After slow melting up for years, the US market has finally decided to correct off the back of higher interest rates, taking the ASX200 with it.
The S&P500 is off its highs after having a parabolic rise in January 2018, the S&P500 going parabolic was always a sign that FOMO buying was coming in to play and we were pushing towards correction territory. The current correction is causing margin calls on highly leveraged derivative positions. The market closed on its lows indicating traders are not catching this knife yet.
VIX has reached 37%, causing short puts to rise by hundreds of percentage points putting massive strain and margin calls on short vol strategies. After this, I expect short vol to settle in the 15-20 range, rather than back to the 9-12 range we have seen in the past few years. The spike in VIX is caused by a major imbalance towards demand for put protection.
Australian markets (ASX200) is following suit today.
There are 2 main stages to this. After the first stage, if we see high buying volume come in, the correction could stop and reverse. As we go deeper, it will get exponentially harder to stop the correction.
Stage 1 – Highly Leverage Derivative Positions Unwind
This should see a correction of 10-20%. We will need to see high volume buying at this point and hopefully, some sort of fundamental news such as a pullback in the number of rates rises that we should be expecting in the next 12 months. If this is the case, this is a good opportunity to buy in.[wd_hustle id=subscribe-now type=embedded]
Stage 2 – Cash Equity Positions Unwind On Margin Calls
This will see the correction turn into a crash. If the market reaches 20% down, it is very likely it will keep going down to 50% or more. This is due to cash equity markets experiencing margin calls, which will create a negative feedback loop as margin calls will force prices lower and feed into more margin calls.
The problem with catching the knife and buying the dip here is that it will work 9/10 of the times like it has in the past few years. However, the one time it doesn’t work and the market crashes, that’s when wealth gets destroyed.
At this point, we aren’t sure what will happen. Without high volume buying we would see the markets fall further and turn into a crash – hopefully, this isn’t the case. Having said that, it would be prudent to let some of those stops hit, take some profit or buy some protection on some positions and keep some powder dry for bargain hunting some bluechip yielders such as CBA shares (ASX CBA) or ANZ shares (ASX ANZ).
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This is general advice only. MF & Co Asset Management has not considered your personal financial needs, objectives or current situation. This information is not an offer, solicitation, or a recommendation for any financial product unless expressly stated. You should seek professional investment advice before making any investment decision.