The structure of the market has changed from the investing trends of 2017, and since the Great Recession. VIX and Inverse VIX products have changed the way volatility is traded. This crowded the volatility trade of 2017, and created the volatility events we have seen in 2018. Low-volatility dividend strategies have changed the dynamics of stocks that are historically stable. Passive investments have changed the way volatility hits the markets.
2017 was a historical year, but 2018 has not had such luck. The investing trends of 2017 are to blame.
Selling Volatility 2017 was one of the least volatile years in U.S. stock market history. In fact, one of the big trades was to sell, or short volatility. This means that investors were selling volatility protection, and making money on it.
This was a great trade in 2017, but if volatility came, these investors could lose a lot of money, quickly. In 2018, volatility popped, and more than just investors were hurt.
An Over-Crowded Trade Shorting volatility was such a good trade in 2017, that it soon became overcrowded. Inverse ETFs and ETNs were growing in size as more retail traders and investors began to enter into the trade. This sent the VIX to the lowest levels it has ever been, since its creation in 1992. (The VIX is an index that tracks implied volatility in the options market.)
The VIX is a volatile index on its own. On days where large drops occur in the S&P 500, the VIX could move up upwards of 30%. When volatility did strike (Read: Volaility Strikes! What do the Technicals Say?), investors began to cover their positions. This means they had to buy back, what they previously sold.
This started the "short squeeze". So many people were on the short side, that they needed to buy the VIX, in order to "sell" their short positions. This pushed up the VIX even higher, and structurally, the market could not take it.
Some inverse VIX ETFs and ETNs are now shutting down, or are in the process of closing because of the sudden spike in volatility. Covering their trades further exasperated the VIX and sent it up over 130% on Friday, February 2nd. These funds lost upwards of 90% of their value.
As VIX traders were covering their positions, sending the VIX higher and higher, fear was spreading through the rest of the markets, causing more selling pressure in the indices.
The Other Low Volatility Trade Low-volatility funds have become prominent since the Great Recession. These funds are designed to be "bond-like". They look for low volatility stocks that pay a good dividend. The result was bond like price movements, and dividend payments that mimic bond coupons.
These trades became very popular as interest rates continued to fall. However, as more money was put into these funds and stocks, they inherently become more volatile. This forces actively managed funds to trade and try to keep their funds from being too volatile. This in turn affects the markets, and can be part of the reason why utility stocks have been having a hard time.
The Rise of Passive Investments Passive investments have also become very popular since the great recession. They offer exposure to the markets, and do not require further action. An investor can create an entire portfolio with only one to three investments.
Younger investors find this great. They do not need to do learn how to invest, or learn how to research a company to invest in. They deposit their money and they are done. As passive investments grew in popularity, it changed the structure of the market.
When someone buys an S&P 500 ETF, they are purchasing the 500 or 502 companies contained within that index. That creates a demand for those 500 companies, and should push them up. There is no discrepancy between a good performer or a bad performer, they all get their required amount.
This changes the structure of the market because now these companies are getting a demand, regardless if they deserve it or not. It also changes the structure of the markets because when investors sell their ETFs in a panic, it is going to hurt all of the companies involved.
Conclusion: Structured Volatility The structure of the economy and the market have changed the way investors need to look at the stock market. Inverse VIX funds made it easy for less sophisticated investors to participate in a complex trade, where they may not even know the full spectrum of risks.
Low-volatility funds changed the way that investors participated in the market, and they have changed the dynamic of the market. Usually unpopular stocks became popular and grew frothy as more money was invested into the strategies.
Lastly, the rise of passive investing has changed the inherent structure of the market. Investors purchase and sell an index, and this changes the distribution of risk within the index. Rather than investing in a diversified pool of stocks and bonds, passive investors diversify by index. All of the stocks in the index participate in the growth and decline of the index. This increases volatility when it spikes, because more stocks are forced to participate than they otherwise would in an active investment environment.
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Submitted February 12, 2018 at 06:00PM by BR-Technicals http://ift.tt/2EEYD6t
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