Thursday, September 03, 2015

Stock Markets Are Broken!

The turmoil Monday, August 24th began when a steep selloff in Chinese stocks overnight in New York led to sharp declines in U.S. stock-index futures ahead of the market open. According to Black Rock, “This was one of the most extreme trading days in U.S. history. Markets opened under heavy selling pressure, with the New York Stock Exchange invoking “extreme market volatility” rules. In this unprecedented environment, over 40% of all U.S. equities did not open in the first 10 minutes of trading. Equities traded at extreme discounts, as did a number of ETFs.” Circuit breakers, which are designed to pause trading in single stocks and ETFs during big moves, were triggered nearly 1,300 times Monday.

Because this happened so quickly, many ETF market makers, or the broker-dealers who buy and sell those products, were unable to accurately calculate the value of the underlying holdings or properly hedge their trades. That caused them to lowball their buy offers and overprice their sell orders to ensure they didn’t take on too much risk. This sent ETF and stock market values tumbling.

Matt Hougan, chief executive of, says his inbox lit up with people complaining about odd ETF trading Monday. He decided to run a screen for ETFs that were down more than 35% and found seven. Four of those were small, and odd trading occurs often in such ETFs, but the decline in the other three did appear to be anomalous. Guggenheim S&P 500 Equal Weight ETF, for example, simply holds equal weights of stocks in the S&P 500 index and should not have fallen by that magnitude.  According to Mr. Hougan, “It probably should have been down 6% on the open, but it proceeded to trade down more than 40%.”

The $2.5 billion Vanguard Consumer Staples Index ETF and the $5.8 billion Vanguard Health Care Index ETF both plunged 32% within the opening minutes of trading. The Vanguard Consumer Staples ETF was halted six times over the course of 37 minutes early in the day, according to trading records. The health-care ETF was halted eight times Monday. The declines in these and other ETFs were notable in that they exceeded the declines in the prices of their underlying holdings. In the case of the Vanguard Consumer Staples ETF, the value of the underlying holdings in the fund fell only 9%, according to FactSet.

“There needs to be a deeper examination of how the stock-market circuit breakers behaved on Monday,” said Joel Dickson, a senior investment strategist at Vanguard Group. “There was a major market-structure component to what happened.

While several big-name stocks and ETFs traded down more than 20%—and some more than 40%—Monday, they didn’t meet the standards to be canceled under the “clearly erroneous transactions” rule of the stock exchanges. During the so-called flash crash in May 2010, when some trades were executed at as low as a penny or as high as $99,999, which was determined to be erroneous and canceled. NYSE canceled all trades that day that were more than 30% beyond opening prices, though that only affected a handful of stocks and ETFs.

I have had to flash type crashed in the past, one in 2005 and the other in May of 2010.  Both times the trades were reversed. This time however, the markets chose not to reverse trades that were caused by the markets and market makers not working together and/or doing their job. To me the markets are now broken.

I am going to have a hard time trusting the stock markets and the market makers in the future.  It is time for action to be taken by the markets, Washington and who ever else their might be to change the current systems so this will not happen again.

Who am I kidding, the markets made money on this and they control Washington. So is anything really going to get done?