Insight into the Stock Markets’ ‘Quick’ Correction
As US stock markets conclude 1 of the worst weeks point-wise in history, below is a list of the Key things to know about the quick 9 day corrective action, as follows:
- It was driven by technicals, not fundamentals. The ongoing market correction does not reflect a worsening of economic and corporate fundamentals, as it is being driven by technical factors, including the unwinding of “short-volatility” trades, the testing of relatively new highly leveraged products (ETFs) and a shift in investor conditioning away from “buying-the-dip” .
- This is somewhat unsettling. A Key reason why this selloff is unsettling is the difficulty of pointing to familiar issues, be they economic, geopolitical or corporate. This makes investors and traders more cautious, suspicious and less confident about what could happen next.
- Diversification is not translating into risk mitigation. Government bonds, the traditional “safe assets,” have not provided any meaningful risk mitigation, which adds to investor discomfort. And rather than increasing in price, some have declined concurrent with the selloff in risk on assets.
- It follows a highly unusual low volatility frame. The selloff follows an atypical time of extremely low market volatility where stocks only go up. Before the recent action, US stocks went more than 400 days without a 5% pull back and, in Y 2017, the DJIA marked 70+ all time highs.
- The main technical driver of this quick correction is an unwinding of Short-volatility positions. Some of these were taken directly through the highly leveraged ETFs, those that offer investors the inverse of the move in volatility indexes like the VIX. Some were constructed via derivative positioning. And some reflected the extent to which investors departed from their natural investment strategies, stretching far and wide for returns and not being sure how they really might work under stress. This was charged by leveraged positions that, once volatility spiked, triggered margin calls that forced professional and civilian investors alike to sell a wide spectrum of their holdings.
- The action is global not just domestic. Some participants and analysts have been fast to blame US-specific factors such as the increase in the government budgetary funding requirement and the latest wage data. But, few market indicators support this view. The signals from interest rates around the world point primarily to higher global growth and inflation.
- These unique developments have reduced for now, what was a very strong appetite to “buy the dip,” regardless, Now investors with cash on the sideline are waiting for the technicals to play out. The very experienced market participants are keenly aware of how hard it is to call a bottom when forced deleveraging and other selling pressures not seen before are happening.
- The economy is fine. Technical driven selloffs do not spread to economic and corporate fundamentals. This is the case in the context of a growing economy, strong corporate balance sheets and prospects for pro-growth measures.
- The action is unlikely to deter the careful and measured removal of monetary stimulus by the central banks. As comments last week from Fed officials and signals from the Bank of England demonstrated, central banks do not see the market volatility derailing their gradual normalization of monetary policy.
- Yes, this action is painful for many short-term, this correction will likely underpin healthier markets longer-term. With improving real and forward GDP, the correction can be part of a move from liquidity-driven notions to ones built on better economic and corporates conditions, thus narrowing the gap between asset prices and fundamentals, resetting trust in the markets traditional actions.
Have a terrific week.
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