Viewpoints: Collars and caps

Unprecedented volatility

The first quarter of 2020 saw the fastest ever retracement from bull and then bear markets at 20% and the fastest global equities drawdown of 35%!

 

Headlines screamed panic

• ‘US stocks suspended amid panic … S&P 500 fell more than 7% … next halt at 13%’ (Business Day, 18 March).
• ‘No end in sight for meltdown as oil plunges 24% in a day’ (Business Day, 18 March). (By April, traders pay you to take oil.)
• ‘Rand at record low … R17,54/$ …Volatility expected to increase …’ (Business Day, 19 March). (By April, over R19/$.)
• ‘Gold loses ground as investors favour cash again’ (Business Day, 19 March). (By April at $1 700, a record high.)
  ‘JSE surges on the back of global stock rebound … Capitec up 42%, ARC up 34%, PSG up 30% … (Fin24, 20 March).
• Equities, property, bonds, gold, currencies and oil became an incredulous roller coaster ride with nothing left unscathed. And everyone knew.

 

Were markets rational?

In the world of supercomputers, artificial intelligence and globalisation, many trades today are a consequence of pre-programmed algorithms. ‘Most algo-trading today is high-frequency trading (HFT), which attempts to capitalize on placing a large number of orders at rapid speeds across multiple markets and multiple decision parameters based on pre-programmed instructions’ (Investopedia).

There are ‘trend-following’ strategies, ‘arbitrage’ opportunities and ‘index fund rebalancing’, to name but a few, coupled with increasing sophistication and automation in hedging strategies using ‘collars’, ‘caps’ and ‘floors’. Collars can hedge against losses but limit gains – buy an out-of-the-money put option at the same time as an out-of-the-money call option. Then there is the phenomenal growth in passives, ETFs, and index funds − ideal for algorithms.

‘Shorting’ the markets was extreme as speculators took advantage of the volatility − a one-month paper profit of $343,67 billion from the S&P 500 and NASDAQ. So, bring in the ‘circuit breakers’ that temporarily suspend trading when computers start ‘panic selling’ – S&P 500 drops of 7%, 13%, and 20%. Some exchanges closed for the day.

At ‘sale of a lifetime’ prices, the opportunity then was buying ‘jewels’. Though, talking to various investment managers, the problem was insufficient liquidity in the market – they actually couldn’t find enough of the bargains.
Arguably, when the computers are humming across different time zones seeking the tiniest margins, and with forced sell instructions at whatever price, is rational and human investing − so cherished by Buffett − being replaced with high-frequency trading and computer programmes?

 

Making sense of the markets

• COVID-19 precipitated a once-in-a-lifetime crisis but, arguably, significant opportunities.
• How will active, passive and algorithmic investment management work together?
• For every seller, there is a buyer.
• A recession or depression is certain. But for how long and how bad?
• Government intervention and global stimulus is unprecedented – but who pays?
• There is a ‘new norm’ – the markets will not revert to being rational as traditional investors understood.
• Volatility does not mean liquidity.
• Leave the markets and your financial planning to the experts, but stay informed.