Is the worst ahead for stocks? Why some say the one-day drop 'has legs'

  • Stocks rose in early Thursday trade, following the worst session since September.
  • Some say the continued low levels of implied volatility are a good sign.
  • Others say the low volatility suggests that investors have been caught off-sides.

    After the worst day for stocks since September, it appears that markets continue to be on edge.

    While the S&P 500 was up slightly in the first hour of trade, the CBOE Volatility Index rose in the early morning to 16.3, its highest level since November 2016.

    To be sure, the VIX remains below its famous long-term average level of 20, and fell as low as 14.6 after Thursday's open. It is also worth remembering that the index — which measures how much traders are willing to pay for options on the S&P 500, and thus essentially tracks interest in portfolio protection — is coming off of 10-year lows.

    As Nick Colas, chief market strategist at Convergex, wrote in a Thursday note: The VIX "may be up from super-depressed levels, but +20 is the level that correlated with real warning bells."

    Others approach the situation differently, arguing that the low level of current volatility (which is the reason expected future volatility, as measured by the VIX, is also so low) actually makes stocks more vulnerable.

    As Neil Azous of Rareview Macro wrote in a Thursday newsletter, the current surprising news events having to do with President Donald Trump differ from the surprising outcomes of recent elections, given that this time, investors have not had time to prepare and were "caught off-guard." The most recent parallel, to him, is China's currency devaluation in August 2015.

    The "key difference" between markets now and markets in August 2015 is that markets are only half as volatile this time around, Azous wrote. "So, the shock effect today is two times as large as back then when comparing the events on a volatility-adjusted basis."

    As D.C. events spook investors who have bought in due to optimism surrounding Trump, and with the market potentially caught off-sides amid the drop, "the selling yesterday was not a one-day event. It has legs. To what degree is yet to be determined."

    Boris Schlossberg, a macro strategist at BK Asset Management, put it more bluntly in a Wednesday interview on CNBC's "Power Lunch."

    "This was a political trade on the way up, and I think it's going to be a political trade on the way down," he said. "So I don't think the story is over."

    On the other hand, Mark Tepper of Strategic Wealth Partners called Wednesday's drop "a short-term move" that's "being driven by political headlines and not fundamentals."

    Referring to earnings and recent economic readings, Tepper argued that "with the fundamentals being good, the markets should continue going up."


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    Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

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