Reflecting On The Market Sell-Off

I was out of the office on the two trading days that followed last week’s “flash crash,” which allowed me some time to reflect on the events of that day.

In case you haven’t heard, market indexes dropped precipitously in a matter of minutes last Thursday on basically no fresh news (unless you count the reports that a new Pampers diaper made by Procter & Gamble is causing rashes).

The first conclusion I’ve come to is that last Thursday’s market action clearly demonstrates the inherent risks of our increasingly automated stock market.

High-frequency traders account for 50% to 70% of daily trading volume and, thus, these computerized trading systems provide gobs of liquidity in a normal market. But when the high-frequency crowd jumped ship last Thursday, they took their liquidity with them. I don’t think this right or wrong, fair or unfair. However, I will remember this event the next time I hear someone argue that the “constant” liquidity these computerized trading systems provide justifies their grab-every-fractional-cent-in-sight nature.

Another conclusion I have reached in the aftermath of the “flash crash” is that while human error and computer glitches are accused of being the primary culprits for the epic freefall, I think in some sense the market had been craving a sell-off.

In my April 22 post I suggested that the market would take a breather once earnings season slowed down. There is nothing wrong with sentiment growing bullish, but it’s a problem when markets are willing to shrug off just about any bad news. The bright side of a sharp market reversal like last week’s is that the jubilation dissipates and investors more soberly assess the potential risks at hand.

I’ve said this before and I’ll say it again: stocks rarely go up in a straight line. The S&P 500 has seen five pullbacks of at least 5% since March 2009, none of which ultimately prevented the market from continuing upward. This latest 8.7% drop from the April 23 peak may prove no different than the others.

The final topic I’ve reflected upon is Greece. Before the big plunge, the S&P 500 was already down on concerns about Greek debt problems and the stability of the Euro zone.

I’ve avoided talking about Greece in past weeks simply because I was never that concerned about the situation to begin with. Greece’s economy is just 2.3% the size of the U.S. economy. A default on Greece’s debt would not be big enough to derail the global economy or topple any major financial institutions in the U.S. That said, if a Greek default causes a major bank in, say, Germany to fail then all bets are off.

Still, even if Euro zone economies stagnate for years, the global economy is not highly reliant on them. Only 13.6% of U.S. exports go to Euro zone countries and only 12.7% of our imports come from the Euro zone. Europe’s economy is also of little threat to Asian economies, which are leading the world’s economic recovery. This is not to say that there wouldn’t be any global economic consequences of a Greek default, but I don’t think pain and terror would spread across the globe the way it did following the Lehman Brothers bankruptcy in 2008.

That’s all for this week. Thanks for reading and keep those comments and questions coming!

Peter Lazaroff, Investment Analyst
www.acrinv.com