What a Correction Feels Like
By Jared Dillian, Editor, Bull’s Eye Investor
In the summer of 2007, while employed at Lehman Brothers, I prepared for an unusual vacation to a semi-primitive resort on Cat Island in the Bahamas. It was a stark contrast to my typical routine, as I had taken barely five vacation days in six years of work. The tropical heat of August in the Bahamas seemed inviting, but I sensed turbulence in the market and considered the potential for trouble while I was away.
To hedge against this uncertainty, I decided to invest in 30 strike calls on the CBOE Market Volatility Index (VIX), anticipating a surge in volatility. I spent over $100,000 on these options, which would only hold value in the event of extreme market panic. I instructed my colleagues to sell the options if the VIX exceeded 35. (Keep in mind, my recollection of the specific details surrounding the trade is somewhat murky.)
As I lounged in the warm sun, oblivious to the chaos unfolding in the markets, I chanced upon a local newspaper featuring a picture of black swans. I couldn’t resist capturing a photo of myself in a hammock, reading the paper with the striking image. I still cherish that memory.
Upon my return to the mainland, I eagerly checked the market. The VIX chart was astonishing, indicating that, if my friends had executed my orders correctly, I would have pocketed a profit of over $800,000. However, looking at my spreadsheet revealed a stark reality: I made less than $100,000. I hadn’t considered the frantic conditions under which my colleagues had to operate during the market downturn.
This situation highlights an essential aspect of market behavior known as state dependence. For instance, one may plan to buy stocks when the market dips below a certain level. Yet, when that moment arrives, several factors might interfere, such as lack of capital or a frenzy that compels one to sell rather than buy. As the saying goes, “everyone has a plan until they get punched in the face,” echoing insights from Mike Tyson.
Blowing My Chance
In my readings of Russell Napier’s book, *Anatomy of the Bear*, I delved into significant bear markets in the United States, notably the stock market crash of 1929 and the ensuing Great Depression. One striking takeaway was that precise timing during market lows can lead to rapid wealth accumulation. For instance, those who invested at the low in 1932 doubled their money within months.
Longing for such opportunities, I found myself desiring a bear market to seize my moment.
Little did I know, my chance would come just two years later—only for me to lose it.
When the market is down by 60 percent, the prospect of buying stocks can be terrifying. In retrospect, we can criticize those who thought the market would plummet to zero, but in March 2009, many genuinely believed that was a possibility.
However, for those with available capital who weren’t gripped by fear, it was a once-in-a-lifetime opportunity.
A Thousand Days with No Correction
So let’s examine point a): Does everyone have capital? The real challenge lies not in identifying market bottoms—many can do this adeptly—but in the ability to act. Often, individuals are fully invested and lack the liquidity to take advantage of panic-induced opportunities.
As for point b), those who possess capital tend not to be paralyzed by fear.
Currently, everyone is aware that the stock market is undergoing a correction. The price movement has been markedly negative. Is it likely to worsen? I suspect so. The market has been devoid of significant corrections for over a thousand days, and the excess seen in corporate credit and growth stocks suggests we’re overdue for a shift. With the market down approximately 5 percent, there’s little alarm—previous dips of this nature have invariably rebounded.
Returning to the idea of state dependence, what will the emotional climate be if the S&P 500 drops to, say, 1,700?
Let me tell you: it will evoke memories of August 2007, when my colleagues were overwhelmed and unnoticed my VIX call trades amid a torrent of panic-driven sell orders. Before widespread algorithmic trading, the trading floor was rife with sound; one could discern market movements merely by listening. At an S&P of 1,700, I expect that sound level to return.
Given the lengthy absence of corrections, many investors may have forgotten what it feels like. After an extended period without significant fluctuations, individuals often find themselves holding substantial capital gains, reducing the urgency to sell. However, if you own airline stocks that have plunged by 30 percent, that reality can sharply focus your attention.
Every steep correction presents incredible opportunities, but they are only accessible to those equipped with capital. It’s crucial to remember that bear markets don’t solely diminish the wealth of bulls; they can wipe out the bears’ capital just the same.
Bear markets obliterate everyone’s capital.
Sincerely,
Jared Dillian
for Economic Prism
[Editor’s Note: The Fed has ushered everyday Americans and investors into unprecedented economic conditions. Their money-printing strategies have propelled the markets upward, inflating a new bubble post-crash. This continuous price manipulation creates cycles of booms and busts. Discover how you should invest in this environment. The article The 10th Man: What a Correction Feels Like was originally published at mauldineconomics.com.
