Shaken out of many months of calm, Wall Street braced for a higher level of volatility in the days ahead, after a roughly 2 per cent rebound in US stocks on Tuesday followed the biggest one-day selloff in more than six years.
The question that vexed traders: were the wild swings of the past two days the start of a deeper move down or just clearing the way to the resumption of the aging bull market, which would turn nine on March 9?
“Today’s market action is a classic of a market that has searched for a bottom,” said Peter Cardillo, chief market economist at First Standard Financial In New York, who predicted a rebound back to record levels.
Bulls argue that strong US corporate earnings, including a boost from the Trump administration’s tax cuts, will ultimately support market valuations. Bears, including short sellers that bet on the market decline, say that the market is over-stretched in the context of rising bond yields as central banks withdraw their easy money policies of recent years.
Tuesday’s wild trading session saw the Dow swing more than 1,100 points from its low to its high and ended with the benchmark S&P 500 tallying its best day since just before President Donald Trump’s November 2016 election.
Meanwhile, Asian share markets were trying to find their footing on Wednesday as a semblance of calm returned to Wall Street.
Analysts said distressed selling by leveraged funds looked to have run its course for the moment, allowing volatility to abate a little, though the prospect of monetary tightening across the globe remained a challenge for the long term.
“The removal of stimulus in a measured way is a perfectly reasonable proposition, although it has yet again caught the unprepared by surprise,” said analysts at AMP Capital.
“Given rates are going to rise in the Atlantic economies over the coming months, we may see further jitters.”
In early trade, MSCI’s broadest index of Asia-Pacific shares outside Japan had crept up 0.5 per cent, recouping some of Tuesday’s 3.5 per cent fall. That had been its biggest daily drop since August 2015.
Australia’s main index rallied 1.1 per cent and Japan’s Nikkei rose 2.9 per cent. The latter slid 4.73 per cent on Tuesday for its steepest fall in 15 months.
It was also a wild ride for Treasuries, with US 10-year yields diving as deep as 2.65 per cent before a fresh sell-off dragged them back up to 2.80 per cent—the sort of range seen very rarely.
While the pullback in bonds was a hint that risk appetite might be returning, it also had the potential to trigger another spasm of selling in stocks.
It was a steep spike in yields last Friday that sparked the initial rout on Wall Street, forcing sales by a host of highly leveraged funds which ramped up volatility and drove yet more selling.
Many of these were algorithmic funds crowded into similar trades—long stocks and short volatility. The selling then cascaded through their computer systems in a way almost beyond human intervention.
The pivotal gauge of S&P 500 volatility, the VIX, did come off almost 20 points overnight but was still relatively elevated at 29.98 per cent.
“Short volatility funds were caught by the spike in the VIX and had to cover,” said Greg McKenna, chief market strategist at CFD and FX provider AxiTrader.
“You’re a genius until you’re not and when it takes just a day or two to unwind your whole strategy then you were never a genius,” he added. “But volatility does cluster, so there is no guarantee that markets are out of the woods yet.”
With stocks calming, investors also unwound safe haven positions in currencies. That saw the Japanese yen retreat and a rally in riskier plays such as the Australian and New Zealand dollars.
