19 Mar 2020
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Last week, for the first time in many years, trading temporarily halted in the US and other exchanges across the world. The circuit breaker was triggered as prices were being pushed too far and a snowball effect was dominating the markets. Circuit breakers were brought in during the Reagan administration, post the 1987 crash, as a mechanism to stop wild swings and to stabilise the markets. They are activated at strategic points and allow pause for thought to stop irrational exuberance from taking hold. In the New York stock exchange, circuit breakers kick in at three thresholds. A 15-minute trading halt is triggered when there’s a drop of 7% from the prior day's closing price. A drop of 13% generates a further 15-minute halt and a dip of 20% activates a cease in trading for the day.
Why has this happened? Markets hate two things: fear & uncertainty. The spread of the Coronavirus has caused an extreme reaction in the market. There is fear over the health of the population, the supply of goods, individual earnings and the profitability of companies and guidance from policy makers such as central banks and governments is needed, but interest rates are so low that manoeuvrability is restricted and policy can only have a limited effect. As stimulus to keep things moving, the Bank of England has reduced interest rates from 0.75% to 0.25%, reducing mortgages and allowing companies to refinance at lower levels.
It could be argued that markets have been complacent for a long time. The CBOE Volatility Index, or VIX, is a real-time market index representing expectations for volatility over the coming 30 days. Investors use the VIX to measure the level of risk, fear, or stress in the market when making investment decisions. The VIX has reached 76 in the last few days, the highest since September 2008. The market is waking up to this unprecedented event and fear has taken over, resulting in irrational investor behaviour.
Most asset classes have started to go down this week, including Bitcoin and gold. Markets are fluid and timing them is difficult, it’s like a kaleidoscope where you’ve just got the focus and the picture changes. Policy decisions have been made by the Fed to try and stimulate the market and on Friday a short-selling ban policy was brought in on certain stocks. Traders can benefit and distort the market by buying and selling during periods of volatility. The short-selling ban will help companies that are affected by this profiteering and bring some order back into the market.
Volatility is a trader’s best friend but an investor’s nightmare. Markets are driven by emotion, but we have to step back and take an objective rather than subjective view. We’re in it for the long term and we construct portfolios with diversity to navigate uncertainty.
It’s a nerve-racking situation and the shock is causing violent movements, but the market will absorb it, the fear and uncertainty will subside, and rationality will return. It may feel like it’s the end of the world right now and there will be more bumps in the road, but this climate is momentary, and markets will stabilise.
Important Notice This is intended for investment professionals and should not be relied upon by private investors or any other persons. Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise, is not guaranteed and your clients may get back less that they invest.
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