The weeks since early November 2016 are emblematic of a period when a quantitative indicator of true stock market stress can be most helpful to protect investors from their psychological biases. You may recall that many respectable economists predicted severe and immediate financial market panic if Donald Trump won.
On election night, at roughly 2:30 AM when Fox News first called the election for Donald Trump, Walt received a call from a close friend (who is however not a Huygens client). “Is there any way I can sell all my mutual funds before the market opens tomorrow?” he asked. At the time of that phone call, U.S. equity index futures were dropping precipitously.
The panic quickly subsided. Within a day of the election, our market stress indicator turned offensive and has stayed in that state ever since, and as a result our strategies have captured much of the ensuing strong equity market run. An individual’s natural response would have been to expect volatility to resume, and therefore to wait on the sidelines for a better market entry point. Our system recommended otherwise, to our clients’ benefit.
Earlier in 2016, we pointed out that equity market stress, as measured by rolling 12-month volatility of daily returns, has been continuing its long decline from the 2008-9 global financial crisis, despite having reached a recent minor peak in February of 2016. The Kansas City Federal Reserve Bank’s index of financial market stress, which combines measures of stress in multiple financial markets including equity, debt, and foreign exchange markets, illustrates this well: