INSUBCONTINENT EXCLUSIVE:
By Barry RitholtzLast year was unusual in many respects for financial markets
When expectations for how events normally unfold become challenged by data way outside its normal range, it is easy to imagine the world has
A science-fiction genre exists where the protagonists have jumped to (or awoken in) an alternative world
revert to historical means -- eventually
And so that is what we are living through this year
Indeed, if 2017 was a year of eccentricity, then 2018 represents a return to normalcy.
What has changed Combine above average returns, the
passage of time and a very specific technical event and you create the right environment for reversion
The US equity markets have risen for nine consecutive years, and during seven of those nine years, it rose by double-digit amounts
It is easy to see markets getting a little ahead of themselves, and needing to digest those gains
volatility suddenly return Consider that long run of gains by the broad indexes
Active traders and hedge funds found a profitable trade in making highly leveraged bets against volatility
Of the dozen or so exchange-traded funds and exchange-traded notes designed to make this bet, much of the capital was concentrated in just a
The precise factor that precipitated the blow up of these products is unknown.
My best guess is that someone somewhere back in February
decided enough was enough -- it was time to take their chips off the table
hit a cyclical low of 9.39, just as the housing market began to stumble and stock markets were beginning their final run up ahead of the
Great Recession and a subsequent 57 percent crash
For anyone looking for a technical signal that the moment had come to unwind a levered VIX trade, that time was as good a time as any.
As
the VIX was getting closer to its record low of 8.56 in November 2017, my guess is a chain of events led large holders of the leveraged
volatility notes to start cashing out
A trickle at first, then a flood
As so often happens, selling begat more selling, especially with this highly leveraged trade
Pretty soon, a vicious volatility cycle was underway
cash gets sold, often to meet margin calls
Anecdotally, some traders owned SP500 ETFs market indexes as the underlying collateral for volatility notes purchased on margin
As volatility spiked, the value of the notes exceeded its value underlying the margin
When the trade began to get squirrely, someone needed to raise cash, and fast
This could explain why markets took a hit in response to a rise in volatility.
This is only theory, a surmise barely disguised as a guess
So why did traders respond to things in 2018 that they ignored in 2017 Your guess is as good as mine.
I have said before that presidents get
too much credit for market rallies, and too much blame for their crashes
But today, the world sees thing differently.
