A preview of markets in free-fall

Well, it looks like I picked the wrong day to quit sniffing glue.

Yesterday was the sort of day where you either need a steadier (like glue, or whisky), or you need the experience to keep calm and not panic. If you’re going to panic, you want to do it before everyone else and avoid the rush.

Seriously though – and for investors nothing could be more serious than what happened on markets yesterday – what lessons did you draw by the close of the day? The Dow futures were down 1,000 points at one point. Then the circuit breakers kicked in. By the end of the day, the loss had been limited to 588 points, or 3.57%.

The FTSE 100 finished the day down 4.7%. About £74bn in market capitalisation was wiped off UK stocks. The index is now down 17% from its highs in April. What next?

Well, the calm, collected, rational, long-term and institutional way to play it is that you might see another 4-5% decline that takes us into bear market territory. Although the market was up over 2% this morning, big moves tend to over-shoot in either direction. A 20-25% decline in the index by the end of August would be just the platform to build a cracking fourth quarter on the back of (insert platitude about everything being fine here).

That’s definitely one play. And it seems like the safest play. It’s probably what your broker will tell you. It involves doing absolutely nothing. And in a secular bull market, your best strategy is to ignore the news and buy shares in productive enterprises when they’re cheap (and then hold on for dear life). Life gets better and everyone gets richer. But there is another view.

Fail safe = system shut down

When is a price not a price? When the marketplace is shut down and no trading is allowed. The ultimate form of a capital control is to shut the market. It’s the only fail-safe when a system ‘goes critical’.

Did the system ‘go critical’ yesterday? That is, did computer-generated trading (algorithms) create a feedback loop where selling triggered more selling and you saw massive declines in shares and indices? Well, yes, that appears to be what happened.

In the era of high-frequency trading, the market was flooded with tens of thousands of quick orders to buy and sell stocks. These weren’t decisions being made by someone on the verge of retirement. Or a fund manager looking for deep value. They were drone orders.

It’s a drone market now. And that’s what you should take away from yesterday’s trading action. The only way to make safe a market over-run by terminator traders is to shut it down. The next few days will see a nice little rally and that sense of fear that comes from the back of your brain will abate.

But you’ve essentially been warned. You got a free preview of what market in free-fall looks like. The intervention – the suspension of normal trading – is a preview of what to expect again and again in a drone-driven stockmarket. If that’s the kind of market you’re comfortable having your retirement money in, carry on.

If not? Consider your options now and use the time you have carefully. More on that later this week.

Category: Market updates