Coronavirus is temporary. Stimulus is limitless.

Eoin’s Treacy’s email to Exodus Trader subscribers on Friday morning had this in the title: “let’s lock in the 9,000-point profit”.

Not bad… Perhaps that’s why he sounds remarkably calm in his latest video to Exponential Investor Premium readers.

Calm voices are few and far between at the moment. And so I think you need to hear what he had to say. At least, how I understood it.

The key message is that coronavirus, as terrifying as it may be, is temporary. The stimulus designed to combat it will be longer lasting. It’ll win in the end.

Combine this with his next point and you begin to see where things are going.

For every piece of bad news about coronavirus, there’s a correspondingly larger piece of stimulus which central bankers and politicians can engineer. Money printers know no limits, after all.

So, the real question is how long and how far markets will plunge. And how volatile they’ll get before stabilising.

Buying back into the market at this level is a good idea, if you believe stocks will eventually recover. The real question is what your stop loss should be. Because, if you’re taken out of your position in the next short-term plunge, then you won’t get the benefits of the eventual recovery.

That’s why traders like Eoin focus on things like volatility and where to set your stop losses, not just what to buy and sell.

But back to recent market action. Volatility works both ways. Up and down. Market crashes are accompanied by soaring days as well.

That volatility is what makes times like this dangerous. Inexperienced investors who want to sell out or buy into the market do so on precisely the wrong days – after big moves. It’s basic human psychology to sell during a crash and buy during a bounce.

Worse still, the usual stop losses aren’t adequate during times like this. Protection and risk management become traps.

What investors should really be doing is adjusting their risk tolerance for the market’s volatility. During whipsawing markets, you should be willing to weather more of a loss, and demand more of a profit. But that’s especially hard to do during volatility. The hotter your emotions are running, the more you feel each percentage gain and loss.

How do you offset the compulsion to do the wrong things at the wrong time? That’s precisely what our online event The End of the Bull Market was all about. A tool which helps you figure out what stop losses to set adjusted for volatility. That’s something few investors factor in.

I’m told the online event is still available. With the bull market technically over, it should be obvious why you need to tune in.

But back to Eoin Treacy’s key point. Given that fiscal and monetary policy will outlive coronavirus, you’d think markets will recover eventually. The panic in the meantime is what’s dangerous to investors.

My own worry is that there’s a fly in this ointment. It’s a fly that I warned investors about over the Christmas break.

Sure, stockmarkets should recover eventually. But which companies won’t survive that long? And, even if you don’t own them, are you exposed to them?

Traders who hedged against or bet on a market crash in 2007 might’ve done so with Lehman Brothers as their counterparty. And received next to nothing, despite whopping paper profits.

Investors who held too much cash in a Cypriot bank account in 2013 lost chunks of their capital too. The same bank bail-in legislation now applies in the UK, Europe, Australia and many more nations. Keep that in mind if you’ve sold out of your stocks or are considering staying in cash…

Then there were the likes of Madoff, Woodford and the PPI mess. Who can you trust? How many people are not being honest about what they’re doing with your money?

Counterparty risk is the most underpriced risk in the market. Nobody worries about their broker going bust or misleading them. But sometimes they do. And financial crises have a habit of exposing this.

It’s the failure of a counterparty that really triggers a crisis. It’s why the Lehman Moment gets capital letters and why the AIG bailout was so important.

Believe it or not, we may already have our trigger. It’s almost as obscure as the one which kicked off the Asian financial crisis in 1997. Back then it was a Thai property developer defaulting on $50 million in bonds.

Yesterday, the Reserve Bank of India bailed out Yes Bank. Which sounds good, but the deal wipes out high-risk bondholders too. And we’re not talking $50 million…

The Financial Times has the details:

The RBI has proposed that Yes Bank’s additional tier 1 (AT1) bonds be wiped out. These quasi-equity instruments, introduced after the financial crisis of 2008-09 to shore up banks’ balance sheets, have high coupons and perpetual maturities, meaning that banks do not need to repay the principal. But crucially, the bonds can also be written off if the lender ceases to be a viable entity.

Similar instruments were issued by banks around the world, as regulators encouraged funding structures that could be dissolved relatively easily if a lender hit trouble.

In India Yes Bank was one of the largest private-sector issuers of such bonds, with about Rs108bn ($1.5bn) of AT1 debt outstanding, according to Acuité. The move by the RBI has therefore come as a shock to asset managers such as the Indian arms of Franklin Templeton and Japan’s Nippon, which in recent years stuffed mutual funds full of these higher-risk bonds, luring customers with the prospect of better returns.

Is this the domino we’ve been waiting for? The snowflake that triggers the avalanche?

How many European banks are eyeing their AT1-style debts? Banks’ convertible and hybrid securities are already in the news in Australia.

In coming days, I suggest you have a think about which financial institutions you’re reliant on. The ones you hold your shares with. The funds you invest in. The exchange-traded fund providers. The company which stores your gold.

Have you considered just how reliant you are on those companies? And how they are in turn reliant on other financial institutions like banks?

One weak link in the chain and we’re back to 2008. That’ll be the real crash.

Until next time,

Nick Hubble
Editor, Southbank Investment Research

Category: Commodities

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