Why have equity markets got "weird"?

He told WP that while the coronavirus was the catalyst that set the market spiralling, the actual spiral was more of an endogenous event as markets became fundamentally broken from a liquidity and pricing standpoint.

Hoffstein saw hedging pressures, a kind of “derivative tail wagging the market dog”, and it set him off on a research project to examine the narratives and ask: why the market is acting differently? He found three main threads. Firstly, that the U.S. Federal Reserve’s policy, aside from creating a moral issue, is forcing investors to take more risks. Secondly, that the growth of passive investing is also creating risk and thirdly, that liquidity asymmetry means high frequency traders are pulling liquidity when it’s needed the most.

He said: “With all these narratives, I didn't find them in and of themselves to be sufficient - there wasn't enough evidence; it was highly circumstantial. But when you started to put all these pieces together, what you saw was this underlying risk that seemed to be latent to all of these narratives. When liquidity in the S&P 500 disappears, the market goes into complete and utter chaos, and a lot of these narratives are putting more and more pressure on liquidity.

“When that exogenous risk occurs, like the coronavirus crisis, it sends the market into this spiral; it's completely procyclical and requires someone like the Fed stepping back in to stabilize the market, at which point the whole cycle begins anew.”

This is not a healthy situation, Hoffstein said, with the huge run-up in the tech names, for example, largely driven by the speculative pressures of short-term call options that were forcing the hand of dealers to hedge in a way that creates huge levered pressure on these individual names.



OTTAWA'S RETIREMENT PLANNING BLOG If you have questions about retirement or financial planning then take a look here. Tons of articles & information on Canadian financial planning topics such as life insurance, investing and more.There are still a lot of misconceptions about money & retirement planning. I just want to help you retire when you want and how you want. As a Registered Retirement Consultant-RRC® and independent adviser, I share my unbiased knowledge to help you have a better understanding of investing, insurance and financial planning.Getting on track for retirement doesn't have to be confusing or complicated. Get the information you need to avoid mistakes and be Ready For Retirement!