The Dow went up 2 percent in the last 45 minutes Thursday. THAT is ridiculous.» Read More
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)
Covering the global markets is starting to sound like the daily suicide note. Or at least "Groundhog Day."
Every day with the gloom and doom. I get up at 5:30 a.m. I look at Asia. Down again. Europe, down again. U.S. futures, down again.
I call around, I read a bunch of trading desk notes to ascertain the source of this angst. I see nothing, I hear nothing, except whining and the vague sense of dread and unease that has permeated markets since June, coupled with a strong dose of ennui.
Like I said: "Groundhog Day."
The dread and unease centers on:
The concern over "collateral damage" is a particular concern of traders. It ranges from fallout in the high yield debt market to concerns some traders will start selling better performing sectors.
Were the Federal Reserve minutes really that that dovish? Was it worth a 14-point rally in the S&P 500 in the middle of the day, even if the embargo was accidentally broken?
"Conditions for a rate rise increasing"—the initial headline—was hardly a sudden rallying cry.
Little wonder we were all scratching our heads on the NYSE floor as the S&P 500 briefly turned positive.
Everyone looked for reasons to be dovish. Some pointed to "Almost all voters needed more evidence for inflation confidence." OK, a bit more dovish but again often-stated.
Others pointed to the line that there were only "some participants" who saw conditions for liftoff as "having been met or were confident that they would be met shortly." That message, some insisted, was more dovish than thought.
Really? I find that hard to believe, as well.
No, I think this is a very clear sign that the trading community is "positioned" bearish. Bearish on China. And many seemed to be positioned hawkish on the Fed.
And when that changes, you get sudden reversals on heavier volume. You could see that because we rallied on much heavier than normal volume. The biggest ETFs, including SPY and IVV (both S&P 500-indexed) and IWM all seeing heavier than normal volume.
Even the Energy ETF rallied almost into positive territory in the middle of the day, though it too fell back.
Volume in the XLE was also much heavier than normal. Indeed, this was probably another "throw in the towel" day for Energy investors.
I mean a day where the sector hits a new bottom on heavy volume. Capitulation. "Get me out, I can't take it anymore" days.
Investors have tried to pick bottoms in energy on several occasions this year, and have been burned each time. Selling climaxes occurred at the end of January, the middle of March, twice in July, then in early August, and it looks like there's another one today.
Still, despite all the drama, the market fell back to where it was before the minutes came out. Volume may have been heavier than normal, but there still wasn't enough to rally the troops significantly.
The news in the commodities business is not showing any signs of improving.
Overnight, global commodity giant Glencore dropped 9 percent in London trading after announcing that its cash flow (EBIDTA) in the first half of year was down almost 30 percent from same period last year.
The stock, which began trading in 2011, hit an historic low, and is down 43 percent since the slide began in June of this year.
Which, not surprisingly, is when the slide in China began.
What is surprising is the comment from Glencore's CEO, Ivan Glasenberg. He did not place the blame on China. He blamed it on speculative hedge fund activity.
"It's the funds driving [prices lower] and not the actual demand in China," he reportedly said in a media call. "The actual demand in China is actually not that bad on our commodities."
There are very clear winners and losers emerging as retail earnings reports continue to shed light on the sector.
Wal-Mart is the clear disappointment, down nearly 3 percent to a new 52-week low, the only S&P 500 company at a new low at the open. Shares are down 18 percent year to date.
The focus has been on Wal-Mart's lower guidance for the year, but the company highlighted many positives:
And if you read the report carefully there are several reasons guidance has been lowered, only a couple due to lower sales:
Morningstar has just released its monthly report on fund flows (the movement of money into and out of mutual funds and ETFs) and we are seeing the continuation of two trends that have been gathering steam all year:
1)Outflows from U.S. funds to international funds;
2) Outflows from active investment into passive investments
These outflows from U.S. funds to international funds have been particularly strong. Morningstar said "Outflows from U.S. equity funds for only the first seven months of 2015 exceeded any previous annual outflows since 1993."
Wow. Pretty strong language.
But it's not surprising. The U.S. stock market is up only 1% this year, while the Vanguard Europe ETF is up almost 5%. The WisdomTree Europe Hedged ETF, which removes the effect of the strong dollar, has had huge inflows this year and is up 12%.
As Morningstar and everyone else knows, "flow follows performance," that is, investors put money into winners. They chase performance.
On the second trend, we all know that actively managed funds have been losing money to passively managed funds, and the trend is accelerating. That is, those that charge relatively high fees for "active" management (mostly mutual funds) are losing business to passive investments (like ETFs) that are generally index-based and charge lower fees.
Even firms that are continuing to stick with a heavy investment in active management are looking to reduce fees to keep investors. Fidelity, for example, has been setting up new investment structures called Collective Investment Trusts (CITs) that allows them to provide lower cost funds, though these are technically still actively managed.
Chatter about what the Fed's next steps will be has shifted from when it will hike to when it will offer stimulus.
For years, Piper Jaffray has been one of the biggest bulls on Wall Street, and with good reason.
Mohamed El-Erian said Monday stocks must fall much further before investors can be coaxed back into the market.