All that’s left to do is…

The last bastion is falling and things are playing out much like a classic bear market. Except AAPL, which I think is only a matter of time, everyone else has started firmly giving in. GOOGL seems exceptionally weak and is probably one more earnings report away from demonstrating a global advertising slow down and AMZN cannot be far behind. Though AMZN has not made new 52 week lows, its descend from a valiant attempt at rebounding has been rather stunning. The remaining battalion in  the form of META, NFLX and MSFT look like they want out too. All this without even getting to the high fliers like ADBE, CRM and DOCU. 

The real tell here is the utilities and the retailers taking a big leg lower even after taking a good amount of the beating earlier this year. This is primarily a reflection of the bond yields and where the 2-10 years yields are hovering. Not to mention the 30 year fixed mortgage at 6.5+, an almost exact double from a year ago. When rates run up so quickly, the part of the market that hurts the most is the one that runs on leverage. Most of the retailers, industrials and utilities operate on debt to a great extent because they are capital intensive and also focused on returning money to investors in the form of dividend and buybacks. All these are a drain on the cash flow and when commercial paper or long term debt rates spike, there is a very real chance that these companies will face severe pressure on cash flow and will be unable to borrow to sustain any of the shareholder return programs they have in place. This is when dividend cuts start happening followed by equity dilution. The shareholders of such stocks rarely want to see that happen. If your stock yields you 5% paid out to you based on 50-60% payout ratio and have a very high revolving debt you can be assured that they are seeing their stock suffer in this market. After all, I can go buy a 5 year treasury bill today for over 4.1% without any of the risk that comes with the operations of these very efficiently run organizations running head long into a global recession, or so it seems.

But what does this say about the market? Take down the weak hands, but why is everyone else looking sick right now? Enter the last act of this play. A financial/debt crisis. The pound dropping last Friday and continuing its downward  trajectory and the spike in 2-10 treasury is an indication that somewhere someone is uncomfortably leveraged and wants out. This usually has to manifest into a grand finale where some whale somewhere puts their hands up and sells out. That is when the final leg of fear plays out. 

Right now the volatility index is elevating but in a very orderly fashion. Last ten days things have trended down without a big heave or drama. Even with the pound dropping close to parity and a 20+% jump in 2 year yield the markets have been relatively orderly. The real opportunity would be when things start looking hairy with a disorderly VIX and a real crisis of liquidity in the commercial paper market. With that we might finally get a Federal reserve that tones down the hawkish rhetoric as well. 

It’s always possible that the day may not come, but all things indicate that that is where we are heading.  So until then, all thats left to do is wait!