On May 6th, 2010, the U.S. stock markets experienced an unusual decline (and an immediate upswing) that temporarily erased $1 trillion in market value (the Dow Jones Industrial Average plunged about 1000 points) and puzzled both actors and experts following the markets. Given the ongoing controversy about “flash orders” and its portrayed usage by high-frequency traders, this incident was quickly referred as the flash crash and just as quickly blame fell on the electronic trading industry. While it is true that some high-frequency trading firms stopped running their algorithms when the decline started (human traders stopped participating in the markets in Black Monday as well), some of them stayed in the market, and helped the markets recover just as quickly as the decline happened.
Fast forward two years and we find a twit from the Associated Press with supposedly breaking news that President Obama was injured due to explosions at the White House. That report made $136 billion in market value temporarily disappear, with the Dow Jones Industrial Average quickly dropping 150 points before swinging back.
Examples of dramatic swings can go all the way back to the origins of stock markets. We only need to take a look at Black Monday, October 19th, 1987, when the Dow Jones Industrial Average dropped by 508 points, 22.61%; by the end of October, stock markets in the United States had fallen by 22.68%, not showing any improvement for many weeks. Meanwhile, on May 6th, the Dow Jones had regained most of the drop only twenty minutes later.
Like major technology innovations in the past, computer trading was blamed for Black Monday back in 1987; as observed by economist Richard Roll though, program trading strategies were used primarily in the United States, and not in markets such as Australia and Hong Kong where the crisis started. Therefore, it is unsurprising by now that high-frequency trading has been blamed for the flash crash, the now called Twitter crash, and mini-flash crashes of certain stocks, commodities and currencies.
As Manoj Narang, CEO, Tradeworx, says in my book The Speed Traders, no matter what regulators do, there will be times when herd-like behavior among long-term investors will all be stampeding for the exits at the same time, and simply there won’t be enough high-frequency trading to cover the demand for liquidity. That is exactly what happened on May 6th, as described in painstaking detail in the CFTC/SEC report of September 30th, 2010; the report made clear that a mutual fund, identified by Reuters back in May 14 as Waddell & Reed Financial Inc., initiated a program to sell a total of 75,000 E-Mini contracts (valued at approximately $4.1 billion), certainly influenced by the pessimism in the markets due to street protests in Greece, among other reasons; the computer algorithm used to trade the position in the futures markets was set to target an execution rate set to 9% of the trading volume calculated over the previous minute, but without regard to price or time. Similarly, we will always experience technology and human errors. Dave Cummings, Chairman, Tradebot, would ask about the flash crash, “Who puts in a $4.1 billion order without a limit price?” That was the catalyst that initiated the flash crash. Knight Capital Group Inc.’s $440 million trading loss in August 1st, 2012, when the firm lost approximately $10 million per minute, is another recent example that comes to mind.
On March 7th, 2013, the U.S. Securities and Exchange Commission announced Regulation SCI (Systems Compliance and Integrity). As explained by Commissioner Luis A. Aguilar, the proposed rule would move beyond the current voluntary program and require entities to establish, maintain, and enforce written policies and procedures reasonably designed to ensure that its systems have adequate levels of capacity, integrity, resiliency, availability, and security to maintain the entity’s operational capability and promote the maintenance of fair and orderly markets, mandate participation in scheduled testing of the operation of the entity’s business continuity and disaster recovery plans, including backup systems, and coordinate such testing on an industry- or sector-wide basis with other entities, and finally make, keep, and preserve records relating to the matters covered by Regulation SCI, and provide them to Commission representatives upon request.
Electronic trading, like any other area of finance, should have sensible regulations imposed to promote sound trading practices and protect the average American investor from predatory behavior. If a market participant who does not use high-frequency trading believes that he or she cannot enter into fair transactions, then that individual will not invest in that market. But regulators could restore trust in the market without eliminating high-speed trading. They simply must be armed to analyze trading activity in real time.
In an area of finance predicated on speed, regulation must be as well. Real-time information would allow regulators to see everything that is occurring in the markets, no matter how quickly the order information is being posted and transactions are occurring. This would require significant commitments to invest in both human capital and information technology, but the investment is worthwhile: it is vital for regulators to level the playing field of electronic trading in general.
Real-time policing for potential malfeasance is the most efficient way to regulate high-frequency trading. Analysis of real-time data would provide for effective regulation of these trades. This in turn would provide peace of mind for market participants big and small.
Having spoken with professionals in the world’s most important financial centers, I can attest that America’s capital markets continue being the envy of the world, thanks to the innovation people like high-frequency traders, educated in the country’s top schools, bring to the markets. Let’s allow innovations like high-frequency trading to continue and regulators to police them accordingly, and not try to ban them, as vocal activists tried once with major innovations such as automobiles and derivatives.Read Full Post | Make a Comment ( None so far )
Stocks in the US markets slipped on Friday, ending the Dow Jones Industrial Average’s (DJIA) longest winning streak since 1996, just after snapping a 10-day run. Data from Thomson Reuters’ Lipper service showed that investors in U.S.-based funds had poured $11.26 billion of new cash into stock funds this last week, the most since late January. The DJIA slipped 25.03 points, or 0.17 percent, to 14,514.11 at the close. Meanwhile, it was announced that the fewest workers on record were fired in January and job openings rebounded, showing employers were gaining confidence the U.S. expansion would be sustained.
According to some pundits, recent market activity is essentially driven by positive corporate earnings. The S&P500 Price/Earnings (PE) ratio is currently slightly high at 16.5, if we compare with past indicators. The median S&P500 Trailing Twelve Months (TTM) PE ratio has been about 14.5 over the last 100 years; average is around 16. It was during much of 2009 when the disconnect between price and TTM earnings was so extreme that the P/E ratio was in triple digits, as high as the 120s. Going back to the 1870’s, the average P/E ratio has been about 15; therefore, the US equity markets are not excessively valued, leaving some room for further growth.
Other pundits point to the Federal Reserve’s determination to continue stimulating the economy with increased liquidity. Mohammed Apabhai, head of Asia trading at Citigroup Global Markets, favors this train of thought. He has noted that there is a 70 percent correlation between stock market performance and liquidity, “whether it’s through the promise of lower rates, QE (Quantitative Easing) or promise of more QE.” The Federal Reserve has launched three rounds of Quantitative Easing since the financial crisis hit in 2008.
More likely, both factors are in play, very good corporate earnings and monetary policy that pushes investors to take risks in equities. So is the earnings momentum sustainable? Unfortunately, savings from the smaller share of the pie from labor, government spending and earnings coming from emerging markets (EM) outside the US are all factors that will be curtailed at some moment. Is the Fed eager to continue being the huge player in this equation? Some of its members are increasingly worried about the effectiveness of the continued QE; if the labor market recovers, as the January numbers showed, the Fed most probably might be ending its bond purchases soon.
As pointed out by James Saft, wages in the US have taken a smaller and smaller piece of the pie; now below 44pc of GDP and dropping, down several percentage points since 1999. That is in part the consequence of globalization and the offshoring of jobs. However, the labor which can be offshored largely has already been and the likely trend is for new manufacturing technologies to start pushing jobs back into the US. As has been of national knowledge as well, there is a real danger of declining government spending. A dollar spent by the government is a dollar that supports household income, and consumption, and of course corporate profits; there will be less dollars starting this month thank to the sequester, a series of spending cuts and tax increases aimed at reducing the budget deficit.
Emerging markets are looking overstretched heading into the second quarter, Barclays Capital said in a report dated March 15, pointing out that the cyclical recoveries in EM have slowed down. Consensus growth forecasts (according to Bloomberg) have been revised down by 0.75 percentage points on average since mid-2012. EM equities have been slow to react to these developments due partly to the continued inflows into the asset class from retail clients. The correction has started recently and the performance by country year to date has been mixed, but the most pronounced selloffs have been associated with the largest revisions to GDP growth forecasts. Adding to this dire situation, the economies of emerging markets grew at a slower pace in February than the month before, according to HSBC’s monthly purchasing managers’ index. The PMI recorded a level of 52.3, down from 53.8 in January, its lowest since August. The index covers 16 leading emerging markets, including India, Brazil and China, which all saw their rate of growth fall. Investors had been questioning whether emerging markets, whose growth depends in part on exports to mature markets, could continue to expand at fast rates of almost 10% in some cases.
What the equity markets want indeed is stable and/or predictably increasing US profits and the Fed to stay in the bond markets. Saft ironically suggested that markets’ best hope might be a cut in government spending deep enough to kill job growth and indefinitely extend QE, something that nobody else would agree with. Instead, markets would be happy with a bit of positive news today followed by another bit of negative news tomorrow. Unfortunately for the markets, profits will start showing stagnation starting with first quarter results. Federal Reserve said in September 2012, when QE3 was announced, that it would start pumping $40 billion a month to purchase agency mortgage-backed securities (MBS) until the labor market improves substantially. When will the Fed determine that the job market has made enough progress to reduce stimulus? The numbers for February will prove paramount in this regard. As these two important factors converge in a nightmarish scenario, equities markets should beware of the ensuing correction, coming as early as in the second quarter.Read Full Post | Make a Comment ( None so far )
Beyond the memories of the recent financial crisis and doubts about the safety and fairness of the equity markets, events such as the Flash Crash of May 2010, the hugely distressing Facebook NASDAQ initial public offering and trading malfunctions at Knight Capital and Nasdaq OMX were wrongly associated with high-frequency trading (HFT) and characterized as shocks to the psyche of average investors. The around $130 billion outflows from domestic equity mutual funds in 2012 led to Joe Saluzzi, co-head of trading at Themis Trading, to say as recently as of December 2012 that “all of those events are confidence-shattering events.”
Furthermore, U.S. congressman Ed Markey tried to persuade the SEC that high-frequency trading was driving investors off the electronic trading highway completely because it was eroding confidence in U.S. markets. Congressman Markey wrote that “sophisticated trading firms can make full use of light speed HFT algorithms, while the ordinary investor day-trading his 401k remains at more terrestrial speeds. There is a real risk that algorithmic trading is making investors hesitant to re-enter the equity markets because they fear that the entire game is rigged.” Ultimately, he proposed that HFT should be curtailed immediately.
Data from Trim Tabs Investment Research appeared to support Mr. Saluzzi and Congressman Markey’s concerns. Their data show outflows from U.S. equity mutual funds in 2008 hit a record $148 billion; in 2009, confidence appeared to be stabilizing as outflows from U.S. equity mutual funds totaled just $28 billion, only to grow again in 2010 to hit $81 billion, $132 billion in 2011 and last year totaled $130 billion. So what would they say now that the Washington-based Investment Company Institute has revealed that equity mutual funds have gathered $29.9 billion in January’s first three weeks, more than for any full month since 2006? Moreover, long-term funds, which exclude money-market vehicles, attracted $64.8 billion in the first three weeks of the month. The previous record was $52.6 billion for all of May 2009.
What was the catalyst of the change in trend? Was HFT suddenly disappearing from the equity markets? As we have suspected in the past, it was the health of the economy. The dysfunctional behavior of the leadership in Washington, leading to a crisis of significant proportions in December 2012, was holding market participants from making investment decisions; when Washington still managed to temporarily solve the fiscal cliff issue, allowing the government to remove its borrowing cap and removing the terrifying prospect of sovereign default, investors rushed into stocks (and bonds too), setting the stage for the biggest month on record for deposits into U.S. mutual funds.
We are looking at forces beyond the niche of algorithmic and high-frequency trading in action here. Signs of improvement in the U.S. economy and a rising stock market (that pushed the Dow Jones Industrial Average above 14,000 on February 1 for the first time since 2007) are now prompting Americans to step up their investments. Hiring climbed in January as well, providing further evidence that the U.S. labor market is making progress. As the economy overall makes progress, inflows will increase as more and more households and companies start to invest in the financial markets, creating a net impact in the real economy, and further reinforcing the performance of the markets. Once again, the phrase “it is the economy, stupid!” remains as valid as ever.Read Full Post | Make a Comment ( None so far )
2010年5月的“闪电崩盘”及Facebook在骑士资本和纳斯达克的IPO交易故障等事件，都被错误地与高频交易联系到一起，被描绘为对普通投资者造成灵魂冲击。但真正原因是经济健康问题。It is the economy, stupid。这个短语仍旧有效。
除了与最近一次金融危机有关的记忆以及有关股票市场安全性和公平性的疑问以外，2010年5月份的“闪电崩盘”及Facebook在骑士资本和纳斯达克市场上令人感到非常沮丧的IPO(首次公开招股)交易故障等事件都被错误地与高频交易联系到一起，被描绘为对普通投资者造成了灵魂冲击。Read Full Post | Make a Comment ( None so far )