02/2018-
The current market correction which saw the Dow Jones whipsawed more than 4,000 points in just 2 weeks from 26 Jan 2018 to 9 Feb 2018, was amplified by algorithm-driven, or “algo trades” which used huge amounts of computing power to spot price arbitrage differences in market movements.
The momentum in algo trades picked up steam when prices were falling and instantly started to sell into falling markets in huge volumes, greatly exacerbating the sell-off, broadly similar to the 1987 stock market crash which saw the worst ever crash on the Dow in a single day on 19 Oct 1987. Then, Portfolio-insurance programs worsened the crash, inflicting heavy losses on the very portfolios that they were designed to protect.
Investors also learned first-hand that it is indeed true that when the tide subsides, that you know who is swimming naked. This time, it is the hedge funds, speculators and traders who placed directional bets on exchange-traded notes that depend on the VIX or volatility index to fall. These players would have reaped pennies in the past year when the VIX was as low as it can ever get to zero, but all these “pennies” had been wiped out fully in 1 spike of the VIX in the current market malaise. It is a wonder that such bets amounted to US$8 billion, certainly no small pennies.
What amazes me is that these “smart/hedge funds” sold options on options as the VIX is actually an index derived from the expected volatility levels implied by option price on the S&P 500 index. Running through my cerebrum was clearly – why would anyone, let alone US$8 billion-worth betting on the VIX when it was near zero, has been at below 10 for the past 10 months? Either these “smart/hedge funds” have a huge ego problem of not been able to understand the risk they are running or that they do not study financial history. Financial history clearly shows that markets will eventually revert back to the mean and when the VIX moves up, it rarely moves up steadily – it spikes and these spikes can be lethal.
It is exactly how the song “Yesterday Once More” made by the Carpenters in the 1950s went –
“Those were such happy times and not so long ago
How I wondered where they'd gone But they're back again just like a long lost friend All the songs I loved so well
Every sha-la-la-la Every wo-o-wo-o, still shines Every shing-a-ling-a-ling, that they're startin' to sing's, so fine”
To me, it’s another case that exemplify that investors invariably take on all sorts of silly risks just to earn a little extra return, then got complacent with their positions and then bet bigger on them only to be wiped out when the crunch time comes. In the process, there is no shortage of bankers or insurance companies that will sell them such products like the “collateralized mortgage obligations” in 2008 and “portfolio insurance products” in 1987 whose value promptly fell to zero when the crunch time came.
And as the song goes -
“When they get to the part Where he's breakin' her heart It can really make me cry, just like before It's yesterday once more”
For investors who never learn, every sha-la-la-la, every wo-wo-wo, will never shine. For the smart investors who do, they will certainly shine and go on to sing every shing-a-ling-aling.
Happy Valentines.
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