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Friday May 7, 2010 - 13:21:34 GMT
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What happened? (FXA)

I don’t pretend to know what really happened in markets, but I can say I have heard many explanations and credit to NYSE’s Niederauer and CNBC I think I can kind of understand what happened in stocks (CNBC has yet to post the interview but hopefully will have by time I am done with this note).   


There are two prevailing catalysts in equities…one is a fat finger hit a button and inadvertently sold a huge amount of P&G and the other is that a mini S&P order (at a futures broker) saw fat finger sell $16bln worth of the contract instead of $16mln.  In most shops there are governors on the electronic trading machines to prevent outlier deals from being entered by pilot error.  Today if one of these stories is true shows not all shops have the latest risk control software.


But the more interesting story as told by NYSE CEO Niederauer was the NYSE has human intervention in market making and suspends trading from 30 seconds to 60 seconds in gapping markets (it sounded like it was discretionary).  The NYSE is where there is liquidity.  The problem is there are all sorts of electronic exchanges making markets in these same stocks and they stay open when the mother of all markets shuts on individual stocks, even if for up to a minute.  The (algo) high frequency trading systems immediately go from NYSE to a less liquid (illiquid in this market) market automatically and sell where there is a buyer…in the case of Accenture on one platform it went from $40 to 1 cent.  Niederauer also made the point that the orders driving price down on these platforms don’t have to be big at all to make the stock price plummet (or surge).  My guess is the NYSE was closing stocks repeatedly as incoming prices from illiquid platforms kept market gapping down, creating a vicious cycle.


However, I also think there was a fundamental backdrop to today’s massive sell-off and sizeable bounce in risk that reflects the state of the world…the sequel is out to financial crisis 2008 and it is playing at a theater near you.  Trichet and the ECB today snubbed their collective nose at the crisis and said essentially it is not our problem, look to Brussels for answers.  The reality is the banking system in Europe is starting to freeze up and it is now a monetary problem demanding a monetary response.  Maybe he and the ECB know this and are fearful of playing their cards too early…or maybe they simply don’t get what is going on…interlinked markets, economies, asset prices (correlation is back) and crowd emotion – from the streets of Athens to the trading floors of the major financial centers.  In two days this week the risk on-risk off or correlated trade is back in force – with one difference - the euro has replaced the dollar as the inverse currency to gold.  Dollar/yen fell over 6% between 1Pm and 3PM…I have not seen that kind of move since the1990’s.  Surely some in the market won’t survive today. 


It should be clear to all that bother to look that the world financial system is again skating on thin ice and in need of intervention. 


It will be interesting to see what if anything is done Friday and then Sunday from the ECB, EU, IMF, Fed and US Tsy…if the current course (fat fingers and, electronic trading inefficiencies and big fat Greek weddings are inseparable) is allowed to continue unaddressed by the powers that be, then we will learn that the sequel is as devastating as the original that opened in September 2008.


Lastly how can any investor, retail or institutional, have much faith in the capital markets when events like today happen just 18 months after capitalism’s near-death experience?   Confidence in the capital markets is critical to asset markets operating efficiently.  Today is a serious blow to confidence in the stock market and while it may not rank up there with the loss of confidence in the bank system in 2008, we are not in a world where the real and financial economies can withstand these kinds of episodes and survive.


David Gilmore  




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