There is a saying on Wall Street, “There is never just one cockroach”.
Keep that in mind when you are scanning headlines & stories of the day.
The Cockroach Theory states that when a company reveals bad news, many more related, negative events may be revealed in the future.
The term comes from the common belief that seeing one cockroach is evidence there are more.
Over the past week, there was much confusion over the magnitude of the losses in certain stocks.
Was it company news, or forced selling?
News travels fast, and it was soon confirmed that a very large fund was forced to sell billions of dollars worth of stock to meet margin calls.
The portfolio under pressure included shares concentrated in a basket of Chinese stocks and a very large USA media company, Viacom.
In this period of massive inflation-adjusted negative rates that we are in right now, it's hard to imagine that there aren't others in the same boat.
There must be more than one fund swimming naked in that vast sea of liquidity, and leverage, no?
Is there another shoe to drop-(there must be!)
And therein lies the cockroach theory- it says it's rarely just one.
So what exactly has happened and what do we look for?
Regulatory changes, interest rate changes, tax policy changes are some very important things to consider.
In the above-mentioned portfolio liquidation, we note that on the regulatory front the SEC has plans to require that foreign companies listed on US exchanges have their foreign audited financial statements reviewed by U.S. regulators or face delisting.
On its face, that sure seems to be prudent for investor protection and market integrity.
However, in a system and market structure that is based and built on leverage, could it be like yanking the bottom out of a card stack?
We suddenly appear to be re-valuing an entire foreign market (China). Just look at the carnage in the FXI index.
One of the stocks sold Friday in the block-selling was communications company Viacom (VIAC).
The stock had climbed from $10 in April 2020 to about $30 in November but then soared up to $100 by the middle of March.
Such performance was breathtaking and is likely a sign of available leverage.
Additionally, many companies look to raise money when their stocks are performing well and valuations are high.
So the management of Viacom decided that a 3 billion dollar secondary offering of stock and convertible preferred shares was in the company’s interest. Almost always, the market hates dilution, and stocks sell-off.
But what would another announcement of a secondary offering of shares due to the next set of leveraged longs?
Surely there must be other leveraged longs...
and there must be others planning secondary offerings?
Won't they want to take advantage of the record-high market?
News of a secondary, in general, is enough to compel leveraged longs to exit.
And sometimes the stocks are down on news before they can trim...and then it snowballs into forced selling.
From the lows of April 2020 to the mid-March highs Viacom has now retraced 62%.
That's quite a fall.
It is also worth noting that deleveraging is not a one-day event, it is usually a multi-month process.
When circumstances and perceptions change, we should expect shocks to the downside.
As Warren Buffet was reputed to have said “It is only when the tide goes out that you discover who has been swimming naked.”
And that brings us back to the bugs, and bug theory & that there must be others.
Do you see any other potential cockroaches out there?
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