With the S&P 500 and NASDAQ futures both down approximately 3% as I type this on concerns about the ability of Dubai World to repay some $59 billion in debt, tomorrow’s half day session is likely to be ugly and volatile. In a vacuum, this type of event would be concerning, but not likely to cause panic. With the emotional scars of the financial crisis still looming large in the memories of investors (i.e., Availability Bias and Disaster Imprinting), I would not be surprised to see an overreaction in the markets tomorrow.
On average, a 3% drop in the SPX yields a spike of about 12.6% in the VIX. Yesterday the Dow Jones STOXX 50 index of European companies fell 3.36%, yet the VSTOXX, (the corresponding volatility index, which is similar to a pan-European VIX) spiked 28.16%.
For the record, a 28.16% increase in the VIX would put it at 26.25.
With the shortened trading session tomorrow providing below average liquidity and investors having an entire weekend to fret about possible contagion or additional cockroaches suddenly appearing, I am predicting a wild ride.
My general approach to events like this one is to try to fade the VIX spike as it shows signs of having topped, but there are frequently multiple spikes to contend with in these types of scenarios.
I will do the best I can to provide some commentary and analysis as the events of the Dubai World debt problems unfold.
In the interim, readers who are interested in previous posts on related subjects, readers are encouraged to check out: