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   Disruptive Markets  

   Managing Uncertainty    

Causal Capital ~ The Knowledge Capital Specialists

The Correction was expected

The last week of market madness [LINK] should be a stark reminder to all of us that [1] Donald Trump may not be the reason for the market highs [LINK] (nothing unexpected there) and [2] as a community, we haven't learned too much since the Global Financial Crisis. The good old saying for bubbles, what goes up quickly has the propensity to come crashing down, especially so it seems in long-only markets like US equities.

Gaussian models are evidently not so good for predicting corrections, that too was a lesson from the Global Financial Crisis but then it isn't the Gaussian distribution that is the problem so much as to how the model is applied. The Gaussian distribution may fly when an outcome is expressed as a number which is being continuously measured but identifying the possibility for a correction should not be tested in such a manner, as we can see below.

Chance of volatility on the VIX to punish & please

So the potential for volatility (a source of uncertainty and mayhem it seems) might find several occasions over the last few years ... Five or so in a decade when we use today's volatility limit as the threshold for risk appetite. Breaching that threshold is massively more frequent than the Gaussian claim of one chance in a million but one would have thought that living through this reality should debunk strangely applied distribution models from the Gaussian corner.

By monitoring the jumps across the CBOE volatility index which is a weighted blend of current market prices for all out-of-the-money calls and puts in the S&P 500, we can find the commonality for shock similar to last weeks propensity as being ummm relatively common it seems. Risk analysts need to feel the pain from those red dots on the chart because one chance in a million over the course of a few years is a claim of heresy to a business owner.

As it is, Jason Browne was right after all [LINK], three months later the market corrects. The problem isn't just a mathematical one with investors but perceptional and driven by plenty of bias too, and for a few months several analysts have been saying that it is not normal that the market volatility is so low.

"People need to flip their rhetoric on its head, the anomaly is not the correction but the long period of stability"

Martin Davies | Causal Capital

Alas, this realisation will come a little too late for those short on VIX ETFs, like you have to be mad and clearly some people have been caught out on this. It's the GFC mentality all over again where plebeians discover exotic products to hold and hold them they do to the bitter end. Today, if you had bought a negative VIX ETF while the VIX was on the floor, an utterly ridiculous proposition but if you have done this, the losses are going to be a sensational experience for you.

"The ProShares Short VIX Short-Term Futures ETF has lost almost 90 percent of its value this week."

Jeremy Campbell | Barclays Plc

You can find out more on this development here [LINK].

Correction in US Equities

So where to next?

Well, the financial advisers have already started to swoon in on the action, pitching to their clients buy the dip, buy that dip, my inbox is filling up with such advice. But if sense prevails, you may find a brief pause will bring further opportunity in time. Things of great proportions and corrections of this size are certainly that, but such things often take time to work their way out of the system and so it follows, there may be a few more dips to come yet. All this said, don't expect a bear market anytime soon ~ let's see.


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