Here's how the vicious circle that sends the stock markets down works

Why are sectors such as defence (despite the European rearmament plan), utilities (defensive stocks) or even the refugee asset par excellence such as gold also taking the stock market crash with them? The performances are merciless: defence stocks such as Leonardo from the evening before Trump's duties (2 April) to Monday have lost 12.5%. Utilities ditto: -7% in Europe, -8.8% in Milan, -5.1% in Frankfurt. Yesterday at mid-day, observed one trader, no stock in the European Stoxx 600 index had a plus sign on the stock exchange. The same in Piazza Affari: not a single stock in even a faint rise. Why is no one saved? Is it possible that no corner of the stock markets can benefit in any way from this duty chaos?

The answer to this question has to be sought in the very mechanisms that govern the financial markets: at times of high volatility and violent 'repricing', forced sales are always triggered, exacerbating everything. Partly in order to replenish collateral (margin calls), partly because skyrocketing volatility forces managers to reduce risk quickly, partly because leverage needs to be reduced, partly because algorithms use volatility as a parameter to measure risk: there are many reasons, but all together they cause markets to spiral. The last time we saw a similar film with a comparable (indeed greater) magnitude was in 2020, at the beginning of the Covid. Everything collapsed then too. That is why it is still happening today.

The fastest to move, because forced to do so, are the hedge funds. Goldman Sachs calculates that the day after Trump's tariffs these funds recorded the largest collective sale of shares ever in history. JP Morgan analysts add that long-short hedge funds reduced leverage (i.e. borrowing to invest) by 5-6% last week. They have done this to protect themselves, because the economic scenario has changed radically, but also because they have been forced to do so: when markets collapse so violently, those who have borrowed to invest (as hedge funds do) are often called upon to replenish collateral (in jargon, margin calls). "The movement of the stock markets in recent days has been amplified by margin calls and algorithms," observes Matteo Ramenghi, chief investment officer Ubs WM Italy. "Since after positive stock market years all investors were very exposed to equities, that is where they are selling now.

When a fund gets financed by a bank or a broker, it puts up collateral against the loan: usually government bonds, cash, gold or even shares. But when markets collapse so violently and suddenly, and the value of the investment goes below the value of the collateral, the bank asks for it to be reinstated. Otherwise it is forced to sell the collateral and close the loan. So the fund, in order to replenish them with cash, is forced to quickly liquidate what it can: this is how sales on gold (a safe haven asset), but also on stock market sectors such as defence and utilities, have been triggered. In fact, gold and the stock market have been turned into huge 'ATMs': places to withdraw cash to be returned to the banks.

All the forced selling revolves around volatility indices. The Vix, the one that measures it on Wall Street, rose to 60 yesterday: a level not seen since the start of the pandemic in 2020. Well: when the Vix rises that fast, many funds and investors sound the alarm: risk managers are forcing them to reduce risk. Translated: it is mandatory to sell shares. Risk parity funds, for example, must do so. JP Morgan estimated on Friday that they would have to sell between USD 25 and 30 billion in the US. Leveraged ETFs must also do so: JP Morgan again estimated sales of 23 billion. Thus cascading everyone is forced to sell. And if everyone sells, prices fall even faster, triggering further alarm thresholds. The good news is that when this sell-off ends, there is then every opportunity to rebound. The bad news is that nobody knows when this might happen.