The Flash Crash of 2015

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The Flash Crash of 2015

By Alan Gula, Chief Income Analyst

Monday morning, August 24, found me sitting aboard a ferry called the Jessica W, furiously reading the news and checking stock quotes on my phone.

I was returning from a relaxing vacation on Block Island, which is located about 12 miles off the coast of Rhode Island. I couldn’t believe it – I was traveling during one of the most chaotic financial market events in years.

My friends sat in amazement as I summarized the astonishing events unfolding that morning.

A global stock market rout had set the stage for panic selling in the United States. Equity index futures and pre-market trading had suggested the day would be ugly, and the U.S. stock market open at 9:30 a.m. was chaotic.

Large, bellwether stocks were going “bidless.” For example, General Electric (GE), JPMorgan (JPM), Ford Motor (F), PepsiCo (PEP), Colgate-Palmolive (CL), and CVS Health (CVS) all declined over 20% at one point before bouncing back.

Amid the turmoil, many exchange-traded funds (ETFs) deviated significantly from their underlying net asset values. The popular dividend ETFs – SPDR S&P Dividend ETF (SDY), Vanguard Dividend Appreciation ETF (VIG), and iShares Select Dividend ETF (DVY) – were particularly hard hit.

I’ve compiled a list of some of the more remarkable low “prints” in the table below:

Macro events may have been the overall catalyst for this broader market selloff, but these brief, sharp declines in individual stocks occur because of a lack of liquidity. In other words, the number and size of the bids were insufficient to handle the volume of sell orders.

This is an example of how high-frequency trading (HFT) leads to market instability. During times of market stress, market-making algorithms are less likely to provide liquidity than human traders tasked with maintaining an orderly market. Basically, because of HFT, there’s less liquidity when there’s acute risk aversion and everyone wants to sell. This is a recipe for disaster.

Furthermore, in the post-crisis era, bouts of risk aversion have proliferated without stimulus. Late last year, I warned that we would have another flash crash in the absence of quantitative easing (QE). Well, we just had one.

To be sure, Monday’s 5.3% intraday decline in the S&P 500 was smaller than the 8.6% drop on May 6, 2010. But make no mistake, the U.S. stock market experienced an extraordinary liquidity event on Monday, and there are likely more to come.

Safe (and high-yield) investing,

Alan Gula, CFA

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By Alan Gula