Sound and Fury, Cabbages and Kings

It’s been one of those weeks in financial markets. After months and months of genial drifts upwards, global stock and bonds markets angrily erupted over the past few days, with bonds plunging of fears that the US economy – held in check by a stern Federal Reserve hellbent on pushing inflation back to 2% - was on the verge of a recession and a new wave of joblessness. At the same time, stocks sold off, in an orgy of programmatic trading triggering sell NOW and sell EVERYTHING and ask questions later. Japan, which has been basking the glow of some actual positive news about economic growth and consumer spending, saw its worst stock losses since the crash of 1987, with the main Japanese index declining 12% on Monday alone.

In the increasing short-termism of everyone everywhere, this surge of negative volatility freaked people out, even – or maybe especially – the supposedly ice-in-their-veins traders who are supposed to trade with sangfroid and never blink. Some market participants warned that unless the Federal Reserve took the rare steep of reversing course between regularly scheduled meetings and cut short-term interest rates sharply and immediately, there would be a global meltdown of untold chaos and harm. Hearing this pain, Fed Chicago president Austan Goolsbee tried to assuage fears and assured CNBC viewers that “if the economy deteriorates, the Fed will fix it.” Even crypto assets such as bitcoin and Ethereum, the darlings of the we-don’t-give-a-shit-about-the-real- world-economy set, crashed by double digits as once-loved assets were taken out to the trading woodshed and unceremoniously liquidated.

So intense and rapid are these contemporary bouts of market volatility that by the time you are reading this, the storm may have passed. In fact, no sooner than the headlines portended doom, global markets staged an equally stunning reversal, with the aforementioned Japanese index soaring 10% the following day, its best one-day performance since 2008. I can only write on the day that I’m writing, so things may have gotten worse. Who’s to say - though that doesn’t stop innumerable machines and algorithms and professional traders at their screens in Laguna or Jackson or Jacksonville or Greenwich or Manhattan from thinking they pretty much know what tomorrow will bring. If only…

Skewering the very serious sensibilities of very serious people, Lewis Carroll of Alice in Wonderland fame and inappropriate photograph infamy once wrote or the walrus and the carpenter, “the time has come”, the Walrus said, “To talk of many things: Of shoes - and ships - and sealing wax - Of cabbages - and kings…” The point, and there may not have been one, was that sentient creatures (such as humans and fantastical walruses) seek profundity and meaning but frequently end up spouting gibberish. There is no more apt way to characterize the effluvia of commentary that follows market volatility.

Yes, the U.S. Labor Department jobs report of Friday August 2 was not rosy. Yes, the Fed may be behind the proverbial curve: waiting too long to cut interest rates before the economy and the labor force weaken. But that alone doesn’t explain the vertiginous moves of the past days. In fact, the first explanation of these moves is more about machines than people. And that alone should give us pause before making any sweeping statements about what this all means.

If you think a plethora of guys (and yes, they are mostly guys – gender diversity on trading floors exists only to a limited extent) with their Schwab and Fidelity trading accounts read the jobs report and then started selling everything in a panicky tizzy, then don’t think that. This cascade of selling stocks and plunging money in U.S. Treasury bonds was largely triggered by a series of programs, some of which told actual human traders what to sell and what then to buy and some which told other programs to buy and sell.

While the Terminator in these stories isn’t a beefy Schwarzenegger but instead a line of code written by a late- 20 something Stanford computer or data science major, the rise of programs and machines goes a long way to explaining a key aspect of how markets move. For sure, markets plunged and soared in pre-computer days as well, based on rumor, attempts to corner the market, limited liquidity. But, the way markets tend to erupt today is more about 50-day moving averages of stocks or rules that supposedly dictate cause-and-effect patterns between macroeconomic numbers such as the unemployment rate and future data on jobs, growth and inflation. Algorithms that have scoured the past decades for patterns then add to the mix by triggering buy and sell orders based on…the volume of buy and sell orders, which of course often becomes a self-fulfilling prophecy leading to intense bouts of market movement.

There is no way that any appreciable number of actual humans saw the carnage in East Asian markets on Friday and just decided to sell it all come Monday morning. Yet as of Sunday night, the derivatives that determine at what level markets will open were plunging because the handful of major global trading desks were getting flashing red lights to snap into action. That set the stage for more than a trillion dollars of global declines, without anyone in particular actually panicking and then selling. That of course then created its own self-fulfilling prophecy as people then started to freak out. The result was that the markets declined for reasons having nothing to do with anything actual intrinsic to financial markets.

Sometimes, as in March of 2020 when markets reflected a global WTF moment in the face of Covid and shutdowns across the planet, financial markets and attendant commentators reacted meaningfully and understandably to disruptive events. But often, they are a walrus preaching vociferously about future outcomes that no one knows and making deep assumptions about government data than even government statisticians would be loath to say publicly or think privately.

Finally there was the oft-discussed yen carry trade, which makes an appearance from time to time as a phrase suggesting deep knowledge of arcance things. Yes, a number of hedge funds try and sometimes succeed in profiting off of the imbalance of currency, the yen and the dollar especially. Sometimes, when the few who do decide to close out their trades, a bout of selling ensues. Maybe that explains what happened the past few days. Or maybe invoking the phrase “yen carry trade” simply makes it seems as if the person saying it knows what they are talking about.

Today may be the start of some new paradigm; that does happen. More likely than not, what has gone on is just a flurry of previously unexecuted algorithms and a product of trading triggers and bored traders. They sell, sell, sell, and then they buy, buy, buy. It’s incredible how much machines and programs now govern markets that directly affect the retirement savings of more than half the U.S. population. It’s incredible how few actual humans manage the self-offs and then snap-backs. That can be disconcerting, but it also suggests that unless confirmed by other factors – Covid, a bubble as we saw in the 2007-2008, these eruptions of more like those active Hawaiian volcanoes, wild to watch as they spew but very rarely leading to lasting, widespread damage.

It’s always tempting to say “don’t panic” during these selling bouts. That’s the wrong reassurance. Panic as a mechanism to check and assess what you’re doing and change immediately to fix it if need be is vital to navigating crises, provided you take note of the why of the panic and don’t then act precipitously on it. So instead, we should remind ourselves, ‘don’t act on your panic – unless you are very, very certain that you know how this will unfold.” I don’t know what the next days will bring in market land; I have moments of WTF. But these storms more often than not portend nothing, and as Shakespeare’s MacBeth elegiacally said, they are instead “sound and fury, signifying nothing.”