April 23, 2020

A Gentle Singularity

We are in Wonderland.

Spot oil prices briefly went negative earlier this week. That didn’t surprise anyone working in the oil industry. Spot oil had been in the low single digits for a while. But it’s alarming to anyone with a Bloomberg terminal who isn’t used to the price of exchange-traded futures going negative.

For the uninitiated, commodities can have negative prices. It means you pay for someone to take them away.

There is actually a market for spot sulfuric acid, which is a byproduct of making steel. The price occasionally shifts between positive and negative, depending on market conditions.

Still, crazy.

Of course, people wigged out when investors started buying the par calls on Euroyen futures years ago, a prelude to interest rates going negative in Japan. Interest rates subsequently went negative in Europe and a lot of other places. They will eventually go negative here, too.

A few weeks ago, we experienced the highest levels of volatility—ever.

We already saw gold futures become untethered from spot because of delivery concerns.

We are running out of superlatives to describe this market. Things get a little strange when prices approach the zero bound. People like things that are free.

There is a minor league baseball stadium here for the Myrtle Beach Pelicans, Class A-Advanced-affiliate of the Chicago Cubs. After the top of the second inning, the mascot comes out with a pizza and commences the “Pizza Scream.” The person in the crowd who screams the loudest gets a free pizza. It’s super annoying.

Every time they do the Pizza Scream, I wonder what would happen if, instead of giving out the pizza for free, they charged $1. Do you think people would scream as loudly?

I call this phenomenon “The Event Horizon,” where prices cross the zero bound and enter the fifth dimension.

It Can Always Get Worse

One of the most dangerous statements ever uttered in finance is: “It can’t go any lower.”

It can always go lower. And it can always go higher.

I’m sure people who bought WTI crude oil futures expiring in May at -$10, -$20, and -$30 a barrel didn’t think it could go any lower. Then the price dropped to -$40.

The key thing to understand here is that markets are occasionally irrational. They are mostly rational, with pockets of irrationality.

I saw a quote floating around on Twitter about how Stan Druckenmiller said that his worst trade was shorting tech stocks in 1999. Markets were incredibly irrational at that point, and they got more irrational. Druckenmiller described himself as “an emotional basket case.”

The bitcoin guys were having some fun with this:

I don’t want to get into the weeds on this, but I don’t think it’s possible for bitcoin to trade below zero.

Negative rates, negative oil prices, gold futures, what’s next?

Beats me. But from a risk management standpoint, if you’re sitting with a losing position, and you think you have a “margin of safety,” you probably don’t. Things can always get worse.

Trend Following

This is one reason why, if you’re in a winning trade, it is probably best to leave it alone. If things can get worse, things can also always get better.

People have small imaginations about corporate bonds these days. They find it shocking that corporate bond ETFs are back to where they were pre-crisis, more or less.

Guess what: they could go higher, and probably will.

Once a central bank starts a liquidity program, it usually doesn’t stop… for years. The European Central Bank started buying corporate bonds years ago, and it’s still doing it. Most investment-grade (and some junk) bonds were trading with negative yields.

If you can imagine it, it will probably happen.

So let’s use our imaginations. Can stocks go down 89%, like in the Great Depression?

Maybe.

Can they go up 200%+? Can the Dow Industrials trade at 100,000?

Maybe.

Can the long bond trade with negative yields?

Maybe.

Can the volatility index (VIX) go higher than 90, or lower than 9?

For sure.

Usually when you mention these sorts of things, someone will tell you “that’s impossible.” But it’s not impossible. Anything is possible.

I saw Citigroup trade at 99 cents.

I saw an IPO go up over 600%.

I saw the Palm spinoff and watched the new company’s valuation soar past that of its parent 3Com. Bet you read a book about that.

I saw cotton go to the moon a few years back. For miles around, everyone was planting cotton.

Remember the rare earths bubble? That was a good one.

Remember the cannabis bubble? Another good one.

The misbehavior of markets. Markets make big mistakes in both directions. The goal is to be positively exposed to the mistakes. You don’t want to get caught on the wrong side of one of these.

Remember, anything is possible.

A Song I Wrote

I produced a track with my friend Supatheef down in Miami about a month ago! I’m super proud of it—it’s not bad for a first effort. I’d be honored if you’d give it a spin here. It’s called Interstellar.

Something else I recommend: Marking your calendar for May 11–21 for our Strategic Investment Conference. This is the first year you can attend live from the safety of your home or office. The Mauldin Economics team is putting together a top-notch lineup of thought leaders who are prepared to help you separate the signal from the noise in this soon-to-be post-pandemic world. Check out our announcement video here, and stay tuned for more details.

Jared Dillian

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