As one of our team said, “The Quast Vacation Put strikes again.”
Wearing puka shells and vacation pants, we split March 25 for the trade winds of St Vincent and the Grenadines to sail the following seas. And the stock market crumbled.
You can see sea views here and here and here and here and here.
Let me posit a thesis: The stock market was already tilting toward a topple before everyone started blaming tariffs. I wrote about The Big Problem Jan 29.
The problem IS volatility. Not necessarily what causes it. Stay with me – I’ll explain. It’s not “investors.” Machines are behind it. And ETFs.
Yeah, but Quast. Uncertainty causes volatility. If the Trump administration wasn’t moving willy nilly, markets wouldn’t be caroming like sailors on swelling seas (we had a bit of that).
It’s inarguable that prices of stocks have become overheated molecules in a microwave. The VIX is up 123% in five days.
Stock exchange operator IEX demonstrated some years ago how orders from proprietary traders gyrated prices vastly more than those from full-service and agency brokers.
Prop traders react to prices. The other two are trying to buy and sell things. Aren’t those the same? Nope. If your aim is to change the price, you do it in the smallest increments possible. If you’re trying to buy and sell things, you need size.
So the size of real orders meets the paper shredder of proprietary trading. Even so it works most of the time.
It breaks down when gaps form between the single price at which ETFs are created and redeemed in large blocks off-market, and prices IN the market set in tiny bouncing increments.
Say Blackrock and Morgan Stanley – just making up names here – do an off-market creation unit for 50,000 shares of IVV, the S&P 500 ETF. Blackrock supplies shares of IVV. Morgan Stanley offers a basket of S&P 500 stocks (not all but a readily available statistical sample) in exchange and the two transactions have identical value.
Then prices go wild. Now, one party or the other is at risk and moves to mitigate its exposure by buying or selling baskets of related options and futures. Market-makers for stocks, ETFs and options – which should generally track each other – react and magnify the effects.
This is pandemic in the stock market today.
The underlying basket of equities continues to shrink, while the number of ETFs, now 3,750 trading in US markets, relentlessly rises, and options are traded daily, weekly, monthly, and indexes tracking equities are futures contracts that then fluctuate wildly too.
The pervasive presence of these conditions and the need for arbitrage among them to stabilize prices and benchmark-tracking compounds any Butterfly Effect.
I’ll submit that what set the entire thing off was a single volatility event Dec 18, when options expired as Jay Powell spoke. It proved to be the biggest volatility event, so far as we can tell, ever in SPY.
Volatility events become part of the data set powering machines creating prices. They can compound into a harmonic vibration. It doesn’t take tariffs. It takes an event imprinted on the historical data, that then bumps the market ahead – as it did, all the way till now.
I shared with our EDGE users that I’d put on my version of the Big Short in December, which drove 15% returns in Q1 2025. As we left for the sea, I shifted to cash.
The stock market is principally a place where investors put money into passive asset-allocation models called indexes and ETFs, and machines arbitrage the spreads between those and stocks, and derivatives on all three.
At December options-expirations, prices of derivatives changed sharply. It’s continued ever since, with building momentum, because machines will find and consume divergences, leading to what we saw April 8. Stocks opened up 3.5% or more. And the spreads were consumed. And nobody is buying the market. And machines tipped it right over.
This will continue until gaps stop forming. Reactions by machines to tariffs are an input but neither cause nor solution. Bear markets happen for their own reasons.
And here’s the convergence. Agree or disagree with the tactics, which are messy, the Trump administration is trying to redress a global addiction to the heroin of American consumption that has drained the country of manufacturing jobs. Changing course will give the planet the shakes.
In the stock market, our dependency on ETFs and derivatives compounds volatility risk.
We can and must understand the market we’ve got, public companies and investors. Having a strategy for this market is essential. Companies fixate on the strategy of “telling the story” when prices are determined by characteristics, not stories, and the money is running on models. Fixation on story can compound volatility (ask us and we’ll explain).
And investors, you can’t beat the machines. But you CAN see Demand/Supply imbalances on a timeframe that doesn’t matter to machines focused on daily arbitrage. And you can manage your exposure to risk and make money in any market.
