Anyone paying even the slightest amount of attention to the stock market recently is aware that traders are behaving more like lemmings than investors. One day they all run north and the market advances 400 points. The next day they all run south and it declines 600. It even happens in the same day. This has been the pattern for the last several months. The economic numbers having changed not a wit.
So we wonder, what is going on here?
Financial writers always have an answer. Fears about a trade war with China. Worries over Brexit. Oil prices are too low (how exactly cheaper fuel hurts the American economy remains a carefully guarded mystery). The Federal Reserve is moving too fast (or slow) on interest rates. Trump tweeted something Wall Street didn’t like. The experts have a good selection of terms like back filling, profit taking and normal correction. The list goes on.
We nod as if we really understand and believe that they know what they’re talking about.
Recently a study of the phenomenon was highlighted by Zach’s Investments. They found that the biggest reason money managers have been selling recently was because other money managers were selling. Call it the Lemming Effect. Of course, the old grizzled Wall Street veterans understand that two fundamental things actually move markets over time, fear and greed. Those two pillars haven’t changed.
But a number of things have changed over the years that contribute to the volatility we see today. Options are one of them. More traders today buy puts and calls on stocks. Options represent a huge piece of the pie for Wall Street. For a relatively small amount, traders can buy options to buy or sell stocks at some future time at a specified price. To many, this seems more like gambling. Some players borrow the money from the brokerage firm (think book maker) to place their bets. As markets move, traders dump their positions which in turn increases volatility. The house always wins, but exactly how this benefits small investors or the general economy is yet another mystery.
Another factor driving today’s volatility is computerized trading. More and more shares held by large institutions and mutual funds aren’t bought or sold by human beings at all. It’s managed by sophisticated algorithms. And as we know, computers can be incredibly stupid creatures, regardless of what the genius programmers tell us. The exchanges have attempted to put bumpers on these systems to keep them from going off the rails. But, small investors have no idea what these cyber traders are thinking. This clearly cries out for more oversight.
One last factor, and perhaps the most pernicious, is short selling. We all understand that stocks are bought by people who believe that their value will go up. Stocks are sold by people who believe that, relative to other potential investments, the stock will underperform. Short sellers sell shares that they do not own, betting that a stock will go down. They must have actual shares of the company available to cover their bet. So, they rent them from the brokerage. Those shares of Apple that you have sitting safely in a brokerage account may actually be rented out to short sellers so that they can bet against Apple shares going up in value. Large short positions against any stock will drive down its value. That’s right, the house may be renting out your stock essentially to drive down the value of your stock. They of course collect a nice fee. And they don’t tell you.
How do like those apples?
There is genuine apprehension about Rep. Maxine Waters becoming the next Chair of the Financial Institutions Committee in the House. She is unquestionably the ultimate loose cannon. In all likelihood, she will waste her Chairmanship on pointless investigations. But, just as only a Nixon could open the door to China and only a Trump could now confront the Chinese, perhaps only a Maxine Waters can tackle some of these matters. Candidly, Republicans have been far too deferential to the Wall Street barons.
Even if no legislation would come of them, some hearings and public debate over these practices would be useful. Today an overwhelming majority of Americans, either directly or indirectly own shares of stock. We are both shareholders and stakeholders. Volatility doesn’t benefit small investors. The brokers collect more fees. But, it undermines consumer and investor confidence. A little sunshine into these dark corners of Wall Street would be beneficial.
And who knows, it might even help to tame the lemmings.
Gil Gutknecht served six terms each in the Minnesota and the U.S. House of Representatives. He writes about healthcare and political issues of the day.