It’s not your imagination: Stock markets are lurching from meltdown to melt-up like never before.
After one of the swiftest corrections in history, the S&P 500 is now back within a spitting distance of pre-crisis levels. Likewise the February 2018 crash was followed by a swift resurgence, while the late December swoon that year was a mere memory the following April.
The danger now is that investors are stampeding into yet another cross-asset rally ripe for a violent reversal. This tendency for markets to sway suddenly between extremes highs and lows is increasingly a feature of modern trading.
Bank of America Corp. strategists have a term for this: Fragility. They reckon high-fragility events are kicking off five times more frequently since the global financial crisis compared to the decades from 1928 onwards.
“In a world where alpha is hard to come by, you have to go with the trend,” said Benjamin Bowler, Bank of America Corp.’s chief global equity derivatives strategist, in an interview. “Because of that low conviction, when the trade turns, everyone wants to get out at the same time because they were only there when the trade was working.”
Societe Generale SA strategists calculate the frequency of freakish moves in the S&P 500, a measure known as kurtosis, is nearly double its three-year average after reaching a two-decade high this year.
Blame investor herding, monetary stimulus, weak liquidity, or excessive leverage. Whatever the culprits, it’s no easy problem to hedge, with market shocks becoming ever-more unpredictable and the intermittent rallies painful to miss.
Beyond Volatility
Bowler’s recommending to clients a ‘W’ trade that buys out-of-the-money S&P options which pay off sharply when there are extreme moves both up and down, while collecting a steady premium from selling contracts that are nearer to in-the-money. SocGen has a strategy that follows intraday stock trends, built for fast-moving markets prone to outsized price moves.
“If all the central banks continue to artificially suppress volatility and support markets and have a heavy hand, I think this environment is going to continue,” Bowler said.
Herd mentality is on full show of late in the nearly $23 trillion global stock rebound. The Nasdaq 100 has been flirting with overbought levels while corporate bond prices are recovering to their pre-pandemic highs.