The ASX stock market crash we're all enduring right now has been unprecedented.
Not unprecedented in terms of total losses – there have been far worse crashes, including the GFC.
But unprecedented in terms of how fast the ASX has fallen from its highs.
It was less than 2 months ago (even though it feels like an eternity) that the ASX was at all-time highs.
Today, we are more than 25% down from these highs – and that's after a modest recovery. If you go back 2 weeks, we were looking at falls of around 35% for the S&P/ASX 200 Index (ASX: XJO).
So why has this 'flash crash' been one of the worst on record? Well, I have a theory.
The hidden 'ETF effect'
See, one of the biggest investing trends of the past decade has been the rise of exchange-traded funds (or ETFs). Most ETFs work by passively holding all of the shares in an index (such as the ASX 200) in proportional weightings. An incredible amount of capital has flooded into these passive index ETFs over the last decade or so. Just last year alone, the ETF sector saw a 52% increase in funds under management over the previous year.
This is great for the markets when everything is hunky-dory. The most popular ETFs like the iShares Core S&P/ASX 200 ETF (ASX: IOZ) buy all 200 shares in the index – boosting the entire market and making everyone feel richer.
But when bear markets hit, I think more capital locked into ETFs raises the volatility of the entire market. That's because when investors are scared of losing their money, they tend to sell everything, including market-tracking ETFs. That means the ETF manager has to sell all 200 shares of the ASX 200.
And if everyone is doing this at once (like they were in March), it creates a very formidable snowball effect – an effect that has been amplified since the GFC due to sheer volume of ETF funds under management. I would say it's been a huge reason why this crash has happened so quickly and so fiercely. As Michael Burry put it so eloquently last year "the theatre has become more and more crowded, but the exit doors remain the same size".
And if ETFs remain popular (which I think they will), it looks as though this phenomenon is here to stay.
