Why ‘Buying the Dip’ May Have Run Its Course
Why this time it looks different.
Why this time it looks different.
“This time it’s different.” These can be the four most dangerous words that any investor can utter.
The phrase can trip up the unwary in myriad ways. “These valuations seem unsustainable,” one might contend. Don’t worry, this time it’s different. “This technology has failed every time it’s been tried before.” No problem, this time it’s different. Any of us can attempt to justify all sorts of wild schemes or nosebleed prices on the idea that they aren’t subject to the norms that have applied before.
But here’s the rub—sometimes it really is different. Major turning points occur when there is a secular change in the economy’s fortunes or a notable development that affects a company’s long-term prospects.
Think back to early 2020. The global Covid-19 outbreak was indeed something different, and markets fell precipitously. The massive monetary and fiscal stimuli that were offered in the crisis’s wake were something different as well, causing asset prices to leap. Enormous opportunities were available to those investors who astutely recognized the seismic shifts.
If we acknowledge that monetary and fiscal stimuli were key factors in the great bull run of the past 18 months, how do we reckon with the possibility that both may be coming to an end? Federal Reserve Chairman Jerome Powell recently acknowledged that the central bank would be tapering its $120 billion monthly bond purchases “soon” and would likely end them completely in a matter of months.
The Fed may be taking its foot off the monetary gas pedal, but it won’t yet be tapping the brakes by raising interest rates. It isn’t clear how markets will react to a less expansive monetary policy, even though one is likely to be upon us soon. Furthermore, investors appear uncomfortable with a Congress whose lack of progress on the debt ceiling, budget reconciliation, and infrastructure bills have turned fiscal policy from an economic tailwind to a potential headwind. And, after a long absence, inflation seems to be rearing its ugly head.
It should thus be no surprise, then, that volatility has returned to major U.S. indexes. Uncertainty begets volatility. Volatility ebbed when it was clear that market-friendly policies were in place and pushed higher after the Fed’s stance began to morph.
Each of the past three weeks has featured at least two days with over 1% changes in the S&P 500 index and at least one 2% decline in the Nasdaq 100. When the S&P hit an all-time high on Sept. 2, its 10-day historical volatility was 8.09. On Oct. 5, just over a month later and after four sequential 1% up and down days, that measure had nearly doubled to 15.76.
While implied volatilities on S&P 500 options have risen across the board, we recently noticed a significant change in the relative valuation of out-of-the-money options, or “skew.” Early this week, implied volatilities had risen most for options that are about 5% below market and barely budged for options that are 10% above market. This tells us that traders are focused on hedging a decline that would signify a normal correction and less eager to speculate on a significant short-term bounce.
Markets in general, and the options market in particular, are telling us that we should be concerned about how events could play out in the coming weeks. Contrarian traders who are risk-tolerant and well-capitalized could attempt to take advantage of the pricing disparity described above by selling put options to finance call-option purchases. But I would also suggest that investors consider whether their risk exposures are appropriate and use options to manage them in the face of a changing monetary policy and fiscal uncertainty.
Quite frankly, this time looks different.
Steve Sosnick is the chief strategist at Interactive Brokers.
Reprinted by permission of Barron’s. Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: October 7, 2021.
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Food prices continue to rise at a rapid pace, surprising central banks and pressuring debt-laden governments
LONDON—Fresh out of an energy crisis, Europeans are facing a food-price explosion that is changing diets and forcing consumers across the region to tighten their belts—literally.
This is happening even though inflation as a whole is falling thanks to lower energy prices, presenting a new policy challenge for governments that deployed billions in aid last year to keep businesses and households afloat through the worst energy crisis in decades.
New data on Wednesday showed inflation in the U.K. fell sharply in April as energy prices cooled, following a similar pattern around Europe and in the U.S. But food prices were 19.3% higher than a year earlier.
The continued surge in food prices has caught central bankers off guard and pressured governments that are still reeling from the cost of last year’s emergency support to come to the rescue. And it is pressuring household budgets that are also under strain from rising borrowing costs.
In France, households have cut their food purchases by more than 10% since the invasion of Ukraine, while their purchases of energy have fallen by 4.8%.
In Germany, sales of food fell 1.1% in March from the previous month, and were down 10.3% from a year earlier, the largest drop since records began in 1994. According to the Federal Information Centre for Agriculture, meat consumption was lower in 2022 than at any time since records began in 1989, although it said that might partly reflect a continuing shift toward more plant-based diets.
Food retailers’ profit margins have contracted because they can’t pass on the entire price increases from their suppliers to their customers. Markus Mosa, chief executive of the Edeka supermarket chain, told German media that the company had stopped ordering products from several large suppliers because of rocketing prices.
A survey by the U.K.’s statistics agency earlier this month found that almost three-fifths of the poorest 20% of households were cutting back on food purchases.
“This is an access problem,” said Ludovic Subran, chief economist at insurer Allianz, who previously worked at the United Nations World Food Program. “Total food production has not plummeted. This is an entitlement crisis.”
Food accounts for a much larger share of consumer spending than energy, so a smaller rise in prices has a greater impact on budgets. The U.K.’s Resolution Foundation estimates that by the summer, the cumulative rise in food bills since 2020 will have amounted to 28 billion pounds, equivalent to $34.76 billion, outstripping the rise in energy bills, estimated at £25 billion.
“The cost of living crisis isn’t ending, it is just entering a new phase,” Torsten Bell, the research group’s chief executive, wrote in a recent report.
Food isn’t the only driver of inflation. In the U.K., the core rate of inflation—which excludes food and energy—rose to 6.8% in April from 6.2% in March, its highest level since 1992. Core inflation was close to its record high in the eurozone during the same month.
Still, Bank of England Gov. Andrew Bailey told lawmakers Tuesday that food prices now constitute a “fourth shock” to inflation after the bottlenecks that jammed supply chains during the Covid-19 pandemic, the rise in energy prices that accompanied Russia’s invasion of Ukraine, and surprisingly tight labor markets.
Europe’s governments spent heavily on supporting households as energy prices soared. Now they have less room to borrow given the surge in debt since the pandemic struck in 2020.
Some governments—including those of Italy, Spain and Portugal—have cut sales taxes on food products to ease the burden on consumers. Others are leaning on food retailers to keep their prices in check. In March, the French government negotiated an agreement with leading retailers to refrain from price rises if it is possible to do so.
Retailers have also come under scrutiny in Ireland and a number of other European countries. In the U.K., lawmakers have launched an investigation into the entire food supply chain “from farm to fork.”
“Yesterday I had the food producers into Downing Street, and we’ve also been talking to the supermarkets, to the farmers, looking at every element of the supply chain and what we can do to pass on some of the reduction in costs that are coming through to consumers as fast as possible,” U.K. Treasury Chief Jeremy Hunt said during The Wall Street Journal’s CEO Council Summit in London.
The government’s Competition and Markets Authority last week said it would take a closer look at retailers.
“Given ongoing concerns about high prices, we are stepping up our work in the grocery sector to help ensure competition is working well,” said Sarah Cardell, who heads the CMA.
Some economists expect that added scrutiny to yield concrete results, assuming retailers won’t want to tarnish their image and will lean on their suppliers to keep prices down.
“With supermarkets now more heavily under the political spotlight, we think it more likely that price momentum in the food basket slows,” said Sanjay Raja, an economist at Deutsche Bank.
It isn’t entirely clear why food prices have risen so fast for so long. In world commodity markets, which set the prices received by farmers, food prices have been falling since April 2022. But raw commodity costs are just one part of the final price. Consumers are also paying for processing, packaging, transport and distribution, and the size of the gap between the farm and the dining table is unusually wide.
The BOE’s Bailey thinks one reason for the bank having misjudged food prices is that food producers entered into longer-term but relatively expensive contracts with fertilizer, energy and other suppliers around the time of Russia’s invasion of Ukraine in their eagerness to guarantee availability at a time of uncertainty.
But as the pressures being placed on retailers suggest, some policy makers suspect that an increase in profit margins may also have played a role. Speaking to lawmakers, Bailey was wary of placing any blame on food suppliers.
“It’s a story about rebuilding margins that were squeezed in the early part of last year,” he said.
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