Unexpectedly Intriguing!
22 June 2020

Coming into the third week of June 2020, we introduced two hypotheses for what caused the sharp, sudden, and now sustained deviation in the trajectory of the S&P 500 (Index: SPX), which rose on the week, but not by anywhere near enough to recover to its previous trajectory.

Alternative Futures - S&P 500 - 2020Q2 - Standard Model (m=-1 from 13 April 2020) - Snapshot on 19 Jun 2020

The two hypotheses for what caused the S&P 500 to plunge by 5.9% on Thursday, 11 June 2020 can be summarized as follows:

  1. The S&P 500 experienced a new Lévy Flight event, in which, investors suddenly shifted their forward looking focus from 2020-Q4, where it appears to have been since about 1 May 2020, to instead focus on the nearer term future of 2020-Q3.
  2. Investors adjusted their expectations for the future of the Federal Reserve's monetary policies, going from the anticipation of more expansionary policies to less expansionary ones.

Through the close of trading on Friday, 21 June 2020, we find the level of the S&P 500 is still consistent with what a dividend futures-based model would predict for both hypotheses, but that state of affairs will almost certainly change in the week ahead.

As shown in the alternative futures forecast chart above, the model anticipates the level of the S&P 500 will rise significantly in the week ahead to follow the trajectory associated with investors fixing their attention on the near-term future of 2020-Q3 if the Lévy Flight hypothesis holds, assuming they have not changed their expectations for how expansionary the Fed's monetary policies will be going forward following the end of its last meeting on 10 June 2020.

But, if the shift that occurred on 11 June 2020 was the result of a change in expectations for the Fed's monetary policies, where the amplification factor in the dividend futures-based model suddenly changed to become less negative than it has been, we will see the trajectory of the S&P 500 start to consistently underrun the levels projected by the model as shown on the alternative futures chart above, which currently assumes no change in the amplification factor since 12 April 2020.

There's also the possibility that both things we've hypothesized could have happened, but here, we would still see the trajectory of the S&P 500 underrun the model's projections as currently shown on the chart above, which would allow us to reject the first hypothesis because of its assumption that there was no change in investor expectations for how expansionary the Fed's monetary policies will be.

With the stock market's behavior so interesting, this is definitely a fun time for us. Perhaps not as much fun as the first time we took advantage of a natural experiment with the S&P 500, but we're learning quite a lot in near real time!

Monday, 15 June 2020
Tuesday, 16 June 2020
Wednesday, 17 June 2020
Thursday, 18 June 2020
Friday, 19 June 2020

Elsewhere, Barry Ritholtz presents a succinct summary of the positives and negatives he found in the week's markets and economy news.

Update 24 June 2020: It looks like we may be able to reject the first hypothesis. With the level of the S&P 500 clearly underrunning all of the dividend futures-based model's projections, as the index dropped 2.6% today to close at 3,050.33, it looks like we will be able to rule out this hypothesis because of its assumption that investors did not lower their expectations for how expansionary the Fed's monetary policies will be in the future.

Alternative Futures - S&P 500 - 2020Q2 - Standard Model (m=-1 from 13 April 2020) - Snapshot on 24 Jun 2020

Now the question is how much much of the change is Lévy Flight and how much is change in amplification factor? We'll need to develop two new hypothesis to sort out that question, but unlike this natural experiment, we suspect it will be much tougher to answer.

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