Sleeping Beauty: Can Anything Wake the Market? – Kiran Damodaran
Themis Trading typically hosts a high school intern each year during the month of May. It’s always a symbiotic relationship, and all our past interns are indeed quite special. This year we are privileged to be hosting Newark Academy’s Kiran Damodaran. He began this week sitting alongside each of us – learning how equity markets work, and how we trade for investors.
Kiran is unique. He is captain of several sports teams, involved intimately in the arts, and also is the editor of his high school paper. When he expressed to us his passion for writing, and brought to our attention this article discussing our “weirdly calm” stock market, we just had to put him to the test. We don’t often send out “guest notes”, and to be certain, this is the first one written by a high school senior.
Please enjoy this morning’s guest morning note, authored by Kiran Damodaran. We can only hope that young men and women of his caliber will one day be excited to work in our capital markets. Enjoy.
When I arrived at my school (where Clinton won by an almost 70-30 majority in a mock presidential election) on the morning of November 9, 2016, the despair and tear-filled hallways seemed to indicate that Trump’s election meant the world was going to end, driving an unpredictable future.
Well, the recently declining Volatility Index (VIX) suggests that the stock market didn’t get the memo. The market’s volatility has not increased, as many anticipated it would; in fact, according to the VIX, a measure of the market’s expectations for volatility for the next 30 days, the stock market is less volatile than ever – the VIX has approached its all-time low, dropping to 9.96 from 18.74 at the election and 11.54 at Trump’s inauguration.
While both US and global politics have been more hectic and eventful than ever, with questions being directed at significant domestic policies and institutions as well as international ones, the stock market has been oddly calm. Neil Irwin, economics correspondent for the New York Times, attempted to explain this phenomenon in his article for The Upshot, “The Stock Market Is Weirdly Calm. Here’s a Theory of Why.”
Historically, politically significant events have had heavy economic ramifications as well. As a result, political controversies have often been conflated with economic volatility, leading to spikes in VIX values and increased price volatility in the stock market. For example, the debt ceiling standoff in 2011 led to extreme market volatility, with the VIX reaching heights as high as 48. According to Irwin, however, more recently, these sorts of events have caused less uproar, and this decreased effect has become even more prevalent under Trump. Why?
He argues that simply put, we adjusted. Investors realized that these knee-jerk reactions to political events are often not warranted, as many political changes do not affect the actual value of companies or their products – just our perceptions of them. Instead, investors have begun to understand that our actions should derive from events which directly impact economic fundamentals; Irwin notes, however, that many of Trump’s proposed policies do affect the real economic status of firms and their outlooks, as trade policy, taxes, and healthcare will bear significant consequences. Nonetheless, he argues that investors have learned from previous experiences not to overreact to these changes, and thus, with this newfound wisdom comes lower market volatility. For the most part, he believes this is an improvement, with the biggest downside being that the lack of investor response may cause complacency and limit the ability of investors to send signals to political leaders that they disapprove of new measures.
While there is certainly some validity to this theory, I am not sure it is complete – or maybe I am just a bit more cynical. Following this cynicism, although people rationally should learn from the past and adjust their actions accordingly in the future, most do not. If people did act rationally and learn from past overreactions, why would this change not have appeared sooner? Has there been a change in the degree to which political action affects the economic status of these firms? In all likelihood, no. Luckily, there are a few other possible explanations.
- The decrease in the role of the average household investor in the market (AKA the increase in high-frequency trading and algorithms): With high-frequency trading and algorithms taking over a much greater percentage of the market, market participants, who often trade in this style, are likely more aware of market trends and are more likely to base decisions off of these trends than off of popular sentiment. This theory is supported by a longer term decrease in the VIX, which has been occurring since the financial crisis in 2008. This trend has implications for the future of the market; if we prescribe to Irwin’s philosophy that the market should act as an indicator of popular sentiment, then he is correct that the market will begin to fail in this area, as it is no longer be controlled by average citizens.
- The desensitization of the investor: This one is more specific to the Trump era. Since Trump was elected president, there has been a constant stream of news and political action that is almost unprecedented. In the past, during times when issues such as the debt ceiling caused heavy market volatility, influential events were at the center of national and international attention for weeks. In today’s world, however, with so many changes coming so quickly, there is rarely a single event which dominates coverage. This increase in action, both in the US and globally, has likely led to a form of desensitization among investors, who no longer react as strongly. Consequently, this desensitization has decreased the impact of political action on market volatility.
Whatever the case is, one thing is clear: the despair of those tear-filled hallways has not transferred to the market.