Market Note – September 8, 2015

Last week was another ride through the Volatility Machine. Here’s a look back at the past three weeks, keeping in mind that our daily stock price movements are roughly three times the daily movements of just a month ago.

We can begin the period on August 17, when we saw the first correction in stock prices in over two years. That week, the market was down -5.8%. The following week closed up +1% despite downwards movements of more than -5% through the week. And finally, last week, the market moved down -3.4% leading up to the holiday weekend.

So the volatility continues, and the movements down follow the volatility.  The move up in Week 2 was typical of a “dead cat bounce” when buyers come in seeking quick profits or short traders come to buy back their positions.  Last week, however, saw the continuation of selling with little reprieve.

Meanwhile, reasons for this sell-off are still being postulated.  China is having troubles, but the U.S. and European economies are on stable footing, and we don’t appear to have a systemic collapse of any single sector that would warrant such moves.

One interesting theory has to do with a type of hedge fund that trades based on volatility measures, called ‘Risk Parity’. While the strategy takes many forms, it is designed to move funds out of certain asset classes when the volatility measures start to spike in order to avoid downwards movements. Put simply, stocks start to gyrate, so these hedge funds sell.

This theory would explain the massive selling that we have been seeing, specifically as all stocks are being sold off at the same time regardless of differentiation in solid earnings, high dividends, or both. If it is stock, it is being sold.  However, the theory doesn’t hold much water until we see the data on the hedge funds that will come out in several weeks.

Another variation on that theme is the explosion of risk parity strategies that are being mimicked by the retail asset managers.  While these strategies are far less sophisticated than the hedge funds, the premise is the same – sell before the market dives.  This simple approach of ‘get out the door first’ results in a self-fulfilling prophesy.

Whatever the reason, the trend that we are seeing stays the same.  Volatility has spiked, and with that spike, asset prices are going down.  A bottom will eventually form – and with that, we will see the stock price of good companies move independent of the market – but until that time this is a market that is moving in one big rush for the door.

Regards,
David Matias

 

Managing Principal