24th August 2015 saw the start of an interesting week in the Indian stock market with a near 200 point fall on Nifty and over 1000 point fall on Sensex. Sensex has seen over 1000 points fall in a single day only 8 times till now, so it was a historically significant event. Almost all the other seven 1000+ points fall happened in 2008, so this 2015 crash understandably caused lot of panic, but as we can see in the chart below Sensex managed to recover almost all of the losses within the next 4 days of trading. Let's look at what we can learn from it and what lies ahead.
Major Sensex Crashes
[21-Jan-2008: 2062, 22-Jan-2008: 2272, 11-Feb-2008: 1007, 17-Mar-2008: 1022, 10-Oct-2008: 1088, 24-Oct-2008: 1204, 27-Oct-2008: 1003. 24-Aug-2015: 1153]
What caused it?
Unlike other major stock market crash where the reason was mostly known like subprime mortgage crisis in 2008, the reason behind 2015 crash is not yet well understood. Lot of things are going wrong around the world like Greek debt crisis, China Stock market bubble, fall in commodity prices (crude oil fall being the most dramatic), deflationary environment in most developed countries around the world, impending rate hike in USA after ending the multi-year quantitative easing program, geopolitical instability led by terrorist groups like ISIS, political non-cooperation between major super powers like USA, Russia and China. These events have been developing over several years now and nothing can be directly linked to the one day stock market crash on 24th Aug 2015.
So what happened on 24th Aug?
The most convincing argument I found was from this article that I cannot find anymore :( but it mentioned from what I remember that big institutions use interest rate FX swap to make money out of the difference between the interest rate offered on different currencies and sudden devaluation of yuan by China caused huge losses to these institutions on their Dollar/Yuan interest rate swaps which they had to cover by selling their equity positions leading to the flash crash around the world on 24th Aug 2015. The remedial measures employed to fix this is discussed in this article. Similarly this article describes it to some extent with a nice chart on the offshore/onshore USD-Yuan 1 year swap and an unusual movement between the two on Aug 24th. Something like that would make sense for a one day flash crash followed by almost complete recovery. The whole episode of 24th Aug could be more of a trading phenomena instead of a significant change in market fundamentals. I agree that the market fundamentals is bad, but it has been been bad for a long time and possibly 24th August market crash is not directly related to it.
USD-Yuan swap graph reproduced from the article referenced above
It also came into news later that perpetual long only investors like Abardeen Asset management liquidated their holdings in blue chip names like HDFC in the Indian market. What would force them to do something like that?
Another interesting article showing divergent behavior by 30 Year US treasury bond is discussed in this bloomberg article. Here for a short period bonds and stocks show a positive instead of negative correlation which is reverse of what is expected. US treasury yield was expected to fall in the US market due to flight to safety from equity to bonds, but it actually spiked due to US treasury dumping by Chinese government during the same time. The Chinese govt used the dollar proceeds from the US treasury sale to prop up renminbi as part of their strategy to support their currency & market volatility. This led to huge losses across portfolios of bonds and equities for major institutions triggering a sell off. Again some kind of technical adjustment phenomena due to heavy volatility in the currency and bond market along with technical divergence from normal behavior around 24th-Aug
Chart of US Treasury yield reproduced from the bloomberg article referenced above
What lies ahead?
No clue. From the 2008 fall in the markets we can see that initially when the fall started in 2008 the 1000+ points fall were quiet frequent. We had three almost back to back crash on Jan 21st, Jan 22nd and Feb 11th within 3 weeks time frame without any recovery in between followed by a relatively quite period but continuously sliding market and another series of back to back crash in Oct 2008. According to me the markets have already negated "2008 like crash" by recovering almost completely within a week. If the next 2-3 weeks pass without any major incident then probably we can safely forget the "black monday" as a one off technical adjustment event. However this is not to say that everything is fine now. We need to maintain a safe equity:cash ratio in our portfolio for a long time to come. I would say 60:40 is safe and 70:30 is aggressive. This is a major shift in my strategy from being almost fully invested into equities to take maximum advantage from the "Modi led reform rally in Indian markets".
I also have a gut feeling that this year large institutional asset managers who are diversified across geography and asset classes like bonds, forex, equity, debt and commodity are going to report huge losses. As this article points out StanChart was just the first of many to loose billions at the beginning of this year.
Summary
Keep a close eye on the markets for the next few weeks and months and maintain a safe equity:cash ratio at all times going forward until the clouds of uncertainty clear out reasonably. Note that I am not at all pessimistic and hoping that the markets will resume its uptrend reflecting upon the fundamental changes in Indian politics and economy and there will be fewer shocks from other parts of the world that will be handled better by the governments and central bankers.
Note: I have limited capability to understand advanced financial macros and geo-political impact so the above analysis might be highly inaccurate. But when faced with extremely complex events like this, we go with what little we can understand instead of just closing our eyes and forgetting the demat account password :)
Good luck & happy investing ! (In times like these, we do need little bit of luck to not only make money but also to not loose our capital). Be safe :)
References:
Everything you heard about china stock market crash is wrong
Major Sensex Crashes
[21-Jan-2008: 2062, 22-Jan-2008: 2272, 11-Feb-2008: 1007, 17-Mar-2008: 1022, 10-Oct-2008: 1088, 24-Oct-2008: 1204, 27-Oct-2008: 1003. 24-Aug-2015: 1153]
What caused it?
Unlike other major stock market crash where the reason was mostly known like subprime mortgage crisis in 2008, the reason behind 2015 crash is not yet well understood. Lot of things are going wrong around the world like Greek debt crisis, China Stock market bubble, fall in commodity prices (crude oil fall being the most dramatic), deflationary environment in most developed countries around the world, impending rate hike in USA after ending the multi-year quantitative easing program, geopolitical instability led by terrorist groups like ISIS, political non-cooperation between major super powers like USA, Russia and China. These events have been developing over several years now and nothing can be directly linked to the one day stock market crash on 24th Aug 2015.
So what happened on 24th Aug?
The most convincing argument I found was from this article that I cannot find anymore :( but it mentioned from what I remember that big institutions use interest rate FX swap to make money out of the difference between the interest rate offered on different currencies and sudden devaluation of yuan by China caused huge losses to these institutions on their Dollar/Yuan interest rate swaps which they had to cover by selling their equity positions leading to the flash crash around the world on 24th Aug 2015. The remedial measures employed to fix this is discussed in this article. Similarly this article describes it to some extent with a nice chart on the offshore/onshore USD-Yuan 1 year swap and an unusual movement between the two on Aug 24th. Something like that would make sense for a one day flash crash followed by almost complete recovery. The whole episode of 24th Aug could be more of a trading phenomena instead of a significant change in market fundamentals. I agree that the market fundamentals is bad, but it has been been bad for a long time and possibly 24th August market crash is not directly related to it.
USD-Yuan swap graph reproduced from the article referenced above
It also came into news later that perpetual long only investors like Abardeen Asset management liquidated their holdings in blue chip names like HDFC in the Indian market. What would force them to do something like that?
Another interesting article showing divergent behavior by 30 Year US treasury bond is discussed in this bloomberg article. Here for a short period bonds and stocks show a positive instead of negative correlation which is reverse of what is expected. US treasury yield was expected to fall in the US market due to flight to safety from equity to bonds, but it actually spiked due to US treasury dumping by Chinese government during the same time. The Chinese govt used the dollar proceeds from the US treasury sale to prop up renminbi as part of their strategy to support their currency & market volatility. This led to huge losses across portfolios of bonds and equities for major institutions triggering a sell off. Again some kind of technical adjustment phenomena due to heavy volatility in the currency and bond market along with technical divergence from normal behavior around 24th-Aug
Chart of US Treasury yield reproduced from the bloomberg article referenced above
What lies ahead?
No clue. From the 2008 fall in the markets we can see that initially when the fall started in 2008 the 1000+ points fall were quiet frequent. We had three almost back to back crash on Jan 21st, Jan 22nd and Feb 11th within 3 weeks time frame without any recovery in between followed by a relatively quite period but continuously sliding market and another series of back to back crash in Oct 2008. According to me the markets have already negated "2008 like crash" by recovering almost completely within a week. If the next 2-3 weeks pass without any major incident then probably we can safely forget the "black monday" as a one off technical adjustment event. However this is not to say that everything is fine now. We need to maintain a safe equity:cash ratio in our portfolio for a long time to come. I would say 60:40 is safe and 70:30 is aggressive. This is a major shift in my strategy from being almost fully invested into equities to take maximum advantage from the "Modi led reform rally in Indian markets".
I also have a gut feeling that this year large institutional asset managers who are diversified across geography and asset classes like bonds, forex, equity, debt and commodity are going to report huge losses. As this article points out StanChart was just the first of many to loose billions at the beginning of this year.
Summary
Keep a close eye on the markets for the next few weeks and months and maintain a safe equity:cash ratio at all times going forward until the clouds of uncertainty clear out reasonably. Note that I am not at all pessimistic and hoping that the markets will resume its uptrend reflecting upon the fundamental changes in Indian politics and economy and there will be fewer shocks from other parts of the world that will be handled better by the governments and central bankers.
Note: I have limited capability to understand advanced financial macros and geo-political impact so the above analysis might be highly inaccurate. But when faced with extremely complex events like this, we go with what little we can understand instead of just closing our eyes and forgetting the demat account password :)
Good luck & happy investing ! (In times like these, we do need little bit of luck to not only make money but also to not loose our capital). Be safe :)
References:
Everything you heard about china stock market crash is wrong
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