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Glitch in the System
On Thursday, shares tumbled across all major indexes on fears that Greece’s debt woes would spread to other vulnerable countries in the E.U.. What began as a down-day on Wall Street, quickly turned into a full-blown rout as blue chips, financials, techs and transports were all caught in a program-trading downdraft. The bloodletting was mind-numbingly swift. In one 15 minute period, stocks plunged more than 300 points (and nearly 1,000 points at their nadir) before bouncing off the bottom and clawing back some of the day’s losses. For the big brokerage houses and investment banks, the massacre could not have happened at a worse time. Skittish retail investors have already been steering clear of Wall Street, convinced that the markets are rigged. Thursday’s ructions are sure to keep them on the sidelines even longer.
"During the sell-off, Procter & Gamble shares plummeted nearly 37 percent to $39.37… prompting the company to investigate whether any erroneous trades had occurred. The shares are listed on the New York Stock Exchange, but the significantly lower share price was recorded on a different electronic trading venue.
"We don’t know what caused it," said Procter & Gamble spokeswoman Jennifer Chelune. "We know that that was an electronic trade … and we’re looking into it with Nasdaq and the other major electronic exchanges." Mathew Goldstein, Reuters)
When stocks nosedive, falling prices can trigger stop-loss orders which spark a selloff. Add high-frequency trading to the mix–which accounts for more than 70 per cent of daily volume–and a normal correction can quickly turn into a major crash. The high-speed computers make millions of trades in a flash without human intervention. The potential for a catastrophe like Thursday, is a near-certainty.
"Guys are getting carried out on stretchers"
From the Wall Street Journal:
"An electronic trading algorithm issued by an unknown trader caused a massive selloff in futures contracts tied to the S&P 500, according to a long-time electronic trader of the products. A mistaken order was issued to sell $16 billion, rather than $16 million, of e-mini S&P futures contracts, according to the person….
“Jay Suskind, a senior vice-president at Duncan-Williams Inc., said the combined string of negative news about Goldman Sachs Group Inc. (GS), the Greek debt crisis and the rise in Libor evoked memories of the uncertainties that plagued the markets in 2008. He said the most nervous investors on Thursday simply decided to sell, rather than wait for information.
"’It just felt like liquidation’ said Anton Schutz, manager of the Burnham Financial Services Fund. ‘This isn’t profit-taking. This is guys getting taken out on stretchers.’" ("Financial Stocks Plunge On Broad Market Selloff", Wall Street Journal)
Thursday’s panic reminded many of the darkest days of the financial crisis when trillions of dollars were pared from market-cap in 5 months of carnage. Now risk aversion is back; the yield on the 10-year Treasury is falling, the dollar is strengthening, Libor is on the rise, and the flight to safety is on. All of the upbeat data on manufacturing, retail sales, consumer spending and inventory restocking, won’t allay the fears of jittery investors. When volatility is this extreme, animal spirits are curbed and people look for a place to hide.
Zero Hedge has railed against high-frequency trading for more than a year. Maybe now, someone will listen. Here’s an excerpt from their website in 2009:
"What happens in a world where the very core of the capital markets system is gradually deleveraging to a point where maintaining a liquid and orderly market becomes impossible… When the quant deleveraging finally catches up with the market, the consequences will likely be unprecedented, with dramatic dislocations leading the market both higher and lower on record volatility… (and today) What happened today was no fat finger, it was no panic selling by one major account: it was simply the impact of everyone in the High-Frequency Trading (HFT) community going from port to starboard on the boat, at precisely the same time…..After today investors will have little if any faith left in the US stocks, assuming they had any to begin with." (zero hedge, The Day the Market Almost Died)
The Securities and Exchange Commission (SEC) knows that High-Frequency Trading (HFT) is fraught with danger, and that a drubbing like yesterday’s can happen at any time. Apparently, that’s a risk that SEC chair Mary Schapiro is willing to take in order to give the big financial institutions a leg-up on the little guys. But that’s not the way to restore confidence or lure people back into the markets. For that, Schapiro’s going to have to do her job and fix the system.
MIKE WHITNEY lives in Washington state. He can be reached at email@example.com