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Algorithm Markets and a Bumpy Autumn Ahead

Algorithm Markets

In the modern struggle between old-school balance sheet fundamentals and computerized, trend-measuring “quants,” the robots seem to have won, as more than 70% of today’s markets trade on algorithms working at 15 gigaflop speeds, effectively confirming we are an algorithm markets, which bodes for a bumpy autumn ahead as well a just plain weird “new normal”…


I’ve taken to referring to this market as the “terminator market;” one that is driven by impersonal formulas and extremely expensive software rather than human intelligence.

I’m not here to mock this new style of investing, as it can and does work – until it doesn’t, usually due to some unforeseen human event, which machines can neither predict nor control.

I’m often reminded of John Meriwether’s infamous disaster of a hedge fund, Long-Term Capital Management.

It had two Nobel Laureates and tons of applied math software designers on its expensive staff in 1998, none of which prevented that $125 billion fund from tanking with historical panache when the Rubel went one direction and the computers went another.

Alas, Long-Term Capital didn’t last very long…

But rather than get into the minutia (or debate) of artificial intelligence vs. human common sense, below I’m simply going to employ both fundamentals and quantitative technicals to measure the state of our current markets and the direction of your money.

And what do both approaches tell me?

Well, get ready for a volatile autumn…

The Quant Signals – Volatility Ahead

As to the purely technical indicators, they are providing ample evidence of trouble ahead, thanks in part to algorithm markets taking over.

Last Monday, the quants (aka the CTA funds and other members of these algorithm markets ) saw the S&P dip below their key selling support lines (what the fancy lads call “negative gamma”).

Without getting lost in Greek market definitions – this essentially means that buying support is weakening, and hence the markets saw their biggest daily drop for the year.

The quants are worried in these algorithm markets. As we enter August, the traders exit for vacation, and thus markets typically become less liquid. This is a bad convergence, a perfect setting for volatility spikes driven by computer signals rather than human discretion.

The VIX, which is the market’s “fear indicator,” helps measure this volatility. The quants also have another scale, the VVIX (which essentially tracks the volatility of the VIX), and the VVIX seasonally spikes in late August and September which algorithm markets typically use as a sell indicator–and hence market punisher.

The quants are forecasting two waves of pending volatility moves this autumn: first, a sell-off, as we saw last week, that sent the VIX above 20 and the VVIX above 100.

Specifically, the algorithm markets were watching the big market movers and players (hedge funds), who had been super bullish (buying) in June and July and using other bullish strategies (selling puts and shorting the VIX futures).

Such moves created a herd mentality, and then, as of August 1, that herd got nervous and began selling rather than buying U.S. stocks. This is flow-tracking 101, and it matters. There is now mathematical evidence of “risk-off” for the coming fall season among the computers who comprise our algorithm markets.

And sure, there will be a rebound. The dip-buyers are programmed to buy the dips. They’re machines, after all, and algorithm markets tend to create their own “dips” and then subsequently buy those very dips in the next cycle.

Nevertheless, signals from the CTAs, the macro funds, and the trend-following algos of the algorithm markets are telling us that the big players are going market-neutral this fall, which means less buying support and thus more market volatility – both up and down – but mostly down. It will likely get dicey enough for the Fed to step in and start printing some money. Let’s wait and see…

As hedge fund alumni, we know this pattern well.

There is growing evidence that the CTA funds and algorithm markets will do more selling than buying this autumn, hence adding pressure on price declines, the key trend to anticipate, especially (and typically) at the tail end of the month when risk-parity funds (i.e. funds going both long and short) re-balance their portfolios.

Finally, the quants are tracking global stock market sentiment indicators, which, driven by signals from an escalating trade war, are deteriorating and setting up a summer-into-fall pattern dangerously reminiscent of the technical patterns seen leading up to the 2008 crisis.

In short, there are technical reasons within these algorithm markets to be cautious as we finish Q3 and head into Q4.

The Old-School Signals – Recession Ahead

The above data is, of course, highly important-and it’s based on charts, flows, trends, and very sexy math. Most of the foregoing “quant data” from these algorithm markets is agnostic to the otherwise glaring signs of a classic, good old-fashioned recession, which we also track.

As we’ve noted for months, the classic (old-school) patterns of flat-lining/declining GDP, a dying middle class, massive retail closings, trucking and rail slowdowns, PMIs at dangerous lows and a totally rigged to fail market supported by a dishonest Fed and a now tired (rather than “mid-cycle”) business cycle ALL point toward an imminent recession. This means we can, agai, expect the Fed to soon intervene and send markets to new highs because, hey, in these distorted markets, bad news is just an excuse for good news from the Fed…

Recessions, however,  eventually matter. They kill portfolios for the unprepared once Fed support runs out of credibility. That is hard to “time,” all we can do is watch and react before the meltdown gains traction.

The Fed, of course, is a powerful body, and it can postpone a recession’s official entrance in ways difficult to gauge (i.e. by boosting retail investor hope with media-complicit promises and more magical rate cuts or more magical money printing down the road).

But know this: The Fed can only postpone recessions; it can’t prevent them. Nor can algorithm markets.

In the end, I believe a recession on Main Street (which the Fed and algorithm markets effectively ignore) can ultimately trigger the recession on Wall Street (which is all the Fed sees and bows to).

One doesn’t need a quant fund or a degree in applied math to see the U.S. rotting all around you as costs rise despite mythical inflation data.

Furthermore, old-school common sense reminds us that where growth and earnings go, so too goes the stock market. In their recent announcements, the Fed forgot to tell you that both earnings and growth are set to go much lower in Q3 and Q4.

And that’s pretty telling. Again, I expect the Fed to come charging back in Q4 to “save the day” and kick this market can down the road to even more dangerous levels of debt and money printing.

Summing It Up

Whether one looks just at the modern robots of these algorithm markets,  or whether one tracks the old-fashioned and common sense lessons of Fed history, earnings, and growth, all signs are currently pointing to a volatile autumn.

In the meantime, get ready because I’m going to show you one of the weakest sectors of the market on Friday.

I won’t spoil it for you, but I’ll just tell you that Warren Buffett has a lot to lose…

Catch you Friday.


5 responses to “Watch Your Step As We Move Into Autumn”

  1. Richard Phillipssays:

August 14, 2019

Thank you!

  1. Tom Shetterlysays:

August 14, 2019

Matt: I couldn’t agree with you more. I have several shares of CLX and PG.
Those stocks have done well in the recent market, but I see a downside when all of what you describe occurs. What would you or your team suggest I do with those to save their value?

  1. John Harwoodsays:

August 14, 2019

Thanks for the concise overview of the many market ‘storm clouds’. Of course, the ‘inverted yield curve’ has been flashing yellow-red for awhile. RE main street, when our country spends almost 20% on health care and the average family can’t afford insurance or the high deductible, the breaking point happens quickly when the breadwinner becomes ill or injured.
Given the huge and growing cost of health care, including prescriptions drugs, you have to laugh, or cry, when the Fed reports ‘low inflation’. Average families are really stuck between a rock and a hard place. If we could somehow use those high powered tools that turn ever fraction of a second/penny into profits to help solve our health care quagmire, it would truly be a miracle worth celebrating.

  1. Phillipp Jasonsays:

August 14, 2019

You make more horse sense than the last three Triple Crown winners. I’m totally into gold and silver and have been waiting for this moment to arrive. Now I’m watching the melt down and reading Critical Signals Report. I will look forward to any reports coming up on gold and silver as well as any other advice from you regarding the market. I have not as yet invested in futures or ETFs. My investments have been in solid gold mining stocks like AEM and a few more speculative mining ventures in the field.

  1. Robert Barth says:

August 14, 2019

On 08/13 one of my CD’s rolled over. The old rate was 2.17 and the new one is 2.11 for one year. As this does not equal the price of inflatio
I will receive a negative return. However on 08/14 bank stocks fell and
I earned 3.45 percent in one day by shorting the banks.
Better return than the one year CD
Bob B


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