The Cboe Volatility Index (VIX) hits its highest level since March 2020, Japanese equities plummet, recession fears become increasingly pressing and investors lose confidence in tech giants. Is this a flash crash that US markets can recover from, or something far worse?
A flash crash usually sees a market recover quickly after a sudden decline, and tends to be prompted by a rapid sell-off of securities. These can often pass without note, with end-of-day prices leaving no trace of the blip. The most infamous took place in 2010, when the Dow Jones Industrial Average lost a cool US$1 trillion in equity on May 6th. Despite falling more than 1,000 points in 10 minutes and losing 9% of its value, the market had recouped 70% of its loss by the end of the day.
Today, the Dow has fallen by more than 1,000 points. Whether it can recover before market close remains to be seen.
While the 2010 flash crash was caused by a rogue futures trader intentionally trying to spoof the market, today’s crisis has been looming for a number of weeks. According to a research note by Peter Garnry, chief investment strategist at Saxo Bank, there are five key factors that have driven the sudden sell-offs in the US.
Firstly, troubling US unemployment figures have seen the Sahm Rule triggered. Former Federal Reserve economist Claudia Sahm’s model states that when the 3-month average US unemployment rate is up more than 0.5% from its low over the past year, the US economy is in recession. On Friday, that figure was met.
The sudden shift in sentiment as investors withdrew from what has been a strong bull market for AI and semiconductors has also played its part, the note said. As technology firms have amped up their AI spending, investment has fallen away – prompting concerns that they are headed for losses.
Volatility has been pushed even further by US equity market concentration, Garnry continued, which reached its highest level since the 1930s last month. Poor diversification causes fragility, and paired with changes in sentiment, the cracks are certainly showing.
Yet another factor is the growth of the US options market, the note said, along with the adoption of ‘dispersion trades’ – selling VIS futures and buying call options on technology stocks. As the VIX Index spikes, these trades have to be unwound quickly, further driving volatility.
After optimism in Japanese equities earlier this year, markets have tumbled to their lowest levels since the stock market crash of 1987. At the time, there were worldwide fears that the rout could domino into a global downturn. Following the Japanese central bank’s shock rate hike last week, and the subsequent spiral of JPY and funding markets, those same fears are returning now.
Concerns are far from being allayed by the actions of investors like Warren Buffett, who has not only sold off more than half of Berkshire Hathaway’s Apple stock but also taken the conglomerate’s cash holdings to record levels. Intel CEO Pat Gelsinger’s recent X post citing Biblical scripture has similarly failed to inspire confidence.
Saxo’s Garnry advises long-term investors to stay calm, warning against overreaction and suggesting that “if anything, the recent sell-off will create a lot of interesting opportunities in equities”. Speaking to Global Trading, several traders have concurred that the situation is being blown out of proportion – “buy the dips”, one suggested. But with an increasingly complex web of factors playing into the crisis it is clear that today’s events are far from a flash in the pan. Perhaps 1987’s predictions are set to come true – a mere 37 years late.
©Markets Media Europe 2024
