by Zach Marsh on Feb 28, 2020
Some weeks writing the weekly update can feel like a slog. I wrack my brain to come up with a topic that creates interest and captivates the reader. It can be a real challenge some weeks. This is not one of those weeks. If anything the challenge presented this week is how to stick to one concise thesis. It is hard for me to remember a week with a more dramatic drop than the week we’ve just lived through.
In 2008, I was trading equity options on the floor of the Chicago Board Options Exchange. On September 11, 2001 I was trading equity options from an office in the City of London. In 1998 and 1997, I was trading equity futures on the Chicago Board of Trade when the “Asian Contagion” became the “Russian Collapse” which became prologue to the financial crisis when the hedge fund, Long Term Capital Management, collapsed. I have witnessed firsthand many dramatic events in the market. But this week seems a bit different from the others.
The events in 1997 and 1998 and the “Financial Crisis” in 2008 were all highlighted by dramatic moves in the market and rampant increases in volatility, but these three events moved in like that thunder you hear in the distance that slowly builds into a load crescendo. September 11th was a dramatic “rogue wave” event, but the market was already teetering on the edge of a bear market, and the economy was already slumping into recession. This week felt like a tsunami that hits out of nowhere on a clear, blue afternoon.
On February 19th, seven short trading days ago, the S&P 500 made a record closing high. Today, as I am writing this letter awaiting the Friday market open, the S&P 500 is indicating a level which is nearly 14% down from the February 19th level. In seven short days, the market has gone from oblivious delight to all-consuming fear and dread. That, I have never seen before.
I used to love the definition of volatility as the difference between the world as we project it to be and the world as it really exists. It seemed to encapsulate the exact nature of volatility much better than the mathematical definition, which is the standard deviation of returns. Volatility is always present, just most of the time it doesn’t show itself because it lies hidden by the perception of understanding, or our ability to make sense of what is going on. In that sense I really thought that the definition captured volatility’s essence.
Now, I’m not so sure it does. There is another layer of volatility that is not quite illustrated in that definition. The one where we lose complete sight of even what our perception of the world is or should be. It is frightening when we enter this unknown territory. The coronavirus and its capacity to spread has gripped the market and sent it into chaos. Perhaps the market was already extremely overvalued, as I’ve highlighted in previous notes, but this has provided an entirely justifiable reason for the market to sell off from its highs. For me to say where we go from here would be just conjecture.
At current writing, the momentum strategy that we follow will have us “de-risking” out of stocks. Meaning that we will be cutting equities to underweight. While I believe that the market is dramatically oversold as we open down big this Friday, I am not in the business of making guesses. I believe that a system is needed to clear out the poor decision making that comes from allowing emotions to dictate our thinking. We may be wrong on timing, but we aren’t playing for the next day or week. The process is our guide and the process is designed with the long run in mind.
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