After stock markets in the United States started off 2016 with the worst first two weeks' performance in history, we are experiencing the muddled maundering of financial gurus and pundits on the causes of the severe market malaise. First, the facts: the Standard & Poor's index was down about eight percent so far in 2016, and down about eleven percent from its 2015 peak. The Dow Jones Industrial Average, on the Ides of January, Friday January 15, fell nearly 400 points. The Nasdaq Composite Index sank by 2.7% during that same period. Many pundits stated that we were likely to be entering the dreaded "Bear Market" period, when stocks drop by at least twenty percent, and stay way down for months. The funds of millions of investors worldwide seem to be in jeopardy: why, oh why, oh why?
The same stock market gurus and pundits have a simple explanation for this grave malaise: it is all due to the decline in worldwide oil prices, now under four dollars a barrel, which obviously endangers the revenues of such oil-rich nations as Saudi Arabia and Russia, and through some mysterious and unexplained process makes the entire financial world much worse off. This "conventional wisdom," however, ignores the reality that low oil prices usually fuel economic health and growth. The consumer sector now has more income to spend in a host of other markets; the industrial sector has lower costs for oil and oil-based chemicals to enhance profits; the commercial sector -- from truck transport to airlines -- can now spend much less on fuel and related costs. All of this sounds like a blessing, not a curse. Indeed, looking into the past, lower oil prices helped to "fuel" prosperity, not recession.
Given those realities, one must seek alternative explanations for the recent market malaise. For starters, given the complexity of both securities markets and today's economies, no one simple explanation is likely to be fully credible. Still, there is indeed one aspect of our securities markets which has expanded greatly in recent years, while at the same time exerting serious destabilization on those markets: program trading is the name for the major culprit causing our present worldwide market malaise -- but because market professionals make lots of money from such trading, that truth tends to be hidden.
According to Investopedia, "Program trades are usually executed if index prices sink or rise to a certain level. This tends to create very volatile situations." Truer words were never written about program trading: it destabilizes financial markets badly, as from one-third and one-half of all trades on major exchanges are automatic in nature.
The obvious result of the vast recent growth in program trading -- obvious to everyone except those stock market gurus and pundits who have their own financial interests to protect -- is the volatility, destabilization, and wide swings in various stock markets due to what I term "robo-trading" wherein both buy and sell orders are triggered by market movements, independent of any fundamentals or underlying market factors. Program trading is the enemy of order in our securities markets, exacerbating swings and magnifying small changes downward into disasters!
The drastic present market declines are indeed a tribute, of sorts, to the power and impact of program trading in causing extreme swings in securities prices. What we actually have is a prime example of the famous "fallacy of composition": while no one program trade has any significant impact, the totality of such trades can destroy any orderly market processes. This is essentially "robo-trading" with little or no human intervention; as such automated trading grows in volume, its impact also grows, often exponentially, vastly worsening any initial slide in stock values!
Declining oil prices are merely the tip of the tail of the dog when it comes to massive market declines. Indeed, no one single economic or financial event is likely to have the downward impact we have experienced recently; such developments often tend to cancel each other out. What is desperately needed, however, are limitations on the volume, frequency, growth, and impact of program trades, combined with an enhanced "rapid response" in terms of temporary shut-downs of securities markets under conditions of extreme volatility. New securities rules and regulations may be needed to achieve these goals, and the next United States Congress needs to take a good, hard look at such measures, as does the next American president -- whomever he, or she, turns out to be. Until those steps are taken, our market malaise will be quite malevolent.