Forced To The Margin

Phew ! What a week we saw in the markets. Weeks like this are only rivalled by a couple times in history such as the COVID 19 meltdown in 2020 meltdown, the GFR in 2008 and the tech wreck in 2001. It is something when we see global indexes plunge by double digit amounts in a matter of 2 or 3 days.

For those of you thinking the worst is behind us – bad news bears all around. As pre markets opened tonight, the selling looks to continue with the Dow Jones Industrial average already dropping 1633 points ( 4.51% ) the S and P 500 down 239 points ( 4.68% ), and the Nasdaq looking to drop 941 points ( 5.31% ) at the open. Tomorrow morning looks to continue the torrid selling we saw last week. Good news though – if you loved certain stocks a couple of weeks ago, you should really love them now. Now matter how bad things may seem though, when we look back in time it will be a simple blip in the ups and down of stock market performance – nothing more and nothing less. While a lot of people are quick to point fingers and lay blame, this is how markets work – they go up, and they go down.

A lot of people have been reaching out and asking for the ‘why’ of the situation, so I am going to try and break it down for everyone. As is my usual style, I will tell you what I think without any sugar coating, without any bias, and with a healthy does of reality. Who knows, I might even spit facts to a dance on TikTok or something.

A lot of what we are seeing in markets – whether it be stock, bond, or commodity markets is broken down in to 2 different categories. I am going to go through the 2 categories, and give you a bit of background, and why we are seeing the markets react the way we do. This is not meant to be all encompassing, but a general breakdown so you can settle down clients. While what we are seeing is mainly stock market related, a lot of the goings on are also related to housing, the economy, consumer thoughts and perspectives and the bond market.

1. First and foremost we are seeing a reaction to what the markets are viewing as a negative for economic performance. A lot of economics in the last 40 years has been based on global trade in what is commonly referred to as globalism. Globalism is the reason you can buy all your shit at the dollar store for cheap. For the last 40 years companies have continuously outsourced manufacturing and production of items to country’s that could complete the items for cheaper due to lax environmental laws, labour laws, etc. Always being able to make something cheaper and import it back to the country the company is based in – whether that be the US or Canada has allowed company profits to grow as a percentage over the years. Since stock markets are a forward indicator, they always ‘bake in’ an earnings multiple to the profits to arrive at a stock price. I will give you an example, and I am going to pick on Apple. Why? Well, because everyone loves their damn Iphones. For the last 12 months, Apple has recorded massive profits. Much of these record profits have been made because they manufacture their phones and devices in low labour cost countries, bring them back to the US and Canada, and sell for huge margins. Apple also does this by recording a lot of their global sales in a shell company in Ireland which is famous for its very low Corporate tax rate of around 2%. Okay, so for the last 12 months, Apple reported earnings per share ( EPS in stock market speak ) of $6.96 USD. Earnings for stocks are what is referred to as the mothers milk of Wall St. Almost every company derives their stock price as a multiple of those earnings. Now, Apple currently enjoys a multiple of 27.06. That means if you take the $6.96 earned per share and times it by 27.06 you will get $188.34. Ironically enough, Apple stock closed Friday at a share price of $188.34. Easy, right? Well, this is exactly why markets are down. The tariff policies that have been announced by DJT will most definitely have an impact on Apple’s profits. So, lets say the economists, analysts, stock pickers etc. figure out that Apple’s profit will drop from $6.96 per share down to $5.96 per share in the coming 12 months due to the tariff. Well, at a 27.06 multiple ( $5.96 x 27.06 ) you get a stock price of $161.27. So, the stock would drop in and around $27.07 to get back into that 27.06 valuation. A $27.07 drop in price is roughly another 14.37% drop from here. Now, I am not saying Apple’s profits will drop by $1.00 per share, I am using that as an example. Stock markets take every available piece of info, and project that info forward. Most of the companies that have the largest weighting in US stock markets ( Microsoft, Nvidia, Apple, Meta, Google ) will feel the effects of DJT’s tariffs policies worse than most due to the fact that they source a lot of product and labour from countries most affected by tariffs. This means that the companies that were responsible for a majority of the stock market gains in the last couple of years, will be the same stocks to lead the markets lower. This is nothing to panic about – it is simply Mr. Market doing what Mr. Market does – repricing the value f a stock based on all readily available information. Also keep in mind that if we see a reversal of tariffs ( let’s be honest, the only thing we can predict is that DJT and his policies are unpredictable ) could also make Mr. Market re price stocks to the upside just as violently.
2. The second reason we are seeing mass selling is due to a thing called margin. Margin is how a lot of people invest in the stock market. If you have $10,000.00 to invest, you can borrow against that $10,000.00 to ‘lever up’ your investing. Leverage is an awesome way to amplify your returns in a good market, but it is also a super way to go bankrupt in a bad market. Most leverage works on a 3 to 1 ratio. Generally you need to have 25% equity if you are a retail client. So, in a $10,000.00 stock portfolio, there is $2500.00 of your own money, and $7500.00 of the banks money. The problem arises with this strategy when we see large moves in values in short time periods. I am going to pick on Tesla here. Not because I don’t like Elon, but just because it tends to be a volatile stock. And for the record and in the interest of full disclosure, I own 2 Tesla’s. Back on January 20th ( random day, a completely random day ) TSLA stock traded for $426.50 a share. So, if you had $10,000 dollars of stock, you would have bought around 23.4 shares of TSLA. Today Tesla trades at around $239.43. That is a drop of $187.07 PER SHARE for a about 43.8%. The real issue is that you have lost 43.8% of your investment, but you only had 25% of the funds to lose. The remainder is the banks money on your leverage. So, what starts to happen is the bank makes you either throw more money in to the investment to bring it back on side, or they sell you out of the market to recover their money in a technique that is called ‘margin selling’. When the bank margins you out, they simply sell at current market prices – much like a power of sale in mortgage land. Since we have seen a lot of markets dropping, the amount of people getting margin calls on the daily is running about 300% higher than just 2 weeks ago. Since markets are already down, this forced selling of the banks to recover their margin dollars simply puts more selling pressure on a down market, and that is how we get these massive down days. Margin is a big reason why the Down futures are down 1600 points at 7 pm on a Sunday: bank computers went through their margin loans over the weekend, and it has placed sells on any accounts that are not onside. Margin sellers are forced sellers – they do not want to sell into a low market, but they are forced to due to margin requirements. Think of margin selling like a mortgage client who comes up for renewal but their existing lender will not renew. They are unemployed, have zero equity, and bad credit, so you cannot put the mortgage elsewhere, so the mortgage loan is called, and the bank takes the asset and sells it. The difference is that mortgages and houses can take months to settle and sell, stocks take mili-seconds to do the same. Everything moves quicker in the stock market.

These 2 reasons are the reasons we are seeing massive moves. The stock markets are re pricing company profits and global growth going forward, and margin clients are being forced to sell into already down markets – further depressing prices. Also of note is that the large institutional buyers of stocks like pension funds, mutual funds and the like, are on what we call a buyers strike. No one wants to try and catch a falling knife, so they step to the sidelines and will wait for a little more calm before they step in to load up on positions. With lots of sells, and the big money players not buying, prices have to find their new normal until we get to the point where the institutional money steps back in to buy.

Bonds and Gold. A lot of people want to know why bonds and precious metals didn’t protect them better during all this, being as these 2 areas are usually safe havens during stock market stupidity. Of special importance for mortgage brokers is the bonds. We saw Canada 5’s drop about 12 bps in the week. Not a whole considering that the stock market dropped double digits. Bonds ( and gold ) have been a pretty good performing asset class for the year, and when people are losing money hand over fist in the market, they always sell their winners first ( sometimes in an attempt to keep margin on side ), and bonds and gold have been the big winners, so they got sold first. Selling a bond drives the price down, and the yield up. While some were buying bonds this week to protect them from turmoil, there were a lot of sellers counteracting the move, so yields did not drop as much as you would think. We also have to remember that if we are truly undoing globalization with new tariffs around the world, that tends to be inflationary for almost everyone. Inflation expectations drive bond yields, so you are going to be hard pressed to find safety in bonds ( or see yields drop for that matter ) when the reason the stock market is falling apart is due to an inflation event. Also keep in mind that almost half the drop in the Canada 5’s occurred after the jobs report in Canada was released. Talk about a dumpster fire? That employment report was probably one of the worst ones I have seen in a very long time.

If we see a lot more selling in equities after Monday or Tuesday, you might see a buyers bid to bonds which should raise prices and drop yields, but if the selling kinda fizzles out by Monday or Tuesday, then bonds won’t really see much action. I fully expect to see a monster intra day reversal in the coming week, where we start the day deep in the red, and end the day either flat or to the green side. This much selling eventually begets bargain hunters, and we are sitting pretty close on some technical numbers here, so once the emotions are out of the buying and selling, traders become focused on technicals and fundamentals, and that could drive some monster rally’s to the upside, or monster declines to the downside in bonds. As we see politicians promising everything to almost everyone, I can’t help but think that these billions of new dollars that will be spent will have to be printed, and that always tends to raise inflation. Bonds markets aren’t stupid and have seen this type of shit before. This past week has probably been one of the sharpest, deepest meltdown in recent stock market history ( outside of Black Monday 1987 ) and yet we still couldn’t get the yield down more than 12 bps? That tells me there is probably room to run higher on yields once we get past this stock market hiccup.