Executive Summary

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If you have not yet read Part 2: The Brave New ”Markets” available free to all readers, please click here to read it first.

One thing is clear – this isn’t your daddy’s market anymore.  Unless your dad is only 10 years old, then I guess it could be. 

Why?  Because about 10 years ago the Rise of the Machines completely altered the terrain of what we used to call ‘capital markets.’  Let’s look at this as a before and after story.

Before the machines the markets were a place that humans with roughly equal information and reflexes set prices of financial assets by buying and selling.  Fundamentals mattered. 

After the machines took over the markets became dominated in terms of volume, liquidity and pricing by machines that operated in time frames of a millionth of a second, and used remorseless routines that used trickery and spoofing and price manipulations to ‘get their way.’  Fundamentals didn’t matter, only endless central bank supplied liquidity because such machines and their coders are very expensive and require a lot of funding.

The various financial markets are so distorted that I first resorted to putting that word in quotes – “markets” – to signify that they were not at all the same as in the past.  In recent years I’ve taken to putting double quote marks – “”markets”” – because they are so massively distorted that they bear little resemblance to actual capital markets of the past.  The “”markets”” are no longer a place where humans actions really have much of a remaining role.

The reason this matters to you is twofold. 

(1) Such “”markets”” are easily manipulated by central banks and other state actors by virtue of their automated responses to liquidity injections.  Markets going down and you don’t want them to be?  Just use any one of several highly leveraged means of signaling to the computers that it’s time to buy instead of sell.  Common leverage points include the Japanese Yen to USD price level, selling VIX to lower volatility, and buying massive quantities of index futures ‘all at once.’ 

(2) These manipulations will work until they don’t.  When they fail they may well fail spectacularly resulting in shattered markets that have to be shuttered until the damage can be fixed.  Investors will not be able to access the markets to either buy or sell while things get sorted out.  When the markets finally reopen, minus a huge block of the supposed volume previously offered by now-shut down algos.