As it happens, markets have recovered their poise rather quickly. After falling 7 per cent in a week, the S&P 500 recovered nearly 2 per cent on Tuesday, apparently vindicating the stance of those who’d suggested this was an opportunity to buy on the dips – or, as Rothschild once put it, “when there’s blood on the streets”. False alarm, for now at least.
But are they breathing a sigh of relief too soon? Even a 10 per cent fall would hardly look like a buying opportunity in the context of the recent extraordinary gains on markets – more a graze than a bleeding wound. And even if this turns out to be a small and temporary correction, it has revealed weak points in the financial system, not least a much greater than expected sensitivity to the prospect of rising inflation and interest rates. Veteran activist fund manager Carl Icahn suggested that these “rumbles” could prove a precursor to a bigger financial earthquake.
I pick Mr Icahn out from the many commentators taking to the airwaves this week because his specific worry is the rise of passive investing, and particularly the exotic ETFs that were at the centre of this week’s turmoil. The speed of the sell-off has been partly blamed on products that allow investors to bet on the Vix volatility index; several – like the now infamous XIV – collapsed in value and ceased trading as the Vix spiked from its long slumber.
Leveraged derivative products abound on the ETF market, and it’s certainly possible that another hidden “faultline”, as Mr Icahn described such products, could be lurking somewhere. I would go further and suggest that to add to this hot money can be added vast quantities of dumb money, with the market boom sucking money indiscriminately into the market with no concern for quality and valuation. While there is certainly a role for passive funds to play in many portfolios, they are not a ‘no thought’, one-way bet on markets, as years of supportive monetary policy has led many to think.
As for where the smart money is going, I doubt it is hiding under a blanket. Some reports suggest there has been some selling into strength and canny investors are now waiting, cash at the ready, to take advantage of bargains when they appear – as Warren Buffett said in 2010, “we’ve put a lot of money to work during the chaos of the last two years”. We’ve rounded up more of his best advice in this week’s cover feature, reassuring truisms to help you keep your head when others are losing theirs.
