Come September, Where Will The Market Be? by Market Technologies
The market is churning, grinding up value, reducing valuations to almost irresistible levels. Traders are trading the headlines, and investors are sunning themselves wherever it is that investors go on summer vacation. This, of course, begs the question: Will the big money go back to work in September, or will it remain on vacation until there is more clarity in the big issues that are spooking the market?
The European debt issues and the fallout from that on the European financial sector is a big reason for the current level of volatility, no doubt, but it is also clear that the market is now discounting the potential of a double-dip recession. Let us not forget that simmering on the back burner is a pot full of political soup likely to boil over as well ? the upcoming, news-dominating ?Super-Commission? debate about the U.S. deficit and debt. Beginning in September, this political sideshow should light up the news for some time. What the effect will be on the market is unknown. Perhaps, the market is including this in its discounting process, the one it is going through now.
One should assume that all of the above are the energy for the churning market, but one should not assume that any one or all will be resolved quickly. I think it reasonable to expect continued volatility for the near term. Whether it will be as wild as what we saw earlier in August is also unknown, but it is certainly possible given the reality of today?s technologically driven market.
Computer programmers are constantly working to write programs that find and dramatically exploit the weak links in the market. High-frequency trading is fast becoming the dominant player in the price action of any and all markets. When traders can computer-trade millions of shares in fractions of seconds, the result is a new ?normal? for the market. It means, unless the activity is regulated or curbed, those who can afford super fast computers and the best of breed programmers will compete against each other, leaving the singular trader/investor to fend for himself in the new world of high-speed trading.
Another problem developing from this new normal is the precipitous falling of stocks on any given day, or, for that matter, intraday. On August 8th, for example, every stock in the S&P 500 fell precipitously intraday, ending the day with all those stocks in the red. Experts are calling this phenomenon "a liquidity black hole." What happens is that the price action heats up so much and such intense pressure is put on large-cap stocks that all stocks drop precipitously.
The above may or may not explain the phenomenon well, but it certainly expresses the essence of what is going on with this type of trading, and it certainly captures the real change it is bringing to the market. Andrew Karolyi, a finance professor at Cornell University Johnson Graduate School of Management, suggests it not something to dismiss. "We have to be aware that we can be hit by one of these liquidity black holes with ever increasing frequency ? If you are a long-term buy and hold investor you better be aware of these and not panic when you see it."
So, if this phenomenon begins to occur with greater frequency (no pun intended), how will ordinary, retail investors react? Since the great market collapse in 2008 and the ?flash-crash? a year ago May, we have seen a clear wariness on the part of the retail investor. As more and more money players move into this type of computerized trading, and we see more and more of this ?hair-trigger? volatility, it is possible the retail investor will want out, completely out. This does not bode well for the equities market going forward. In fact, it suggests the recent strong movement into U.S. Treasury bonds might not be a temporary phenomenon. It suggests those who can will move out of equity-based retirement plans and equity-based mutual funds into treasuries, if for no other reason than to avoid the anxiety stemming from the market volatility.
How the above will affect the market come September remains to be seen. If the big money gets off the sideline and jumps back in to the equities market, both volume and liquidity will increase, which could tamp down the extreme volatility of the market these days.
Now, if we get some good news on the European fiscal front, and if the congressional Super-Commission acts like it is serious about coming up with a ?country-first? solution to the U.S. deficit/debt problem, the market turbulence could subside as well. And, if the economic indicators continue to tick up, as the manufacturing numbers of France, Germany, and China did this past week, then the volatility might switch directions. Instead of the market falling off a cliff, it might just start blasting off into space. Then again, perhaps not, as it seems unlikely programmers are designing algorithms to exploit strength and even more unlikely that politicians here and in Europe will turn over a new leaf and stop kicking the can down the road. Yes, that does seem unlikely. So, hold onto your hats because we may be in for a rough ride.
