The recent stock market correction started as a murmur and turned into a roar, then went away almost as soon as it came.
In its wake, though, comes a reckoning for investors: The days of low-volatility markets are over and a new day has come in which bizarre intraday moves and a far less predictable environment will become the norm.
Wall Street experts remain at odds over just how it all happened. Most trace the beginning to Feb. 2, when the Labor Department reported an unexpected yet long-awaited jump in average hourly earnings. Yet there's a case to be made that the underpinnings arose two days earlier when the Federal Reserve indicated a subtly more aggressive stance on interest rate hikes, while at least one analyst believes Treasury Secretary Steven Mnuchin's comments on the dollar a continent away helped stir things up.
Regardless, here's where we are: The market has changed in ways that participants will struggle to understand. In the new paradigm, inflation replaces deflation as a major concern, a Fed closely aligned with the market's interests will now chart its own course and what's good for Main Street may run counter to what's desired on Wall Street.
Those upset with the kind of rapid-fire moves that happened during the correction must get used to them.
"You need to understand how stock markets trade. It's a fragmented system," said Joe Saluzzi, a principal at Themis Trading. "These rapid moves are going to keep happening. For some, these moves are an opportunity. For others, it's a panic opportunity."
Those are considerations on the horizon. To grasp them, though, one must first look in the rearview mirror.
Dissecting the correction
Where should we start? Was it the nonfarm payrolls report that indicated the wage increase, the Fed meeting with the hawkish message, or should be go way back and look at the foundation of the bear market that turned bull in March 2009?
Any would be a valid jumping off point (including the Mnuchin-dollar angle), but the raw effects remain most relevant: In early February, stock prices started falling and government bond yields went up, disconnecting a relationship precious to stocks. While the equity side of the ledger rallied for all these years, fixed income stayed in check as the Fed sought to create a "wealth effect" in which financial riches would cascade through the broader economy.
The linchpin for all of it was that inflation also would hold steady as the Goldilocks economy — not too hot, not too cold — chugged along.
On Friday, Feb. 2, the low-inflation narrative started to crack, and markets reacted strongly.
The Bureau of Labor Statistics reported that along with another nifty 200,000 payrolls gain came a 2.9 percent annualized earnings gain. Markets that already had gotten restless from comments Mnuchin had made at the World Economic Forum that were seen as pro-weak dollar, so the mood for selling was already in place.
Major indexes tumbled that day, with the Dow industrials shedding an ominous 666 points, or 2.5 percent. Bond yields jumped, with the 10-year Treasury note hitting a four-year high.
Things only get worse the following Monday.
On that day, the market would see the first of two 1,000-point-plus drops, and this was about more than inflation. Huge bets that volatility would stay low suddenly went horribly wrong as the CBOE Volatility Index, or VIX "fear gauge," soared to levels not seen since the financial crisis. Those who had used exchange-traded notes to make the low-volatility play got crushed, and one of the biggest securities in the space faced liquidation.
Afternoon trading would see bizarre moves reminiscent of the 2010 "Flash Crash" as the Dow saw successive 100-point declines happen seconds apart.
Turmoil continued through the week as a correction that everyone had been asking for finally arrived, and suddenly no one wanted it. Trading volume soared through the week before the market reached its low point on Feb. 9, with the major averages all in correction mode on 10 percent drops.
But what really happened?
Theories abound
Market watchers remain at odds over what tripped the sell switch. Primarily, the conversation comes down to fundamental vs. technical, and both sides have a reasonable case.
In the days since the correction began — the market's recouped more than half the downside since the low point — a volley of explanations has been bandied around in analyst notes.
"Anytime the stock market falls like it has over the last couple of weeks, investors rush to find the reason for the decline, and usually there are no shortage of opinions as to why the market did whatever it did." Raymond James analyst Andrew Adams said. "This most recent correction has been no exception."
Occam's Razor is a philosophical concept positing that when confronted with a question that has multiple potential answers, use the simplest one. In that vein, Adams offers up a big-picture look:
"In truth, plenty of sellers likely sold for no other reason than others were selling and the market was going down!" he wrote. "The point is that it is often difficult to determine 'the why' when it comes to stock market moves, considering the market is made up of many unique buyers and sellers who have their own motivations, time horizons, and strategies."
Then there's a theory considerably more complicated.
Banking analyst Dick Bove, at the Vertical Group, sees the seeds for the correction as being planted earlier by officials in the Trump administration.
"The market decline began on January 26, 2018. There were two events that precipitated this decline: The first is the comments by Treasury Secretary Mnuchin suggesting that he would let the market set the price of the dollar. The second on January 30, was the State of the Union address," Bove siad.
"These two sets of comments frightened many because they suggested to holders of United States debt that the government would let the value of Treasury holdings fall at the same time as the country would be seeking more money to pay for expansionary plans in infrastructure rebuilding and defense."
Whether simple or complex, the issues led up to market upset not seen since the latter days of the financial crisis.
The volatility argument
The Raymond James 30,000-foot view is that the markets saw a "reversion to the mean" that saw an overextended stock market, off to its fastest start ever, in need of a splash of cold water to the face.
"Concerns over inflation and higher interest rates may have helped trigger the initial decline, but that was just one of the factors that contributed to the ultimate fall," Adams said.
That's true enough. There were many players in this game, and the ones most often pointed to are those who made a fortune betting against market volatility, then lost it just as quickly in a few hectic sessions.
Traders in exchange-traded notes, the most notable ones being the ProShares Short VIX Short-Term Futures and the VelocityShares Daily Inverse VIX Short-Term ETN, had billions at stake in the volatility game. Both use leverage to bet on market volatility and are seen as a root cause of the correction.
Oftentimes a market sell-off will push the VIX higher, but in this case the opposite looks to have happened.
"This correction was led by the surge in volatility — in other words, the spike in volatility caused equity prices to plunge; not the other way around," said Liz Ann Sonders, chief investment strategist at Charles Schwab.
The demise of the low-volatility trade could be seen as a watershed moment for this bull market, the second-longest in history.
"The low-inflation and low-volatility era is likely in the rear view mirror," Sonders added. "The bull market, although likely still intact, will be met with sharper bouts of volatility and greater frequency of pullbacks/corrections."
Inflation rears its head
For investors, that new environment will pose challenges. Prior to February, it had been two years since the last correction and the longest time span ever without a 3 percent or 5 percent move.
While it would be easy to call this simply a technical correction where the market was overbought and had to pull back, there were fundamental drivers.
Most notable among them was the inflation/interest rate factor. Percolating inflation in the form of the wage increase reported two Fridays ago coupled with rising price pressures as reported in the consumer price index Wednesday feed a very fundamental fear that the low rates behind bull market are fading away.
At the center of that storm is the Fed, which has kept rates low since 2008 but is expected to get considerably more aggressive over the next two years. Worries that the central bank would tighten even more than expected also helped create a perfect correction storm.
"The bloom is off the rose for this bull market," said David Rosenberg, chief economist and strategist at Gluskin Sheff. "The sea-change we are seeing in real-time as it pertains to monetary, fiscal and trade policy is a whole new chapter, and an uncertain one at that."
There's another tangential element that likely contributed to the sell-off. Jerome Powell's first business day as Fed leader happened Feb. 5, and it's almost a rite of passage for the market to test new chairmen.
Powell is expected to be fairly dovish when it comes to rates, but he still represents an unknown for which the market must account.
Looking inside the market
In addition to the fears of a new day, the modern market has another nemesis with which to contend: the machines. Programmed trading is becoming an increasingly significant factor, and it likely helped amplify the downturn.
That was particularly the case in the Feb. 5 decline, a 1,175-point manic trip that rekindled "Flash Crash" fears and had market participants wondering just how much damage could occur before the panic selling ended.
Saluzzi, the Themis Trading official, said the action is probably just a preview of what investors can expect as trading gets more and more driven by algorithms and their accompanying programmed trades. Selling has always begat selling, but in the current environment things can get out of hand in seconds.
"That was a structural event. It was right around 3:08 in the afternoon on Monday," Saluzzi said. "It burned a hole through the market."
But while the market may have been burned, it wasn't broken. The sell-off, aggressive as it was, didn't even trip the 7 percent circuit breakers the market has built in to prevent major crashes. (There also are accelerated stopping points at 13 percent and 20 percent.)
What's ahead
Does that mean more of these kinds of events are likely in the future? Absolutely.
"Nothing broke technically, but you still had rapid rollercoaster moves, which are unsettling," Saluzzi, of Themis Trading, said. "That's not going to change. Anytime there's stress in the market, you're going to see moves like that."
Getting used to a world where the markets can gain and lose hundreds of points in seconds won't be easy for investors.
But there's reason for hope: Despite all the rollicking and rumbling, the market has come back nicely even if it faces an uncertain future. In the current climate, most strategists are advising a tactical approach that doesn't including freaking out at gyrations.
"One important driver of the market sell-off was that investor sentiment had become too complacent these past two years and bullish sentiment prevailed as the major equity market indexes trudged higher to record price gains, along with the absence of volatility," said John Lynch, chief investment strategist at LPL Financial.
Indeed, sentiment indicators showed strong levels of bullishness, and exchange-traded funds saw their biggest single month of investor cash in January. Now that some of that froth has been burned off, investors can assess the damage.
For its part, Schwab was advising customers earlier this week to wait for two straight up days, strength into the close and a VIX below 20. Each condition has been met, and the market has had a strong week after its bout with the correction flu.
Overall, though, it's probably still a time to be cautious.
"The net is that we have moved into a more mature phase of the cycle — both in terms of the economy and markets," Sonders said. " So although the technical salt in the market's wounds may be getting washed out, enthusiasm for the 'all clear' sign should be curbed."
Correction: An earlier version misstated the date for when concerns about low inflation changed. It was Feb. 2.