The U.S. equity market is an institutional market, controlled by the very institutions that are now screaming about market volatility. These, by the way, are some of the very institutions that wanted to do away with humans, wanted completely automated markets, wanted to let the computers and "high frequency" market makers step in and take over, wanted massive market fragmentation to make the U.S. capital markets "more competitive." (Currently there are 10 exchanges and 60+ alternative venues that do nothing but add to the chaos).
So, how's that working for you?
You see, current market structure does not allow for fair and orderly trading when the sh*t hits the fan — oh, no. Algorithms and computers make assessments and place orders well outside of the last sale in multiple market centers in times of distress – as the computers makes decisions based on what it perceives to be fair value at that moment.
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On Monday, we saw some stocks — American blue chips — open 10 percent to 15 percent lower than their last sale, causing sellers to scream bloody murder. But who can they blame? The brokers? NO. The specialists? NO! (Specialists no longer exist — you see they made them all go away.) And so, you ask, what about all those electronic market makers that were going to fill in the gaps?
Those are exactly the people who abandoned the system when they were needed the most. Unlike the market makers on the New York Stock Exchange, the off-floor electronic market makers have NO obligation to do anything and so they chose to sit it out and see how it all shook out. And when the market had suffered enough, they come running in like gangbusters to scoop up the bargains, while the sellers, who are now exhausted, leave a void in the marketplace, causing prices to rally to almost unchanged.
Since those electronic market makers weren't there to buy stock on the way down, they are not there to sell stock on the way back up — and so, you have a market that appears to be more volatile than it should be.
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Continued uncertainty over the indecisive Federal Reserve and the growing sense that the Chinese government has lost control of its markets is fueling this latest bout of investor angst. It is not the slowing China story — that is old news — it is the lack of control and respect that the Chinese have for what a free and developed market and economy should look like. The surprise yuan devaluation a few weeks ago ignited this fire and the sense is that the global capital markets do not know what is next. Now, bear in mind — this current crisis in the developed markets is a direct result of the illiquidity in the emerging markets. When asset managers need to raise cash and can't sell what they want to, they are forced to sell what they can and that is developed market equities – Europe, U.S. and Japan.
This is a repeat of the global financial crisis of 2008 and 2009, when, after the Lehman Brothers collapsed and the credit market froze, panic set in and global equities suffered.
Look, a lot of damage has been done to the equity markets — damage that will take some time to repair. Until the markets feel that the China syndrome is under control — we can expect more volatility and tough days ahead.
And remember: If you're going to trade with the machines, buckle up! It could be a wild ride.
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