Unintended consequences: A market that almost fell apart - Morphic Asset Management



  • Everyone is a little weary in the office today after another long night. We don’t normally blog on these sort of moves, after all it was in many respects a “Price is News” night – the news story of the night was the fall in prices, rather than say an event that leads to a fall (the Greece referendum say).
  • But I want to revisit something that we wrote earlier in the year about what the coming next crisis might look like, based on what we saw in October of 2014. Readers can review it here. I did not expect to be writing this piece so soon after that, with our base case being that it was actual Fed hikes rather than the fear of  Fed hikes that caused this.
  • So most readers this morning will of course have noticed that markets had a rough night. Perhaps what is less obvious, is that, AGAIN, below the surface, things were going awry at a scary pace leading into the US market open. To the point where we thought it could turn into 1987 quite quickly.


  • Selling had continued across all time zones, with both Asia and Europe moving lower across the board. This then stabilised somewhat around 6pm to 9pm (Australian time), with a slight rally of the day’s lows. But selling accelerated from 9pm to 11pm and started to go vertical around 11:15pm At this point (the boxed area) trading was halted on the Chicago Mercantile Exchange (CME) at 11:21pm – where the world’s largest equity futures market trades (the Chinese aren’t the only ones who intervene) to give a pause.


Source: Bloomberg, Team Analysis

  • This then saw either machines or other traders switch to selling markets that they could, like the European Index, which was driven down 8%. But things were spilling over into currency markets at the same time (or alternatively they were spilling back into equity markets: around the same time the Japanese Yen, which is one of the world’s largest currency pairs, gapped 3% lower at 11:09pm. This is extremely hard to do given the volume of currency traded in this market, but it appears liquidity just dried up.



Source: Bloomberg, Team Analysis

  • Then, believe it or not, things got really heavy. As the cash markets (where stocks are traded for what is called “real money” – long only firms and individuals), the pressure to equalise on futures and what, again we can only guess where machine driven orders, cause a malfunction on a number of exchanges.
  • Some stocks started trading down up to 30% in the first few minutes – below is the USA’s largest Hospital provider, a $30bn market cap stock that shouldn’t have liquidity issues. It appears to us, based on what we saw, the issues were concentrated in the New York Stock Exchange “MKT” market and the NASDAQ (remembering that the US has a large number of different exchanges).
  • We were seeing some stocks and ETF’s down 10-20% across the board.
  • Trading was then halted on these exchanges. The Wall Street Journal has a short article here and you can see most halts were concentrated on the NYSE as per our view above.



Source: Bloomberg, Team Analysis


  • As we wrote about in our piece in February, post-2007 there has been an explosion in a number of new products: more ETF’s; more “passive funds”; more “tail insurance”. When people decided to sell now, through an ETF rather than having a diverse group of long-only mutual funds, there would appear to be…nothing. No bidders. Barron has a piece this morning on it as well.
  • And how can we back up this assertion? I provide you one anecdote. Signature Bank of New York (SBNY) is a stock we are long (well-run bank). We are also long Wells Fargo (again like it, but for different reasons). Both US banks, though one is Small Cap stock, the other a Mega Cap. Now normally into a risk off day in say 2008, SBNY would have a horrendous day. Yet 10 minutes in Wells Fargo was down 10%, SBNY was down 5%. The only way one can rationalise this, is that Wells Fargo is in the SPX futures and large ETFs, SBNY doesn’t feature anywhere.
  • Last night was “righted” because the cash market wanted to buy. The cash market is dominated by the much maligned active bottom up long only Fund Managers. The ones who no one wants to use as they are too expensive and destroy value.

However, there may come a night or time when there are few of them left as everyone goes passive in the world or they decide they have run out ammunition.

I’m trying not to think of that night…

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