Trillion Dollar Thrill Ride

By Brad Thomason, CPA

 

New information out today points to the possibility that a particularly large order of e-mini contracts coming from Waddell & Reed was perhaps the actual catalysts for the rapid melt-down seen in the stock market a week and a half ago.  A single order for 75,000 contracts – the equivalent of the total trading volume for a normal hour and a half period, on a typical day – is being examined by exchange officials and regulators.  It is not believed at this time that the order represented any sort of wrongdoing; it was just a very large order, so it is noticeable in the data.  But there is still no definitive word as to exactly what happened.

Earlier this week the head of the SEC testified before a Congressional sub-committee.  Chairman Mary Shapiro devoted part of her time to addressing some of the candidate theories about what happened, including the much talked about “fat finger” error which was the early front-runner as the sparking event.  She reported that this had not shown up in the data, as had been the case with several other possibilities which had yet to be proven through the investigation.  The upshot was that they still didn’t know.  Her entire testimony is available on the SEC website, if you’re interested.

Among her comments was the statement that short term fluctuations were especially damaging to long-term investors, and that this was a concern.  Investors’ Business Daily reported that Rep. Barney Frank said that Congress was “mulling” the idea of some type of compensation for investors.  There are lots of different sub-stories that one can focus on when something like this happens, but it was these two statements that really jumped out at me.  I’ll tell you why.

You know that interview with the expert that they always have on the news after someone is attacked by a shark?  You know, the one where the guy (usually) always ends up saying something about the ocean not being a controlled environment, and concludes by saying, “These are after all, wild animals we’re talking about.”  Well, that was what popped into my mind when I read these two items.  Because it stirs thoughts of one of my favorite soapboxes, the one from which I proclaim that the stock market is a dangerous place; made all the more so by the fact that so few people seem to really get that.

The image that many people in our country have of the stock market – one supported strongly by the mutual fund industry – is one of a fairly benign place where one walks up to the window, life savings in hand, and receives their historically mandated 12%, just for showing up.  Sure all of the fine print mentions risks of loss and all that, but hey, they just put that there to keep the lawyers happy…

Reality is different.  Reality is an environment very much not in control, where dangers every bit the scariness of toothy sharks abound.  Reality is a world where government types are uncomfortable enough with the inherent risks that they want to talk about offering protection.

I have long been of the opinion that most investors take on much more risk than they realize; and more risk than is necessary for the type of year-in/year-out returns that they would be satisfied with.  I believed that back in the day that 12% was still a strong possibility; and I believe it even more on the back end of a decade where the buy-and-hold return was effectively nothing.  Twice in the last decade the market lost 40% of its value for a time.  Does that sound overly safe to you?

Episodes like the one we saw last week are usually talked about in terms of what should have happened and what should be changed in the future.  But I think the real story is what did happen.  The why is an important academic question, but it sure isn’t going to change short-term history.  The stock market is a dangerous place.  Every time it does something it “isn’t supposed to do” it proves its true nature anew.

Now I’m not saying you should avoid the stock market any more than I’m suggesting you stay away from the beach.  Just please take note of the fact that it’s not a walk in the park; and Jaws plays for keeps.

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