Japan’s Black Monday and Blood on the Street

It was a historically bad day in financial markets, particularly in Japan where the Nikkei index was down more than 12% on the day.  There are a lot of reasons for the selloff. The Japanese carry trade has been extremely popular, where large investors borrow at Japan’s ultra-low interest rates, and invest the money in higher-returning assets such as U.S. tech stocks. With Japan recently hiking rates, the carry trade started to crumble, forcing an unwinding and immense volatility. In addition, Warren Buffett’s Berkshire Hathaway announced that they had sold roughly half of their massive stake in Apple, after previously divesting a big chunk of Bank of America. We have been flagging the fact that Apple, along with most of the other large cap Tech stocks, is trading at a significant premium valuation to its historical averages, so I can definitely understand why Berkshire would want to lighten up at these levels.  The Nasdaq was down 3.4% and the S&P was down 3% on the day, continuing the declines we saw last Friday.

The S&P is now down close to 10% from its highs, so we are close to correction territory. It’s important to note that we have had 26 declines of 5% since 2009, and they often seem like they are the end of the world at the time. At T&T Capital Management, we have expected a market decline and volatility, so I feel that we are very well prepared for this situation. It’s not that we attempt to be market-timers, as we believe that those efforts are mostly futile. Our investment thesis has been predicated on the fact that equity markets are extremely expensive, particularly in the heavily concentrated large-cap Tech sector. Conversely, we have had the opportunity to buy bonds with some of the highest yields in 20 years, and to buy super high-quality real estate investment trusts with growing dividend yields from 5-8%, at heavily discounted valuations. Both bonds and Reits should benefit from the Federal Reserve likely reducing interest rates, so I think both asset classes can generate double-digit returns with considerably less risk than the overall market.

In a global selloff like we are seeing, a lot of stocks get hit indiscriminately, as investors try to raise cash. We will absolutely look to take advantage of opportunities as they come up. Volatility is spiking aggressively, which creates an attractive environment for our cash-secured put selling strategies, as we get more premium and can go further away from the market to make the trades even safer. If you have extra cash, it is a fantastic time to add to your accounts. I plan on adding significantly to mine. Rule number 1 is never panic in a market selloff. That is the surefire way to take permanent losses of capital. We put in place protection prior to the volatility, so I think we will be in great shape even if things get worse. Please keep in mind though that when volatility spikes, option prices do too. This means that on our sold options, the prices go up, causing short-term mark to market losses, which ultimately will be irrelevant, as the options expire, and time and volatility value go to zero. This is why we normally look at performance at the end of January, when the bulk of our options expire, as that gives you the full picture of where things are at given the strategy that we employ. Perhaps the market turns upwards, but I certainly wouldn’t be surprised if this is the beginning of an overdue bear market, so we are prepared for however the chips fall.