A volatility storm – has it passed?

February 7th, 2018 by Brian Kantor

The S&P on Monday lost 4% by its close. The Dow had its largest one day loss in history, over 1000 points. In percentage terms it was the worst day for the New York markets since September 2011.

It is easier to understand what didn’t move the New York markets on Monday than what did. It was not any economic news, which was notably absent on the day. Nor was it interest rates. Interest rates moved the markets on Friday when they rose sharply in response to the impressive employment report. Both real and nominal bond yields closed sharply lower by the close on Monday and have maintained lower levels compared to Friday’s close on early Tuesday morning, even as the equity markets remained under pressure before the markets opened.

The most conspicuously unusual behaviour on markets was registered by the CBOE Volatility Index, the VIX. It closed 20 points higher at 37, the largest point and percentage change in this Index ever. And most of this increase took place in the last two hours of trading: it moved from 10 to over 30 in two hours. It appears that much of the price move and the huge volumes of trading activity associated with it was the result of special funds attempting to close out strategies based upon low volatility. Their attempts to do so forced up the Index and forced share prices lower.

The issue for market commentators before the market opened was how soon, as it is described, the systematic bid for volatility would subside. Judged by the strong recovery of the equity markets (S&P up one per cent as I write on Tuesday evening) in the first hour of trading the danger posed by rebalancing volatility strategies may have passed. Yet volatility – the form of minute to minute movements in share prices and Index averages of them – remains highly elevated. The VIX on 6 February continued to trade at these elevated levels as the market indices gyrate between positive and negative values.

Some economic realities

Perhaps in times when economic fundamentals appear irrelevant to company valuations, it is good to be reminded of just what has been happening at the economic coal face. Though coal is surely the wrong metaphor, the companies we refer to here are moving the frontier of economic activity – of how we work and consume that has changed so dramatically.

Some of the leading new economy companies reported their results for Q4 2017. The scale of their operations and the growth in their revenues is nothing less than very impressive. Apple for example reported quarterly sales of $88.29bn, up 13% on the same quarter in 2016. Amazon reported Q4 sales of $60.5bn, up no less than 38% on the same quarter a year before and up 31% for the year. Facebook grew sales in Q4 2017 to $12.97bn and by 47% and Alphabet generated revenues in Q4 of $32.32bn, up 24%. And Microsoft (in business for much longer) grew its sales in Q4 2017 by 12%, to $25.83bn.

All these companies that are thriving impressively and are being generously valued accordingly – described as the FAAGMS – have a competitive and a regulatory threat. Their success to date is as vulnerable to disruption by competitors – known and unknown – as they have proved to be to what were then established ways of doing business.

However their success and the market dominance it seems to create – of which their approving customers are the arbiters – is bound to attract the attention of regulators and tax collectors. That is of economic agents, with interests and powers of their own, who are philosophically unwilling to concede the race for dominance in a market place is to be determined by consumers and regulate accordingly. They would do well to accept that what constitutes the relevant market place is fluid and incapable of being usefully defined and confined. Competition for the budgets of households and of all the firms that ultimately compete for their favour remains highly intense, as the fast growing sales of the Apples, Amazons, Facebooks, Googles and Microsofts prove. Society should best leave the unpredictable outcomes to this competition. 7 February

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