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Portfolio > ETFs > Broad Market

Taming the Panic Around Market Volatility

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Stock markets around the world plunged on Monday, Aug. 24. The Dow ended down 588 points, the worst single day loss since 2011. More than $600 billion traded hands and nearly 14 billion shares were traded on the NYSE and Nasdaq, making August 24 the most active trading day since 2011. 

The long awaited selloff in U.S. markets felt inevitable, as it broke the third longest run in history without a 10% correction. Stretched valuations, uncertainty about Fed policy, and volatility in China were the most-cited catalysts for the correction. 

I remembered one of my favorite episodes of the television show 30 Rock while watching market activity that morning. In the episode, one of 30 Rock’s main characters, Tracy Jordan, is asked by Larry King to comment about a major sell-off in the Asian markets. Jordan’s response: “New York as we know it will no longer exist tomorrow” and he calls for panic, sending the people of New York into madness. There were signs of panic in the markets on August 24, with arguably the most disorderly trading activity since the “flash crash” of May 6, 2010.

U.S. investors have enjoyed three years of low volatility and six years of a bull market, so it seems a little greedy to complain too much about a 10% correction. More troubling was the evident dislocations within the market structure, which were more of a red flag for professional investors. Futures were halted twice before the markets opened; the VIX measure of volatility reached its highest level since the Greek crisis in 2011; and nearly half of stocks didn’t trade in the first 10 minutes of trading. There were more than 1,200 trading halts on August 24; nearly 80% of them reportedly involved ETFs.  

Major companies such as JP Morgan, General Electric and Bank of America were briefly quoted at prices 20% to 30% below the previous day’s close, prices that were significantly below the price implied by their quoted index value. We saw some of the same decoupling in pricing of ETFs, with some high-profile ETFs temporarily trading at dramatic discounts to their prior day’s price and to the price of their underlying index.   

The iShares Select Dividend ETF (DVY) fell 35% at one point, decoupling dramatically from its underlying index. Other dividend-focused ETFs had similar experiences.

During a beautiful summer week when thoughts should turn to the final weeks of the baseball regular season, the start of football season and Labor Day barbecues, professional investors found themselves examining the effectiveness of market rules that were designed to stabilize the system. Discussions centered around rules such as NYSE Rule 48, which allows suspension of the normal pre-market opening price discovery mechanisms, and clearly erroneous transaction guidance, which guide markets in determining when to cancel trades.   

China’s Wizard of Oz Moment

Slowing economic momentum in China, a meltdown in the Chinese local share market and China’s currency devaluation were key catalysts for the fall in markets on the August 24. Headlines from China have been covered extensively by investment firms and the financial press. Purely financial factors are indisputably a major factor behind increased market volatility, but I think behavioral factors are also at work, adding to the volatility. 

The rapid economic rise of the “Asian Tigers” in the 1980s and 1990s led to a fair amount of insecurity among American business, political and academic leaders. When I was a graduate student in Berkeley in the early 1990s, a meaningful part of the curriculum involved an examination of Asian business practices. I appreciated the lessons, cultural and economic, from the diverse curriculum and found my world view enhanced beyond my imagination by the global perspective provided by talented classmates from around the world. But I remember thinking that there were advantages and disadvantages to “Western” and “Eastern” business, economic and political models, and that no single approach was perfect. Of course, a few years later we experienced the Asia crisis and many of the attributes celebrated in the admiration of the Asian tigers became flaws critiqued by observers with short memories.

The growth mantle passed in recent years to China. Until recently, China’s economic success was the talk of the world press. Many articles about China shared the sentiment expressed in a 2012 Guardian article title:

“China’s economic success sets an example the world should follow:
 China has bucked the crisis with high investment and a strong state sector that could be replicated by western economies” 

Despite the undeniably impressive accomplishments of the past few decades, China faces significant challenges in the next phase of its economic development. The “bill” for China’s rapid industrialization – pollution, overbuilding in certain cities, corruption and immature credit and equity markets – may be coming due. Slowing growth, as measured by official and unofficial economic statistics and a meltdown in locally traded Chinese stocks are among the leading indicators that the steady march forward for China has hit some serious obstacles. 

Failed interventions in the stock and currency markets have shaken investors who believed that the Chinese leadership had found the magic combination of policies necessary to ensure uninterrupted growth. This seems to be China’s “Wizard of Oz moment” when people realize that the person behind the curtain isn’t “all-powerful. I think that realization is contributing to the unrest in markets.

What Should You Do?

It’s easy to lose perspective on a day as turbulent as August 24. Try not to panic. Turning off the television is often a good idea, unless you’re watching a comedy show about a fictional market meltdown!

Examine the news for data points that comprise the base case for your investment portfolio. Take action based on a change in your outlook, not as a knee-jerk reaction to headlines on a bad day.

If you don’t have a pressing need to trade, don’t trade. If you have to trade on a day as volatile and disorderly as August 24, protect yourself by using a limit order rather than a market order. Limit orders give you control over the price at which you trade, giving you more protection against a “flash crash” than market orders.   


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