September 04, 2015
Things I Don't Understand about Last Week's Markets
Posted by Usha Rodrigues

Typically I read the WSJ over breakfast and then careen through the day from class prep to administrative tasks to meetings to emails, all in a virtual news vacuum.  My husband catches me up on the day's events over dinner.  Altogether I generally get a good picture of what's going on.

Not last week.  Monday August 23 was a crazy trading day, with the Dow opening with a historic drop of 1,000 points.  Tuesday was a different kind of rollercoaster.  Questions below, answers welcome:

1.Were circuit breakers the problem or the solution on Monday, August 24?  Circuit breakers, or the Limit Up/Limit Down Plan, was adopted after the May 2010 Flash Crash.  I learned from this WSJ article that "The rise of ETFs has its roots in the Black Monday selloff of 1987, when investors holding mutual funds were frustrated that they couldn't sell shares until the market closed—at which point the Dow industrials had tumbled 23%." But ETFs became less liquid that fateful Monday.  According to the next day's WSJ, circuit-breakers halted trading in many stocks (they were triggered 1,279 times on the 24th) and that many ETF market makers couldn't accurately calculate the value of the underlying stocks. "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 market values tumbling, too, and caused disruptions in the trading of other assets." 

A later WSJ post-mortem suggested that "at times on Monday they exacerbated trading problems and prevented some securities from recovering after a big initial drop in the day.“The limit-up prevents the stocks from recovering quickly,” said Reginald Browne, head of ETF trading at Cantor Fitzgerald. “You have this staggered effect where the underlying stocks can’t move quickly.”

2.What about the decision of the NYSE to invoke its Rule 48? Rule 48 suspends the requirement that stock prices be announced at market open. According to the WSJ, some question whether that decision affected Monday's market. "Many stocks listed on the NYSE didn’t start trading for up to 10 or more minutes, even while exchanges operated by BATS and Nasdaq OMX Group Inc. started trading at the open."

3. What went wrong in the BNY Mellon glitch on August 24?  The markets that day were extremely volatile.  Here's from today's WSJ: "People can trade thousands of securities betting on assets around the world in a blink of an eye. Ultimately, though, they all end up with BNY Mellon or rivals that officially record who owns what and what those holdings are worth. If the system that tracks that information fails, trades can’t flow smoothly, and some investors may have difficulties getting their money. Last week, that system failed."  The "system" is SunGard's InvestOne, and here's their joint statement, which says that it was not "related to the recent turmoil in the equity markets."  It was just an upgrade gone wrong.  Hmm, somehow that's not comforting me.

4. Did the interrelation between #1, #2, and #3 make things worse?  If so, how much of the problem was attributable to each? 

5.  Why did the market go up 442 points on Tuesday August 25 and then crater in the last half-hour?  Was there some important news item I missed?

Generally I watch the markets with detached interest. We're long-term investors and I nearly always think the market is overvalued and we're due for a correction.  It's not that the market is down that worries me. It's that I don't understand how it's working.  And I'm not sure if anyone does.



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