Guest Post: The "Matrix" Market: Effects Of Quantitative Easing, High Frequency Trading

Tyler Durden's picture

From Eugene Linden of Minyanville

The "Matrix" Market: Effects of Quantitative Easing, High Frequency Trading

A well-trodden meme of TV and cinema has been the plot in which someone or something uses tantalizing illusions to sap humans of their will to resist while simultaneously pursuing hostile ends. In The Martian Chronicles, the subtle race of Martians distracted the invading Americans with irresistible life-like illusions that spoke to their most intimate yearnings. In one episode of the X-Files, a fungus slowly digested an unlucky couple who lay in a field and were rendered completely passive by the fungus’ hallucinogenic properties. And then, most famously, the machines of the movie The Matrix ruled over a ruined wasteland and seduced people with a beguiling virtual reality in order to maintain their passivity while they tapped humanity’s body heat as an energy source. Now, a lot of investors believe that life is imitating art in an alliance of the Federal Reserve and the big banks to create the illusion of healthy equity markets despite massive retail equity withdrawals in the years following the financial crisis.

In this broadly believed scenario the Fed’s motives are comparatively benign -- to foster asset inflation that improves animal spirits, promotes a wealth effect, and restores access to the equity markets for financial institutions and other companies in need of capital. The idea is that through its program of quantitative easing the Fed is buying Treasuries from its primary dealers who then turn around some portion of the proceeds in the equity market. Data miners have discovered strong correlations between the Fed’s permanent open market operations (POMOs) and up days in the equity markets, with a statistically significant spike on such days during the final 45 minutes of trading. So strong is the perception that these operations pump the market that Bernanke’s announcement of a new quantitative easing program last August set off a rally that moved the market up more than 14% before the program was scheduled to begin in November.

Whether or not there is a direct connection between QE and a bid for stocks, the mere fact that the link is so widely believed has played a non-trivial role in the equity markets. Which begs the question: If the markets have risen on this scenario, does it matter whether or not an actual connection exists? After all, millions of investors have been benefiting from the ride. The cynical answer is that it probably does not matter -- if such manipulations could continue in perpetuity. There’s the rub: Nothing continues in perpetuity. In fact, QE2 is scheduled to end around midyear and if it is not extended, the markets will face a crunch whether or not there is a real connection between QE and the market. Thus, if the Fed will not (or cannot) extend QE past June, it behooves its officials to convince investors well beforehand that it has not provided the invisible hand supporting stocks.

Regardless of the Fed’s role, there have been other, more disturbing bits of evidence that we are in a Matrix Market. Exhibit One is the so-called flash crash of May 2010 during which stocks fell by 600 points in five minutes before staging and equally vertiginous recovery. The crash offered evidence that something truly scary lay behind the reassuring façade of buoyant markets. Subsequent investigation revealed that High Frequency Trading, which relies on algorithms to execute super-fast trades, exacerbated the collapse. Revelations about the extraordinary percentage (sometimes over 80%) of trading attributable to HFT programs in stocks such as Citi (C) and AIG (AIG) suggest that the metaphor of a Matrix Market may be literally as well as figuratively true, and also helped explain how a market suffering continuing retail withdrawals could still rise to a multi-year high during a very weak economic recovery. Economist Michael Hudson of the University of Missouri calculated that the average time a stock was held during 2010 was 22 seconds, not exactly buy and hold.

Of course it’s entirely possible that both HFT and the impact of the Fed’s easing program are overblown; that the market’s rise can be simply explained by solid corporate earnings and the perception of a real recovery. If that’s the case, the market will continue to plug higher so long as the recovery story remains credible to investors and earnings hold up. If, however, the rally is largely an artifact of the jet fuel supplied by the Fed and amplified by algorithmic trading, then watch out.

The recent example of the auction-rate securities market shows that fake markets can seduce and then trap the most sophisticated investors. Adapted for municipal finance in 1988 by Goldman Sachs (GS), the market grew to about $300 billion before it collapsed amid a series of failed auctions when the main players -- Citi, UBS (UBS), Morgan Stanley (MS), and Merrill Lynch (MER) -- pulled back from their practice of being the bidders of last resort. What was revealed subsequently was that for several months before that, auctions had basically been a sham with the big underwriter banks supplying the majority of bids for the securities they helped issue. Given that the investors were institutions and high-net-worth individuals, it’s remarkable that this could carry on so long without being uncovered.

The ARS market was doomed in March 2007 when FASB announced that ARS should not be counted as cash on balance sheets and liquidity began to dry up. From that point on the auction rate securities market was a ghost. Those who paid attention (which did not include me) saved themselves much grief. Others remained oblivious for 11 months before the axe fell, and when it fell, it fell suddenly -- one week after the first cracks appeared in the market, 80% of the auctions that priced the securities failed. In hindsight it’s obvious that during that “dead man walking” period it wasn't in any underwriter's or broker’s interest to say that the ground had fatally shifted under what had been a highly profitable market.

This was not a grand conspiracy or racket, but, more likely, a series of individual crimes as like-minded players continued a game because they could see no alternative. I’m sure that many of the players were amazed that it continued as long as it did. Something similar happened in the mortgage-backed securities market as firms such as Bear Stearns continued to package and push them on investors long after it became obvious that the underlying mortgages were going sour in unprecedented numbers (when the MBS market finally did collapse new issuance went from hundreds of billions annually to zero). Something very similar is going on right now in the commercial real estate market where lenders are extending maturities because no one wants to face the consequences of setting off a cascade of defaults and subsequent massive write-downs in a weak market.

Is something similar going on in the equity markets? For sure, we’re gonna find out, probably by midyear.

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cougar_w's picture

Uh. Yeah. Whoa.

There. Is. No. Spoon.

The Count's picture

Hmmm. I have news for us all. What exactly do you think the brain dead TV we are being fed is supposed to achieve? All those totally idiotic reality shows, background music whereever we go (dentist, supermarket, waiting room, etc). It's all designed to keep us from actually thinking about anything of importance. The movie Matrix is much closer to reality than most of us care to believe.

system failure's picture

They are not getting my body heat for free.....

InconvenientCounterParty's picture

they'll need to pay me to urinate on their flaming epidermi.

SayTabserb's picture

But can QE really end while the govt. is running at least $1.5 trillion deficits (check Denninger out today, where he forecasts a $2 trillion calendar deficit prompted by a very weak January tax haul, a month which is supposed to be good). I don't see how the Fed can ever exit the program now. Can the Treasury really assumed that the "indirects" are going to take up the massive slack if the Fed quits buying Treasuries? Makes no sense, based on recent history. The goosing of the market may be a convenient cover story for the Fed's real purpose of avoiding failed auctions, the real Doomsday scenario.

Alcoholic Native American's picture

You haven't heard? Deficits and tax revenues don't matter.

Tyler Durden's picture

Treasury took in $152 billion in individual income taxes in January 2011 compared to $140 billion last year.

Thinking Bulldog's picture

The delay in processing itemized returns might have something to do with that.  I for instance got my taxes done and am due several thousand dollars of refund (poor planning on my part, I know), but the IRS won't even accept 1040s with itemized deductions until February 15, so I get to enjoy my interest-free loan to Uncle Sam for several more weeks.

SheepDog-One's picture

QE cant go on, and it also cant stop...nice job chairsatan!

cougar_w's picture

Irresistible force meets an immovable object.

This is how a vise works. I've got one in my garage that I use to crush metal tubing for building bike frames. Whatever ends up in the middle gets twisted, doesn't matter what it is.

America. In the middle.

alien-IQ's picture

"Have you ever stood and stared at it, marveled at its beauty, its genius? Billions of people just living out their lives, oblivious."

Agent Smith

RobotTrader's picture

Right now, with financial stocks leading, there is no clear sign of the market stopping yet.

No way I would consider going short with these type of stocks going ballistic.

alien-IQ's picture

Why short? NFLX hasn't hit $500 yet. Plenty of upside still left right? After all...we are in a "strong recovery"...or whatever.

SheepDog-One's picture

But hows your gold short doing? Hard to figure out these guys like Robo, rear view mirror traders, no matter what happens they find some stock thats up and make believe thats what theyve been talking about all along.

lieutenantjohnchard's picture

hahaha! another knee slapping, laugh out loud post from the old catfish mouth robo uber bull bear wanna be.

remember it was barely 7 trading days ago when he/she was lamenting the market top in a saturday post. before that he/she was mocking eric king and gentleman jim sinclair re: gold & silver. now yesterday we find the old catfish mouth taking - get ready for it - the exact position (long gold and silver) as gentleman jim sinclair and eric king. and today he's long stocks - er ... at least with 30% of his money.

ya gotta hand it to the old catfish. he's certainly not afraid to mock himself.

Bluntly Put's picture

But isn't the entire debt based monetary system an illusion? Governments and central banks conspire to weave an elaborate illusion of the future (growth) to sell debt which supposedly will be paid off with interest in current purchasing power based on the illusory growth of the system. In a free market that means if those estimates were incorrect the people/investors who purchased the debt would take a loss since they didn't access the risk. But now, the treasury issues debt with these prognostications into the market and if these bonds won't perform or the underlying economy cannot service them then the fed comes back and monetizes the debt, withdrawing all the expectations of the future and no one in mainstream economics seems to blink an eye.

In this twisted incestuous relationship between governments and central banks the public is duped by the Charlatans. Credit is not the same as wealth generated from past productivity, but it spends the same in the eCONomy.

kridkrid's picture

Back when Mako used to post here, someone (I forget who) summarized his position this way... I copied it down... best explanation I've seen.  Echos what you say here:

The bottom line is that if humanity chooses to utilize a credit system in which to facilitate economic production, then production growth MUST exceed credit growth.

If production growth does not exceed credit growth, then the compounding principle+interest of the debt must, at some point, necessarily exceed the carrying capacity of the underlying economy.

Typically, over the long-term, productive growth never exceeds credit growth, because humanity continually realizes that the same credit facility can be used for current consumption. Hence, the illusion of prosperity as we pull forward future demand.

Once the credit system reaches terminal velocity, the system implodes on itself since there isn't sufficient new credit being generated to pay off (ie roll forward) older debts coming due with attached interest coupons.

This cycle of typically runs in 50-60 year increments; we were due back in 2000. The Fed knew it, but chose the real estate bubble as a temporary out.

What Mako is saying is that if we collectively choose to dance with the Devil, don't complain when the bill comes due. He gets annoyed, because here at ZH of all places, many people still do not understand the nature of our credit-money system.

Absent some really game changing event in the energy arena, there isn't any way out - the system must and WILL crash. No political party has any answers to solving our problems; if the TPs think it can be reformed, they are sadly mistaken.

What any anti-incumbent movement will do (as the far right & far left unite), however, is bring on the crash, either intentionally or unintentionally, which can get us going again after the slate is cleaned. At that point, hopefully mankind will have a good chance to contemplate exactly what type of system we need to move forward.

If the cabal of private money changers retain control, then the cycle will just be re-visited in another couple of generations.

B9K9's picture

I seem to recall posting that back in 2010. Of course, that was before Denninger calculated that the US has been incurring debt in excess of production for the entire post-WWII period.

IOW, for the last 50-60 years, we have never lived within our means. Our 'economic growth' has always been an illusion.

So now it comes time to pay the piper. Yet like any organism, the US does not want its system to die, so it will increasingly do anything in order to survive. We are only just beginning our slow descent into hell.

kridkrid's picture

But when money itself is an interest bearing debt instrument, won't debt always grow in excess of production?  I think that's the point.  We have chosen a monetary system to support our economic growth that requires the constant expansion of debt until it reaches a point where it simply can grow no longer and them implodes.  There is nothing that can be done about it.  QE is what is "needed" to keep the current system from imploding, but it requires the next round of QE be larger than the one before it (or... in its place... we would need something around which additional debt can be levered up... which is what housing did for the "system" starting in the early '00s). 

Actually, this is the one positive contribution Krugman made to my understanding of the system.  He basically called it... that this is what the fed was trying to do... blow up a housing buble to avoid the greater recession that was due.

cougar_w's picture

Everyone has a vested interest in seeing the wheel go around one more time. They saw that old guy get rich, money for nothing, and everyone wants to be "that old guy" the next time.

The problem is not that it is a cycle. Cycles are everywhere, we live by them, they even give us comfort and hope. The problem is that unnatural cycles swing with increasing velocity with every iteration. Harmonics set in. At some point it does not come around again, it just breaks, and that old guy who got rich last time turns out to be the last of the old rich guys.

Past performance is not a good indication of future returns.

After this there will be no more rich old guys.

But there will be a lot of meat.

StychoKiller's picture

Kinda gets a Cougar to salivatin', ne? :>D

tellsometruth's picture

just enter your zip


Patriot Act extension vote TODAY

serotonindumptruck's picture

No, thanks.

I suspect that my Homeland Security file is already thick enough. There's no doubt in my mind that the Thought Police know where to find me.

tellsometruth's picture

Pu$$Y!  I just called mine and gave first and last name



SteveNYC's picture

What an astonishing name "serotonindumptruck". I'd love to know what you were thinking when you came up with that one.....


serotonindumptruck's picture

I can neither confirm nor deny any experimentation with 3,4-Methylenedioxymethamphetamine in my youth.

I used to drive a dump truck.

chistletoe's picture

Did you forget Dorothy's field of poppies?


Follow the yellow brick road ...and don't stray from the path!

buzzsaw99's picture

pay no attention to the bernank behind the curtain.

cocoablini's picture

The problem for the stock market is that it needs to appear like a longterm investment even though it has been losing money for the last 15 years or so( inflation adjusted and so on.) its just a bad deal. Mish did a good article on PEs. Basically, until PEs get to sub 10, its not worth looking at. Or the markt in general- there are going to have to be new companies that are excellent investments- overall garden variety companies have jumped the shark years ago. They have no growth story and just fiddle the books and offshore labor to make a better margin.
The stock market is a shitty deal- stuff is overpriced- and the banksters who are supporting the hologram of + 25 PEs are just trying to create a buying panic for suc,ers. BUT, God bless em, the retailers are not buying but extracting. Unemployment is also forcing people to eat into their 401ks.
The market gets manipulated higher, and people still leave. So now its NOBODY versus NOBODY on the exchanges.
Is this what the FED wanted? A dead free market and command control asset system?
Didn't Obama opine that he wished the stock market just went up slowly over time and everyone made money on stocks like a savings account?
Well,they killed it

thepigman's picture

I've come to the same conclusion. The shitty economy we will have for the forseeable future is worth a 10 p/e at the most. These idiots have ramped it to a 28 p/e or the scale for shitty economies, historically. What this really means is they've KILLED the market for the duration. QE did the same thing in Japan which is why even after the Nikkei was crushed, the Japanese STILL don't invest in it, leaving it to be batted around by offshore speculators.

Hedgetard55's picture

The machines probably used more energy in maintaining the humans than they ever harvested from their "body heat". Stupid machines!

serotonindumptruck's picture

Yes, it's doubtful that the movie's writers performed EROEI analysis on the basic premise, although perhaps no energy sink would exist if given sufficient population-derived orders of magnitude.

StychoKiller's picture

It wasn't just body heat, the Human body also generates electrical fields.

Just add "Tasty Wheat!"  (That's goood eatin'!) :>D

Reptil's picture

Check out this EXCELLENT docu; the introduction is in dutch, but the (imporant) interviews are all in english.

It identifies the SEC as obscuring the truth; that they know very well who was responsible for the 2010 flash crash.

Well worth watching. (there's an iPad download of it, and yes, this was aired on dutch TV ;-P)

tellsometruth's picture

30 plus silver spot right now woooohooo

Jonathan North's picture

I've got my stash and it just keeps appreciating.  Wo Hoo is right my freind.

gwar5's picture

I'm partial to "DUNE" and the tale of the empowering seduction of the "Spice" on said planet.

Of course, the coveted spice was just the poop of giant worms that crawled through the planet's subsurface

Much like our oversized nematode in charge, Bernanke, who is also producing the spice to supply the planet


Hedgetard55's picture

Don't forget "Shoreleave", that episode of Star Trek where all sorts of things from their past came alive to entertain them. Kirk gets to pop Finnigan, the dude who tormnted him at the Academy, Sulu becomes a swordsman (ironic).

Reptil's picture

poop and worms

I like it. ;-P

serotonindumptruck's picture

"The Spice must flow." -- 3rd Stage Guild Navigator

"He who controls the Spice controls the universe...!" -- Baron Vladimir Harkonnen

StychoKiller's picture

"He who has the power to destroy a thing, controls a thing." -- Paul Atreides

serotonindumptruck's picture

"It is by will alone I set my mind in motion. It is by the juice of Sapho that thoughts acquire speed, the lips acquire stains, stains become a warning. It is by will alone I set my mind in motion." -- Mentat Piter de Vries

system failure's picture

What kills me with lower value POMO days such as today, the $USD drops more so than on higher value POMO days. If the R2K suffers to much, just glance at the $USD and watch the ratcheting down to maintain their key support levels. It's comical.....

ak_khanna's picture

The speculators who are in control of the markets have reduced the commodity, stock and currency exchanges to gambling dens whereby the more powerful traders with deep pockets move the markets to maximize their own profits at the expense of the remaining not so powerful players. The big boys have enormous money power to move the markets in the direction which results in maximum profits for themselves. They effectively use the media to lure the other players in the market to a position where they would incur maximum loss.

The markets will fall only when the banksters have eliminated all the short positions and only they themselves have positioned themselves to profit when the market falls


When an unexpected world event catches the banksters with their pants down and the softwares they use to rig the markets go berserk beyond their control.


Hedgetard55's picture

Yes, the banksters will be like the Krel, destroyed by the machine that was supposed to make them like Gods.