Going down

December 12, 2018

Published on ‘Medium’ site on December 9th:

Massive volatility in the financial markets has become the new norm. But while the smart money is adjusting to the changed environment, most investors and their advisors have their heads firmly in the sand.


Last Friday (December 7), American share markets behaved somewhat unusually. After a brief attempt to rise, in early trading, they spent most of the day heading downwards. What was unusual was not the outcome of the day’s trading — a sharp fall — but the absence of sharp intra-day swings, which have now become the new normal in many markets, especially the American ones.

The previous day, Thursday December 6, provided an outstanding display of intra-day volatility, even by recent standards.  The Dow Jones Industrial Average (DJIA — the ‘senior’ and most widely-followed American share index) fell 800 points — over 3% — and then recovered over 700 of them, closing only slightly down. That’s a roundtrip of 1,500+ points on the day.

A second important feature of Thursday’s trading, over and above the huge swings, was the lack of a coherent or consensual explanation for them. The slump early in the day followed sharp falls in Asian and, later, European markets, which were attributed to news reports that the Canadian authorities had arrested the CFO of Chinese telecom giant Huawei — who is also the daughter of the firm’s founder — and intended to extradite her to the US, there to face unspecified charges.

Most remarkably, this arrest had occurred the previous Friday — at the very time President Trump and his advisers were having dinner with Chinese President Xi and his advisers, in Buenos Aires. This meeting had been presented — especially by Trump — in a very positive manner, which spurred strong rises in global bourses on Monday. The sharp falls on Tuesday were attributed to subsequent negative vibes from the Buenos Aires meeting, as well as to other developments.

But the belated reporting of the arrest of Ms Meng Wangzhou, alongside the assumption that this was part of a wider American effort to expose and block electronic espionage on the part of Chinese technology companies — such as Huawei — destroyed any remaining hope of a quick resolution of American-Chinese trade tensions. The timing of the arrest made it seem that Trump and co. were being two-faced, whilst the event itself represented a major public assault on Chinese corporations and thus rendered remote the chances for significant Chinese concessions on the trade front.

These are undoubtedly important developments, whose impact is primarily bilateral but also — given that the US and China are the two global economic superpowers — global. Nevertheless, there is no obvious reason why this event should have an outsize impact on global stock exchanges. To illustrate this, let’s suppose that the same series of events had occurred in 2017, when the level of volatility in stock trading was at record lows — to the point that several months went by without a move of even 1% in either direction in the course of a day’s trading. Would the dinner, the supposed understandings, their subsequent downplaying and, most critically, the arrest of a senior corporate executive — would any or all of these have caused even one move of 3%+ in the market, let alone a series of such moves?

The answer, almost certainly, is no. The environment/ atmosphere in the financial markets in late 2018 is vastly changed from that of late 2017. Last year’s extremely low volatility has been replaced by high and rising volatility in many financial markets — not just shares, but also bonds, precious metals and oil, although not (yet) currencies.

What’s going on?

Let’s sum up the story so far: Last week was a very bad week for equity markets, especially in America. But the large net fall over the week was punctuated by sharp rises on Monday and on Thursday afternoon. Furthermore, when investors went home for the weekend to lick their wounds, there was no single event, fact or piece of data they could point to as the sole, or even primary cause of this fall. There were plenty of possible candidates for this role — which is to say, there was no consensus explanation.

That is the worst possible scenario for any market. Heavy trading volume, massive gyrations in price, a clear negative trend — but no clear-cut, generally accepted ‘cause’ Rather, many factors which may all be contributory causes, of greater or lesser weight.

So, instead of pinning each swing up and down on this or that news item, it is probably more useful to relate to the market itself. And, instead of obsessing over daily or even hourly moves, it’s preferable to step back and examine the trend.

As noted, the big change in the market from last year to this, is in its overall behaviour — from steady and positive to frenetic and, underlying all the volatility, negative.

This change in mood and behaviour occurred early in 2018, after the American markets surged to a long series of record highs. In late-January/ early-February, there was a short, very sharp sell-off. Thereafter, the background mood never recovered — despite almost all the main share indices recovering and making new record highs, in August, September and/or in early October. These later highs obscured the fact that more and more — indeed most — share prices were weak and falling and the final round of highs was driven by a very narrow group of shares (mainly ‘FAANG’ — Facebook, Apple, Amazon, Netflix, Google).

In fact, by the summer and autumn, the US was the only place where shares were making any kind of new highs. Elsewhere, weakness was well-established by then, with some key markets — Germany in Europe and China in Asia — actually leading the way down.

A prominent feature of this new trend was the emergence of much greater volatility, especially compared to the extremely low levels seen in 2017. That was a sufficient hint for many leading fund managers and well-known analysts to become increasingly wary of the markets and, in most cases, to switch from long-standing bullishness to reluctant but steadily more confident bearishness.

For those to whom these measures of ‘technical’ activity — how the market is actually behaving — and/or of sentiment are unconvincing, the rise in interest rates, both long and short-term, could and should have played the same role.

Basically, these indicators — indeed, a whole host of them, covering every kind of methodology and perspective — were delivering the same message: it’s over. ‘It’ referred to the long and powerful bull market that had begun, almost everywhere, at the nadir of the Great Financial Crisis of 2007-09, in roughly March 2009.

After such a long and strong run, it may seem surprising that so many people found — and still find — it difficult to accept that the trend has changed. After all, isn’t that what markets do — move in both directions? And isn’t there some inherent awareness that ‘the bigger they come, the harder they fall’, so that after markets had tripled and quadrupled over some nine years or more, there would have to be a meaningful decline?

Yet even after almost all markets and the great majority of shares have fallen by 10% or more, marking a definite ‘correction’, while many have passed the 20% mark in their decline and thereby moved into a formal ‘bear market’ — even so, both investors and advisors are mostly in firm denial.

This willful blindness is doubly dangerous. It prevents a timely response to what is already happening and — potentially even more problematic — it frustrates any attempt to form a coherent strategy for the future, both short- and long-term.

Subsequent articles will review possible responses and examine available strategies.

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