Flash Crash Redux?

The ink from today’s stock market meltdown is hardly dry, so perhaps it’s premature (and dangerous) to write anything about it.  So far, at 5pm, there is virtually nothing in the news that would seem to justify how quickly the market tanked this afternoon, nor why it ended the day down so much.

If you’re just tuning in, the Dow fell the most points on record today, 1,175 points.  Granted, that number is downright shocking (the Dow level was 1,175 as recently as 1983!), but the 4.6% decline wouldn’t register even among the worst 100 days ever.  Today’s performance took the Dow into negative territory for the first time this year, now at -1.5% year-to-date, after a strong January.

Perhaps we should have foreseen this, since the Dow fell 666 points on Friday.  But the market opened down slightly today, and at one point was actually up for the day.  Here’s the intraday chart: 

The Dow was actually down over 1,500 points at 3:10 pm. Those with good memories might remember the “Flash Crash” on May 6, 2010, when the market suddenly tanked, and no one knew why for years.  Even the SEC’s 2015 report didn’t exactly shed much light on why the market suddenly took a noser, other than there was a trader (or traders) actively manipulating the futures market, and there may have been a fat finger trade error.  This “revelation” didn’t inspire a lot of confidence in the market.  Here’s how trading went that day:

Some similarities there, eh?

The new news of the past few days is that wage inflation is starting to tick up, per the employment report which came out last Friday morning.  It is still not even close to the danger zone yet, but bond yields have continued to march upward, with the 10-year treasury yield hitting 2.85% Friday (up from 2.05% last September).  This is certainly not a bad thing either, but when you look at how the rise in yields suddenly took an asymptotic turn higher since the start of the year, at the same time that the stock market suddenly started shooting higher every day, that’s unsustainable.

When the market kept going up and up and up in January, unabated, we were all wondering how long it would last.  The best answer:  “it’ll keep going up until it doesn’t anymore.”  But the problem is that, apparently, some market players probably became very leveraged to the market’s strength.  The market had been so strong that it was being called a “meltup” in January.  Much like in 1987, investors kept buying as the market went up throughout the first 9 months of the year.  When the market stopped going up, many were forced to sell, and when selling begets selling, you get a waterfall drop like we had today.

Our best guess is that there were some vulnerable traders or hedge funds, which were too leveraged and needed to unwind their positions, and the market caught a whiff of it, and pounded them.  Their intention is not so much to inflict pain, but rather to make profitable trades.

One thing we do know is that the worst-performing stocks were the biggest, most liquid stocks, many of which had outperformed the market lately, like 3M, Berkshire Hathaway, and Home Depot.  Safety stocks were not spared:  Wal-Mart was -4.2%, J&J -5.3%, and Coke -3.9%.  So, today’s action had nothing to do with economic concerns; this was truly a computer-driven selloff.

Whether this is a good time to dabble in stocks, or trim them, remains to be seen.  The market could easily be way down tomorrow, or way up.  In 2010, the market saw a short-lived bounce up after the flash crash, only to be lost as the market went down even further by July, for a total loss of 20%.

If you have any questions or concerns, don’t hesitate to ask!

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