"All or Nothing" Markets

The increased influence of things like high frequency trading in recent years seems to be at least part of the reason for additional market volatility (or instability, depending how you look at it, that has the potential to have a negative impact on the real economy) and higher correlation.

These wild swings are actually good for the disciplined value-oriented investor (as it likely contributes to the increased mispricing of individual securities) even if the capital markets are likely serving their intended purpose less well than they otherwise could.

This CNBC article says we are on pace for 61 so-called "All or Nothing" days which is defined as when 400 or more stocks in the S&P 500 are moving in the same direction as the index. That's more than what we saw during the financial crisis and the most on record.

"All or Nothing" Markets

Consider that the bursting of the dot com bubble through the worst days after the attacks in 2001 produced a total of seven "All or Nothing Days".


All or Nothing Days Becoming More Common Than Uncommon

We had only seven so-called "All or Nothing" days during a very difficult time.

Seven over a two year period.

This year we are having one of those days every four trading days or so. That's a good way to illustrate the extreme correlation but what about volatility? The CNBC article also points out there have been 12 moves of 7 percent or more in less than than three months.

The article goes on to say "This is not normal". Nicely understated.  In this earlier post, Doug Kass had this to say about the increasing influence of algorithm based "strategies" that, as he says, lack "any redeeming social and/or economic value":

...one can argue that their influence on the market's volatility is contributing to the negative feedback loop that is threatening our domestic economy's growth trajectory.

A market dominated by short-term oriented participants focused on macro issues seems destined to frequently misprice individual securities and be less stable.

Beyond that, this inevitably leads to misallocated capital and a bunch of unnecessary frictional costs in the system (including the not easy to measure cost of lost of human capital...all that engineering, physics, and math talent who could be building something more useful that are instead using their brainpower building things like algorithms).

 More from Doug Kass...

...a risk-on/risk-off atmosphere (which changes daily) owing to the increased presence and disproportionate role of high-frequency, momentum-based trading strategies. Some have estimated that high-frequency trading now accounts for about three-quarters of all trading!*

This unfortunate set of affairs has, in essence, transformed a relatively stable marketplace into a casino-like environment (up 400 points one day, down 400 points the next day), as investors have been replaced by machines that trade securities not based on intrinsic value decisions but on small trading edges and price-momentum-based algorithms.

If you add up all the "All or Nothing" days that occurred in the entire 1990s decade the total comes to 27.

So what was happening twice or three times a year that decade now happens every couple weeks. It's a somewhat arbitrary measure for correlation, but a nice way to illustrate how much day-to-day market price action has changed.

The past century threw a few curveballs at us and the next century will likely be no different. The point is none of this relatively new and, for the most part, economically useless activity that may be contributing to high correlation and volatility has been around long enough to know how stable it really is.

Something has fundamentally changed and not for the better. As outside observers, we can't know for sure what really is at the root of it. Yet, it seems obvious that much probably gets back to the epidemic of short-termism and the many new tools available to rapidly trade (and maybe aided by some forms of hidden leverage).

High frequency trading and the extremely high-turnover in ETFs (some leveraged) seem likely to be near the heart of the problem. Maybe not precisely the heart of it but near it.

If not the right house then at least the right neighborhood.

The tail does seem to be wagging the dog.

Unintended, yet permitted advantages within market structure have come to dominate and overshadow the true intent of the capital markets - to facilitate the allocation of capital from investors to businesses. The market has become a servant to short-term professional traders, in particular high-frequency traders ("HFT"). - Mason Hawkins of Southeastern Asset Management

So there have been meaningful structural changes to the market and an unbiased expert look at this is in order before it really costs us something.


* So maybe the various types of high speed trading does now account for something like three quarters of all trading. If so, that goes a long way toward explaining the startling reduction in the average holding period for stocks to 2.8 months from what for decades was a more healthy 2 to 4 year average holding period. 
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"All or Nothing" Markets
"All or Nothing" Markets
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