WHY DID STOCK MARKETS PLUNGE? RISK AVERSION BITES BACK
Yesterday, stock markets all around the world went into a downward spiral, notably during the American session. A variety of commentators tried to explain what happened, giving various reasons as a justification. Some say that the fundamentals were to blame, given that people were worried about corporate profits, especially in the tech sector. This appears to be a rather misleading explanation: corporate profits recorded a huge improvement, with most companies across many sectors registering better than expected results. Among them, Microsoft reported double the increase analysts expected, while Tesla Motors suggested that it was a “historic” profitable quarter. The same is expected to hold regarding the 2 tech giants which are expected to post profits today. While the idea is that investors somehow appear to be worried about future profit flows this does not seem to be justifiable either, given that forecasts, both on the corporate and especially the macroeconomic front, also appear to be positive. Overall, all of the above do not support the view that the 3.4% decline was due to fundamentals.
Technical analysis should also be ruled out as it cannot really be blamed for such large movements in the markets. The reason is that technical analysis usually operates within bands and is also usually following the trend, which usually is in accordance with fundamental developments, not acting ahead of it. The only possibility for technical analysis to have been the culprit is if insiders know that the 3 tech giants which will announce earnings today, are to face worse than expected outcomes and have traded heavily on such information, with technical analysis assisting them along the way as prices went below certain pivot points. However, this is quite unlikely (and also very illegal!).
What we are left with then is market sentiment. As the FX-Risk Aversion Index Chart shows, uncertainty reached a 3-month high, as the Kashoggi issue, which undermines the US-Saudi relations, the proposed Fed interest hikes, as well as Brexit and the rejection of the Italian budget yesterday, continue to dominate discussions. Naturally, all of these issues pre-existed the crash and have not intensified that severely yesterday. This is where the US 10-year bond, which has increased above 3% over the last month, comes in.
Let’s underline that psychology is important in the markets and what matters is that they expected a stock market bust. In fact, they have been expecting it for a while now. Put yourself in the position of a fund manager: you’re recording profits because the market has been going up since the start of the year. All of a sudden, markets start to react badly in the beginning of October, with macroeconomic risks increasing. Can you trust that they will continue to do so and they will not eat up your profits? Not really. So what you can do is sell, in order to lock in your profits, and switch to something safer, such as US Treasury bonds, which would guarantee a stable income until the end of the year. If risk aversion continues to be high, you may actually end up also getting a handsome profit from the increase in the bond price as well. The fact that market participants are expecting a drop and then selling ahead of this, makes it a self-fulfilling prophecy, a theme which often arises in the markets.
Note that I’m not saying that this is exactly what happened. However, it could be the case that something similar took place as stop loss orders reached their limit and the market received more than it could handle. Besides, this is also the most likely explanation regarding the 1987 Black Monday incident. Why yesterday then? The most honest answer one can offer is that we do not know. Perhaps it was the fact that Ford profits were 37% lower than expected, on account of China woes, and helped trigger this reaction in the market. It could, by any means, also happen on any other day, as long as participants were expecting it to happen and they were thus ready to push through with the switch to the bond market.
Overall, the drop had nothing to do with tech fundamentals, and its timing had really nothing to do with any event on that particular day. It was just a reminder that the trade war with China will also harm the US (as we have predicted in our Quarterly Outlook), with ongoing tensions all over the world adding to this. On their own, they would not have caused such a sharp decline. However, add them up with market expectations of a decline in the stock market and an increased attractiveness of the 10-year bond and you have a perfect storm forming. As for the straw which broke the camel’s back? We will likely never know.
Nektarios Michail, PhD
Market Analyst
HotForex
Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
Technical analysis should also be ruled out as it cannot really be blamed for such large movements in the markets. The reason is that technical analysis usually operates within bands and is also usually following the trend, which usually is in accordance with fundamental developments, not acting ahead of it. The only possibility for technical analysis to have been the culprit is if insiders know that the 3 tech giants which will announce earnings today, are to face worse than expected outcomes and have traded heavily on such information, with technical analysis assisting them along the way as prices went below certain pivot points. However, this is quite unlikely (and also very illegal!).
What we are left with then is market sentiment. As the FX-Risk Aversion Index Chart shows, uncertainty reached a 3-month high, as the Kashoggi issue, which undermines the US-Saudi relations, the proposed Fed interest hikes, as well as Brexit and the rejection of the Italian budget yesterday, continue to dominate discussions. Naturally, all of these issues pre-existed the crash and have not intensified that severely yesterday. This is where the US 10-year bond, which has increased above 3% over the last month, comes in.
Let’s underline that psychology is important in the markets and what matters is that they expected a stock market bust. In fact, they have been expecting it for a while now. Put yourself in the position of a fund manager: you’re recording profits because the market has been going up since the start of the year. All of a sudden, markets start to react badly in the beginning of October, with macroeconomic risks increasing. Can you trust that they will continue to do so and they will not eat up your profits? Not really. So what you can do is sell, in order to lock in your profits, and switch to something safer, such as US Treasury bonds, which would guarantee a stable income until the end of the year. If risk aversion continues to be high, you may actually end up also getting a handsome profit from the increase in the bond price as well. The fact that market participants are expecting a drop and then selling ahead of this, makes it a self-fulfilling prophecy, a theme which often arises in the markets.
Note that I’m not saying that this is exactly what happened. However, it could be the case that something similar took place as stop loss orders reached their limit and the market received more than it could handle. Besides, this is also the most likely explanation regarding the 1987 Black Monday incident. Why yesterday then? The most honest answer one can offer is that we do not know. Perhaps it was the fact that Ford profits were 37% lower than expected, on account of China woes, and helped trigger this reaction in the market. It could, by any means, also happen on any other day, as long as participants were expecting it to happen and they were thus ready to push through with the switch to the bond market.
Overall, the drop had nothing to do with tech fundamentals, and its timing had really nothing to do with any event on that particular day. It was just a reminder that the trade war with China will also harm the US (as we have predicted in our Quarterly Outlook), with ongoing tensions all over the world adding to this. On their own, they would not have caused such a sharp decline. However, add them up with market expectations of a decline in the stock market and an increased attractiveness of the 10-year bond and you have a perfect storm forming. As for the straw which broke the camel’s back? We will likely never know.
Nektarios Michail, PhD
Market Analyst
HotForex
Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
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