NOTW #9: Fear Sells but Doesn't Make Much Money
NOTW #9: Fear Sells but Doesn't Make Much Money
Hi reader,
It was a very volatile week that got the bears out of the cave, only to send them back in 4 days later.
It was the first time in a while that I saw true fear again in the market, although it did not last long. I’ll explain in this article what might have caused this fear and three things that we tend to see in financial markets that are positive for long-term investors.
Without further ado, let’s start with the articles of the week.
Articles of the week
I uploaded three articles this week. The first one was Nintendo’s earnings digest. The company reported what appeared to be terrible results, but these needed context and were in fact pretty good all things considered. This article is free to read for everyone:
The second article of the week was Amazon’s Q2 earnings digest. I discuss the numbers, the highlights and lowlights and the now-famous Capex dilemma that Big Tech companies are subject to:
The last article of the week was Texas Instrument’s Q2 earnings. I shared the section on the numbers and the highlights and lowlights for free, but the valuation section (which includes the price at which I would add to my position) is reserved for paid subscribers:
Market Overview
Very few people would’ve guessed on Monday that the indices would end the week as they did (flat), and that’s (deep down) the beauty of financial markets: they are completely unpredictable over the short term, even if people sound confident as to what’s “moving markets.”
This week was marked by two words: volatility and fear. Of course, both are closely related because the former stems (almost always) from the latter. Fear came from the now-famous Yen carry trade. As you might know, macroeconomics is a very complex topic (this is the reason why it’s so tough to forecast accurately), but I’ll try to explain it as simply as I can.
Many people had been apparently taking debt in Japan for some years due to its relatively low interest rates compared to those of the rest of the world. With expectations that the Fed might take longer to lower interest rates and the announcement of a 25 bps hike by the Bank of Japan, the Yen appreciated significantly against the dollar, which makes this strategy less appealing; why? Because if you borrow 1 billion yen to convert it to USD to invest in treasury bills, you are exposing yourself to the USD/JPY exchange rate. If the dollar depreciates against the Yen (as it did after the hike), you’ll need more dollars to repay your debt in Yen, and therefore the trade is less profitable or even loss-making.
In short, the appreciation of the Yen caused by the rate rise of the Bank of Japan made many people unwind their positions to repay their loans in Yen (fearing further deterioration of the strategy), spreading fear across financial markets. This is what I’ve read that has happened, but obviously, nobody really knows what caused everything (and this is the point I’ll make later).
The Nikkei dropped more than 12% on Monday, and this weakness spread to the US, where the Nasdaq was at one point down 6% pre-market. The ending outcome wasn’t as severe (unluckily for me as I was ready to add significantly to many positions), but one could definitely sense some sort of fear (bears were taking hold of the X algorithm). This situation can teach us several things, in my opinion…
No matter what markets do over the short term, many people will try to find a logical explanation (even when there might not be one) to make sense of the reality around them
Macro is extremely complex to forecast and probably a loser’s game long term
Information has made markets less (not more) efficient
While all of these might sound “bad,” I’d argue they are all positive for long-term investors. Let me explain why.
The natural human need to explain what’s happening
Most humans can’t live without finding (or at least looking for) a logical explanation for every event. Searching for explanations is natural because humans dislike uncertainty, but I think it’s sometimes futile for two reasons…
Things might happen for reasons we don’t know/understand
Things might happen due to the occurrence of tens or hundreds of interrelated events
Of course, I am not saying that we shouldn’t look for explanations because investors should be curious; it’s just that our effort might be better used in other more value-added tasks.
If you want to understand why not every short-term event takes place for a logical reason, I recommend reading the book “Flash Crash.” It’s entertaining and should help you understand that stocks and markets move for reasons that are almost impossible to foresee and understand. Since I read this book, I have become less worried and obsessed with short-term moves and what those might mean.
The futility of forecasting macro
I’ve discussed this many times in many articles: macro is very tough to forecast. The reason is that there are so many interrelated variables in financial markets (more so in a globalized world) that one can be driven crazy trying to understand how every variable will move and what this movement means for the remaining variables. The best example is the recent post-pandemic period. Despite many bears claiming that it would be impossible for the Fed to reduce inflation without going into a severe depression, the Fed seems to have pulled it off against all odds. There’s nothing wrong with having an opinion on macro, but maybe going as far as basing investment decisions on this opinion might not be the most profitable strategy.
Believing that forecasting macro is futile does not mean that I believe that macro does not impact the earnings of the companies in my portfolio (I am not that naive). I am well aware macro plays an important role in the earnings of pretty much any company, and I am also aware that there’s a recession hiding somewhere that will present itself in due time. The way I try to protect myself from my inability to forecast macro is by investing in companies that are resilient to recessions, either by a resilient business model, an extremely solid financial position, or, in most cases, both. The average leverage ratio of my portfolio is 0.48, and three companies don’t even carry financial debt, so I don’t really have to worry about a recession so long as I don’t have to sell my stocks during one!
Information, automation, and market efficiency
Some people have long held the view that more technology and data have made markets more efficient, but I believe the opposite is true: markets are becoming less efficient precisely for this reason. The fear we saw this week is a good example. I obviously don’t know what happened, but the drop in Japan probably led to algos taking action and spreading fear across financial markets, eventually leading many humans to panic, selling pressure upon which other algos acted. Information travels so freely and quickly that it can potentially send financial markets into a downward spiral rather quickly.
The good news is that the three topics I’ve just discussed are probably 90% responsible for the opportunities we find from time to time in the market. If everyone were rational and long-term oriented, finding any long-term opportunity would be almost impossible. Luckily for us, this is not the case, or I have no reason to believe it is.
The industry map was mixed this week, with most stocks/sectors relatively flat:
The fear and greed index dropped considerably to extreme fear after a volatile week. I think we are still far from extreme fear, although we did get a glimpse of it this week:
