For years, as the market rose in seemingly uninterrupted fashion buoyed by trillions in excess central bank liquidity and algos programmed to buy any dip while frontrunning each and every buy order, virtually nobody - except for a few "fringe", "fake news" blogs - complained about the threat posed by algo trading and the quiet but dire deterioration in market liquidity.
Now that the S&P has finally suffered its first bear market in a decade, the mass media is out in full force looking for scapegoats and, predictably, in an attempt to deflect attention from the biggest, and only, culprit behind each and every bull-bust cycle namely the US central bank, has focused on "computerized trading."
In a front page article, the WSJ is out today with "Behind the Market Swoon: The Herdlike Behavior of Computerized Trading", in which a bevy of WSJ authors, among which the paper's new 'Fed whisperer' Nick Timiraos (who may or may not have been tasked with delivering a piece drawing attention from the inhabitants of the Marriner Eccles building), write that "behind the broad, swift market slide of 2018 is an underlying new reality: Roughly 85% of all trading is on autopilot—controlled by machines, models, or passive investing formulas, creating an unprecedented trading herd that moves in unison and is blazingly fast."
A quick note: 85% of this "autopilot" trading also took place on the upside, yet the WSJ - and all the other bulls - were oddly quiet for years and years. Of course, to Zero Hedge readers, the story is all too familiar: after all we have covered all of this not just when the market snapped lower, but more importantly, during its levitation phase, setting up the inevitable crash:
Today, quantitative hedge funds, or those that rely on computer models rather than research and intuition, account for 28.7% of trading in the stock market, according to data from Tabb Group--a share that’s more than doubled since 2013. They now trade more than retail investors, and everyone else.
Add to that passive funds, index investors, high-frequency traders, market makers, and others who aren’t buying because they have a fundamental view of a company’s prospects, and you get to around 85% of trading volume, according to Marko Kolanovic of JP Morgan.
In terms of specific downside factors, the collapse in momentum has been explicitly highlighted:
One reason the dynamic might have changed: Many of the trading models use momentum as an input. When markets turn south, they’re programmed to sell. And if prices drop, many are programmed to sell even more.
Of course, the topic of collapsing momentum was widely discussed here just last Saturday, when we said that as a result of the dominance of algo trading, Deutsche Bank argued that momentum has emerged as the most important force in markets, something we have claimed for years:
However, one key reason why trading has become so complicated for most, and certainly the algos, is that there is currently virtually no momentum in the market - with the MTUM ETF which tracks momentum stocks having its worst month and quarter since its 2013 inception - results in making any attempt to piggyback on the market a money-losing trade.
There are the usual quotes from traders who are suddenly very concerned about stuff:
Boaz Weinstein, founder of credit hedge fund Saba Capital Management LP, said the market had been underpricing uncertainty. Now it’s taking into account political issues “at the same time as the Fed is hiking, the economy is slowing, and a lot of people are feeling like the best days for markets are over,” he said.
Mr. Weinstein says there are dangers building in the junk-bond market. One worry, he says, is that so many junk bonds—he estimated about 40%—are held by mutual funds or exchange-traded funds that allow their investors to sell any day they like, even though bonds inside the funds are hard to sell.
When enough investors want to cash out, such a fund has to start selling bonds. But without much liquidity, finding buyers could be hard.
A selloff could start simply, he said. “It has its own gravity.”
It's "suddenly" so bad, in fact, that comparisons to virtually every previous crash are coming out of the woodwork:
Some analysts see similarities to the late 1998 pullback in U.S. stocks that followed a year of turmoil in emerging markets, punctuated by the Asian financial crisis of 1997 and the Russian default of 1998 and culminating in the collapse of the highly leveraged Long Term Capital Management hedge fund.
Others point to the market shakeout in late 2015. Like the current episode, it lacked an obvious trigger and was accompanied by anxiety over the Federal Reserve’s plans to raise interest rates—in that case, the Fed’s first rate increase in nearly a decade. Like this year, the 2015 retreat featured a sharp decline in oil prices and a significant drop in the S&P 500.
And the punchline:
"Electronic traders are wreaking havoc in the markets," says Leon Cooperman, the billionaire stock picker who founded hedge fund Omega Advisors.
There is much more in the full WSJ article, which also focuses on the collapse in market liquidity (which we covered just last week), the equity contagion to credit markets (which we also just covered), and virtually all other pernicious aspects of pervasive algo trading which have been discussed ad nauseam on this website for years.
Odd how electronic traders were not "wreaking havoc in the markets" when the markets were rising. A cynic may almost say that the president, the Fed and/or traders such as Cooperman (who have had an abysmal year) are desperate for a diversionary cover, and hence the WSJ article finally reporting on the other key facet of what made market levitation possible for the past decade: HFTs, algos and various other computerized traders, which however merely do what their human programmers instruct them to do, and which is to simply accentuate momentum either up, or as the case may be for the past 3 months, down by frontrunning key shifts in investor sentiment (as a reminder, all HFTs really do is frontrun orderflow) and in the process confirming that instead of adding liquidity to the market, HFTs were notorious in soaking it all up as recent market moves demonstrate.
In any case, we are content that the mainstream press is finally reporting on the event which we have warned for the better part of the past 10 years will ultimately catalyze the next big crash - the takeover of the market by computerized trading - a crash which, however, will only be made possible by the Fed blowing the biggest asset bubble in history to monstrous proportions, something which the WSJ article does at least acknowledge in its final paragraph:
“It’s not just about the equity market throwing a temper tantrum, it’s far deeper than that,” said David Rosenberg, chief economist at Gluskin Sheff & Associates in Toronto. “This is a much broader global liquidity story.”
Encouraged by signs of economic strengthening, the Fed has been gradually raising interest rates from rock-bottom levels and selling back the trillions of dollars in bonds it bought in the postcrisis years. The central bank says the roll-back of stimulus is smooth. Others aren’t so sure what comes next. There has never been such a huge stimulus, and one has never before been unraveled.
Some believe there's a hidden risk in debt that consumers and companies took on when borrowing was inexpensive. The Fed’s campaigns were “fundamentally designed to encourage corporate America to lever up, which makes them more vulnerable to rising borrowing costs,” said Scott Minerd, chief investment officer at Guggenheim Partners. “The reversing of the process is actually more powerful,” he said.
Read the full WSJ article here.