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How to Get a Flash Crash

Written by Briton Ryle
Posted July 12, 2017 at 7:15PM

I know, I know. Nobody wants to read yet another passionate article about President Trump. (I know I don't, so I probably won't even proofread this when I'm done writing — thank goodness for copy editors.)

For the most part, a sitting U.S. president doesn't have a huge effect on the stock market. Sure, we could say George W. Bush's tax rebates helped push stocks higher. And Barack Obama's seeming indifference to businesses has been blamed for keeping the stock market's animal spirits caged up.

But really, there's always a lot more moving the market than just policy.

So I'm not going to sit here and tell you that Trump should get all the credit for the fact that the stock market is at all-time highs.

Sure, his election absolutely kicked off the rally back in November. The prospect of tax cuts, regulation cuts, and some stimulus spending sounded great. But none of them has happened. And yet here we are, at all-time highs.

I will admit, I was worried when the Trump administration chose to start with health care instead of tax reform. It seemed like that could take the enthusiasm out of the market. 

And that's because much of the optimism you now see in stock prices is the result of really good first-quarter earnings numbers. And much of the reason for the solid quarter was oil prices. Oil rallied, and energy companies started actually making money again. So the year-over-year comparisons for the S&P 500 looked really good. 

That wasn't Trump's doing. It was OPEC. Or, more specifically, Saudi Arabia. (And they didn't do it to help U.S. companies make more money. They did it because they want to fleece international investors when their national oil company, Aramco, IPOs next year.)

Now, with all that said, I want to call your attention to something that happened yesterday morning. You could have easily missed it if you weren't glued to the market every minute of the trading day like I am. Starting at about 11:05 a.m. ET, stocks started selling off. The Dow dropped 120 points in less than 20 minutes. 

It seems that Donald Trump, Jr., had just posted emails about a meeting with some Russian official on Twitter. And the market did not like the implications...

Risk Is High

There's no need to get into the meat of what those emails said or what it all means. Though I do want to get on the soapbox for just a second and say that the adoration some people have for Vladimir Putin is really weird. Some Americans see him as a strong, charismatic leader, someone to emulate. He's not.

He's former KGB, for crissakes. He's basically stolen tens of billions from the Russian people. He invaded Ukraine to keep it from joining NATO. Cross him, and he'll have you thrown in jail on false charges or have you killed. 

Simply put: Putin is not a friend to the U.S. 

For the record, I don't much care if Donald Trump did business with Russia. That's the way business works. You make deals with China, with Russia, with Saudi Arabia. 

But if you're trying to get elected president? That's a problem. And this isn't just me saying it. The market just told us yesterday that it's a problem in no uncertain terms.

Think about it: For months we've been bombarded with stuff about Trump and Russia. And what has the market done? Yeah, ignored it and rallied. But those emails that Trump, Jr., posted yesterday sure got a response from investors... 120 points in 20 minutes.

I don't even want to think about what that pace of selling would look like over the course of a day. 

My point here is pretty simple: This market is vulnerable. Everybody knows it's — ahem — richly valued. But sentiment is good, the Fed's not aggressive, and there's plenty of liquidity. So stocks go higher.

However, when this thing does turn, when some event is too significant to ignore, we ARE going to see one (or more) of those "no bid" days where stocks just fall and no one steps in to buy. 

Remember May 6, 2010? Flash crash ring any bells?

This market is driven by machines. Algorithm trading accounts for 70% of the action. When the machines do our bidding and push prices higher, we like it. But those machines have the capacity to go "Terminator" on us. And they will. 

It's Quiet. Too Quiet...

This is exactly why traders and investors talk about volatility so much. Volatility is sometimes called a fear indicator. And it's been super low for months. There's very little fear that something bad might happen.

And that's exactly when a really bad sell-off can happen: when everybody knows the market is expensive but is long anyway. 

In these conditions, investors will dump stock fast at the first sign of trouble. And the machines jump on board and run prices lower, trying to find the levels where the buyers have their "buy orders" in. Only there aren't any buy orders (bids).

That's how you get a flash crash. And I think right now, conditions for a nasty flash crash–type decline are ripe. 

I worry that a significant drop could be one of those "what were we thinking" moments that can change the whole complexion of this rally.

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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