By Gregory Zuckerman, Julia-Ambra Verlaine and Paul J. Davies
Treasury prices extended their declines Thursday while U.S.
stock indexes suffered their worst losses since 1987 -- an unusual
dual downturn that raised concerns that the Wall Street rout is
entering a painful new stage: The forced unwind of a number of
popular trading strategies, some of which involve leverage, or
borrowed money.
The Dow industrials dropped 2,352 points, or 10%, bringing their
decline to 27% in the month since the last record high. The yield
on the 10-year Treasury note, which hit a record low Monday at
0.501%, rose to 0.842%. Bond yields rise when prices fall.
Sharp stock declines aren't unusual, particularly at a time of
economic stress following a long bull market. But the sight of bond
and stock prices declining sharply together unnerved some traders,
suggesting further selling could follow in response to margin
calls, risk limits at banks and investment firms, and other
factors. Also surprising investors: Gold, a traditional haven,
dropped 3%, marking its third straight decline.
"There was nowhere to hide today with stocks, bonds and gold all
hit hard," said Jonathan Krinsky of Baycrest Partners LLC.
The latest carnage came even after the Federal Reserve said it
would inject more than $1.5 trillion into Wall Street on Thursday
and Friday to prevent ominous trading conditions from creating a
sharper economic contraction.
Investors view the Fed intervention as providing relief to banks
facing demands for cash, as economic shocks force companies to tap
credit lines and draw down revolving loans.
The Fed's action marks an effort to interrupt what some analysts
and investors view as a dangerous negative-feedback loop, in which
market declines beget further declines, even absent changes in
financial and economic fundamentals.
But the Fed announcement only paused the selling, adding to
concerns in the market involving two long-running trades: The
"basis trade," which seeks to exploit pricing gaps between Treasury
securities and futures, and "risk parity funds," which try to score
strong performance with moderate risk using futures contracts that
can boost the returns of low-risk assets.
On Thursday morning, Bank of America warned clients that the
unwind of several leveraged trading strategies risked creating "a
cascading effect whereby U.S. Treasury yields rise sharply and
force liquidations from other similar investors."
Thanks to the disruption of short-term funding, securities
dealers could be left with $300 billion of 30-year Treasuries on
their books whose ultimate sale would cause U.S. Treasury yields to
rise sharply, potentially forcing further unwinds and worsening
conditions throughout financial markets, analysts at Bank of
America and JPMorgan say.
The risk parity strategy is intended to adapt to market
conditions and be a one-stop shop for investor assets. Firms
including Bridgewater Associates LP and AQR Capital Management LLC
are the leading investors in the strategy. Bridgewater founder
Raymond Dalio says he helped invent the risk-parity category nearly
two decades ago and in the past has told clients he has the
majority of his net worth invested in the strategy.
A spokesman for Bridgewater wouldn't comment.
Risk-parity investors, who manage about $175 billion, according
to industry estimates, usually buy futures tied to the performance
of bonds, stocks and commodities. They use risk metrics to
determine the proper allocations to various markets, shifting
assets to maintain an equal distribution of risk. The goal of these
funds: Somewhat higher returns with the same amount of risk of
other investment classes.
The key to the trade is assessing the volatility of each asset
class. If stocks are determined to be three times as volatile as
Treasury bonds, an investor would put three times as much in bonds
as in stocks, for example. As stock volatility increases, as it has
lately, a risk-parity portfolio manager would sell some stocks --
something that has been happening in recent weeks -- adding
pressure on the overall stock market, risk-parity traders say.
And if bonds or other safer asset classes also come under
pressure and become more volatile, as has also been happening this
week, they'd sell those as well, incurring losses along the
way.
Risk-parity specialists say the bond losses haven't been enough
to cause true pain, and that the broader concerns about the
strategy are unfounded.
"Risk parity is not big enough, doesn't trade enough, and
doesn't trade quickly enough to ever be noticeable in the movements
of stock or bond markets," says Michael Mendelson, a principal at
AQR.
The AQR Multi-Asset fund is down 6.63% this year through
Wednesday, and was down 2% Thursday, topping the overall market.
The S&P 500 is down 27% in 2020.
In the view of many in the markets, the underlying key factors
are the scarce liquidity in many markets, which is causing prices
to move sharply, and the prevalence of technical trading driven by
trends in a few key gauges including certain prices and measures of
volatility.
One such gauge is the value-at-risk framework, used at many
banks and investment firms to judge the likely losses they would
face in any single day under certain stated conditions. Some
analysts say that when volatility is high, this value at risk, or
VaR as it is known, increases -- prompting firms to sell riskier
assets in a bid to reduce the risk of their position.
Nikolaos Panigirtzoglou, global markets strategist at JPMorgan
Chase & Co., said that much of the widespread selling of all
kinds of assets in recent days has been driven by risk management
rather than any fundamental view on the economy or securities
prices.
"With the lack of liquidity in markets, one thing is feeding the
other," he said.
The main measure of stock market volatility is the Cboe
volatility index, or VIX, which on Thursday approached levels last
seen in 2008. A high reading on the VIX can cause some investors to
breach their risk limits and become forced sellers, Mr.
Panigirtzoglou said.
Investors also said the market was losing faith in political
leaders in some countries to tackle the coronavirus, or in
policymakers' ability to support markets and the economy with rate
cuts or other stimulus.
"It's become that kind of liquidation where you see people sell
what they can and move to cash," said David Riley, chief investment
strategist at BlueBay Asset Management.
(END) Dow Jones Newswires
March 12, 2020 18:15 ET (22:15 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
Bank of America (NYSE:BAC)
Historical Stock Chart
From Aug 2024 to Sep 2024
Bank of America (NYSE:BAC)
Historical Stock Chart
From Sep 2023 to Sep 2024