I am not one of those old school traders who yearns for the days when the NYSE still had specialists. I understand better than most the true costs of those specialists. In my younger days, I worked on the proprietary trading side of an institutional equity derivative desk for a big Canadian bank. We traded a lot of stocks that were inter-listed between Canada and the US. On certain stocks (Nortel), whenever we sent our orders down to the NYSE floor, somehow the liquidity would “mysteriously” trade ahead. I used to joke that most fathers wanted their daughters to marry lawyers or doctors, I was hoping mine would marry a NYSE specialist. Well, good thing my first daughter was still in diapers when I made that comment because it wasn’t too long after that the advent of electronic trading wiped out the considerable advantage enjoyed by the specialists. Nowadays, the role of making markets has migrated to a hybrid model of HFT algos manned by a new breed of electronic traders. But this new cross of man and machine has a sinister edge to it.

http://themacrotourist.com/images/Azure/VaderDec0114.png

There is now no one actually assigned the responsibility of maintaining a fair and orderly market in most stocks. There is no one obligated to show a bid and offering. It is also now so fast that regular humans cannot react quickly enough. Yes, there are circuit breakers at certain pre-determined levels, but the moves to those levels can occur with frightening speed.

We saw the downside of electronic trading a half dozen years ago when we experienced the flash crash. Although there were various studies about the causes of the crash, the only real change has been the addition of more individual stock circuit breakers. Since the flash crash, electronic algorithmic trading has become even more popular and the stock market has become even more bubbly with the advent of unprecedented US and Japanese QE programs.

The rally of the last month and a half has been unrelenting, but more importantly, completely unnatural. Stocks do not rally with that sort of consistency in a regular environment. The stock market bulls all claim that the rally is born out of the great fundamentals, but I continue to call bullshit. The rally has been the work of Central Bankers, whether it is directly, indirectly, or some combination of the two.

In the process they have pushed stocks to levels where there is going to be very little to hold them up here if (when) sentiment turns. And the really scary thing is that these algos, instead of providing liquidity by bidding on the way down, are going to do the exact opposite and will be front running the selling when it comes.

Yesterday we got another taste of the fragility of this electronic nightmare we have created. The world’s biggest stock, Apple, lost almost $50 billion of market capitalization in a blink of an eye.

http://themacrotourist.com/images/Azure/AAPLDec0114.png

In a span of 10 minutes, Apple was hit with a series of cascading sell orders that drove it down $8 on no real news. Look at that chart. Down $8 and then completely sideways for the rest of the day. That is not how stocks used to trade. The down move was too violent to then have the stock go quiet so quickly. Yet, that is exactly what happened.

I have said it in the past, and I will say it again. The market is extremely unstable and it wouldn’t take much for us to get another flash crash. I am not calling for a crash by any means – don’t take me for some perma bear that is busy calling for the end of the world all the time. But the bulls are much too confident about the stability of this QE induced science experiment that they have created. The action in Apple yesterday should give them all pause… although I doubt it will.


Inflation expectations

Last month [I am not one of those old school traders who yearns for the days when the NYSE still had specialists. I understand better than most the true costs of those specialists. In my younger days, I worked on the proprietary trading side of an institutional equity derivative desk for a big Canadian bank. We traded a lot of stocks that were inter-listed between Canada and the US. On certain stocks (Nortel), whenever we sent our orders down to the NYSE floor, somehow the liquidity would “mysteriously” trade ahead. I used to joke that most fathers wanted their daughters to marry lawyers or doctors, I was hoping mine would marry a NYSE specialist. Well, good thing my first daughter was still in diapers when I made that comment because it wasn’t too long after that the advent of electronic trading wiped out the considerable advantage enjoyed by the specialists. Nowadays, the role of making markets has migrated to a hybrid model of HFT algos manned by a new breed of electronic traders. But this new cross of man and machine has a sinister edge to it.

http://themacrotourist.com/images/Azure/VaderDec0114.png

There is now no one actually assigned the responsibility of maintaining a fair and orderly market in most stocks. There is no one obligated to show a bid and offering. It is also now so fast that regular humans cannot react quickly enough. Yes, there are circuit breakers at certain pre-determined levels, but the moves to those levels can occur with frightening speed.

We saw the downside of electronic trading a half dozen years ago when we experienced the flash crash. Although there were various studies about the causes of the crash, the only real change has been the addition of more individual stock circuit breakers. Since the flash crash, electronic algorithmic trading has become even more popular and the stock market has become even more bubbly with the advent of unprecedented US and Japanese QE programs.

The rally of the last month and a half has been unrelenting, but more importantly, completely unnatural. Stocks do not rally with that sort of consistency in a regular environment. The stock market bulls all claim that the rally is born out of the great fundamentals, but I continue to call bullshit. The rally has been the work of Central Bankers, whether it is directly, indirectly, or some combination of the two.

In the process they have pushed stocks to levels where there is going to be very little to hold them up here if (when) sentiment turns. And the really scary thing is that these algos, instead of providing liquidity by bidding on the way down, are going to do the exact opposite and will be front running the selling when it comes.

Yesterday we got another taste of the fragility of this electronic nightmare we have created. The world’s biggest stock, Apple, lost almost $50 billion of market capitalization in a blink of an eye.

http://themacrotourist.com/images/Azure/AAPLDec0114.png

In a span of 10 minutes, Apple was hit with a series of cascading sell orders that drove it down $8 on no real news. Look at that chart. Down $8 and then completely sideways for the rest of the day. That is not how stocks used to trade. The down move was too violent to then have the stock go quiet so quickly. Yet, that is exactly what happened.

I have said it in the past, and I will say it again. The market is extremely unstable and it wouldn’t take much for us to get another flash crash. I am not calling for a crash by any means – don’t take me for some perma bear that is busy calling for the end of the world all the time. But the bulls are much too confident about the stability of this QE induced science experiment that they have created. The action in Apple yesterday should give them all pause… although I doubt it will.


Inflation expectations

Last month](http://gfbblogs.azurewebsites.net/blog/2014/11/19/nov-1914-quantitative-tightening/) I continue to believe that the Fed’s actions in terms of reverse repos and the term deposit facility holds the key to understanding many financial markets’ behaviour. The Fed’s withdrawal of excess liquidity is starving the globe of US dollars, making credit tighter, causing the US dollar to rally and making inflation expectations plummet. What is interesting is that the Fed has now pushed their favourite long term inflation gauge, the five year forward five year breakeven inflation rate, down below the levels where they instituted the previous QE programs.

http://themacrotourist.com/images/Azure/FED5YForwardDec0214.png

Inflation expectations continue to fall across the globe, yet the Fed just keeps withdrawing excess reserves through the two new programs.

This morning we are going to get the results of the latest term deposit. You can find the results of each tranche of the Federal Reserve’s program on their web site. They keep doing more and more, sucking more and more US dollars out of the financial system.

http://themacrotourist.com/images/Azure/TermDec0214.png

It should be interesting to see if the Federal Reserve is going to slow down this process. I am not sure if they are watching market conditions, or if this program is on autopilot to rid the system of those excess reserves by a certain date. If the Fed is indeed on a path to rid the system of the excess reserves so they can raise rates later next year then watch out. It will only be a matter of time before something big breaks. Today’s announcement should be interesting.


Positions

http://themacrotourist.com/images/Azure/PositionsDec0214.png</p>