MarketView for May 6

 

 

 

Summary 

  

Thursday was one of those days on Wall Street that if it had not become readily apparent that some degree of error, human or automated, was at the root cause, some traders may have contemplated the jumping out of the proverbial “window.” Nonetheless, the day’s trading activity did conclusively point out what happens when computerized trading rules the day as share prices fell 9 percent in the last two hours of trading. However, humans or machines, take your pick, realized the errors being made and the markets regained much of the day’s losses.

 

What remained in the way of negative numbers was due to real world events, specifically the seemingly ongoing credit crisis in Europe that is revolving around Greece. Nonetheless, the situation on Wall Street still remained unclear long after the closing bell as the Nasdaq Stock Market and others said they would cancel multiple erroneous trades. Other exchanges scrambled to examine orders.

 

Indexes recovered some of their losses heading into the close to end down about 3 percent, the largest decline since April 2009. Equities erased much of their gains for the year. The sell-off comes at time when Wall Street is dealing with fraud charges against Goldman Sachs, fears of a wave of debt defaults in Europe and increasing clamor for financial regulation.

 

Volume soared to twice its daily average for this year and was at its highest since October 2008 when the financial markets seized up after the bankruptcy of Lehman Brothers. Word has it that some traders around the world were shaken from their beds and told to start trading amid the plunge in an effort to stem losses resulting from the rapid sell-off.

 

At 2:47 p.m. the selling peaked and indexes plummeted across the board with several falling to nearly zero. The CBOE Volatility Index, known as Wall Street's fear gauge, closed up more than 30 percent at its highest level since May 2009. The sell-off was broad and deep with all 10 of the S&P 500 sectors falling from 2 percent to 4 percent. The financial sector index was the worst hit, tumbling 4.1 percent. Selling hit major stocks including Bank of America, the biggest percentage loser on the Dow Jones industrial average with a 7.1 percent drop to $16.28. All 30 components of the Dow closed lower.

 

Nasdaq and NYSE's ARCA trading unit said they will cancel trades executed between 2:40 p.m. and 3 p.m. where a stock price rose or fell more than 60 percent from the last trade in that security at 2:40 p.m.

 

Nerves on Wall Street were on edge throughout the trading day after the European Central Bank did not discuss the outright purchase of European sovereign debt as some had hoped they would to calm markets. The ECB gave verbal support to Greece's savings plan instead, disappointing some investors.

 

With markets seriously shaken and still fearful of Europe's mounting debt crisis, thoughts turned to Friday's release of U.S. non-farm payrolls for April by the Labor Department. The report is one the most important on the economic calendar as investors try to judge the strength of the U.S. recovery.

 

Was It a “Fat Finger” Trade

 

A slide of nearly 1,000 points by the Dow Jones Industrial Average, its largest intraday points drop ever, led to heightened calls for a crackdown on computer-driven high-frequency trading. The slide, which in one 10-minute stretch knocked the index down nearly 700 points, may have been triggered by a trading error, generally referred to as a “fat finger” trade, meaning that someone hits the wrong key.

 

However, despite the harrowing decline, the major equity indexes recovered from their 9 percent drops to close down a little more than 3 percent. Nonetheless, the follow-through selling that pushed stocks of some highly regarded companies into tailspins exacerbated concerns that regulators can quickly lose control of the markets in a world of algorithmic trading.

 

Citigroup said it was investigating a rumor that one of its traders entered the trade, a spokesman for the bank said on Thursday. Citigroup, the third-largest U.S. bank, currently has no evidence that an erroneous trade has been made, the spokesman said.

 

Market sources said the erroneous trade may have involved E-Mini contracts -- stock market index futures contracts that trade on the Chicago Mercantile Exchange's Globex trading platform. The composition of the E-Mini is similar to the stocks in the S&P 500.

 

Other market sources said the erroneous trading involved the IWD exchange-traded fund or the S&P 500 Mini. A.

 

During the sell-off, Procter & Gamble shares fell nearly 37 percent to $39.37 at 2:47 p.m., prompting the company to investigate whether any erroneous trades had occurred. The shares are listed on the New York Stock Exchange, but the significantly lower share price was recorded on a different electronic trading venue.

 

"We don't know what caused it," said Procter & Gamble spokeswoman Jennifer Chelune. "We know that that was an electronic trade ... and we're looking into it with Nasdaq and the other major electronic exchanges."

 

Nasdaq said it was working with other major markets to review the market activity that occurred between 2:00 p.m. and 3:00 p.m., when the market plunge happened. The exchange later said it was investigating potentially erroneous transactions involving multiple securities executed between 2:40 and 3:00 p.m.

 

The day’s wide swings in some individual stocks reignited criticism of high-frequency trading, a strategy using lightning-fast computer programs to track market trends. Investors had already been on edge throughout the trading day after the European Central Bank did not discuss the outright purchase of European sovereign debt as some hoped they would to calm markets.

 

Fed Says We Could Feel Fallout From Greece

 

The Federal Reserve reported that it is watching closely the financial turbulence in Europe as it could have repercussions for the United States and its markets. James Bullard, president of the St. Louis Fed, stated that the European crisis, which centers on worries about the high debt level of Greece and other European Union member states, poses a threat to our otherwise improving economic outlook.

 

"One risk to the outlook ... is the fallout from potential sovereign debt default as conditions continue to deteriorate in Greece and other countries," Bullard said.

 

His counterpart at the Richmond Fed, President Jeffrey Lacker, said the ongoing turmoil, which has led to deadly protests in Greece, was not affecting his outlook for the U.S. economy, though the situation bears watching.

 

"They are something we're paying close attention to. It has the potential to develop into something that has noticeable effects. But I don't see that so far," he told reporters after a speech in Richmond.

 

Chicago Federal President Charles Evans also said he's monitoring the potential effects. "To the extent that it's affecting financial conditions in the United States and around the world, obviously we are concerned," he told reporters on the sidelines of a Chicago Fed banking conference.

 

Still, he said, he continues to expect moderate economic growth of 3.5 percent in the United States this year, with a relapse into recession "highly unlikely."

 

The euro and world stocks have fallen over the last three days over worries Greece's debt crisis was spreading to other weak euro zone economies. Greece is preparing harsh austerity measures as part of a European rescue package aimed at staving off a sovereign debt default.

 

Bullard raised the possibility of a debt restructuring, saying other countries have been through such restructurings before. "Restructuring debt, if it does come to that, you can live through it," he said.

 

Strains in money markets reminiscent of the early stages of the global financial crisis, in mid-2007, resurfaced this week on fears the debt crisis could choke interbank lending.

 

Thomas Hoenig, president of the Kansas City Fed, said the U.S. government should not neglect to address its own indebtedness, which he said could increase pressure on the central bank to keep rates low to "monetize" deficits.

 

Hoenig and Lacker, considered among the more hawkish members of the Fed, argued that the central bank should strive to "normalize" its balance sheet by selling some of the mortgage-backed debt acquired during the financial crisis.

 

In response to the most severe financial crisis since the Great Depression, the Fed not only cut interest rates close to zero but purchased more than $1.4 trillion in mortgage-backed securities.

 

"It makes sense ... to begin normalizing our balance sheet in advance of raising rates," Lacker said. "Normalizing our balance sheet means reducing its size (and) also returning to our traditional Treasury-only asset holdings."

 

Lacker said he still supports of the central bank's vow to keep rates low for an "extended period" but added he is always reassessing its usefulness.

 

Evans said he "totally" agrees with the Fed's "extended period" pledge, which he says equates to about three or four meetings of the policy-setting Federal Open Market Committee, or about six months.

 

When the time comes to tighten policy, he said, he expects the Fed to first use policy tools other than asset sales, including raising the interest rate paid on reserves and using reverse repurchase agreements and term deposit accounts to help restrict credit policy.

 

"After we start increasing both restrictiveness and interest on excess reserves, I would not be surprised if we then considered selling assets in order to further improve the size of our balance sheet," he said. "It's still a matter of discussion as to how we go about doing it, but that's still an order that I would see as quite reasonable."

 

Productivity Up and Unemployment Claims Fall

 

Productivity slowed in the first quarter, meaning that it may become necessary to hire additional workers now that it is becoming increasingly difficult to squeeze addition output from the current workforce. Hours worked edged up at a 0.8 percent rate, the highest since the second quarter of 2007, from 0.7 percent in the fourth quarter, further evidence that the recovery is progressing.

ct bearing on Friday's jobs data, as it falls outside the survey period.

 

Data on Thursday also showed new applications for unemployment benefits fell slightly last week, indicating the job market continues to improve only slowly even as the economic recovery shows some signs of broadening out. Both reports were released ahead of Friday's employment report, expected to show payrolls grew for a second month in April.

 

Nonfarm productivity rose at an annual rate of 3.6 percent in the first quarter, while unit labor costs fell 1.6 percent, the Labor Department said. However, the answer to if and when employers will start hiring more aggressively is at the heart of the debate on just how solid the economic recovery really is. Productivity exceeded expectations for a 2.5 percent rise in the first quarter but it is expected that productivity growth will slow during the year

 

Meanwhile, the Labor Department said initial claims for state unemployment benefits dropped 7,000 to a seasonally adjusted 444,000. U.S. financial markets were little moved by the reports as attention focused on developments in Greece. The claims data has no dire Thursday's productivity data also showed total nonfarm output grew at a 4.4 percent rate in the January-March period after a robust 7.0 percent pace in the fourth quarter.