Friday's Plunge May Have Been Manufactured... And A Bottom

Just when you think things can't get any worse for stocks, they get worse. Friday's 2.08% tumble for the S&P 500 topped off 7.0% loss for the index, and continued the losing streak to seven days. Stocks are now down 17.7% from their September high, though the Nasdaq is actually off by more than 20% from its peak.

It looks, and feels, ugly.

What if, however, the selling was largely artificial?

Don't dismiss the idea. Don't read too much into it either. Stocks certainly have some things investors want addressed. Namely, can companies really reach relatively lofty earnings expectations for 2019 when interest rates are climbing and the trade war is still a hotly contested test of spirits? It's entirely likely the bulk of the recent selling was being driven by a couple of different factors that will quite literally no longer matter once the new trading week begins.

Ever heard of a triple-witching or a quadruple-witching day? It's the convergence of expiration dates for a huge number of futures and options... the third Friday of every month, though the third Friday of the final month of any calendar quarter sees an extra batch of expirations. Options and futures can be exercised at any point up until they expire, but they can't be used after they expire.

As one might suspect, a bunch of traders were waiting until the last possible minute to make a decision about all the derivatives that expired on December 21st. Their action may have actually forced an already falling market even lower.

The market environment helps tilt that activity one direction or the other, to be fair. That is to say, a wave of expiration-related activity can make a bad market worse, or a bullish market even better. In this case, matters went from bad to worse.

But stocks were in a freefall before Friday? Yes, they were, but a huge number of traders were also already making decisions about their contracts that were set to expire on Friday, looking to avoid the rush. It's entirely possible that activity started as far back as a week ago.

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Mark Borkowski 1 year ago Contributor's comment

Under any other down cycle or circumstances, I would have agreed with J. Brumley. This market adjustment feels much different than any other I can recall in over a decade. The partial shutdown of the American government is only a head fake that should not last more than three weeks. The big issue that has been ignored is the potential trade deal with China. Now that the door has opened, this will be one of the most difficult trade negotiations in U.S. history. President Trump should take a back seat. Americans and Chinese have lost serious respect for this complex man. Official Chinese media indicate the Chinese are not in a hurry to make a new deal. In fact, they believe they are going to "improve" on current trade relations. The prolonged discussions will force the market down. Stay tuned.

Gary Anderson 1 year ago Contributor's comment

Interesting concept. But we are still led by Hoover 2. Tariff mayhem and labor earnings could hurt the market going forward. We may not be in the Roosevelt era where he was determined to underpin the market with government action. It wasn't Hoover who made the famous quote about fear that you cited.