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Black Monday No Surprise, Say Analysts

Global fears are finally catching up with U.S. markets, and the bull is stumbling.

The international market gloom over emerging economies and commodities has reached the U.S., spooking the bulls. The Shanghai composite Index fell by nearly 8.5 percent one day after China’s State Council approved a shift of as much as $150 billion in fresh equity investments by China Investment Corp., China’s sovereign wealth fund. After weeks of battering by sharp currency declines, developing-markets equities sold off in sympathy.

This global market chaos whipsawed U.S. stocks with futures contracts on the Standard & Poor’s 500, Dow and Nasdaq 100, reaching a limit low prior to the opening in New York. Because of the extreme price swings, the New York Stock Exchange invoked Rule 48, allowing the market to initiate trading without preopen price indications. By 11:30 a.m. eastern standard time Monday, markets had partially recovered after the S&P 500 saw a 12.5 percent swing between the day’s high and low. The Chicago Board Options Exchange Volatility Index (VIX) had a delayed opening and spiked to 50 in initial trading, higher than any closing level for the so-called fear index since January 2009, before declining into the 30 range as investors scrambled to buy insurance for their portfolios.

From a technical perspective, according to analysts, the sharp sell-off was not a complete surprise.

“This is a very overdue corrective decline that was simply triggered by China,” says John Kosar, director of research at Schaumburg, Illinois–headquartered Asbury Research. “The music really stopped when quantitative easing came to an end, but by that time equity managers were long accustomed to either buying every 5 percent dip or explaining to clients why they were underinvested when stocks subsequently reached new highs.” Kosar, who focuses on providing quantitative research to active asset managers, says this market mentality was tested and broken by the combination of sub-$40 oil and the meltdown in emerging markets.

James Koutoulas, CEO of Typhon Capital Management in Chicago, concurs that today’s sell-off was overdue. “China’s central bank has been exposed as desperate and impotent, and the Fed has precious few bullets left,” he says. Typhon Capital designs and manages multiasset class volatility portfolios as both alternative allocations and overlay exposures. According to Koutoulas, who says that his firm has been in reduced risk mode across its commodities strategies for weeks and preparing for a pullback in equities in its overlay positioning, the worst may not yet be over. “I think there’s a good chance that the selling is prolonged and we see a bear market this year,” he says.

For many established equity mangers, the abrupt shift in sentiment may signal a significant change in stock market dynamics. “We are experiencing a market that is questioning global growth while at the same time dealing with shifts in central bank policies,” says Matthew Andrews, chief investment officer at Private Capital Advisors, a New York–headquartered firm that provides asset management services for family offices, foundations, endowments and high-net-worth individuals. “As a result, by deleveraging in an ETF and algorithm-dominated market, it is very easy to create significant gaps in bid-ask spreads that can drive short-term volatility.” Andrews views this correction as a potential catalyst for increased divergence in equity market performance. “I think that you will see explicit winners and losers from here on out, with companies and sectors trapped in a secular decline continuing to come under pressure while those with brighter prospects become attractive from a valuation standpoint and find buyers.”

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