Thoughts on Crashes, Corrections and Computer Volatility
Written October 23, 2018
The market is being asked to discount a lot at the moment.
- US Politics
- US/China trade politics
- US Interest Rate Policy
As a result, people worry that the end of the central bank quantitative easing bubble is causing an October crash. While this is a possibility, we do not think that is the highest probability.
Let’s add some historical context to the current market conditions. Our analysis of stock market crashes show that they come in two flavors.
- The big bull markets that end with a bang (1929, 1987, Japan 1989, Nasdaq 2000). These bulls are generally killed by interest rates north of 6% and crash until year to date gains (YTD) are less than zero (as people aggressively sell to protect gains).
- Bad Markets (1930-1932, 2008, 1973/74). These markets never lift their head and are down all year and people just give up at the end.
Given that stock markets and interest rates were up until the fall – we would put the current market in the ‘Big Bull Markets That end With a Bang’ category but with a lessor magnitude.
The VIX index (CBOE Volatility Index) is now trading between 18-25. Historically, the average is 20 with a standard deviation of above 6, so it seems we are back to normal markets. Because the VIX has been hovering in the mid to low teens since early 2016, People have forgotten what normal markets are like.
Why do I bring this up? Because, computers are programmed to identify events (and then look for those same events) and then repeat the action. So technically, there is still higher risk through about the 29th of the month and the post election period in November. This risk stems from a few historic event patterns and the tendency of computerized trading to repeat actions.
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