By a surprisingly large margin of 52% to 48% the United Kingdom voted to leave the European Union in Thursday’s Brexit referendum.
Global financial markets plunged in a decline all the more dramatic because traders and investors had decided on Wednesday that the United Kingdom would decide to stay in the European Union. On that day, for example, the pound rallied.
As markets opened today on the actual results it was a very different story with the pound sinking to its lowest level since 1985 and the European STOXX 600 index showing its biggest drop since 2008 and the global financial crisis. Around the world money moved away from risk and toward perceived safety. Emerging markets tumbled with the iShares MSCI Emerging Markets ETF (EEM) down 5.38% as of noon on Friday, June 24. The Standard & Poor’s 500 stock index was off 2.8% after an early morning drop in the S&P 500 index futures triggered a trading curb at the Chicago Mercantile Exchange. The U.S. benchmark for crude, West Texas Intermediate, dropped by as much as 6.8% to $46.70 a barrel. Cash looking for safety flowed into the Japanese yen, which climbed 3.5% against the U.S. dollar, and into gold, which climbed 8.1% to $1358 an ounce.
In the short term volatility itself will bring more selling as computerized trend-following strategies designed to limit risk create more selling. When the price trend turns negative–as it has today after four previous days had left the S&P ahead by about 2%–these strategies say sell in order to keep up with index volatility and to limit the size of future losses. Markets saw this pattern at work last August when volatility that started in China led to volatility in U.S. markets that led to selling that finally took the S&P 500 down 11%. The bigger the drop today, June 24, the more selling these strategies will generate next week, Rebecca Cheong, head of Americas equity derivatives strategy at UBS told Bloomberg today. Total sales, she estimates, could reach $150 billion should volatility persist in the S&P 500 next week.
The Standard & Poor’s 500 Volatility Index (VIX) was up 40.46% as of 1:10 p.m. New York time, up from a climb of just 33.51% as of an hour earlier.
If you have volatility trades on the VIX–such as the ones I suggested on April 28 on the ProShares VIX Short-Term Futures ETF (VIXY) up 21.6% today or the ProShares VIX Mid-Term Futures ETF (VIXM) up 7.67% today–I’d suggest leaving them on into next week as this risk-strategy rebalancing plays out. (For that original post on my paid site see http://jubakam.com/2016/04/time-to-trade-volatility-with-the-vix-again/ For a summary of that post see this free site on that date. )
In the slightly longer-term, through, I’d look to exit these trades. Fear and volatility spike in the immediate aftermath of an event like this and then recede–even as the long-term effects just start to play out. I’ll try to sketch in some of those long-term effects in my next post this afternoon.