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Market Chaos! The 998.5 point drop and the mechanism explained

Shawn Baldwin from CMG discusses the precipitous 998 point drop and its connection with the Greek debt crisis

 

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Over two billion shares traded to the downside in the market today, in rapid time due to the incredibly fast (milliseconds) electronic trading platforms and concentration of capital in institutional investment firms. The 998.5 point drop in the Dow created a selling flight that was caused by a “trading” mentality versus an “investing” mentality–although the market rebounded sharply the 3.2% drop it created is the lowest ever.

The sell-off was driven by the institutional capital along with hedge funds who now actively avoid event driven risk. The current events associated with the Greek debt crisis and it’s subsequent support from the other European countries and their potential impact on the global financial markets is frightening anyone with with market exposure. Years ago, there was a movie called “Rollover” with Kris Kristofferson in the lead as a banker that depicted this real life scenario unfolding before our eyes now.

The big opportunity will be in currencies as I have stated more times than I care to remember. In the short term capital flew into gold because it is a safe haven and the global currency markets are extremely volatile due to Greece and the ongoing obligations that the other European countries will have due to the creation of the Euro. These countries ability to finance will be dramatically impacted by their financial obligations to a Greek bailout–this causes insolvency concerns  as fears heighten about potential global debt epidemics. Expect this flight to continue until the risk in Greece is mitigated, most likely by the unwilling European Central Bank affectionately known as the ECB and ran by Mr. Claude Trichet….so far the venerable Frenchman has been unwilling to step in. There will be buying opportunities (particularly in financial companies)at the lows that will turn into strong profits come earnings season. This will occur in select names as capital will continue to concentrate in very few names in what asset managers call a “flight to quality”.

As the scenario is completely unfolded, we are going to find that a number of high-speed, algorithms and high frequency trading exacerbated the problem which was then given additional strength by opportunistic event driven hedge funds along with their long/short colleagues and momentum traders. The expedient market comeback was most likely due to those same algos buying stocks back rapidly–a number of the L/S hedge funds and momentum traders decided to piggy back that too…

The essential problem was caused by the market “circuit-breakers” that the NYSE has in place during highly volatile periods in which price gaps occur. In today’s electronic, liquidity seeking markets a number of exchanges and dark pools have been created that do not have to circuit break at the same time or speed as the NYSE does–this creates wild price variance for fairly small amounts of shares traded–that in turn hits pre-programmed algos which sell without human action.

Regardless of the definitive reason we can be sure that the headlines and obsessive focus on the stock market by the media will cause the Obama administration to: 

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1) Pound the table about the regulation of high-frequency trading, dark pools and hedge funds.

2) Aggressively push the European Central Bank to aid by easing (Geithner is probably on the phone as I write this) this will help to mitigate risk in Europe.

3) Press the regulation of financial companies to the forefront, idiosyncratic problems with the Goldman Sachs case be damned!

These initiatives won’t really create a solution because at the heart of the problem is the mechanism called the Euro…look for a continued pounding of this instrument which will continue to power the U.S. dollar upward.  The entire chain of events are eerily reminiscent of 1997 when the Asian contagion occurred and Messrs. Greenspan and Rubin as Chairman of the Federal Reserve Bank and Secretary of the Treasury respectively allowed market events to cave in Japan.

Japan hasn’t fully recovered yet..

Tomorrow the reports on job creation will undoubtedly be over-shadowed by this event and the continued crisis and consternation in Greece will undoubtedly keep focus on the dollar as safe haven and liquidity are sought. So much for Bernanke’s speech creating lift in the equity markets..oh well..Que Sera, Sera…

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About the author

Shawn D. Baldwin is Chairman of the AIA Group (AIA), an alternative investment and advisory firm based in Chicago

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