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State of the Market

The S&P500 just returned its worst month of the year. Let’s take some time to explain potential reasons for the market’s increased volatility before getting into the ways to protect your portfolio or even benefit with certain positions.

The S&P500 just returned its worst month of the year. Down almost 5% for September, your portfolio may have given up some of the gains the market has generously delivered so far in 2021. Still up over 17% this year, even September’s poor month is a minor drawback when we zoom out. 

Let’s take some time to explain potential reasons for the market’s increased volatility before getting into the ways to protect your portfolio or even benefit with certain positions. Scores of Stake traders are making the most of the current environment by trading inverse and long volatility products available on the platform.

To start, no single event contributes entirely to the market’s movement. What the headlines say is often just one of many reasons that the millions of market participants exchanging billions of dollars happened to push the indexes one way or another. That being said, let’s understand the macro-level state of the stock market. 

All in the yield

Portfolio allocation is all about that risk/reward ratio. Cash in the bank is low in risk but offers almost no return. Stocks are relatively risky and are coupled with a relatively higher return. Bonds are close to cash. The relationship between stock prices and bond yields has a significant influence on markets.

For those new to markets, a bond is debt. The most widely tracked bonds are issued by the US treasury. The US government is borrowing from investors and agreeing to return a fixed rate (coupon). A bond’s yield is simply the coupon over the price. A $5 coupon on a $1,000 bond is 0.5%. The market determines the price of the bond. As the price rises, yields fall and vice versa. Right now, a US 10 year bond pays yields just over 1.5%. You will receive roughly 1.5% per year on every dollar invested into 10-year bonds. They get a bit more complex but that’s the gist.

The recent market retreat is somewhat related to rising yields. The last couple of weeks saw yields on the 10 year rocket from 1.3% to over 1.5%. What do rising yields indicate? 

An uncertain future

Investors see more uncertainty in the medium to long term for the US economy. Since investors are buying US debt, rising yields reflects uncertainty in the strength of the economy. Perhaps inflation will force the Fed to reign in their monetary stimulus. Since the start of the pandemic, the US Federal Reserve has injected unprecedented stimulus into the economy. This has largely benefitted businesses as the stock market’s performance makes clear. A decrease in such spending will occur if inflation starts to happen, a reason the market may be apprehensive in the medium term.

So what?

As such, investors have sold off their bonds which has led to a rise in yield. Why does that matter for the stock market? Apart from a murkier outlook, stocks are priced on future cash flows.  

Such cash flows have to be discounted and priced in today’s terms. Increased uncertainty means investors are less willing to pay for future cash flows. Think of all the unprofitable companies banking on eventual success. While the S&P500 is near all-time highs, names like Uber and Airbnb are over 20% below their peaks: the more uncertainty, the lower the valuations of such stocks in incredibly simplified terms. Such stocks typically make up the Nasdaq: the tech index.

Only 35% of Nasdaq stocks are above their 200 day moving average, as the index sits 8% off its high. Investors have been discounting such stocks for some time now.

Be prepared

So, say yields continue to rise representing increased concern for the US economic outlook o markets start to retreat for any reason, what’s a trader to do?

It’s important to keep in mind that the long-run has almost always righted any short term market corrections. For shorter-term traders, remember to keep your stop losses in place. 

For the more sophisticated investor, increased volatility may provide opportunities. Stake offers a range of inverse and volatility ETFs which perform best during times of market uncertainty. 

Take SQQQ for example, it’s a 3x leveraged inverse index ETF. In short, it rises 3% for every 1% fall in the Nasdaq. Indeed, this is an exotic product and unless you can understand how this is even possible, it’s best avoided. The same goes for volatility.

The VIX measures volatility or “market fear”. It rises with uncertainty and falls during calm market periods. Securities like VXX and UVXY give investors exposure to the VIX index. Again, exotic options for experienced traders.

Over the last 2 months, almost US$30m in the top inverse and long vol instruments has been traded on Stake. $UVXY and $SQQQ are the most popular as trader’s take advantage of the market’s downturn. $FNGD which moves up 3% for every 1% fall in the big tech stocks has also been popular. It inversely tracks names like Tesla, Facebook, Apple and the other leading Nasdaq names. 


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