Unexpectedly Intriguing!
June 15, 2020

We miss the old days when the amplification factor for the S&P 500 was virtually a constant.

Because if it was still a constant, the 5.9% plunge in the S&P 500 would be easy to understand as a Lévy Flight, a sudden large change in value following a series of much smaller changes.

Alternative Futures - S&P 500 - 2020Q2 - Standard Model (m=-1 from 13 April 2020) - Snapshot on 12 Jun 2020

That large plunge came on Thursday, 11 June 2020, following the Federal Reserve's latest two-day meeting the day before, in which the U.S. central bank committed to hold the Federal Funds Rate in the zero bound range, between 0% and 0.25%, for at least two years - which would take a significant portion of the potential for negative rates off the table.

The following snapshot from the CME Group's FedWatch tool shows the expectations that came with the Fed's announcement, which is quite different from what we observed last week.

CME Group FedWatch Tool Probabilities of Federal Funds Rate Changing at Future FOMC Meeting Dates, Snapshot on 10 June 2020

That change in expectations could have prompted the large drop in stock prices on Thursday, 11 June 2020 because it would lead investors to conclude the Fed's monetary policy will be less expansionary than what they had been expecting, with the result being that stock prices fell, just as we described might happen in the "what if" scenario we presented back on 26 May 2020.

That outcome would be the result of changing the value of the amplification factor in a more positive direction in our dividend futures-based model, which would coincide with a similar shift in the future expectations for the Federal Funds Rate away from the potential of becoming negative.

Or, it could be that investors suddenly shifted their forward looking focus from 2020-Q4 toward the nearer term future of 2020-Q3 in a new Lévy Flight event, which is also suggested in the alternative futures chart based on the dividend futures-based model above.

We'll need several more days of data to sort out which of these two potential explanations for the sudden large drop in stock prices makes for a better description of how stock prices have behaved. Right now, our sample size consists of just two days worth of data, which isn't enough in the current environment to get a solid read on the situation.

What we're looking for is whether the trajectory of the S&P 500 follows the trajectory associated with 2020-Q3 in the alternate futures chart above, which assumes that the amplification factor m = -1. If it does, that outcome would be a confirmation that the market experienced a Lévy Flight event as investors acted to change their forward time horizon.

Alternatively, if the trajectory of the S&P 500 persistently falls below the projection for investors focusing on 2020-Q3, that would be an indication the amplification factor has itself shifted.

Welcome to our world. Which is also informed by the market-moving headlines we make a point of presenting each week in case somebody someday needs to reconstruct the informational context in which a stock market event occurred!

Monday, 8 June 2020
Tuesday, 9 June 2020
Wednesday, 10 June 2020
Thursday, 11 June 2020
Friday, 12 June 2020

Did we miss anything worthy of note? If it helps, that's why we both read and link to Barry Ritholtz' succinct summary of the positives and negatives he finds in each week's markets and economy news, because getting a range of viewpoints about what matters to the market makes for healthy investing decisions!



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