Why Stocks Plunged Today (It's Not About Europe)

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Stocks started the day in the black, but that didn't last and they went on to record their largest daily loss since Nov. 7, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average losing 1.8% and 1.5%, respectively.

Market commentators pointed to the uncertainty of the outcome of national elections in Italy, but that didn't bother European investors; all the major European stock markets were up today -- including Italy's, where the FTSE MIB gained 0.7%. The spread between the yield on the 10-year Italian government bond and that on its safe-haven German counterpart did widen to 2.93 percentage points, but only by 5 basis points (a basis point is equal to one hundredth of a percentage point), which hardly indicates a "risk off " stampede.

It appears, to paraphrase Mark Twain, that the report of
the death of stock market volatility was an exaggeration. Consistent with today's sharp loss, the VIX , Wall Street's fear gauge, shot up 34% to close at just below 19. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.) This is the VIX's highest closing value since Dec. 28 -- as the fear and uncertainty concerning the fiscal cliff was reaching its climax.

As a result, "fast money" types jumped on the volatility train today, making the iPath VIX Short-Term Futures ETN -- a toxic product that is the financial equivalent of keno -- the third most highly traded security across U.S. equity markets today. The daily dollar volume was roughly twice or more that of megacaps such as Microsoft, General Electric, and Intel! Another VIX-related product, the ProShares Ultra VIX Short-Term Futures ETF was also in the top 10 volume leaders.

Of course, when I wrote volatility's funeral oration, I knew that its demise could only be temporary and that its reanimation was only a matter of time. Bear in mind that even at 18.99, the VIX remains below its average since its inception in January 1990, which is 20.41, and this is a highly mean-reverting series. In this environment, investors need to stay resolutely focused on underlying fundamentals, valuations, and long-term results. Central banks' experimental efforts to suppress volatility are something akin to Dr. Frankenstein's attempt to create a new Prometheus -- as the good doctor found out, they have the potential to create unpredictable, monstrous outcomes.

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The article Why Stocks Plunged Today (It's Not About Europe) originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends Intel and owns shares of General Electric Company, Intel, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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