Goldman: ‘Naively, Wednesday’s S&P Selloff Was The 5th-Largest Tail Event In History’

Wednesday was a disconcerting day for market participants and not just because stocks fell the most since February and the Nasdaq crashed the most since Brexit.

More notably, perhaps, than the selloff itself, was the character of the selloff. Things snowballed in the afternoon and by all appearances, a pretty dramatic factor rotation was behind the rout.

The Momentum ETF, you’ll recall, had its worst day on record.

Similarly, Growth underperformed Value by the widest margin since the Goldman “Is FANG mispriced?” note:

As Nomura’s Charlie McElligott wrote Thursday, “the 7-day move in U.S. ‘1Y Momentum Longs’ was -4 standard deviations and the largest since dating back to the U.S. debt downgrade scare of 2011.”

(Nomura, Bloomberg)

All of that raises uncomfortable (if familiar) questions about market fragility and about the extent to which forced de-risking and systematic selling might be serving to exacerbate already bad situations.

That’s the context for the latest note from Goldman’s Rocky Fishman who, while at Deutsche Bank, spent a lot of time warning folks about the rebalance risk inherent in the levered and inverse VIX ETPs, a risk which of course materialized in dramatic fashion on February 5.

“Compared with pre-event annualized realized volatility of 6.4%, Wednesday’s 3.3% SPX selloff naively represents an 8-standard deviation event, the 5th-largest tail event in the index’s 90-year history (6.4% annualized vol implies a 40bp one-standard deviation trading day)”, Fishman begins, before adding the obvious qualifier which is that “part of the reason this week’s volatility looks like a tail event is that realized volatility had been surprisingly low prior to Wednesday [as] the five least-volatile quarters for the SPX over the past 20 years were Q1/2/3/4 of 2017, and Q3 of 2018.” Here’s the chart on that tail event point:

(Goldman)

But all caveats aside, the worry here is always the same. This is happening more frequently and that seems to suggest that markets are more fragile thanks to years of low vol. and the proliferation of vol.-sensitive strats.

“What stands out again is the frequency of recent outlier events”, Fishman continues, noting that “three of the 40 largest one-day VIX moves have happened this year, and 13 of the top 25 VIX move have happened in 2010-8.”

Putting Wednesday’s move in historical context, Fishman writes that the “mathematical tail event” (and again, that’s a characterization that seeks to convey a bit of skepticism about classifying Wednesday as a major event while still communicating an appropriate sense of alarm) “was one of just six events in the SPX’s almost 90-year history that had a one-day move in excess of 50% of trailing annualized realized volatility”. Here, via Goldman, are the others:

• 26-Sep-1955 (SPX -6.6%, RV 9.0%): Eisenhower heart attack. News that President Eisenhower had suffered a heart attack in Colorado drove a sharp selloff.
• 13-Oct-1989 (SPX -6.1%, RV 9.0%): LBO failure. The United LBO failed, in a market already worried about recession risk.
• 19-Oct-1987 (SPX -20.5%, RV 31.0%): Market crash. The 1987 crash’s one-day move is one of the largest-ever tail events even though the previous week’s volatility had already pushed realized vol to a 13-year high.
• 27-Feb-2007 (SPX -3.5%, RV 6.5%): China selloff (FXI down 10%). While realized vol subsequently briefly dipped to the pre-event range, this largely marked the end of the 2004-6 low vol period.
• 10-Oct-2018 (SPX -3.3%, RV 6.5%): US growth and inflation scare.
• 26-Jun-1950 (SPX -5.4%, RV 10.7%): Korean war began.

The bank goes on to draw a parallel between Wednesday and the 2007 event. Neither episode, Fishman writes, had an obvious catalyst and both came after an extended period of subdued volatility.

Finally, Goldman notes that market depth (E-mini bid/ask) actually got worse during Thursday’s rout, which speaks to the whole liquidity provision debate.

The bottom line here isn’t so much “can we find a way to make Wednesday seem like a black swan?”, but rather that these types of fragility events continue to happen, despite the loud protestations of those who swear that modern market structure (characterized as it is by systematic/programmatic strats, passive strategies, factor crowding, retail smart-beta products, and on and on) isn’t making things more prone to tail events.