Covenant Weekly Market Synopsis for August 8, 2019

August 12, 2019

Last Week Today. The trade war between China and the U.S. showed the first signs of conflating into a currency war when China allowed its currency to fall through 7 Yuan to $1 for the first time in eleven years, sparking a global equity market rout on Monday. | China’s provocation prompted the U.S. Treasury to label China a currency manipulator, a label that has little legal teeth, but which many feared was a preliminary step towards the Treasury devaluing the Dollar. | Japan’s leading economic indicators fell to their lowest level since 2009, increasing the risk the country falls into another recession. | As the Hong Kong protests continue, China sent an ominous message, “Those who live by fire will die by fire.” All protesters will be punished, a spokesman said, including behind-the-scenes instigators, giving rise to concerns the Chinese government will repeat the mistakes of Tienanmen Square in 1989.

Financial Markets. Stated simply, it was an erratic week. Not that you would notice if you only looked at where equity markets closed week-over-week, which was rather staid. However, if you were watching intra-week, every day seemed to bring new market-moving headlines, and investors were confronted with gut-wrenching up and down moves daily. The opening salvo came on Monday when China allowed the Yuan to trade through 7, prompting an intraday decline of nearly 1,000 points in the Dow Jones Industrial Average, that only partially reversed by the day’s end. The S&P 500 and Nasdaq followed suit, declining almost 3% for one of the largest single-day losses in the last ten years – see the illustrative chart below, which was making the rounds on social media.


It did not get much calmer as the week wore on, as a bounce in asset prices on Tuesday, was met with a fresh round of selling Wednesday morning. The multiple selling impulses in equities provoked massive bond-buying in a bid for safety from the storm. Indeed, flows surpassed the highs in the tumultuous fourth quarter of last year and at one point on Wednesday, the 10-year UST bond yield touched 1.59% (the lowest level since just before the Presidential election in 2016).

As one would expect during such wild swings, volatility woke from its slumber, and the VIX Index jumped 39% to 24.6 in a single day on Monday before falling back to end the week just a hair under 18. Yes, it was a fitful week. In the end, however, equity index losses were modest, while the yield curve shifted downward, flatter, and into deeper inversions.

For specific weekly, month-to-date and year-to-date asset class performance, please click here.


Breathing Room. Take a look at the asymptotic price increase in the chart below. No, it’s not Bitcoin or a graph of Beyond Meat’s stock. It’s the price of a 30-year Austrian Government Bond. The value of these bonds increased by 64% in the last seven months and now yield only 0.25% per year. While an extreme case, it’s representative of the move in global interest rates since the Fed signaled they would cut rates, which, in turn, allowed central banks around the world to follow suit.


Sources: Bloomberg L.P. and Covenant Investment Research.

Indeed, last week alone New Zealand cut interest rates by 0.5%, India cut 0.35%, and Thailand cut 0.25%. Some have characterized the actions by central bankers as a “race to the bottom,” implying there is a competitive motive between central banks to reduce interest rates. This view is an oversimplification that largely misses the point. Central bankers are merely undoing the rate increases they were forced to implement to protect against capital flight when the Fed was raising rates. For many of these countries, interest rates had reached a level restricting economic growth. With the Fed reversing course to lower interest rates, these countries now have breathing room to reduce their rates, which should help stimulate growth.

What if a trade deal is not the objective… for the U.S. or China? The latest tit for tat between China and the U.S. reminded me of a piece I wrote back in October, summarizing two economists views of why a trade deal was not necessarily in the U.S. or China’s best interest. Thus far, the economists’ predictions are coming true, and the piece is worth re-reading as a near-term resolution to the trade war is increasingly remote.



How the Mind Works Against Successful Investing – Regret Aversion Bias

(Entry #5 in a series on Behavioral Finance)

Have you ever met someone who could not make a decision, even when they had all of the available data? Sometimes this situation is referred to as “paralysis by analysis,” but the underlying behavioral science shows that typically these individuals are anxious they’ll regret whatever decision they make. When people are afraid their decision will be wrong in hindsight and avoid taking decisive action, they are exhibiting Regret Aversion. Regret Aversion can be toxic because it often causes people to hesitate most in the precise moments that require assertive action.


At its base level, Regret Aversion emerges when people are seeking to avoid the emotional pain of regret that comes from poor decision making. Unfortunately, Regret Aversion boxes people into a corner as they try to avoid two types of mistakes that, when taken together essentially cover any decision they make:

  • Errors of Commission occur when people decide to do something, and the result is suboptimal. For example, selling their stock portfolio in March 2009 after already incurring losses of greater than 50%.
  • Errors of Omission occur from inaction leading to lost opportunity. For example, not selling high-flying technology company stocks in 2000 when analysts were inventing new valuation metrics to support their thesis that stocks would move higher (remember when the number of viewers’ “eyeballs” on a tech company’s website were considered more important to corporate valuations than profits?).

Interestingly, Regret Averse investors are more likely to commit Errors of Omission than Errors of Commission. In other words, Regret Aversion tends to show-up as inaction because, with Errors of Commission, the investor takes action and feels a greater sense of culpability for the result. But, in committing an Error of Omission, the investor takes no action and is more likely to view the outcome as opportunity cost. The emotion of regret is decidedly stronger for the results of actions taken than for the results from inaction.

Investors suffering from Regret Aversion often commit one or more of the following mistakes[1]:

  • Investing too conservatively – Risk is an inherent part of investing, and in seeking to avoid reasonable risk levels, investors may see subpar growth in their portfolio that jeopardizes their investment goals.
  • Staying out of the market after a loss – Fear is high following significant market declines, but this is often the best time to buy as stocks valuations are lower.
  • Holding onto investment positions too long – This happens with losing positions when the investor fears the stock price will recover without him. This also happens with winning investments when the outlook has changed, but the investor is afraid of missing out on further gains.
  • Preference for good companies – Investors often try to reduce their fear of regret by investing in household name companies, even when the prospects for lesser-known stocks are better. Illustrating this point, an old saying on Wall Street was, “You’ll never get fired for investing in IBM.” While that statement may have been right, IBM wasn’t always the best investment option.
  • Herding behavior – Investors often believe they will feel less regret if they invest in what is considered the consensus. Herding can lead to dangerous asset bubbles that ultimately end in tears (e.g., the Dutch Tulip Mania of the 1600s and the more recent Dot-com Bust).

Regret Aversion is a particularly tricky behavioral bias, because those that suffer from it continually find themselves in a “Damned if I do, damned if I don’t” predicament. Similar to other Behavioral Finance biases, knowledge is power, and awareness of the types of investment mistakes that result from Regret Aversion is the first line of defense. However, for some people, Regret Aversion is simply too powerful to overcome, and it leads to suboptimal investment decisions. For these people hiring a professional asset manager is an important step to getting their financial plan back on track.

Be well,