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State of the Markets: A case of the good, the bad, and the ugly

To the casual observer, it was a good day on Wall Street yesterday. The Dow gained more than 215 points, the NASDAQ rallied +1.6 percent, and the Russell 2000 tacked on +1.8 percent. However, to those watching the action a bit more closely, Thursday was a case of the good, the bad, and the ugly.

Since most folks like to start their day with a smile whenever possible, let’s begin with the good stuff. And cutting to the chase, there was actually a fair amount of “good” happening before the market’s opening bell even rang on Thursday.

The Good

As was suggested in yesterday’s missive, no news out of Canada was a good thing. The bottom line here is that unless there was evidence suggesting that Wednesday’s shootings in Ottawa were part of an organized terrorist plot, stocks were likely to recover most, if not all, of Wednesday’s end-of-day shellacking in short order.

And since there wasn’t any headlines depicting more terror when the screens lit up yesterday morning, it wasn’t terribly surprising to see U.S. stock futures pointing higher in the wee hours of Thursday.

Next up was the data. Both China and Europe had reported “Flash” PMI readings that, for once, were not overtly negative. While it is hard to argue that the weak-ish readings seen in the second and third most important economies in the world were actually “good” it is important to remember that this game is all about expectations.

The key here is to recognize that traders have been fretting over the state of the economies in both China the Eurozone for some time now. Lest we forget, it was the fear of #GrowthSlowing that was at least partly to blame for the recent weakness seen in stock markets around the globe. So, when both Flash PMIs were reported to be in growth mode, well, a sigh of relief was certainly appropriate.

Then there were the earnings. Both Caterpillar (NYSE: CAT) and 3M (NYSE: MMM) are seen, at least to some degree, as global economic bellwethers. (As a quick sidebar, the definition of bellwether is kind of interesting. When searching Google one will find the following: “The leading sheep of a flock, with a bell on its neck.”) And the bottom line is that both CAT and MMM came in with gangbuster numbers.

And finally, there was the economic data. The Conference Board’s Leading Economic Index (aka the LEI) rose a better-than expected +0.8 percent in September. And Ken Goldstein, an economist at the Conference Board said, “The data on the leading indicators continue to suggest moderate growth in the short-term.”

In sum, it is tough to get overly worried about the economy being in dire shape when a company like CAT is killing it out there, the PMIs of Europe and China are looking okay, and the U.S. economy is still growing at a decent clip.

In response to all the “good” stuff seen yesterday morning, the bulls put on a show and broke out to the upside with a vengeance. Suddenly #FOMO (fear of missing out) was being bandied about again and more than one analyst mentioned that “performance anxiety” may soon become a factor given the date on the calendar and the fact that so many hedge funds are underperforming this year.

The Bad

While the Dow did finish with a gain of a couple hundred points, all the major indices finished well off their highs. You see, Wall Street encountered yet another bout of eye-popping volatility yesterday afternoon.

Just before 2:30 pm eastern time, stocks were “melting up” and it looked like the bulls had rediscovered their mojo. But then it happened.

A headline crossed that a doctor in New York had been put in an ambulance with a Ebloa-like symptoms. Oh, and this doctor had just returned from a stint in Guinea (one of the three nations hardest hit with Ebola) for Doctors Without Borders.

While the doctor had not been diagnosed with the Ebola virus, the algos had connected the dots. And just like that, the market got pretty ugly, pretty fast.

The Ugly

Everybody knows that high speed computers power trading algorithms that “read” headlines and react within milliseconds. However, what everyone may not know is what actually happens when a “bad” headline hits the tape.

According to Nanex, when the Ebola headline crossed, a single algo began selling more than 1,000 E-Mini futures contracts (a contract valued at 250 times the value of the S&P 500 stock index) every 2.5 seconds. So, in 30 seconds 12,300 contracts would have been sold. And in a single minute that means this algo would have sold more than 25,000 contracts. The word you’re probably looking for is, wow!

Below is a picture of the result on a 1-minute chart of the S&P 500.

S&P 500 1-Minute

Direct your attention to the big red bar in the middle of the red oval drawn on the chart. In the span of one minute, the S&P fell nearly 7 points or 0.33%. While that doesn’t sound like a lot, please keep in mind that we are talking about sixty ticks on the clock!

If that’s not ugly enough for you, consider this. When bad news starts to happen, those HFT outfits – you know, the guys that are supposed to be providing all that liquidity to the stock market – pull their bids. Yep, that’s right, at the exact moment that some algo begins jamming sell orders into the pipe every couple seconds, the HFT firms stop offering bids. And WHOOSH, down she goes.

And here’s the really scary/ugly part. This type of manic dive occurred on word that a single doctor in New York City MIGHT have Ebola.

So, the real question is what will happen when something bad ACTUALLY happens?

The answer is that it will probably get VERY ugly, very fast.

See more at: StateoftheMarkets.com

David Moenning is Chief Investment Officer at Heritage Capital Management, a Chicago-based registered investment advisory firm. Mr. Moenning began his investment career in 1980 and formed Heritage Capital in 1989. Dave’s firm focuses on “active management” and focuses on managing market risk on a daily basis. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Mr. Moenning is the 2013-14 President of NAAIM (National Association of Active Investment Managers) an organization dedicated to active management strategies. Follow Dave on Twitter at @StateDave.

Dave Moenning

David Moenning is Chief Investment Officer at Heritage Capital Management, a Chicago-based registered investment advisory firm. Mr. Moenning began his investment career in 1980 and formed Heritage Capital in 1989. Dave’s firm focuses on “active management” and focuses on managing market risk on a daily basis. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Mr. Moenning is the 2013-14 President of NAAIM (National Association of Active Investment Managers) an organization dedicated to active management strategies. Follow Dave on Twitter at @StateDave.