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Stocks Sag After Short Morning Rally

Chris Gaetano
Published Date:
Mar 20, 2020

Stocks started off the day in a promising position, having come off a massive rally the day before, but as of 12:15 p.m., those gains had more or less been erased, making it seem more and more likely that markets will continue their downward spiral.

CNBC said that the Dow Jones Industrial Average began the day 400 points up, building off yesterday's rally, which saw it overcome a 700-point morning drop to end up 188 points. These gains, however, have since evaporated, by midday training 105 points lower than Thursday's close. The Nasdaq and S&P 500 were seeing losses too, dipping 0.3 percent and 1.1 percent respectively. However, in a time when even an hour feels like an age, things might change by the time you're done reading this blog post, or even this sentence.

CNBC noted that the market has been extraordinarily volatile lately: Last Monday ended with a 7.6 percent drop in the S&P 500, which was followed by a 4.9 percent gain on Tuesday, which was followed by a 4.9 percent loss on Wednesday, followed by a 9.5 percent drop Thursday, followed by a 12 percent drop this Monday, a 6 percent gain on Tuesday, a 5.2 percent drop Wednesday, and a 0.5 percent gain last night.

The bond market, meanwhile, has seen much better days. MarketWatch is reporting that, this week, bond funds and exchange-traded funds (ETFs) have pulled $108 billion from the market, four times the previous one-week record. Traders were looking to liquidate assets without locking in losses, and cashing out of bond funds is apparently a popular way to do that with investors. Because they were seeking liquidity first and foremost, said MarketWatch, the brunt of the damage was taken by investment-grade issuers rather than riskier, lower-rated companies.

Not that these riskier high-yield bonds are doing great either. The nearly $1.5 trillion market has seen 32.6 percent of its bonds now trading at distressed levels; within the energy sector, which has lately been fueled by high-yield bonds, 86.5 percent of bonds were distressed. When a security, like a bond, becomes distressed, it means that there is significant doubt that the issuer can actually pay its outstanding obligations, making it a much more risky bet than investment-grade debt. MarketWatch said that a 32.6 percent rate of distress in the high-yield debt sector implies an 8.35 percent default rate over the next 12 months, or nearly 15 percent in the case of the energy sector. New bonds, meanwhile, are hardly being issued at all.

What complicates matters is that so many of these risky bonds have been packaged and sold into collateralized loan obligations (CLOs), a similar financial product to the mortgage-backed securities that dominated headlines during the 2008 financial crisis. Like the mortgage securities, CLOs were premised on the idea that while individual borrowers might default, it is unlikely they would do so en masse. Because of this thinking, although the bonds inside were rated very low due to their risk, the security itself was rated very high, some of them even AAA. Currently, there is about $700 billion worth of outstanding CLO debt in Europe and the US.

The Wall Street Journal is reporting that the only ones issuing new debt seem to be the biggest and most venerable blue chip companies. Meanwhile, it's noting that even normally staid sectors, such as municipal bonds and U.S. Treasury bonds, are experiencing unusual levels of turbulence. For example, while the normal pattern is that as stocks go down, Treasuries go up as investors flee to safety, this has not been happening: Stocks are down, and so are T-bills.

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