The news came out yesterday that a Third Avenue fund was liquidating, and putting a halt on redemption, locking up the deposits investors put in the fund, possibly for months. Being important news, and possibly the only really bad news event to come out yesterday, it is only natural that people attribute the 300 point decline in the Dow to this.
The news didn’t come out until 12:30pm, though. If you read yesterday’s early morning post, Volatility Spiking Ahead of FOMC, you knew that the market was already in a downward pattern before the market opened, and well before the Third Avenue news hit the streets.
So, how did the volatility do before 12:30? Just look at this chart, where you see it rapidly climbing all morning.
While the news certainly gave it a lift, it was on an uptrend prior to that, and continued the same uptrend after that news gave it a spike.
Similarly, the S&P futures show a continued downtrend all morning, with virtually no change in the trajectory between 12 and 1.
The news can present a distorted view of why the market does what it does. While the failure of junk bonds is a very important indicator of things ahead, understanding that there are larger forces here that trump a single news event is important for understanding the bigger trend the market is on.
What does correlate well with the rise in volatility is a corresponding drop in the price of oil. While it would be nice for the price of oil if production decreased, the bigger issue here isn’t production, which has been relatively flat this year. In supply and demand, when supply doesn’t change, but price goes down, what did change? The only possibility is a drop in demand. The drop in the price of oil is an indicator of a rapid drop in demand.
On top of oil and other industrial commodities being the canary in the mine, their drop is also part of the reason there are other dominos falling, such as junk bonds, as oil and other commodity producers who cannot pay their debts are on the rise.