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High levels of volatility show fear's role in markets

WASHINGTON — The market's wild hour-by-hour swings have come to exemplify the turbulence of the financial crisis, but they're still puzzling for many market professionals.

The Dow Jones industrial average now routinely travels hundreds of points in a matter of hours, only to reverse direction in many cases. During a single day earlier this month, the Dow spanned 1,000 points for the first time in history. On another, a 400-point rally during the last hour of trading sent the Dow to a historic 936-point gain.

During the final hour of trading Monday, the Dow surged more than 100 points.

Financial analysts suggest that the sharp ups and downs reflect investors' uncertainty about how quickly the financial crisis can be resolved and whether a recession will seep from the banking sector to other parts of the economy. Precipitous gains and losses also have been triggered as stocks reach preset selling or buying levels, prompting automated trading and causing investor whiplash, analysts said.

The largest swings have often occurred during the last hour of trading, prompting a closer look by the Financial Industry Regulatory Authority, a nongovernmental regulator of securities firms. The end of the trading day is when institutional investors, including hedge funds and mutual funds, rush to meet client demands to pull cash out of the market, analysts said.

The gyrations have turned even seasoned market professionals into skittish investors, waiting for a news tidbit that will turn the market's mood and start a stampede in either direction. "Psychology and emotion are a big part of what moves the market," said Andrew Brooks, head of stock trading at T. Rowe Price. "We are clearly in a highly emotional and schizophrenic point."

The Chicago Board Options Exchange's Volatility Index, known as VIX, has become a daily ticker of investor anxiety. VIX measures the degree to which investors expect stocks to swing and is often called the "fear gauge." It closed at 70.33 on Friday, its highest close ever, and hit an intraday high of 81.17 last week. In normal times, it trades at about 15 to 20, analysts said.

"We have no idea where things are going. That is what high volatility means," said Robert Engle, a finance professor and director of the Center for Financial Econometrics at New York University.

The volatility measure declined to 53 on Monday as Wall Street celebrated early signs that government efforts to thaw the credit markets could be working.

But analysts said they expect the volatility to continue for some time, perhaps through the end of the year. The market volatility provides an opportunity for some traders to make money off abrupt changes, analysts said. "It's bad for us, but somebody is thriving on this volatility," said Ashwani Kaul, director of research at Thomson Reuters. "Whenever there is volatility, somebody is making money."

The last sustained period of volatility was from 2000 to 2003, after the collapse of the Internet bubble and the Sept. 11, 2001, terrorist attacks, Engle said. "We have dramatically exceeded what happened in that period," he said.

But the current volatility does not compare with the Great Depression, Engle said. "The news during the Great Depression was even more dramatic. We had thousands of bank failures. We had 30 percent unemployment during some of the Depression," he said. "The stock market dropped 70 percent instead of the 35 percent to 40 percent we have now. It was a much bigger economic catastrophe."

The most volatile part of the day has become the last hour of trading as hedge funds and mutual funds face pressure from clients to cash in their investments.

According to TrimTabs Investment Research, investors pulled $43-billion out of hedge funds in September, the largest one-month withdrawal in history. About $22-billion was taken out of U.S. equity mutual funds last month, another record. October is expected to be worse.

The Financial Industry Regulatory Authority also confirmed Monday that it is looking into whether the historic late-day volatility is related to investor manipulation. The agency is examining whether traders have been inappropriately setting artificial stock prices out of line with the day's trading level during the last 20 minutes of trading.

High levels of volatility show fear's role in markets 10/21/08 [Last modified: Wednesday, November 3, 2010 4:50pm]
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