Global stock markets are moving lower as fear rises. Japan’s Nikkei Index fell 12.41%, the largest single-day drop since 1987. In Korea, the Kospi Index dropped 8.77%. Taiwan and Singapore’s stock markets lost 8.35% and 4.07% respectively. Here in the U.S., the Dow, the S&P 500, and the NASDAQ were off 2-5% in the early moments of trading.
I have often said that stock market declines occur due to a routine correction or a crisis. I may have to add third possibility. Why? The magnitude of this stock decline reflects more of a crisis than a routine correction. However, when you look at the bond market, which is often seen as a more accurate predictor of the economy and by extension, the stock market, it appears to be functioning in a normal manner. In other words, this panic, thus far, is limited to stocks. What’s causing such a dramatic sell-off?
The prevailing view is that the weak job growth in the U.S. may be indicating a recession is near, which some believe could be a bit worse than mild. The U.S. only added 114,000 jobs in July. Even so, earlier this year, in April, the U.S. only added 108,000 jobs and the markets didn’t react nearly as bad. Is this downturn different? For some answers, let’s look to the VIX or fear index.
The VIX is a measure of fear, over the next 30 days, and reflects more how institutional investors are reacting than retail investors. Thus, when the VIX rises, it may be assumed that institutional investors are buying more put options to protect their stock positions from a downturn. In contrast, retail investors tend to sell stocks. In any event, when the VIX rises stocks usually fall. For context, the VIX normally ranges between 13-19. This morning it surpassed 60. Even after the anemic April jobs report, the VIX remained below 22.
I mentioned the bond market earlier. Let’s look at U.S. Treasuries. As more money flows into treasuries, bond prices rise (due to increased demand), and yields fall. This morning, and lately, yields on treasuries have fallen, reflecting more demand for these safe-haven investments. On a positive note, if the yield on the 10-year treasury continues to fall, mortgage rates will follow, which could stimulate the housing market.
Is it time to panic? Not yet. However, since stock prices have risen substantially in a short period of time, it is quite possible that we are in the midst of a correction. Unless there’s another shoe about to drop, it seems to me that this is a correction that must run its course. This also gives more weight to the idea that the Fed will begin cutting interest rates in September. If this proves true, then this downturn in stocks could be temporary as stock investors seek to buy stocks before they rise again. We’ll see.
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