With worries over higher interest rates, concerns of a rising inflation and a new Fed chair – the US stock market has had a very troublesome February. The Dow Jones Industrial average fell a total of more than 10% from it’s ATH this month striking flashbacks of the ’07 – ’08 crises. Similarly, Asian markets reacted poorly, followed by European markets. However, this time there was no panic, because this is the market crash that everyone had expected. US markets had one of their best years in 2017 – in an increase that was dubbed unhealthy, overvalued, and in need of a correction. We addressed the need to re-examine the bull market and adopt more market neutral strategies here and here in 2017 articles.
Many investors recommended placing at the money put options on SPY and Dow Jones ETFs, while others simply rebalanced their equity portfolios with high-ROIC stocks to account for a potential long-term bear market decline. One could also lever up on a long position with ProShares UltraShort S&P500 and receive higher exposure on a long position with the SPY inverse.
Another very popular tool during this market crash was the VIX and the XIV. The VIX volatility index, which measures market turbulence, increased 115% during the unsettling period. The XIV (VelocityShares Daily Inverse VIX Short-Term ETN) fell an alarming 80% during the aftermarket of the crash (5.2.2018). It’s important to note that true value of the XIV is 0. It’s a trading note, not a stock, and it is to be used for day-to-day risk management and is not intended to be held over a long-term. The note was designed as an instrument that would close following a decline exceeding 80%. XIV continues trading until February 15th, 2018, when it will close indefinitely – traders that have not liquidated their positions are expected to be paid on the 21st of February.
While U.S. market fundamentals remain strong, and the generally lesser of the four reporting seasons is showing strength in earnings, it becomes hard to tell how far this correction will extend. Many institutional traders are claiming that few people are filling order books to sell, while automated algorithms and HFT is bringing down the market. For novice traders with little floor experience this crash is the first one they see in their careers. Regardless, a dose of volatility in the market and increase in interest rates suggest a healthy sign for the US economy. The next couple of weeks will let traders know the extent to which this correction develops.