Seeking Alpha
Long/short equity, registered investment advisor, portfolio strategy
Profile| Send Message| ()  

Good Morning. In all honesty, it is difficult to make heads or tails of the "action" in the market on a day like Friday. Stocks opened lower then rebounded quickly and spent the vast majority of the day around the breakeven mark. But then with 21 minutes left in the day, the month, and the second quarter, the algos switched into high gear. During the last 21 minutes of Friday's session, the S&P dove 9 points (or nearly 0.60%), with 6 of the points coming in the last 5 minutes of the day. And since there wasn't a headline to be found to justify the move, we have to assume that the dive was tied to end of month/quarter rebalancing shenanigans.

What amazes me about these types of moves is not necessarily the extent or the even speed of the move. I get it; computerized algorithms are now used for the vast majority of trading as computers can execute orders faster/better than humans. Heck, I even use algos to accumulate orders throughout the day. However, it's the fact that the U.S. stock market, which is viewed as perhaps the most liquid equity market on the planet, can be pushed around by 0.5% or so at the drop of a hat that bothers me.

To clarify, I'm not a crusty old fogey longing for the good 'ol days. I think technology is great and I can't wait to see what our business looks like in next five years (remember, 5 years ago, tablets didn't exist and the idea of using the internet on a phone was a bit of a joke). I'm simply concerned that the sophistication of today's computerized trading algorithms is hurting the psyche of the individual investor.

I understand that there are trend-following algos working on a millisecond time frame. As I've lamented in the past, I am indeed jealous that I don't have the ability to play that game. It would be great to get in and out of the market faster the blink of an eye, to ride the big swings that occur each day, and then go home flat. In short, this is what the really big boys are doing. In my humble opinion, THIS is why the moves in the market tend to be overdone day in and day out. And (again, in my opinion) THIS is why the market all too often appears to have no memory from one day to the next.

The problem is that the individual investor doesn't understand the game that is being played at the speed of light in the NYSE's New Jersey data center. They don't understand that these algos are "tied" to movements in other markets such as the yen, the euro, or the yield on the 10-year. They don't "get" that some moves in the market are based on little, if anything to do with news, the economy, company earnings or any other fundamental metric, for that matter.

As someone who spends a decent chunk of their day trying to ascertain the "drivers" of market moves, I understand the way the game is played these days. And frankly it is more than a little disconcerting to know that the S&P 500 can move 1% in any direction (recently it's been both) because of a sophisticated "trade" that is tied to the movement in some other market.

To be fair, I believe this type of trading makes a lot of sense when we are in a news-driven/crisis environment. For example, the European debt crisis has driven the action in the markets for substantial lengths of time over the past four years. And given that a single comment/headline/rumor out of an ECB official can move the markets, a supercomputer with algos designed to react to news at the speed of light is a good thing to have.

However, when the market is not in crisis mode, the algos are still there and are still keying off of something. And understanding what that "something" is can be quite helpful in trying to determine what the heck is going on during the day.

I'm of the mind that the recent spike in interest rates (and the corresponding dance to the downside in stocks) has been driven by algos simply doing their thing. The bottom line here is that traders (oops, I mean traders' computers) freaked out over the idea that the Fed is now talking about reducing the amount of stimulus it is providing to the economy. News Flash: This is NOT news! Everybody in the game knows that the first move the Fed is going to make when the economy improves is to moderate/taper their bond buying. But, the markets freaked out anyway. In fact, BofA Merrill Lynch said last week that in their estimation, the move in the bond market was the equivalent of the Fed announcing a surprise 50 basis point rate hike.

In effect, traders and their computers just skipped the Fed's "journey" altogether (a year to slowly wind down the bond buying program, another six months to a year of doing nothing, and then finally at some point in 2015, rates would start to be "normalized" - over a long period of time) and took rates to the "destination" of the Fed starting to hike rates.

Why did this happen, you ask? Because, once again, in my opinion, "the trade" amongst the fast money was to get the heck out of their leveraged bond positions. So, with all the computers executing the same trade at the same time, bond prices dove and correspondingly, yields soared. Was this move tied to reality? Was it logical? Was it fundamental? Uh, no. It was simply too much money moving in one direction. As such, it was "the trade" that was likely responsible for the volatility across markets.

Although most of us don't play the fast money games that move markets so quickly these days, I do think it is valuable to recognize why things are happening. And while much of this morning's missive is simply one man's opinion of what is transpiring at the present time, my hope is that understanding some of these games that are played can make the business of investing a little less stressful for individual investors.

Turning to This Morning ...

Despite another round of weak PMI data out of China, global markets and U.S. futures are gaining ground in the early going. China's official PMI came in just above the all-important 50 level at 50.1, which was a four month low and the HSBC PMI, which focuses on smaller companies, was below 50 for a second consecutive month. However, Japan advanced smartly again, rates are behaving, and European bourses are all higher. As such, the U.S. futures are following suit. But keep an eye out for the June ISM Manufacturing data and Construction Spending data due out at 10:00 am as well as the Markit Manufacturing PMI scheduled for release at 8:58 am.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell ...

Major Foreign Markets:

- Shanghai: +0.80%

- Hong Kong: Closed

- Japan: +1.28%

- Germany: +0.37%

- France: +0.78%

- Italy: +1.52%

- Spain: +1.20%

- London: +0.88%

Crude Oil Futures: +$0.64 to $97.20

Gold: +$13.00 to $1237.70

Dollar: lower against the yen, euro and pound

10-Year Bond Yield: Currently trading at 2.527%

Stock Futures Ahead of Open in U.S. (relative to fair value):

- S&P 500: +7.02

- Dow Jones Industrial Average: +69

- NASDAQ Composite: +17.60

Thought For The Day ... You can easily judge the character of a man by how he treats those who can do nothing for him. -James D. Miles

Positions in stocks mentioned: none

Source: Daily State Of The Markets: Understanding The 'Fast Money' Games