Today was a wild day in the US equity markets. The S&P 500 closed down 410 bps. At the height of the sell-off, around 3 PM EST, the index had fallen in excess of 500 bps (with the Dow down 600 bps!). The VIX rocketed higher, with the futures curve backwardating. Congratulations to anyone who was long vol and managed to earn your 2018 bonus and then some on the back of a single day’s trading.
Here are some observations, in no particular order:
- The gap down in prices around 3 pm was clearly caused by some sort of systematic selling program. My guess is trend followers and traders who stopped out. Some retail limit or stop-loss orders may also have contributed to the sudden plunge.
- This gap down in prices illustrates that volatility is far from dead, and can easily be exacerbated by systematic trading strategies.
- As to what caused this sell-off, I think there are a number of issues in play:
- Itchy trigger fingers have been waiting for an excuse to sell equities on the back of a period of extremely low volatility.
- Market participants may be trading around political risk in the US (though honestly this doesn’t seem to jive with sentiment among professional investors).
- Strong macro data reads in the US have gotten folks nervous about inflation and thus higher interest rates. I am not going to link out to every post I have done about the implications of rising rates for equity valuations, but you can find them all by scrolling down the home page (spoiler alert: it isn’t pretty). It makes sense to me that the market would swing around while trying to get to grips with the likelihood and magnitude of additional interest rate hikes, as well as the potential implications for valuations.
- Likewise, some investors are likely re-evaluating where they want to be positioned along the risk continuum. Many years of ZIRP and NIRP have forced investors further out on the risk curve than they would likely have moved on their own initiative. It is possible portfolio allocations are starting to adjust in anticipation of a new era of monetary policy, where MAXIMUM RISK needn’t be the default allocation required for earning acceptable returns.
- If a market sell-off continues, and the S&P 500 draws down, say, 30%, it will be extremely interesting to see how the Fed responds. My bet would be a temporary hold on interest rate hikes. Beyond that, I could see another round of quantitative easing being used to prop up asset prices if market conditions deteriorate significantly.
I have been getting questions from several quarters regarding whether now is a good time to dip-buy the broad market (the questions are not exactly phrased that way). In my view this sell-off changes exactly nothing about cross asset-class valuations, which are my focus when allocating capital.