It's funny to watch all the
commentators and analysts come out of the woodwork this morning to explain how
"things could go wrong in the market." It's as if they haven't noticed the market has been dysfunctional for quite some time. The market, fundamentally, is broken. I think this is because of the lack of liquidity from the small guy and the growing influence of gigantic over-leveraged quant traders.
Think of the crises we've had in the past:
Long-Term Capital Management in 1998, the banking crisis of 2007/2008. Both were basically caused by hot-shot bankers with lots of overleveraged money and too little liquidity. Inevitably, some rocket-scientist trader starts making money, leverages up, and gets a god complex.That's when things go wrong. Case and point: The major investment banks, coming off record profits in 2006/2007, were leveraged more than 30-to-1 going into the 2008 crisis!
The financial markets always have a way over going overboard and plunging us into crisis. I believe there are two things at the heart of this: Overleverage, and ego (or greed). Go back and read
"When Genius Failed," it's a great book that explains this perfectly. Isn't it interesting that the Long-Term Capital Management Crisis in 1998 was triggered by a sovereign-debt crisis.
As for what happened yesterday: For those who weren't there, it was a wild ride, with the largest Dow Jones Industrial Average point swing ever -- with the average down 10% and 1,000 points at some time.
People are still trying to explain what happened. I was actually at my screen when it happened (luckily, I just happened to be short at the time), and it felt like I had been sucked into some kind of science-fiction film. I saw the S&P E-mini plunge nearly 70 points in about 10 minutes. Markets recovered quickly from the 10-minute intraday plunge, and now the analysts and commentators are trying to explain the unreal things that happened with the market and some particluar stocks (at one point in the day, Accenture -- a $40 stock -- was trading at .01).
Here's a chart of the action in the E-mini S&P futures contract, one of the alleged culprits of yesterday's weirdness:
Yes, this was an extraordinary move. But my feeling is that more "strange things" like this are happening all the time. During the recent market "meltup," I can remember many days in which the market didn't move at all for hours, and then suddenly out of the blue it vaulted 10 S&P points in 10 minutes. Should we investigate that, too? Even this morning's action is strange, and discomforting. Looking at the chart above, I would not be surprised if the market heads back down toward yesterday's mythical intraday low (if you blinked you missed it), just because it now lies in the memory chip of some high-powered quant trading fund.
CNBC and others have pointed out that these sort of events
do nothing to restore the confidence of the average retail investor (let alone Jim Rogers), and they are absolutely correct. In addition to the scary trades that still go on in the "dark market" (credit derivatives swaps as detailed in the SEC investigation of Goldman Sachs), we have the market increasing being controlled by highly leveraged computer-driven traders. These shops use the most sophisticated technology in the world and they trade tens of thousands of shares of stock in a microsecond, mostly driven by computer algorithms.
The best analogy I can think of is take a look at what happened to Toyota. Imagine a Prius with bad software. Then imagine that happening to global trading markets. Scary thought.
