Are You Smarter Than A Computer?
Summary
- Computers are programmed to spot words, phrases and chart patterns on the market and certain data on the economy or a specific industry. These phrases, words, etc. based on the program will trigger the computer to sell or buy stocks or a basket of stocks.
- The idea that higher interest rates and inflation are bad omens for the economy and the market is pre-programmed. Instead, these two metrics will be a hallmark of a strongly improving economy.
- There are many instances of rising inflation and interest, even rates moving as a result of a Federal Reserve tightening (1975 to 1983) where equity prices increased and bond prices declined.
The answer is...
It depends on who is programming the computer... GIGO (Garbage In/ Garbage Out), for Pete's sake! This is important when considering the daily/weekly gyrations of the stock market.
"In the U.S. stock market and many other developed financial markets, about 70-80 percent of overall trading volume is generated through algorithmic trading."
- The Robust Trader
These computers are programmed to spot words, phrases and chart patterns on the market and certain data on the economy or a specific industry. These phrases, words, etc. based on the program will trigger the computer to sell or buy (automatically) stocks or a basket of stocks. This trading is all based on a set of rules or algorithms the programmer feeds the computer. If the programmer feeds in rules that are poorly crafted, or if there is no provision for nuance in the program, you get results that are not connected to the actual reality on the ground.
This appears to be what happened Thursday when a comment by Fed chair Powell sent the market into a tailspin. His comment drew this headline on CNBC: "Fed Chairman Powell says economic reopening could cause inflation to pick up temporarily." Of course, this would mean interest rates would be headed north. All of this was bad news for some stocks (higher multiple tech stocks in particular), but it really made no difference. Everything went down... banks stocks were down (thought to be beneficiaries of higher rates) and energy stocks were down (energy prices may be one of the main causes of the inflation as we reopen). It was a good time to be buying both industries, as they took off again on Friday.
The important point here is that the phrase "cause inflation to pick up" hit the computers on both the bond and stock side, causing stocks and bonds both to plunge in value. The nuance of the word "temporarily" did not compute.
It is hard for me to cypher how people make money on this trading gambit because the swings can be so dramatic and in such short time spans. However, I guess they do, and it creates opportunities for those who invest and don't play these games.
The entire move was based on a misconception
The ill-conceived idea that higher interest rates and inflation are bad omens for the economy and the market is pre-programmed. The computers sell on the mention of them. Instead, these two metrics will be a hallmark of a strongly improving economy. By strongly I mean surprisingly strong given the injection of fiscal stimulus over the past 12 months ($2.9 trillion), the added stimulus that just passed in the US Senate Saturday morning, March 6 (an additional $1.9 trillion) and the tremendous pent-up demand that will be unleashed as the country reopens.
There are many instances of rising inflation and interest, even rates moving as a result of a Federal Reserve tightening (1975 to 1983), where equity prices increased and bond prices declined. I am not sure why this dogma continues to be part of the algorithms or a focus of media attention. Nonetheless, it provides dips to commit money to the market.
For those who might not track this information, the S&P 500 ran from about 2174 in July 2016 to 2900 in August 2018, while the yield on the UST 10-year note jumped from 1.55 (approximately where the bond is trading right now) to a high of 3.11%. The reason for these moves was the $2 trillion tax cut (2017 Tax and Jobs Act).
So, are you smarter than a computer? The answer is "yes" if you are armed with the facts and the ability to pick up on nuance not currently being programmed into the algorithms.
What do you think?
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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