Lessons from the Market Plunge

Yesterday’s roller-coaster market, made it even more apparent that ‘quant,’ or computerized, high-frequency trading exacerbates swings in the market.

Rather than supply cash to the market during panics, and supply stock inventory to the market during melt-ups, it appears that these funds do the opposite. Quant trading relies on the same garbage-in-garbage-out models that created such wonders as ‘AAA’-rated CDOs.

The physics and mathematics Ph.D.s that create and modify these models should do something more productive, like apply this math where it’s actually appropriate and predictive: in engineering problems, rather than markets that are heavily influenced by emotion.

This is also what happens when a market with no investment merit at current valuations runs out of speculative fuel.

When governments and central banks manufacture the illusion of an economic recovery driven by deficit spending and money printing, the faith in the sustainability of that recovery is – not surprisingly – weak.

Now, after two market crashes in the space of a decade, the list of greater fools is shorter. Mom and pop investors have largely chosen to sit out this cyclical bull market, making it very narrow and jittery, rather than broad and sustainable.

After yesterday’s drama, I think we can forget about the widely anticipated surge in mutual fund inflows.

Dan Amoss
for The Daily Reckoning

The Daily Reckoning