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Fed Vice Chairman Stanley Fischer may have insisted "I will not, and indeed cannot, tell you what decision the Fed will reach by September 17," but the market is reading his comments as hawkish.
There are other issues weighing on stocks overnight.
2) China's Manufacturing PMI will be out tonight. There is concern it could be weaker than expected. China's Shanghai Composite was down 0.8 percent on reports the government would no longer buy shares. (We'll see.)
3) U.S. crude was down as much as 2 percent before the open, though it rallied somewhat near the open.
And, of course, there is the issues of that extraordinary rally on Thursday and Friday.
There are still plenty of bears betting that that rally will have trouble sustaining itself in early September.
The rally held for a second day, but not without a ridiculous amount of drama.
You know me, I never judge the markets. Don't yell at the stock market, that's always been my motto.
But today? The Dow went up 2 percent in the last 45 minutes.
THAT, is ridiculous.
Once again, looking at a chart of the Dow really doesn't do justice. This is the way to look at the day:
Open gap—up 200
Mid morning rally—up 180
Mid-afternoon swoon—down 300
Late-day rally—up 330
Traders bought stocks hand over fist. There were seven stocks advancing for every one declining.
Volume was heavy once again, though not as strong as early in the week.
A 10 percent rise in crude made energy stocks the star performer.
If you just look at the 300-point rise in the Dow, coupled with yesterday's better-than-600-point rally, you might be tempted to say that we have turned the corner. But the crazy intraday moves do not inspire confidence. We need to see a few boring August days before traders believe the worst is behind us.
There's a new bogeyman in town: market on close orders (MOCs) which most traders blamed for the big decline in the last hour of trading yesterday. But what are they? Who is buying and selling at the close? Let's take a look.
What is a MOC? A market on close (MOC) order is a market order executed at the close. That means the order gets executed at the final price, regardless of what the price is.
Who places MOCs? All professional traders can put in MOCs: institutions, mutual funds, hedge funds, ETFs.
Why put in orders to buy and sell exactly at the close? Some may simply want the last trade because they want the price of the stock before the next morning's open.
Many accounts will judge their performance (for the day, week or year) against the close.
Mutual funds, for example, typically only price their assets once a day, at the close. If you put in an order in the middle of the day to buy or sell a mutual fund, the price of that fund will depend on the closing prices of the underlying stocks.
Likewise, if you put in an order to buy or sell a mutual fund after the market closes, the price of that fund will depend on the closing prices on the following day. You do not get the opening prices, since almost all mutual funds only price once a day, at the close.
How do they know how much there is to buy and sell at the close? Brokerage houses send in orders to buy and sell individual stocks at the close throughout the afternoon. At 2 PM, the NYSE aggregates the data and publishes an imbalance feed for individual stocks that have buy or sell imbalances in excess of 50,000 shares. Floor brokers can see these indications, but they are not public.
These indications are updated continuously. On a typical day, there might be buy or sell indications on a few hundred stocks, though typically there are only a few dozen that are really large and might affect the closing price.
At 3:45 the NYSE publishes the MOCs to the public. NASDAQ publishes at 3:50.
The NYSE does not publish an aggregate of all the buy or sell orders. However, some floor brokers will aggregate all the orders and float informal buy or sell imbalances for the whole market.
CNBC will often mention these informal indications going into the close. You might hear, for example, "There's $400 million to sell at the close."
You get this by adding up the dollar value of all the buy orders, the dollar value of all the sell orders, and then subtract. For example, if there is $1 billion to sell, $600 million to buy, you have a $400 million sell imbalance.
Why publish MOCs? The purpose of publishing the imbalance in individual stocks is to attract liquidity. For example, if there is a buy imbalance of, say, $50 million on Pfizer, that is a signal for sellers to come in and offer stock, and vice-versa.
How are MOCs executed? At the NYSE, the designated market maker (DMM) sets a closing price for the stocks that he or she is responsible for at or just after the close.
What are average aggregate MOCs? At 3:45 PM, it is fairly typical to see a buy or sell imbalance of $300 to $600 million. $1 billion is on the high side of typical.
What happened yesterday? At 2 PM, there was roughly $1.5 billion in aggregate for sale (numbers vary depending on who is doing the estimate), a large number. But it got worse from there, and by the close there was roughly $3 billion for sale, a very large number.
The NYSE does not break out the numbers by who is buying and selling. However, the MOC is traditionally weighted with institutional orders, most of which represent mutual fund flows from retail investors.
Do MOC orders tell us anything about the close? There have been many attempts at this. With the advent of big data, there has recently been attempts to aggregate the orders and see if any trading patterns could be ascertained.
However, there are certain days when orders are so imbalanced that it's clear the final closing prices would be higher or lower.
Yesterday was one such day. It wasn't just that the aggregate orders worsened going into the close, it was the size of the sell imbalance was so great there was no chance that "buy" orders coming in at the close would be sufficient to move any of the indices to the upside.
When traders realized this, they sold ahead of the close.
Once again, the markets have opened up strongly. We'll see if they close that way. In the last four trading sessions:
1) A lot of stock has been sold
2) A lot of protection has been bought
3) Sentiment indicators are at historic extremes
I struggle to describe how far some of these indicators have gone, but by any measure—option put/call ratios, movement in the VIX, or Relative Strength Indicators (RSI)—we are at extreme levels.
Another indicator to look at is the 50-day moving average for the S&P 500, one of the most-watched technical indicators.
According to our partners at Kensho, the S&P 500 is 4.35 Standard Deviations from its 50 day moving average.
It's hard to describe how rare that is.
To give you an idea of how far out we are, one standard deviation means that an event would occur outside the range 1 in 3 times.
Two standard deviations one in 22 times.
Three standard deviations one in 370.
Four standard deviations 1 in 15, 787.
4.5 standard deviations one in 147,160 times
That's where we are, between 4 and 4.5 standard deviations. What has happened here statistically happens somewhere between one in 15,787 and 147,160 times.
Meaning, like, almost never.
Kensho's data only goes back to 1980. There has been one time this has happened: August 8th and 9th, 2011, which is when Standard & Poor's downgraded U.S. sovereign debt.
In the following week later there was a notable snapback:
S&P 500: up 7.5%
Russell 2000: up 10.4%
Energy: up 10.4%
Materials up 9.9%
That's a good sign, which makes complete sense.
Of course, this is only one datapoint, one event. Which highlights what strange times we are living in.
We are in strange, uncharted territory. By every measure of market sentiment we should have had a bounce on Tuesday. If you look at the amount of protection that has been bought, if you look at oversold indicators like relative strength, if you look at 50- and 200-day moving averages, everything is flashing massively oversold.
The problem is, when there are true fundamental issues, you can stay very oversold for a long time.
We now have three areas of uncertainty: first, China; second, the Fed; and, finally—this is the new one—a sort of fear, irrational or not, on the part of retail investors who have decided they want to sell part of their holdings. That's what we saw at the close today.
That's when reports of large market on close imbalances—stock for sale at the close—started circulating, and the Dow fell apart, dropping more than 400 points in the last hour to end down 204.
Mutual fund orders put in during the day get executed at the close, and that's exactly what happened.
This despite the fact that most of the day stocks were up....there were 3,000 stocks up, 120 down at the NYSE at the open. The German stock market went out mid-morning up 5 percent. That gave everyone a reasonably secure feeling.
Then 3 p.m., ET, comes along and everyone on the floor looks at this enormous pile of sell orders at the close from retail investors, and things head south.
My point is that market on close orders from retail investors are now a new risk for the market in the short term.
When does that end? What we need is a few boring days when everything just slows down. Modest volume. VIX goes back into mid-teens. Some time for the fear to dissipate. Not there yet.
There were some dramatic drops in stock prices at the open on Monday. There were dramatic drops in prices of ETFs as well.
This is not surprising. ETF market makers base the price of ETFs on the liquidity and the pricing of the underlying constituents.
Many stocks Monday morning took several minutes to open. There was a very high level of uncertainty about what the price was of those underlying constituencies.
What happens when you have to open an ETF when, say, half of the stocks are not even open?
The market maker has to make certain assumptions. Every market maker has proprietary ways to price their ETFs, but it's not that mysterious. In the absence of a trade, they make a guess.
Remember, there was enormous selling at the open. The Dow dropped nearly 1,100 points in just five minutes.
No one has ever seen that kind of drop in five minutes. You are a market maker, and you now have to make a certain assumption about stocks that are not even open yet.
What will happen is this: ETF pricing is going to be very wide until there is certainty in the underlying prices.
And that is what happened on many ETFs. There was, for lack of a better word, "pricing havoc" in some of them.
Still, I saw some ETF trades that had scratching my head.
It closed Friday around $75, opened at $70.45, and was immediately halted. When it reopened five minutes later, at 9:37, there were several trades at $46.22. It did eventually recover, but only when the market came back.
Wow, that is a big drop. And this was at a time when most of these stocks were likely open.
What is strange is that the bid was $59.62, the ask was $59.63 when this occurred.
If you are going to be a market maker, it would certainly seem to be a requirement to have a reasonable bid/ask spread.
I am not sure what happened here, but it's worth an inquiry.
In 2012, the Securities and Exchange Commission revised the system-wide circuit breakers that would halt the broad market under times of severe stress.
Under those rules, trading halts occur when the S&P 500 decreases 7 percent (Level 1), 13 percent (Level 2), and 20 percent (Level 3) from its previous close.
A market decline that triggers a Level 1 or Level 2 circuit breaker before 3:25 p.m. EDT halts trading for 15 minutes. A similar decline after 3:25 p.m. will not halt trading.
A market decline that triggers a Level 3 circuit breaker, at any time during the trading day, will halt market-wide trading for the remainder of the trading day.
Under these rules, there would be halts at the following levels on the S&P 500:
Individual stock circuit breakers: limit up, limit down. The exchanges and the SEC have also implemented uniform circuit breakers for individual stocks.
The rules vary depend on the stock price and when the declines occur. In general, trading on individual stocks with a price above $3 will be halted for five minutes when a price decline of more than 5 percent below the average price of the stock over the immediately preceding five-minute period occurs. The same holds for a corresponding rise in price.
For the 15-minute period right after the open and before the close (9:30 a.m. to 9:45 a.m. and 3:45 p.m to 4 p.m.), a halt will only occur if a stock declines 10 percent or more.
What caused the sudden drop? BMO's Brian Belski now famous answer on our air: "It's August, dude!" certainly has some truth in it, one reason investors should not over-react.
And it's also true there is not one single event that caused the decline. We have known about China's slowdown since at least June, along with the effect on commodities.
However, two events have occurred in the last two weeks that have added to the anxiety of traders:
1) China's August 11 currency devaluation has thrown a monkey wrench into the two assumptions on which China investors had hung their hats: a) that China could maintain a 7 percent GDP growth, or somewhere very close, and b) that it could engineer a soft landing to its economic slowdown.
Whether fair or not, the markets have interpreted this devaluation as a sign that it no longer was sure it could do either. This has eroded confidence.
2) But the most important story in the market's decline last week was likely the mid-week release of the Federal Reserve minutes, which revealed a Fed deeply divided on whether it should raise rates.
The week could be divided into two parts: Pre-Fed minutes and post-Fed minutes. Markets were relatively calm in the first half of the week, but every metric of stock market activity picked up in the second half of the week: Volume, volatility, and sentiment indicators, culminating in a mild panic on Friday that caused investors to sell even the best performing stocks on the year, winners like Amazon, Facebook, Google, and Neflix, but even less talked-about winners like Mastercard, Nike, Home Depot, and Pfizer.
Volume was heavy in all sectors, indicating traders were lightening up on positions across the board.
For whatever reason, the Fed's indecision seemed to deeply rattle investors. Some explained it by noting the Fed is in a "damned if you do, damned if you don't" situation. If they raise rates, the market is afraid there will be a disproportionate negative reaction. If they don't, it will be an acknowledgement that after eight years of gargantuan efforts on behalf of the Fed the economy cannot even handle a modest 25-basis point hike.
There were several other, smaller events that rattled investors:
1) Brazil's market decline accelerated, hitting a 10-year low as demonstrations against corruption and President Dilma Roussef continued; fear that high-level business executives may get swept up in the investigations has created uncertainty throughout Latin America, as Brazilian investment companies are engaged in much of the infrastructure development on the continent.
2) Tensions between North and South Korea caused large outflows from South Korea, particularly in the main Korea ETF (EWY), which hit a 5-year low Friday, a further blow to confidence in a key investment country.
3) Walt Disney , a dismal performer since it's August 4th earnings release, dropped another 7% for the week after Bernstein downgraded the stock, reciting similar concerns about declining subscriber growth.
Bottom line: A "perfect storm" of negative news descended on the markets. The issue now is whether the Chinese markets can stabilize. Traders are widely anticipating that the People's Bank of China will cut the Reserve Requirements, allowing banks to lend more.
If they can, it is very likely we will see some kind of oversold bounce. I heard of many traders looking to buy into the close on Friday, particularly small cap stocks, where there was aggressive buying of the Russell 2000 ETF, which ended the day down only 1.2 percent, far outperforming the S&P 500's decline of 3.1 percent.
Where is the market bottom? I have no idea, but there are a couple wacky readings among two popular indicators that indicate fear is at a fairly extreme level.
First, I've said many times that I don't pay much attention to the CBOE Volatility Index until it gets over 20.
It's over 20.
But more importantly, it has jumped over 20 fast. Really fast. It was 13 on Tuesday. It hit 24 today.
When the VIX moves from 13 to 24 in a week, you are forcing traders to reposition their portfolios. They have been assuming a certain amount of volatility, but when it goes through the roof in a few days they now have to assume that stocks will be trading outside of ranges they had taken for granted a few days ago.
"The fear is that could give back 18 months of gains in five days," one options trader told me this morning.
The options pits at the NYSE MKT (formerly the AmEx) were as busy as I have seen them in a year. This is an options expiration day, and with the S&P 500 sitting right on the pivotal 2,000 level, there was a lot of activity on either side of that level.
The VIX has been up more than 10 percent three days in a row, which is a rare occurrence.
This is such an unusual move that we may be approaching some kind of at least-short bottom.
According to our partners at Kensho, this has only happened twice in 21 years: In March 1994 and October 2014.
That's not much data to go on, but the trend has been positive. One week after the event in March 1994, the S&P 500 was up 0.3 percent; one week after the event in October 2014, it was up 1.6 percent.
One month after, the trends were also positive, with the S&P up in the month after March 1994 and 8.7 percent in the month after October 2014.
At least the trend is positive on all four accounts.
Another sign of extreme fear: the CBOE Equity Put/Call ratio hit 2.0 this morning, another very rare occurrence (it has since come off a bit). The ratio, which measure the number of puts versus calls on the CBOE, is usually below 1.0. A reading of 2.0 and above is extreme, a sign that investors are willing to buy protection at any price.
Why have stocks taken a dive this week? BMO's Brian Belski may have oversimplified things a bit when he came on our air this morning and proclaimed, "Dude, it's August," but he has a point.
Everyone is lamenting the global decline in stocks, but much of the damage has indeed occurred in only the last couple weeks.
The good news is that the U.S. is weathering this downturn very well, far outperforming the rest of the world. Most of the world topped out in April, while the U.S. did so in May.
Global Markets (from 2015 intraday highs)
Ray Dalio's fund slumped in August and some investors blame the strategy of such funds for the volatility that slammed stocks and commodities.
For all the talk about the 250,000 jobs a month the economy is creating, workers' real wages are going backward.
Volatility could probably last anywhere from three to four months, Brian Jacobsen of Wells Fargo said.