The February Dynasty Monthly Market Commentary: "If You Can Keep Your Head..."

If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
If you can wait and not be tired by waiting,
Or being lied about, don’t deal in lies,
Or being hated, don’t give way to hating,
And yet don’t look too good, nor talk too wise:

If you can dream—and not make dreams your master;
If you can think—and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two impostors just the same;
If you can bear to hear the truth you’ve spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to, broken,
And stoop and build ’em up with worn-out tools:

If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: ‘Hold on!’

If you can talk with crowds and keep your virtue,
Or walk with Kings—nor lose the common touch,
If neither foes nor loving friends can hurt you,
If all men count with you, but none too much;
If you can fill the unforgiving minute
With sixty seconds’ worth of distance run,
Yours is the Earth and everything that’s in it,
And—which is more—you’ll be a Man, my son!

(“If”, by Rudyard Kipling, 1910)

We suspect many people are at least passingly familiar with first line or two of Rudyard Kipling’s classic poem “If” but rarely, if ever, have read the whole thing or thought about its context. It was written as an ode of paternal advice from father to son, and in honor of the heroism and stoicism of a British mercenary who lead a losing raid against the Boer government in South Africa – a raid that ultimately lead to the second Boer War (1899 – 1902). So, to be clear – the protagonist was a mercenary, he lost, and his actions led to a war. Clearly, he deserved a poem written in his honor.

But the market actions of late January and early February brought this poem to mind, as panic (briefly) overtook the markets, and it clearly was critical to “keep your head when all others about you were losing theirs.”

In our January Market Commentary (published just days before the month-ending disruption), we warned of signs that the market was over-heating:

There are some signals that the market is over-heating, specifically (1) sky high investor sentiment / bullishness; (2) the amount of retail money that is coming off the sidelines and into the market as the “fear of missing out” (“FOMO”) syndrome picks up speed; and (3) the rapidly declining “put/call” ratio – indicating that less and less investors are interested in hedging their portfolios (via buying put options) and more interested in buying leveraged upside potential (via buying call options). All of these are clearly bullish sentiment indicators but, unfortunately, history is pretty clear that excessive bullishness (especially at the retail level) frequently precedes market corrections.

To these flashing yellow sentiment signals, we add the following contributory factors to the market decline:

  1. There were signs that inflation was finally rearing its head – wages were increasing and commodity prices had risen with the dollar’s continued slide.
  2. Investors reacted by selling off Treasuries and driving interest rates up. This caused equity prices to drop because future cash flows were being discounted at a higher rate.
  3. Short-term interest rates rose to levels that were higher than the dividend yield on the S&P 500 – so some investors naturally rolled out of stocks (to lock in gains), de-risk their portfolios, and reallocate back into fixed income now that they could generate a positive return.
  4. The market witnessed a “great unwind” of leveraged “short volatility” positions — a vicious cycle of forced selling driving volatility higher, forcing more selling, driving volatility higher, lather-rinse-repeat.