Equity markets volatility has exploded since the Standard & Poor’s 500 broke the 200-day moving average at 1285 and later broke through the head-and-shoulders neckline of 1260. These steep moves are approaching a magnitude not seen since markets collapsed in the fall of 2008.
Like then, a change in sentiment and hope of government support are far more important than the fundamentals. When will this volatility end? History says it could take anywhere from two more weeks to 10 more weeks. It will depend on whether the Federal Reserve announces a third quantitative easing (QE3) program at the end of August, which would bring some stability to the financial markets (but unfortunately also destroy the real economy). If the Fed simply passes the ball to Congress to act, the volatility will continue.
As we approach the Fall, risk aversion will increase should the government fail to announce outright support for the markets. Indeed the majority of bullishness is based on the belief the government will be coming to the rescue of financial markets. Should they not appear, investors will vote with their feet, and the ride down will be very bumpy. Volumes collapsed on the ride up and have exploded on the move lower.
Given that most emerging markets have already established firm downtrends, it is difficult to imagine a catalyst outside of QE3 that can lift the equity markets. In my view, feeble efforts such as the ban of short sales or government announcements of heightened market scrutiny will only increase volatility, but these should be expected as leaders debate whether to intervene or let the markets move to equilibrium.