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Wolf Richter was struck by a mild sense of anxiety on the morning of March 9.
The veteran investor and popular blogger was up about 17% on his personal investment portfolio, and, as he put it, “all heck was breaking loose” in the market.
A surprise decision last Friday by Saudi Arabia to jack up its crude-oil output after the spectacular failure of a meeting in Vienna with major oil producers in a group known as OPEC+, including Russia, resulted on Monday in the worst one-day slump for oil prices since 1991.
The decision, for many bullish Wall Street investors, couldn’t have come at a more inopportune time, with an outbreak of a little-known pathogen that originated in China infecting people so rapidly worldwide that experts had begun fearing a global economic recession due to supply and demand shocks created by the outbreak of COVID-19.
Hand-wringing over the impact of the disease on economic growth and corporate earnings had already knocked the Dow Jones Industrial Average DJIA, -5.86% , the S&P 500 index SPX, -4.89% and the Nasdaq Composite COMP, -4.70% down by at least 10%, meeting the widely accepted definition for a correction — and doing so at a record-setting pace.
Read: Dow, S&P 500 would enter bear market with a close below these levels
Through all of this, on Monday, Richter was struck by one consuming question: Should he finally cover his short bet against the market?
About 10 weeks ago, Richter made arguably one of the boldest calls on Wall Street, betting against a market that had been bounding to new heights nearly unceasingly.
MarketWatch wrote about Richter in early January, referencing his Dec. 30 blog post, where he memorialized his bet and his investment thesis. He said markets had risen too far and too fast, while acknowledging the risks in making such a contrarian play. “If you short individual stocks the maximum gain if the shares go to zero is 100%, while the maximum loss is theoretically unlimited and can easily exceed the entire value of the bet.”
But on Monday, Richter felt that too much negativity had overwhelmed the market, which could manifest in a washout in stocks, a major slump that might signal to him that he should unwind his bearish bets and count his winnings.
“During the day I was looking at [the market] and keeping my eyes on it, and it was distracting me from my work,” he said. “But though I thought about covering, I never got close enough to opening my brokerage account,” he said.
Richter said Tuesday’s 1,200-point gain for the Dow, erasing some of its 2,000-point slide in the previous session — which had been marked by the S&P 500’s triggering a rarely used circuit breaker that kicks in when the index stages an initial 7% plunge — confirmed his bearish view of markets.
The market pro told MarketWatch that Tuesday’s rally in stocks — which was more than fully reversed on Wednesday — was indicative of a bear-market rally. “The down days are more frequent, and the up days are more violent,” he said.
In fact, Richter sees more pain ahead for the market and the economy, he said, with the possibility of a lost decade or more, as in Japan in the 1990s, where monetary policies failed to boost the economy for a multiyear span.
For some bearish analysts, the breakdown of the markets and an economic recession seemed likely even before the near-global pandemic that has so far sickened more than 121,000 people and claimed 4,373 lives, according to data compiled by Johns Hopkins University.
See: World Health Organization pronounces the coronavirus outbreak a pandemic
For Richter’s part, the issues in the market were prevalent even as stocks were putting in new highs, as recently as Feb. 19. He said chief among those issues were signs of slowing manufacturing activity and overvalued stocks. He said the implied backstop by the Federal Reserve was also keeping risk assets afloat.
“We had an overexuberant market, and we have the Fed stepping in, so it didn’t take much in my estimation to knock things down,” he said.
The Fed’s ability to stimulate a market frozen by a global epidemic could, indeed, be limited. The Fed cut its federal-funds rate last week by a half a percentage point to a 1%-to-1.25% range, in the first emergency interest-rate cut since the 2008 financial crisis, but markets haven’t responded kindly to the surprise action. And fiscal measures by the U.S. government, including payroll-tax cuts and relief for small businesses don’t appear to be forthcoming.
“Everybody thought stocks would always go up and the Fed would always make sure that stocks would always go up, and that’s when coronavirus hit,” Richter, who lives in San Francisco and is well-known for his Wolf Street financial blog, said. “And that’s on top of all the fundamental issues we brought into this year before. I think this year could really be rough.”
Of the effects of the virus on businesses and economies, he said: “I’m a little worried that this could cascade.”
About 75% of his short bet is focused on the exchange-traded SPDR S&P 500 ETF Trust SPY, -4.87% ; the remainder is a bet on the fall in price of the Nasdaq-100 via the Invesco QQQ Trust Series I QQQ, -4.36%, known as the Qs.
Richter, as of Tuesday, said he was up by about 10%. That might seem like a relatively modest gain, but by comparison, the SPY and the S&P 500 were down by about 14.1% in 2020, while the Qs were off 7.1%, the Nasdaq was down 10.3%, and the Dow nearly 16%. (A day later, benchmark year-to-date declines stood at 17.5% for the Dow, 15.2% for the S&P and 11.4% for the Nasdaq.)
So when will Richter take off the short?
“I am going to keep my short until the pattern changes,” he said on Tuesday, referring to the current turbulence in equities.
The Cboe Volatility Index VIX, +13.95% is up more than 290% this year.
An ugly crash in stocks would likely convince Richter that it’s time to cover his bets, but he said that, given the tiered circuit breakers in place that trigger if the S&P 500 falls 7%, 13% and 20%, it’s hard to conceive of a 1987-style crash in markets. Instead, he believes markets will dip lower over a longer period, with a scant few upsurges, he said.
