Recent market turmoil has brought bombastic rhetoric and hand wringing from all corners about the state of modern financial markets. Whether it is the “volatility” or algorithmic trading that is either killing the market or taking it to ever further extremes, depending on your bias, there is something for everyone. However, the recent gyrations have if anything proven just the opposite of how robust markets are, the lack of investor herding, and benefits of algorithmic trading.
Despite the hand wringing over market volatility, non-Chinese markets have been, by a variety of measures, almost boring. For instance, if we look at the S&P 500, FTSE, Nikkei, Hang Seng, and Shanghai indexes, of the 100 largest absolute daily movement in 2015, 75 of them come from either the Shanghai or Hang Seng with 60 coming from Shanghai. As the Chinese market has convulsed in near violent gyrations - not to mention emerging market currencies and commodity declines - all but 25 individual trading sessions in major markets outside China have stayed between +-2 percent.
These results are borne out by more widely viewed statistics. Various measures of volatility indicate that not only are Chinese markets 3-10 times more volatile than other major markets but that these other markets are near boring. For instance, the absolute median daily volatility for the S&P 500, FTSE, and Nikkei is between 0.6-0.8 percent. Even after last weeks “volatility” the high-low differential for the entire year is only 14 percent on the S&P 500 implying rather tight trading range for the year. Considering the yearly average since 2010 has been 24 percent, there is little reason to think markets are somehow broken or contagion is running rampant.
Even by historical standards volatility does not appear to be outside normal ranges. Of the top 25 most volatile day to day swings of major markets outside Shanghai since the beginning of 2010, three of the S&P 500 happened in 2015, three for the FTSE, two for the Nikkei, and five for the Hang Seng. Only in Shanghai, where 17 of the 25 most volatile trading days happened in 2015, has there been a notable uptick in volatility. In other words, most markets seem to be going about their business in a business-as-usual manner.
Nor do investors appear to be herding. In 1997 and in 2008, one of the aspects that caught many people by surprise is how closely correlated all markets and outflows became. Now, at least so far, investors appear to be differentiating between countries, businesses, and a variety of other factors. There is little evidence of herding. Certain emerging markets and even developed market economies like Australia and Canada are facing pressure, but investor decisions appear to distinguish between broad classes of countries. Even looking at specific companies, investors appear to be distinguishing by business model, major assets, and revenue sources. Some companies have been pushed down due to their exposure to China whether they are commodity-focused companies or even Apple. However, there is little evidence of mass herding.
Finally, given their importance in the market whether it is stocks or currencies, there is evidence that algorithmic trading has played a significant role in stabilizing the markets. After falling relatively sharply beginning on August 21 for a number of days, major markets outside of China began sharp recoveries that have returned them largely to the point they were on August 21. While we cannot say with certainty that algorithms are responsible, the rapid rebound from a fear induced sell-off would seem to seem to match with how many of those types of programs especially when many of the economic fundamentals of the major markets presented here are better than China.
One final note, markets outside of China have robust day trading, short selling, and algorithmic trading firms. China does not. China has volatility measured any number of ways ranging from 3-10 times higher than other major markets this year. While this is not to say it would disappear or converge to the range of other markets if they allowed these trading strategies, China certainly isn’t making a strong case that arresting short sellers, prohibiting intra-day trading, imposing price limits, and algorithmic is lowering volatility in China.
It seems a little perspective on trading volatility, investor rationality, and algorithmic trading is needed in these times of above average stress.
