I am not confident that reducing inequality solely by disproportionately evaporating the wealth of the top decile is a good thing. Like, taxing and redistributing the same amount of wealth seems strictly preferable? Still, there are those who would argue that evaporating it, while worse than redistributing it, is still better than not evaporating it. If you're in that camp I guess today was good.

9. Epistemic humility.

It is conceivable that there has been an overcorrection in the financial news media such that we now all go around not only confessing that we have no idea why stock prices are up or down, but also imputing the same ignorance to everyone else. Still, I don't have to even pretend to wave in the direction of explaining to you why stocks were down today, which is nice for me at least.

10. The baristas are nicer.

Here's Starbucks CEO Howard Schultz:

“Today’s financial market volatility, combined with great political uncertainty both at home and abroad, will undoubtedly have an effect on consumer confidence and perhaps even our customers’ attitudes and behavior,” Schultz wrote, according to a copy of the email obtained by Fusion. “Our customers are likely to experience an increased level of anxiety and concern. Please recognize this and – as you always have – remember that our success is not an entitlement, but something we need to earn, every day. Let’s be very sensitive to the pressures our customers may be feeling, and do everything we can to individually and collectively exceed their expectations.”

My rule of thumb is that if you had time to go to Starbucks today you probably don't need to worry about today's crash. (See point 1!) Another good rule is that, regardless of what the market is doing, you shouldn't take it out on the baristas. Still it's nice to know that they're there for you.

  1. Unless you are near retirement and have already accumulated most of your pile of stocks, in which case this is unfortunate though still not particularly worth worrying about. What are you going to do about it, now?

  2. Bloomberg shows the S&P 500 with a market cap of $17.39 trillion and a P/E ratio of 16.75 today, implying about $1.04 trillion of earnings.

  3. No S&P 500 companies reported earnings today, and anyway next quarter's earnings couldn't make three quarters worth of difference on their own.

  4. Numbers from Bloomberg. Incidentally compare say JNK against JPM. JNK had an annualized daily volatility over the past year of about 6.2 percent. JPM's was about 20 percent. So JPM is a bit over 3 times as volatile generally, but gapped down almost 9 times as far today. 

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