INSIGHT Crazy days on Wall Street leave some longing for a stockation. REUTERS/(CLOCKWISE) ALEX DOMANSKI, EduardO MUNOZ, FraNK POLICH, BRENdaN MCDERMID THE MADNESS OF WALL StREET Black holes, group think, panic and the age of the machines are all things investors most cope with in the new harrowing environment for stocks BY MattHEW GOLdsteIN, LaureN are lounging at the beach or camping in the Kaplan, president of Kaplan Financial Tara LaCapra, JENNIFER ABLAN woods and not paying attention to stocks. Services, referring to last week’s volatility. AND JOSEPH GIANNONE But for everyone else not on a ‘stockation,’ “Most clients didn’t want to deal with the NEW YORK, AUG 19 watching the markets rise and fall like markets anymore and went back to their giant ocean swells has been an unnerving summer vacations,” said Kaplan, whose HE BEST THING TO be said of the experience that some finance professionals firm manages about $1.3 billion in customer recent stomach-churning turmoil worry could reshape investor behavior for money. onT Wall Street is that it’s taking place in months and years to come. In the short term, doing nothing may well August, a time of year when many people “Everyone felt this was idiotic,” says Susan prove to be the best strategy for dealing AUGUST 2011 MARKET MELTDOWN AUGUST 2011 with the kind of dizzying gyrations that return. occurred the week of Aug. 8 in the U.S. stock And that’s something that could have market. At one point, the S&P500 was down long-term ramifications for the ability of 8 percent for the week before it erased all of investors to build retirement nest-eggs, those losses and then some in the ensuing Find more Reuters special reports at especially given the historic poor ability of days. our blog The Deep End here: retail investors to time market swoons and Thursday brought another August storm. http://link.reuters.com/heq72q surges. A portfolio with 20 percent in cash, The S&P500 plunged 4.46 percent and the 50 percent in a bond fund yielding 3.42 benchmark 10-year Treasury note yield fell and stocks plunge precipitously - as on Aug. percent a year and 30 percent in stocks isn’t below 2 percent for the first time in 70 years. 8 when every single stock in the S&P500 going to enable a person in their 50s to retire And the trouble is this turmoil may not be ended the day in the red. any time soon. some temporary anomaly. “We have to be aware that we can be hit Also if investors flee stocks it could make by one of these liquidity black holes with ever it harder for small, niche companies, such as FREE FALLIN increasing frequency,” says G. Andrew Karolyi, ones in the biotech or clean energy sectors, EXPERTS Say INVESTORS should expect a finance professor at Cornell University to tap the public markets for capital. Or more even more volatility in stocks, as herd Johnson Graduate School of Management. of those companies might take their capital- trading by hedge funds, knee-jerk trader “If you are a long-term buy and hold investor raising business overseas to places like Hong reaction to news and lightning fast computer you better be aware of these and not panic Kong, which would be another blow to Wall programs combine to make for a new and when you see it.” Street. uncomfortable normal on Wall Street. Yet some fear that’s just what ordinary “The market we are operating in is markedly This new trading frontier even has its investors will do as this new hair-trigger different from five years ago,” says Andrew own signature milepost, something called trading dynamic becomes more common. Lo, a professor of finance at the MIT Sloan “a liquidity black hole.” It’s a trading There’s a concern that frenzied trading could School of Management, who frequently phenomenon in which there’s so much drive people further away from stocks at a writes on hedge fund trading strategies intense selling pressure in big-cap stocks time when, other than gold, there are few and markets. “We are seeing extraordinary that it sucks all the oxygen out of the market assets generating any kind of substantial emotional reactions from central banks, 2 MARKET MELTDOWN AUGUST 2011 PERSONAL FINANCE Running scared After the implosion of the tech-stock debacle, mom-and-pop investors have shown a distaste for risk- taking. As volatility rises in U.S. stock markets, they have pulled net cash out of equity mutual funds. Equity mutual fund flows – $ billion VIX (monthly) 40 60 20 50 0 40 Video: Investing on the edge of retirement (Aug. 10): -20 30 http://link.reuters.com/qaq33s -40 20 Personal finance on reuters.com: http://blogs.reuters.com/reuters-money -60 10 A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A politicians, regulators and investors. That 2007 2008 2009 2010 2011 kind of reaction is not conducive for building Source: Lipper, Thomson Reuters long-term wealth. We have an environment Reuters graphic/Stephen Culp 16/08/11 that is highly unstable.” One might say Wall Street is a bipolar market that veers from despair to euphoria Cash flow with each passing news headline. As stocks plunged during the financial crisis, corporations moved dollars into money market accounts faster than retail investors, an indication that corporate treasurers may be more fearful 19TH NERVOUS BREAKDOWN of stock sell-offs. OVER THE paST several weeks, stocks prices Total U.S. money market investments – $ trillions S&P 500 have swung widely based on a range of 2.5 1750 Institutional Retail factors: the perceived progress of European leaders in dealing with the eurozone debt 2.0 1500 crisis; the fears of a double-dip recession in the United States; the fallout from Standard & Poor’s downgrade of U.S. debt; and 1.5 1250 whether the Federal Reserve will embrace a new round of easy money to jumpstart the 1.0 1000 economy. L. Randall Wray, a professor of economics 0.5 750 at the University of Missouri-Kansas City, says much daily trading in stocks is like a self- 0.0 500 fulfilling prophecy. “What matters is what the A S O N D J F M A MJ J A S ON D J F M A MJ J A S ON D J F MA M J J A S ON D J F MA M J J A markets think not what people in the markets 2007 2008 2009 2010 2011 believe,” says Wray. “Traders are constantly Source: Money Fund Analyzer™, a service of iMoneyNet, Westborough, Mass. (www.imoneynet.com) trying to guess how daily events might affect Reuters graphic/Stephen Culp 16/08/11 other market participants.” This guessing game is largely being driven programmers who can write algos to simply chief investment strategist at MDE Group, by super-fast computers with algorithmic buy and sell stocks whenever the S&P hits which manages $1.3 billion in assets. Longo, programs designed to react to headlines a predetermined target, or some bizarrely- also a finance professor at Rutgers Business and overall market trading patterns. The named trading pattern such as a “Death School in New Jersey, adds: “The down-5- Tabb Group, a financial markets’ research Cross” forms on screens. percent one day, up-5-percent the next day firm, estimates that during the frenetic week Some of the surge in volatility is also volatility wouldn’t have happened in the of Aug. 8, high-frequency trading firms and attributed to a growing legion of money past.” strategies accounted for 65 percent of the managers who frequently trade exchange- daily trading volume in the United States. traded funds - which are baskets of stocks, STORMY WEATHER The power of the machines over trading indexes and other assets - as a way to hedge THE TroUBLE for ORDInary investors is one reason why technical analysis, often their positions. is that there are no good market forecasts pooh-poohed as Wall Street alchemy, is “There’s a different dynamic now because for predicting what might spark a liquidity gaining more believers among traders. of the pervasiveness of high-frequency black hole. Fear about the United States There’s more interest than ever in computer traders and hedge funds,” says John Longo, and European countries slipping back into 3 MARKET MELTDOWN AUGUST 2011 “PeOPLE DISTRUST WALL STREET AT ONE OF THE HIGHEST RATES I CAN REMEMBER.” DEVO NATION: Traders still work the floor of the New York Stock Exchange but today more than 60 percent of all daily trading in U.S. stocks is carried out by high- frequency trading firms and strategies.. REUTERS/BRENdaN MCDERMID recession is a legitimate concern that could REUTERS INSIDER have real impact on corporate profits and stocks. But when traders act on those fears at lightning speed it can result in seemingly irrational sell-offs. Take the scary 6.66 percent drop in the S&P500 on Aug. 8. On that first trading day after the credit rating arm of S&P stripped the U.S. of its vaunted Triple AAA debt rating, all 500 stocks in the index closed the day in the red. The selling was so ferocious that shares of McDonald’s Corp, for instance, fell 3.5 percent to $82.11, even though the fast-food giant reported a 5.1 percent climb in same- store sales for July, higher than analysts had James Angel argues high-frequency expected.