The result was the erasure of $1.7 trillion of paper profits in the U.S. stock market in the final two days of the week, according to Wilshire Associates’ tally. But to put that in perspective, investors were still up $13.1 trillion, or 55.7%, from the lows of March 23 and $2.2 trillion, or 6.3%, since the end of 2019.
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Even with a recovery from their lows on Friday, the major averages had their worst week since late June, with the S&P 500 index off 2.3% and the Dow Jones Industrial Average off 1.8%. The technology-dominated Nasdaq Composite, at the center of the market’s turbulence, slipped 3.3%, its worst week since late March.
As for what roiled the market, the suspects fingered most often were options players, both big and small. As reported by several media outlets, SoftBank Group (ticker: 9984.Japan), the big Japanese conglomerate, appeared to be a major buyer of options on megacap tech stocks, giving it the right to acquire $50 billion worth of the underlying shares.
At the same time, relatively small punters also have been actively trading options, especially short-dated, out-of-the-money calls, which effectively give them a cheap “lottery ticket” to play the bull market in the giant tech stocks that have led the market’s advance, observes Peter Tchir, the derivatives and credit maven at Academy Securities. While he concedes that the capital controlled by these speculators is small relative to the market, “in a world where volumes are distorted by the frantic trading of [algorithmic-based accounts], any real order flow has a surprisingly large impact on prices,” he adds in a client note.
After the long run in tech stocks, in which some have doubled or more, both individual and institutional investors have shifted to buying call options, where their loss exposure is limited to the premium they pay for the contract, explains Mark Haefele, chief investment officer for global wealth management for UBS.
Options dealers, who have sold calls to traders, are forced to hedge their exposure. That would mean buying underlying shares as their prices rise, and selling as the shares fall. All of which can exacerbate price swings, as happened on Thursday, Haefele writes in a client note. (Colleague Al Root explains the real nitty-gritty of the options trade, complete with Greek letters describing the math that makes derivatives vastly more intellectually challenging than betting on sports.)
Despite the drop in the big tech stocks, this doesn’t seem like the bursting of the dot-com bubble in 2000. As Evercore ISI points out, a perfect storm had developed then: Oil prices had doubled, and the Federal Reserve raised its federal-funds rate target sharply, by 1.75 percentage points, which inverted the yield curve, a classic sign of tight money and a future downturn. Now, by contrast, the Fed has pushed the funds rate to near zero and expanded its balance sheet by nearly 50%, while oil prices remain depressed.
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Capital Economics’ Jonas Goltermann points to another difference: “Unlike in 2000, the largest tech firms today are highly profitable, and their valuations, while punchy, don’t look so obviously unsustainable. So while this correction may well have further to run, and we continue to think that tech stocks will fare less well than most other sectors as the economic recovery continues, we don’t expect that a collapse in tech stocks will drag down the entire market in the way that it did in 2000-02.”
Corporate insiders apparently are not waiting to cash out, however. The Financial Times reports that U.S. executives took advantage of the market’s rally to sell $6.7 billion of their own companies’ shares in August, the biggest dollar amount since November 2015. As my illustrious predecessor in this space, Alan Abelson, was wont to observe, there are many reasons to sell a stock; expecting it to rise isn’t one of them.
Write to Randall W. Forsyth at email@example.com