Who is selling now?

Hello.  We hope everyone is staying safe & healthy throughout this historic mess of a situation, to put it mildly.  There are a LOT of different directions we could go in terms of this note. However, we first want to let you know that we, at LJI, are fully functional.  We are committed to communicating with any/all clients via email, phone, etc.


Last Thursday we sent a note titled “Should I Sell Now?” where we discussed, historically-speaking, selling after the markets were down over 20% is a bad idea.  Record volatility continues and the market has set lower lows since that note.


Let’s talk about Who is selling now.  What rational person would sell, say, Bank of America, at $20 per share when it was at $34/share just a month ago.  And that is just one example.  There are 1000s.  This has been the fastest 20% selloff in history.  It took 21 days.  To put that in perspective, from the market top in 2007 it took 274 days to fall 20%.  To say this is unprecedented is a massive understatement.


When we try to explain what is going on we tend to think of persons most similar to ‘us’.  In other words, if I am retired, I compare my situation/thoughts/feelings to other retirees.  If I’m a 35 year-old investor I compare my situation similarly.  And so on.  The same goes for net worth, income levels, etc.  It is very difficult for a someone worth $X to consider what someone worth 10 times $X or 20 times $X is doing.


Thus it is very difficult – maybe impossible – for most of us to understand ‘forced selling’.  Especially at the institutional level where, in many cases, billions, are being traded.  Forced selling, simplistically defined, is when a person/company/fund/institution/etc. is factually required to sell an asset no matter what the price.


Let’s use (maybe) a ridiculous example.  And this may hit home for some relative to the mortgage crisis in the 2007-2012 time frame.  Let’s assume there are 5 houses representing the entire US housing market.  Last week, each house was worth $200k.  Three of those houses represent YOU.  You own your home, have steady income, no mortgage, and you plan on staying there for the next 20 years.


Fast forward one week and we realize that two of your neighbors each own Blockbuster Video – the entire franchise.  Over the last week, the internet and Netflix appear, and Blockbuster is obviously out of business.  Your neighbors have lost everything.  They have no income and 95% of their net worth was in Blockbuster stock.  All they have left is $50k total in mutual funds.  They MUST sell their home immediately.


There is one real estate investor and she knows your neighbors MUST sell.  She also knows the other neighbors cannot buy the two houses.  She is the only buyer and offers $100k for each house.  This is all public information.


What would you do?  Would you sell your home to her for $100k even though you don’t need to?  Not likely.  Would it bother you that maybe your home had fallen by 50%?  Yes, very likely.  Most of you would stay in your home, live your life, be patient, and wait for values to catch up to where they were.  Of course, there would be unknowns during that ‘wait’ and the whole scenario would likely be very uncomfortable.  But you know, over time (historically), real estate typically appreciates.  You choose patience over panic.


In most every case that last paragraph describes the housing/real estate recovery since the bottom in 2009ish.  And we believe it is a relevant comparison to the stock market today.  The primary difference between stocks and real estate is…. you cannot login in and check the value of your home EVERY day.  Or every minute.  Or once a month via an account statement.  Stocks are much more emotional for that reason, among others.


If you had to sell real estate during that horrible time frame 10+ years ago it was probably ‘forced’.  Forced by a job change or loss.  A divorce.  A health issue.  Income loss.  The bottom line is it probably wasn’t your choice.  Someone else, or some situation, forced it to happen.  In that scenario, you sell at whatever price you can get, take your lumps and move on.


If you didn’t have to sell your real estate you’re likely in MUCH better shape today than if you had sold back then.  Giving away Bank of America stock, down over 40% in a month, doesn’t really make sense either.  Three days ago, of the S&P500 stocks, 50 were down 20% THAT DAY.  22 more stocks fell 19% that day.  Yesterday, 192 stocks (not necessarily S&P500 members) were down 30% in a day.


This last month has been a bloodbath of historical proportions at a historical velocity.  It could get worse.  But locking in these losses really isn’t prudent.  Time is on our side.  History is on our side.


Let’s get back to forced selling.  Really try and think about that corny 5 house scenario above.  Now imagine there is a $150k mortgage on those two houses.  Guess what must be sold?  The mutual funds.  The bank is owed $150k, those funds will be sold and the bank will be paid.  The bank won’t care where the market is, was, or will be.  There is a contract and it will be honored.  Forced selling.


Who is selling now?  Those who have to sell.  Sellers who are leveraged.  Sellers who borrowed to buy.  What they bought is irrelevant.  This is where it gets tough to really understand because, among other reasons, not one client at LJI has borrowed $$ against their account to buy anything.  We can do that but we don’t and we haven’t.  You haven’t.


What you may not know is that Merrill Lynch, UBS, Morgan Stanley, many brokerage firms, for many years, have made more income via their customer’s lending against their brokerage accounts than the firms have made in trading revenues.  In other words, encouraging clients to borrow has been a primary profit center on Wall Street.  For over a decade.  This has happened at local banks as well.  And at massive banks.  It is rampant.


That doesn’t make any of this unethical – that’s not the point.  The point is there is massive leverage in the system.  So, when a complete unknown – a virus – shows up, and commerce stops.  When life as we know it stops, however temporary, we have forced selling.  Forced selling everywhere.  For the sake of time we won’t go into the institutional side of the industry.  Just understand there is/was $100s of Billions of leverage out there ‘betting’ the markets would continue to climb.  Those bets are now being unwound.  Quickly.


We don’t bet.  We don’t use leverage. We invest.  We believe, to some degree, a rally for the ages, is coming.  It’s just a matter of time.  And when it happens we’ll all be glad we didn’t give away stocks at current, or lower, levels.


You’ll see changes in your portfolios in the coming days/weeks.  Dealing with this economic shock will take time, but we believe selling along with those who are forced to sell is a great way to miss the inevitable recovery.  We believe choosing patience over panic is the correct choice.


Thank you.  Stay safe.




Your LJI Team