Excess confidence in the markets leads to steep volatility rise, as it is well known that “what rises fast, falls fast”. The “disturbances” that had been observed in the volatility futures market eventually led to what was certain to happen. To volatility rise and steep indices’ fall. The following graph is an indicator of the losses during February- March periods as well as the total profits of S&P 500, Nasdaq and Russell 1000 since their lows. What is captured in the following diagram is absolutely unique in the stock markets’ history.
Last week’s fall reached 11% for Nasdaq and 7% for S&P 500 and even so, the margin from the lows of March is great and grants safety. Volatility rise could remain and trigger bigger losses especially in the technological sector, which has been the sector that recorded the greatest returns during the last period.
It appears that there are two main reasons for the impressive summertime rally and the sharp decline of the last days.
1. Private equities giant, SoftBank, reportedly received huge bets in the options market for a range of technological stocks. The amount of bets is estimated between $4- $12 billions.
2. The sharp increase of investment interest and the easy access that the investing public gained to very complex investment tools (options), led to an exchange boom. It is estimated that options trading related to amateur investors amounts nearly to $40 billion.
Both of the above have been the pin that just popped the balloon. In one way or another this would come. Simply, when in a market there is an over-concentration of positions and on the buyers’ side there are index funds which do not sell, it is obvious that in a situation like the recent one, there is a lack of liquidity.
According to a survey of Bank of America, since 1928 till today, pre-election years are marked by intense instability, followed by a summer rally, a pause in September and October, which is just a step before the election, and after that there comes an intense Christmas rally. This “pattern” is observed this year as well and in fact strongly resembles the years of 2000 and 2008, where the beginning was marked by great losses.
The crucial difference compared to the recent crash
At the beginning of February, just a few days before the lockdowns around the world, investors had not realized what was coming. Therefore, when the storm broke out, it became clear that there was a significant “market risk”. Immediately emerged the phenomenon of “panic selling”, as in such circumstances everyone turns to safety that is granted through liquidity and sell literally everything.
This was the explanation why at this critical period of time there had been recorded coordinated stock, gold, short- term government bonds and money market funds sell- offs. At the moment, there is no such risk and this has already been captured in the markets. Currently there are massive technological stocks sell- offs, but on the other hand all the other asset classes (bonds, gold) perform well. This is captured in the following diagram.
It is worth mentioning that, even under such circumstances, even high yield funds trade with remarkable stability, because there is no more that liquidity and sustainability matter like in the first quarter. This stability is of high significance for portfolios.