There Is A High Risk Potential Of An Uncontrolled Algo Selling Feedback Loop

Beyond the risks posed by algorithmic trading, the theme that ties many of the risks together on the list, Sløk said, is the difficulty investors are having quantifying them. The slowdown of the Chinese economy is one example, as are rising trade tensions between the U.S. and China. In both of these situations, investors have little history to turn to help them understand how these forces will act upon equity markets.

"The nature of the challenges facing the market, therefore, is itself a type of risk, as their unquantifiability discourages investors from buying risk assets, because they don’t know how to hedge them. We’re in an unusually difficult situation,” Sløk said. "The fact that there are so many topics on this list, and that they are so diverse, tells you something important about the market."

Indeed it does, but it also tells us that when one is trying to explain away the bursting of the biggest ever bubble created by central banks, it increasingly appears that "algos" (whatever that means) will be thrown under the bus, because we are hardly the only ones who note that it is only when the market is dropping that Wall Street starts blaming "algorithms." When it's smooth sailing higher - as has been the case for much of the past decade - not a single trader could be bothered with the threat that algos pose.

Still, despite some latent criticisms, we wouldn't discount Slok's list; in fact one looks at his "30 risks to the market in 2018" which he published a year ago, shows that many of his "hypotheticals" emerged as credible threats to risk assets.

Incidentally, while Slok certainly raises some critical risks for the coming year, we don't think algo trading is the biggest one: after all, all that would take for momentum to reverse violently to the upside will be for the Fed and other central banks to throw in the towel on tightening and resume easing, in the form of either more NIRP or outright QE. In fact, in light of the ongoing escalation in tensions between Trump and Powell, one can argue that it is only a matter of time before Powell is fired - especially if the market slides deeper into a bear market - and is replaced with some uber-dove.

Which is why in our opinion, the biggest risks listed by Slok are the last two:

  • Fed and ECB re-start QE and risky assets don't rally, and
  • Monetary and fiscal policy are out of ammunition and the world experiences a Minsky moment.

We find those two to be especially critical because as BofA's Michael Hartnett noted last week, we may already be experiencing the traces of the first. As Hartnett wrote last Friday, markets are starting to "lose the plot" as it is rare for combo of such capitulation out of risk, capitulation into US dollar & Fed dovishness not to spark a rally, with the BofA CIO writing that "the only reason it would not is fear of policy impotence." In other words, fear that the central banks no longer have control.

If that is indeed the case, then Slok is correct: a global, and long-overdue Minsky moment will be the biggest risk for 2019.

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Disclaimer: Information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any ...

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