February 28, 2018


“It’s like the market has become some uncontrollable machine lurching around,” said friend Pat at the NIRI Rocky Mountain chapter meeting last week.

I spoke there about Exchange Traded Funds and how they contribute to market instability through the slow adjustment of collateral for creating ETF shares and the very rapid setting of prices for stocks and ETFs. If you want the presentation, send me a note and I’ll share it in pdf.

But first, breaking news from Steamboat Springs: Ski conditions are superb and you can snowshoe in deep champagne powder atop Rabbit Ears between the Yampa Valley and Grand County. We took in WinterWonderGrass too, mass musical ode to banjo, mandolin and upright bass. Blurring genres and maybe the event’s best was Fruition. They might be giants.

Back to Pat’s point that the market seems like a giant robot with the humans inside desperately fiddling with buttons and levers as it swings around destroying furniture, wouldn’t that suggest something awry in the mechanics of the market rather than human irrationality?

While you ponder, the blame may be going unfairly to new SEC chair Jay Powell. Whatever he said to Congress yesterday, the markets had from 8:30a ET to read the text.

Maybe he blew the Q&A. He used the word “strong.” Durable goods were terrible and he thinks the economy can absorb more rate-hikes. GDP may come in lighter still for Q4 in today’s revision.

We’re casting about for rational explanations where there may be none. What you never seem to hear is an investor saying “the reason I sold Powell’s testimony is because of” blah blah blah. What you hear are investors trying to explain why other investors are selling.

What if it’s the machines?

In a terrific interview with the New Yorker last December, Jim Simons said, “I looked at the price charts and analyzed them, and they didn’t look random to me.” Simons, a mathematician, founded hedge fund Renaissance Technologies and is today worth $20 billion.

The firm’s flagship Medallion Fund has generated 80% annually before fees for almost thirty years. It’s size-constrained because big money can’t be moved quickly, and longer-term trading makes algorithms less useful. “It’s like the weather,” says Simons. The nearer in, the higher the certainty.

So think about that. Humans and their fundamental models are trying to produce returns years in the making – which is highly uncertain. Machines focus on the moment. A high-speed trader told me they think of stocks in real time as moving from 5s to 6s, or 6s to 5s. “Buy the 5s that are becoming 6s, and short the 6s that are becoming 5s, and never take your eye off the book – the money at risk.”

I can tell you we rarely see arbitrary scatterplots in the behavioral trends we track. There’s a mathematical symmetry everywhere that defies the idea of a random walk down Wall Street.

It would make sense if the rules required machines to set—wait a minute.  The rules DO require machines to set prices.

Every “marketable” order that wants to be the best bid to buy or offer to sell must by law be on an algorithm, a machine, so it can move fluidly around the market, much faster than humans can react.

The spreads are regulated, to the penny. The bid to buy can’t be higher than the offer to sell, nor can it be the same as the offer to sell.

That’s math. Machines can be programmed to adapt to rapidly changing prices. Simons told The New Yorker he “never overrode the model.”

And maybe that’s your answer. Nobody overrode the model.

So, then? First, investors and public companies have to stop thinking rational thought is responsible for all prices, and boards and management teams better know. Both investors and companies should become better at data analysis if they’re to compete with machines.

Second, there is irreconcilable conflict between humans focused on fundamentals and machines fixated on data patterns – and the machines have the advantage because the market has been handed to them by rules.

Third, should there be different markets for the two? We’ll have opportunity to grapple with that idea when next machines drive the market somewhere it wasn’t prepared to go.

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