When The Algos Hit Stocks, It’s A Buy

December 1, 2017, 4:00 pm EST

Stocks fell sharply this morning, but recovered nearly all the losses from the lows of the day.

Today we got a reminder of the impact that algorithmic trading can have on markets. When the headline hit today about Flynn, here’s what stocks did…

Big institutions have been trading stocks through computer programs for a long time, but the speed at which these algorithms can access markets and information have changed dramatically over the past decade – so has the massive amount of assets deployed through high frequency trading programs. They can remove liquidity very quickly. Combine that with the reduced liquidity in markets that has resulted from the global financial crisis (i.e. the shrinkage of the marketing making community and of hedge fund speculators, and the banning of bank prop trading) and you get markets that can go down very fast. And you get markets that can go up very fast too.

The proliferation of ETFs exacerbates this dynamic. ETFs give average investors access to immediate execution, which turns investors into reactive traders. Selling begets selling. And buying begets buying.

Now, with the Flynn news, Wall Street and the financial media spend a lot of time trying to predict when the market will correct and what will cause it. But as the great billionaire investor, Howard Marks, has said: “It’s the surprises no one can anticipate that move markets. But most people can’t imagine them, and most of the time they don’t happen. That’s why they’re called surprises.”

Still, if you’re not a leveraged hedge fund, this tail-chasing game of trying to pick tops and reduce exposure at the perfect time shouldn’t apply.

More important is the observation that stocks remain cheap at current levels, when we consider valuations in historically low interest rate periods. And we continue to have very low interest rates. So the question is: Is it more likely that corporate earnings will get worse from here, or better from here?

There’s plenty of evidence to suggest the momentum and the fundamental backdrop supports “getting better” from here. And we add to that, the fuel of tax cuts, and earnings should continue to make stocks very attractive relative to a 2.3% ten-year yield.