Digital Tequila: When Markets Enter the Twilight
By Joe Duarte on December 3, 2017
If this market goes to new highs after the
action last week then we are truly in a brave new world. Buckle up.
We’ve all seen an episode of a favorite TV show, perhaps the Twilight
Zone when an unsuspecting reveler is given a tainted drink and what
follows is very uncomfortable to watch. Well, this past week may well
be a prelude as to what can happen when a rigidly programmed trading
algorithm is fed the proverbial tainted digital drink.
Investors got a hint as to what a drunken algo can do last week,
as the market sold off violently influenced when what ABC news is calling
a “serious error” in reporting hit the wires on Friday. The since retracted
false report about events related to General Flynn’s legal adventures,
courtesy of ABC’s now suspended-without-pay Chief Investigative Correspondent
Brian Ross was interpreted by the robots as a factor which could lead
to President Trump’s impeachment. And while this might have been an
appropriate reaction if it had been true, it turns out it was false.
Readers can find the details on their favorite news forum. The bottom
line is the report was retracted, but the losses caused by the algo
selling spree were not returned to investors. Sorry about your bad
luck. For this reason, I believe, the proverbial red line has been
crossed and the point of connection between information and market
reaction is no longer reliable – lost in space.
Never mind the politics. From a market standpoint there is too much
left to the imagination here, which is not a good background for making
decisions about money. In other words investors who hear footsteps
and look over their shoulders instead of the markets tend to make bad
decisions. Ultimately, it seems as if we have entered a new era where
the rubber band that connects reality to prices may be irreparably
frayed or may have even snapped. And given the current political climate,
Friday’s uncanny market action may be a prelude as to what the next
market phase will look like – a volatile and uncertain daily grind
fed by rumors, inaccurate reports, retractions and a Twilight Zone
Indexes Flinch but NYAD Stays on Course
Investors who solely focus on index charts often miss important factors
in the market. And this week’s chart review may be an above average
chapter in importance regarding what happens next.
Take the action in the most accurate market indicator of the past
twelve months, the NYSE Advance Decline line (NYAD). Regardless of
last week’s volatility, NYAD made yet another new high, suggesting
the current rally isn’t over yet. It’s also important to note that
RSI is close to reaching an overbought level and ROC is reaching levels
which have in the past year preceded trend reversals to the down side.
The S & P 500 (SPX) is a bit harder to sort out than NYAD. For
example, note the wide price swing on Friday and the negative close.
This suggests the intraday reversal came from short covering, not new
buyers. Combined with flat On Balance Volume (OBV) and a slightly toppy
looking ROC indicator, it seems investors were not fully comfortable
with moving money back into stocks. The fly in the ointment for the
somewhat bearish case is the slight new high in the Accumulation Distribution
line (ADI) which suggests that money is still moving into select stocks,
although perhaps in lower volume. Indeed, the divergence between OBV
and ADI is definitely worth watching.
The action in the Nasdaq 100 (NDX) is of more concern
than that on SPX. Here is why: NDX is starting to make lower highs
and lower lows in the presence of flat OBV and falling ROC. That ADI
is positive here is more of a sign that the big four stocks at the
top, AMZN and the rest are now gobbling up all the new money. This
is now becoming a bearish situation.
Oil Sizzles while Bonds Mark Time
Last week I noted I was bearish on bonds and bullish on oil and I
haven’t changed my mind. Certainly it’s more difficult to be bearish
on bonds than in it is to be bullish on oil. After all, West Texas
Intermediate (WTIC) remains within distance of yet another break to
new highs while the U.S. Ten Year Note yield (TNX) is still flirting
with delivering a sustainable weekly close above the 2.4% yield.
But here is where the bullish argument for crude up: WTIC is in a
bullish flag pattern in a bullish seasonal period having closed above
$58 with intermediate term support at $53-$56 and with OPEC “promising”
to keep supply cuts in place. That last piece of news should keep the
algos on the bullish side of the trade – if you can’t beat ‘em, join
Strangely enough, I would argue that the bullish action in crude
is likely a major factor in keeping the bond bear case from falling
apart altogether. Here is what I mean. Oil is inflationary for the
economy via higher fuel prices, especially in the winter. There is
also a whiff of activity in the grain markets of late, which could
turn into a price stampede. If both fuel and grain prices move higher
with some conviction, it may be enough to take TNX above 2.45% convincingly.
If that happens we could be on our way to 3% over the next few months.
Throw in a few Fed rate hikes and voila, bear market in bonds.
The Stock Market Is Wounded but Who Cares?
It feels as if the stock market has been beaten with a baseball bat.
And as with any potential such beating there may be some internal bleeding.
Sometimes internal bleeding heals. Mostly it keeps bleeding and if left
uncorrected by surgery it kills the victim of the beating. Thus, the
next few days to weeks will be meaningful. Aside from what the charts
for NDX, WTIC, and TNX seem to be telling us, there is now a very serious
intangible component in this market that may not be fully appreciated.
Never mind what is true. How about what is believable? Markets
trade on information, but as each day passes the line between plausible
and whatever anyone can concoct is blurring beyond repair. Eventually
when traders, human or otherwise, are no longer able to discern truth
from fiction, the potential for mayhem is difficult to measure or predict.
In this case the internal bleeding gets worse, and it spreads like
And while uncertainty may have always been a major influence in the
markets in the past, the situation now seems worse given the near total
domination of trading by headline reading, artificial intelligence
driven algorithms with no ability or incentive to discern fact from
fiction. In addition, aside from market volatility rising, many investors
who don’t trust the information disseminated in the markets may decide
to sit on the sidelines, creating a liquidity vacuum. If this is what
happens, we can all expect more volatility and uncertainty.
Indeed, last Friday’s total wacko trading suggests that false headlines
fed to algos produce the same effect as that one extra tequila shot
that anyone who likes to drink may have regretted the morning after.
What I’m saying is that Friday’s market is an indication of what happens
when robots are fed a poisoned drink.
And while anyone with any trading experience may think that last
week was a watershed event, what’s more important in the short term
is whether any of this makes any difference to the algos. You fill
in the blanks from here and don’t walk away from your trading screen
as you ponder the situation.
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