When History Might Repeat, Here’s How To Trade…
History tells us that markets don’t crash from all-time highs. This time might be different, but history is usually a fairly reliable guide to the future.
While this bit of history regarding market crashes is reassuring, the history of bear markets is not. A bear market is an extended decline in prices while a crash is often part of a bear market. A chart of the S&P 500 from 2008 shows the difference between the two.
The crash is when many investors sell. But selling at the crash means you’ve missed a number of indicators that warned of weakness before that time.
Signs Of The End?
In the chart above, the 200-day moving average is the solid blue line. A break below that MA is one warning.
Of course, there are also usually a number of other warnings in the news. In 2007, some large hedge funds failed. In the spring of 2008, some brokerage firms were in trouble. Bear Stearns is an example of both events.
Bear Stearns tried to bail out two of its hedge funds in June 2007. The funds were invested in illiquid, highly leveraged collateralized debt obligations (CDOs) and they eventually failed. This was a warning that leverage in the debt market, particularly subprime mortgages, was a problem.
Within a year, in March 2008, Bear Stearns would fail. The signs were there before that time, but many investors ignored the warnings. The market would crash later that year and would sink even lower before bottoming in March 2009.
[Related: Are We Close To A Top? Here’s What I Think…]
Of course, we have the benefit of hindsight with all of this. In June 2007, few analysts saw the importance of the CDO hedge funds failing.
But there’s a reason I bring this up… As you may know, last month, a highly leveraged family office named Archegos Capital Management failed.
A family office can be like a hedge fund but only manages money for one family. Archegos was trading billions of dollars using leverage and derivatives known as swaps.
According to The Wall Street Journal, “total return swaps are contracts brokered by Wall Street banks that allow a user to take on the profits and losses of a portfolio of stocks or other assets in exchange for a fee. Swaps allow investors to take huge positions while posting limited funds up front, in essence borrowing from the bank.”
In this example, Archegos went to brokers like Goldman Sachs and asked the bank to write a swap on shares of stock like ViacomCBS and Discovery. As long as prices went up, Archegos made money and the brokers made money from fees and hedging transactions.
Archegos was putting up about 15% of the money it invested in swaps and gaining exposure to billions of dollars’ worth of stock. In March, Archegos suffered a liquidity crisis and couldn’t come up with money needed to complete a transaction. It’s estimated the family office needed about $350 million. When they didn’t have the funds, the brokers sold its holdings and the losses seem to be at least $8 billion.
There were a number of problems with Archegos. Regulators need to understand what was happening because there were no regulatory reports filed listing the holdings and the brokers weren’t aware of the risks they shared.
This might be related to shortcomings at Archegos or it might a sign of systemic issues. Either way, it’s a concern. If there are systemic issues, I expect the S&P 500 to drop below its 200-day MA soon.
How I’m Trading Right Now
The point is, we don’t know for sure if history is repeating. If that happens, we will take action rather than hoping for the best. We’ll keep using strategies that have been proven to work in any market conditions. In the meantime, there are some bargains…
Archegos had large exposure to media companies. When the selling started, ViacomCBS fell 26% and Discovery dropped 27% as Goldman Sachs and Morgan Stanley sold millions of shares to limit their risk.
Because all stocks in a sector tend to move together, Comcast Corporation (Nasdaq: CMCSA) sold off as well. That makes sense as sector and index ETFs are forced to sell when a group of stocks declines.
But there is nothing fundamentally different about CMCSA. Recent weakness seems to be related solely to the fact that some stocks in its sector were sold when a family office failed to meet a margin call.
CMCSA has been forming a base after the selloff.
The company reports earnings next week. If the company beats expectations, as it usually does, the stock could rally.
But rather than simply buying the stock and hoping for the best, my Maximum Income readers and I are using a trading strategy that will allow us to profit from that rally while hedging our downside risks. Even better, we’ll get paid immediately for making the trade.
If you’d like to know how we do this — and how you can pocket hundreds (even thousands) in income from the stocks you already own, go here now.