Why Stocks Plunged Today (It's Not About Europe)

Stocks started the day in the black, but that didn't last and they went on to record their largest daily loss since Nov. 7, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) losing 1.8% and 1.5%, respectively.

Market commentators pointed to the uncertainty of the outcome of national elections in Italy, but that didn't bother European investors; all the major European stock markets were up today -- including Italy's, where the FTSE MIB gained 0.7%. The spread between the yield on the 10-year Italian government bond and that on its safe-haven German counterpart did widen to 2.93 percentage points, but only by 5 basis points (a basis point is equal to one hundredth of a percentage point), which hardly indicates a "risk off " stampede.

Volatility: The resuscitation
It appears, to paraphrase Mark Twain, that the report of
the death of stock market volatility was an exaggeration. Consistent with today's sharp loss, the VIX (VOLATILITYINDICES: ^VIX  ) , Wall Street's fear gauge, shot up 34% to close at just below 19. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.) This is the VIX's highest closing value since Dec. 28 -- as the fear and uncertainty concerning the fiscal cliff was reaching its climax.

As a result, "fast money" types jumped on the volatility train today, making the iPath VIX Short-Term Futures ETN (NYSEMKT: VXX  ) -- a toxic product that is the financial equivalent of keno -- the third most highly traded security across U.S. equity markets today. The daily dollar volume was roughly twice or more that of megacaps such as Microsoft, General Electric, and Intel! Another VIX-related product, the ProShares Ultra VIX Short-Term Futures ETF (NYSEMKT: UVXY  ) was also in the top 10 volume leaders.

Of course, when I wrote volatility's funeral oration, I knew that its demise could only be temporary and that its reanimation was only a matter of time. Bear in mind that even at 18.99, the VIX remains below its average since its inception in January 1990, which is 20.41, and this is a highly mean-reverting series. In this environment, investors need to stay resolutely focused on underlying fundamentals, valuations, and long-term results. Central banks' experimental efforts to suppress volatility are something akin to Dr. Frankenstein's attempt to create a new Prometheus -- as the good doctor found out, they have the potential to create unpredictable, monstrous outcomes.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 25, 2013, at 7:52 PM, techy46 wrote:

    Whenever Mr Market can't figure out what's next it becomes a volatility crap shoot. Seqestration is going to do that now and until anybody and every body can figure out the losers and winners we the Fed stops printing money and issuing phoney T-bills. There not much difference in receiving disability pay from Social Security beyond what you contributed, collledge loans from HEW, or a huge paycheck from our worthless defense establishment to build weapons for the Christian Crusades. Let the spending cuts begin or raise taxes to pay for all of the excesses.

  • Report this Comment On February 25, 2013, at 8:54 PM, petfoe wrote:

    Hi Alex, You failed to answer the question that the heading in your article alluded to. All the numbers I already know. I was hoping that you could make more sense of them.

  • Report this Comment On February 25, 2013, at 9:52 PM, TigerPack1 wrote:

    1- Italy descending into social & economic chaos

    2- Euro about to implode

    3- Full Moon

    4- Sequestration Reality

    5- Japan Hyperinflation

    6- N.Korea about to nuke S.Korea

    7- China preparing to take islands by force from Japan

    8- Israel about to bomb Iran

    9- Federal Reserve leaders turning on each other

    10- China growth slowing

    11- Europe in recession

    12- Japan in recession

    13- USA entering recession

    14- England downgraded

    15- Afghanistan kickin US out of nation

    16- 119 x 119 = Dow 30 High

    17- EVERY important index, average, bell-weather and indicator diverged on Dow 5-year peak trade this AM

    18- A combination thereof

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