Fragility

On a Monday like today, 38 years ago, the S&P500 experienced the biggest single day percentage drop in history, 22.6%. It’s interesting to understand the context surrounding the fall of that day: the market rose 40% in ‘87 up to that point, and there were concerns of being in a bubble. There were also geopolitical tensions between thr US and Iran in the Persian gulf, which paired with low liquidity and program trading. Despite the fact that almost 40 years have passed, we’re still dealing with similar issues. Today market feels frothy, there are geopolitical tensions and, at times, liquidity can be an issue. Leverage is a problem today , with margin reaching new highs at $1.13Tn, and that doesn’t include the leveraged ETFs (around $200Bn) that are popping up like mushrooms. The big question is what triggers those moves. Sometimes it’s an earnings report, or the escalation of an international conflict, that sparks an investor stampede and the market liquidity is not there to absorb the irrational behavior all at once. Nassim Nicholas Taleb defines market fragility as the vulnerability of financial systems to sudden, severe disruptions due to their interconnectedness, over-optimization, and hidden risks. Are we witnessing signs of fragility?

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