Tuesday August 25

Stocks finish the day lower in spite of rally early in the day. The S&P500 lost 1.4% to 1,867 and the Dow Jones fell 1.3% to 15,666. Concerns of an economic downturn in China continue to result in selling pressure across markets. The VIX, which measures equity volatility, fell on the day to 37.49 after reaching 50 yesterday, however it is still above the average of around 20. Markets rebounded early in the day and the S&P at one point was up as much 2.9%. However selling pressure soon returned late in the session and stocks resumed their downward momentum. The S&P now stands 12.5% from a high in May. The index is currently in correction territory, and a loss of more than 20% from the peak will characterize a bear market. The Shanghai Composite fell another 7.6% even as the PBoC further cuts interest rates and lowers reserve requirements. It is somewhat concerning that in spite of aggressive monetary easing Chinese equities continue to fall without any support. This leads many market watchers to fear the worst regarding the state of the Chinese economy. This uncertainty is resulting in ripple effects on US equity markets. Treasury prices edged back from recent highs, as the 10 year yield rose 9 basis points to 2.09% and the two year rose 5 basis points to 0.62%. The dollar index recovered 1.2% and the US currency finished at $1.1494 against the euro.

China’s central bank attempts to calm the stock selloff with further monetary easing. The PBoC cut the benchmark interest rate by 25 basis points to 4.6%, cut the one year savings rate by 25 basis points to 1.75%, and lowered the reserve requirement for banks by 50 basis points effective September 6. These measures are intended to disincentivize banks from holding cash and reserves, and therefore it encourages lending and liquidity in the banking sector and in the economy as a whole. By spurring banks into lending the PBoC hopes to encourage economic activity and growth. These measures failed to have any lasting effect on investor sentiment as stocks in China and the US continued to fall. This is the fifth time that the PBoC has cut rates within the last year.
Implied equity volatility as gauged through the VIX has shot up after a multi-year period of relative calmness. The VIX reached a recent high of 53 after trading in the thirteen to twenty range over the last year. Institutional investors have been compensating for low volatility and low returns in markets by selling volatility, which in a way turns market volatility into an asset class through options and other derivatives. This trading strategy has paid off in recent years as central banks around the world have intervened to calm markets.
Former Treasury secretary Lawrence Summers and Bridgewater CEO Ray Dalio both believe the Fed should reconsider another QE program. Summers writes that the Fed should delay monetary tightening and go a step further by resuming quantitative easing in order to combat deflationary pressures such as the stronger dollar. Dalio, in a letter to investors, had a similar message writing that the “next big Fed move will be to ease (via QE) rather than to tighten.”
Tuesday August 25

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