What happened yesterday, who was involved and how effective is our market structure?
What: The media would have us believe that the sell-off was about the S&P downgrade of US debt. Most traders would argue that it’s really about a recalculation of growth expectations. Last week, several large banks lowered GDP expectations and the Fed is largely expected to do the same. The market has had an incredible run-up, but that can only be sustained by an improving economy. I think the market is finally starting to realize that we are in for a long, slow climb and there are now some concerns that the fiscal measures being put into place are going to slow growth even more.
Who: High frequency traders were certainly active. We have recently downplayed their role in the markets because volumes have been so low this year that they haven’t had the opportunity to play much and many of them have gone out of business or changed to new strategies. This past week however, has seen a spike in volatility with heavy volumes and those two things create the perfect environment for high frequency trading.
We also saw heavy activity from technical traders – those more interested in charts than fundamentals (major indexes have blown through support levels) and quants (they use data like price and volume as inputs in their models).
Probably most importantly, the chatter on the Street yesterday was that select hedge funds were dumping shares and trying to get into cash as quickly as possible. Bank of America is a good example of this – heavily hedge owned and sold off yesterday to the tune of 20% - Appaloosa Management admitted to selling out, but they weren’t the only ones. Many stocks with less hedge fund ownership actually beat the market/peers yesterday.
And market structure: On days when the market is stressed, we see more volume on our market and our DMMs are typically more active. We did over twice the average daily volume on our market yesterday and we saw a significantly larger percentage of order flow than normal. It’s these times when the human judgment, insight, accountability and information flow are most important and the NYSE continues to set the gold standard when it comes to price discovery. No matter where the stock is being executed, investors look to the NYSE to make sure they have gotten a fair price.
In the short term, we will likely continue to see volatility in the marketplace and high volumes. Given the downturn has wiped out all gains for 2011, fund managers will need to capitalize on any discrepancies to make back some of what they have lost. The buying today is not necessarily broad based but more in select quality issues that have been beaten up…and there are many. As long as institutions are active, volumes will stay high and high frequency traders will exacerbate moves by getting involved.
I predict that once this market disruption is over, however, many investors will pack up for the year and barring any unforeseen challenges, things could get very quiet in the fall.