Saturday, September 5, 2020

Tech sell-off - We sort of know why....sellers exceeding buyers

"The market has gotten ahead of itself..." "Sellers overwhelmed buyers..." 
- The phrases used when we don't know why a reversal occurred. 

Tracking the tech sell-off over the last two days gave me a clear picture of the market. We don't know what is going on in the rational sense that there is fundamental information that has changed expectations. Theory and empirical evidence are suggestive that large sustained gains or loses versus a benchmark are susceptible to price reversals, yet that does not address the question of when or why reversal crashes will occur. 

It has been found that the momentum style factor exhibits negative skew and is subject to crashes or quick reversals. See Momentum Crashes. The momentum crash research was focused at the momentum factor, but the framework may translate to specific stock moves. However, the criteria for a momentum crash do not seem to fit the current circumstance. The market is not in a panic state and there is not a melt-up of poor performers. 

Clearly some of the large cap tech stocks have exhibited a strong positive run and would be in the top decile of large cap return performance for momentum. These stocks have also been screened for high growth. Reaching these two extremes are suggestive of a likelihood for reversals as prices normalize, but strong gains alone does not provide any specific reason for when or why it will occur. 

I would look to the herd behavior literature as another source for explanation. Again, herding creates positive feedback loops that will lead to extreme moves, but there is still the problem of explaining when the deflation or reversal of crowd behavior will occur. The herd  behavior school will state there is a focus of expectations that will change with new information that contradicts the status quo, yet again we are not faced with any new tech fundamental information. 

Alas, without new information, human nature will fill the void with explanations that are tautological or simply obvious yet dressed up as learned and deep thinking. Hence, we are given the more sellers than buyers story or extensive call option trading by Softbank being reversed through profit-taking. 

Markets move and these moves are often endogenous to the actions of agents independent of exogenous information. This is a fundamental risk that cannot be explained but must be accepted as part the trading experience. Things happen. 

No comments: