Impact of Global Financial Crisis on Stock Market

logo  5 January 2023

While it was the worst quarterly decline in over 50 years, the 20–30% drop in adjustments that the stock market experienced in the first half of 2022 cannot be fully attributed to the global economic crisis. The drop followed a period of rapid price increases, as well as a parallel rise in unemployment and inflation, which affected the world’s largest economies — the so-called “sumoylation.” In many ways, the COVID-19 pandemic served as the main reason for this decline.

A few words about risks

A few words about risks

By analyzing the market’s algorithmic and passive transformation, plus the systemic vulnerabilities that might emerge, one can see how these vulnerabilities exacerbate market pain with just a little bit of negative news. This only adds to the market participants’ anxiety: what will happen when something actually bad occurs?

It is important to remember that long-term investments’ results depend on the regularity of assets, the amounts invested, and the duration of the investment, not just on entry points.

As the threat of a market crisis mount, from geopolitical tensions and fears of global events to weak market leaders, etc., the issue of ETF liquidity becomes more important than ever. The skeptics arguments are much more persuasive than those of the evangelicals, which means that today, more than ever, caution is imperative. The higher the volatility, the riskier a particular asset or portfolio is.

When it comes to a crisis, the main risk is an increase in costs in the primary and related sectors, which leads to inflation or its more insidious variant — stagflation, when prices begin to rise without accelerating the economy itself. However, the counter-strategy to compensate for this effect is quite simple: add stocks that will grow along with commodity prices to your portfolio, as well as industrial companies that directly serve the growing demand for resources, raw materials, and manufactured goods.

For example, the energy sector of the S&P 500 has been up 80% since last November, driven by higher oil prices. Shares of industrial and infrastructure companies gained, on average, around 25–30%. Banks earn on interest rate differentials, and the growth of long-term yields also stimulates the development of this sector — since the beginning of the year, banks have grown by 31%. With inflation rising, many companies in these sectors have pricing power and can pass the costs on to the consumer.

If you look at the long term, at the time of falling stocks, the crisis, and high prices, you can even buy company shares at a portion of their original cost.

Types of market volatility

When traders talk about market volatility, they may keep slightly different concepts in mind. Despite this, the general definition of volatility — the intensity of market movements — remains valid. Volatility can be interpreted in the following ways:

  • Historical volatility — calculated based on actual price changes;
  • Future volatility — the unknown pace at which the market will move forward;
  • Forecast volatility — an estimate of future volatility;
  • Implied volatility — used in option contract pricing.

In particular, low-volatility ETFs have seen a resurgence in recent years as a tool to smooth out portfolio ups and downs, focusing on individual stocks that tend to experience minor price fluctuations.

Low-volatility ETFs can be beneficial for lowering the risk of investments — in anticipation of a period of falling stock markets — while maintaining the capital invested. They can also serve as an attractive tool for structuring a long-term portfolio. Minimizing losses in a bear market is a critical component of a long-term winning strategy.

A few examples of low-volatility ETFs

Low-volatility ETFs

IndexETFs
S&P 500SPLV
Russell 1000LVOL
Russell 2000SLVY
MSCI EAFEEFAV
MSCI Emerging MarketsEEMV

Most ETFs offer what can be called “static” investments, meaning that the target asset class remains constant over time, even if some of the components change regularly. There are also so-called “dynamic” ETPs that vary their portfolios based on current market conditions. These products typically switch between high-risk and low-risk assets depending on a range of indicators such as volatility and thus have the potential to provide low costs and low access to high-impact strategies.

Some examples of dynamic ETFs and ETNs:

  • Trendpilot ETNs (TRND, TRNM, TBAR, TWTI);
  • Barclays ETN+ S&P VEQTOR ETN (VQT).

Such assets must be handled with great care.

Volatility-sensitive ETFs protect against sudden ups and downs

Direxion currently offers a set of volatility-sensitive ETFs that adjust the distribution of investments across target asset classes (such as large-cap U.S. stocks) based on monitoring the recent volatility of the underlying assets. With low volatility, these ETFs can go up to 150%, increasing the investment efficiency. When volatility peaks, investments move towards risky assets (with cash returns). These ETFs can be an exciting alternative to the asset classes that often form the core of investments in long-term portfolios, offering a cheap way to realize what would otherwise require a very time-consuming and costly process.

Here are a few examples of volatility-sensitive ETFs:

  • Direxion S&P 500 RC Volatility Response Shares (VSPY);
  • Direxion S&P 1500 RC Volatility Response Shares (VSPR);
  • Direxion S&P Latin America 40 RC Volatility Response Shares (VLAT).

Volatility-sensitive funds can safeguard you from sudden surges and capital losses.

The impending economic crisis may lead to increased risks. However, this cannot be a reason to abandon investments. If you choose the right stocks to invest in and can select ETFs with suitable volatility, you can still make a lot of money doing so.

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