Springs Pop in the Fall
Tetelestai Capital’s 2021 thesis of continued volatility has proven correct so far this year. This was a major driver in selecting the strategy for starting Tetelestai Capital and the subsequent portfolios managed.
The chart below shows the upward trend of the S&P 500 index from January 1, 2021 to the market close on Friday, September 24th. We saw volatile growth from January to April this year with several pullbacks causing the index to test the 50-day and the 100-day moving averages. Then we saw more volatility pick up in May, which led us through a calmer summer until September. So what caused a breakdown in September?
Chart of the SPY ETF
September and October are notorious for being the hardest hit months in the stock market throughout history. What is interesting though is markets are known to actually peak during August and start their decline from there (if a major sell off occurs). Referencing the chart above, right on cue you can see the end of August is the peak of the S&P 500 for 2021. In August, the United States controversially pulled out of Afghanistan causing the country to fall into the hands of the Taliban. This captured the attention of the world and financial markets in what is usually a slow month. September opened up with a “Debt Ceiling Problem” in the United States. Additionally, China based real estate giant Evergrande Group is teetering on bankruptcy, with more than $300 billion in debt and off balance sheet securities. This news blew the roof off volatility causing the VIX to jump over 35% from Friday September 17th to Monday afternoon, September 20th. Investors in Asia have already pulled capital from financial markets with the Hang Seng Index (HSI) being down 11% through September 2021 and down 22% from its peak in February this year. The index ran up 14% to start 2021.
Chart of the Hang Seng Index (HSI)
As we stand on the morning of September 27, 2021, the VIX is back below 20 after dropping 10% or more on consecutive days with the market rebounding slightly to recover early losses this month. I believe the worst of this pull back is not over for global markets here. If Chinese market contagion pushes further into global markets (which it has proven to in the past), the S&P 500 and specifically the tech stocks in their glamor phase may be deeply cut as they are flaunting the highest valuations. If the HSI fell 22% in six months and has not shown signs of stopping, what happens when the mood sours in U.S. markets as well and the world goes risk off?
The biggest reason the U.S. capital markets are experiencing only a minor impact here is this is the world’s safety net for assets. With funds and pensions across the globe mandated to be in equities to achieve any remote return to meet the demands on them, they have to be risk on and the best place to do this is the deepest liquidity pool in the world: the United States. However, just because the U.S. has been a safe haven, does not exclude it from financial asset meltdowns. With a Shiller P/E ratio of 38.39 at today’s U.S. market valuation (this ratio being the second highest next to the tech bubble peak in 2000), we have room to come back down.
I am not calling for a stock market crash (though possible given recent global events). I am calling for more volatility to come into 2022. Volatility acts like a spring. Right now, volatility is creeping back down to historic lows and the global markets are not looking as strong as they did coming into 2021. This is counter to what should be occurring. When springs are compressed, they coil back with increasingly more potential energy. The more the spring coils, the harder the release once the pressure is removed. Last week will not be the only time the VIX jumps double digits in a day. Being positioned for this is where Tetelestai Capital can add major value to your portfolio.
Don’t fight convexity.