Earnings Estimates 2019: Bogus Optimism? — Zweckoptimistische Ertragsschätzungen 2019?

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A post in German and English.

Lance Roberts warnt vor der fragwürdigen Qualität der von Analysten präsentierten Ertragsschätzungen für das Jahr 2019.

Die jüngst vermeldeten bzw. die prognostizierten positiven Überraschungen bei den Ertragszahlen leben von starken vormaligen Herabstufungen der erwarteten Werte – von der Größenordnung her ist es so, als sei ein Wert von 71 ausgewiesen worden bei einer Prognose von 70, die jedoch zuvor abgesenkt worden ist gegenüber dem früheren Wert von 90.

Heute zahlen Käufer weitaus mehr für die geschätzten Erträge als vor einem Jahr. Die optimistische Fassade kippt weg: Steuererleichterungen, Aktienrückkäufe, fantasievolle Bilanzkosmetik und andere Tricks zur Verschönerung des tatsächlichen Bildes – diese Haupttreiber des schwungvollen Trends haben keinen Einfluss auf das Niveau echter Erträge gehabt.

So sieht das Profil der Euphorie aus:

Lesen Sie mehr hier.

The reality is that if analysts were held to their original estimates, instead of 70-80% of companies beating estimates every quarter, it would be exactly the opposite.

As noted above, the biggest drivers to bottom line earnings has been accounting gimmicks, share repurchases, and tax cuts. Revenue growth, as a percentage of the total, has shrunk to just 14% even though reported earnings per share surged by almost $3/share from repurchases.

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However, even with the recent decline of forward estimates, they still remain far too lofty for 2019. Economic growth is slowing and, as I penned just recently (see article for composite index makeup), the domestic economy has already shown early signs of a more significant slowdown. Given that corporate profits are a function of economic activity, it should not be surprising that the rate of change of the S&P 500 is closely tied to annual changes in the Economic Output Composite Index.

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The “sugar high” of economic growth seen in the first two quarters of 2018 was from a massive surge in deficit spending and the rush by companies to stockpile goods ahead of tariffs. While those activities create the “illusion”of growth by pulling forward “future” consumption, it isn’t sustainable and profit margins will follow suit very quickly.

Oversold Reverses Back Into Overbought

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A post in German and English.

Lance Robert ist vorsichtig. Er glaubt nicht, dass sich der Bullenlauf verstetigen wird. Lance meint, dass der Markt sich wieder in den als overbought bezeichneten Bereich hineingeschoben hat und massive Widerstandslinien den Fortgang dieses Trends blockieren.

Oversold bedeutet entweder im Sinne der Fundamentalanalyse, dass ein Aktienwert nicht mehr verkauft werden sollte, weil er sein legitimes Bewertungsniveau erreicht hat. Wer jetzt noch verkauft, der betreibt "Überverkauf", sprich: bekommt weniger, als der Titel eigentlich wert ist.

Oversold kann auch im Sinne der technischen Analyse bedeuten, dass ein Aktienwert soweit gefallen ist, dass er einen technischen Wendepunkt berührt, einen unteren Wert, von dem aus ein ansteigender Trend für den Kurs zu erwarten ist,

Overbought – mutatis mutandis.

Lance Roberts nimmt die gegenwärtige Lage, da nicht klar ist, welcher Trend sich wann wie stark durchsetzt, zum Anlass, sein Portfolio insgesamt konservativer zu positionieren: Aktien, die schlecht abgeschnitten haben, abzustoßen, den Anteil an Anleihen und Cash auszuweiten, die Stops enger zu setzen und ein Buch mit Short-Positionen aufzubauen.

Writes Lance Robert:

Last week, we discussed the fulfillment of our expectations for a bull rally. While the rally was attributed to the rather “dovish” stance taken by Jerome Powell and commentary from the White House on potential progress on resolving the “trade war” with China. The reality is it had little to do with those headlines but was simply a reversal of the previous “exhaustion extreme” of sellers during November and December. 

The rally, as we laid out two weeks ago, continues to work within the expected range back to 2650-2700. 

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Importantly, the previous deep “oversold” condition which was supportive of the rally following Christmas Eve has now been fully reversed back into extreme “overbought” territory. While this doesn’t mean the current rally will immediately reverse, it does suggest that upside from current levels is likely limited. 

Nonetheless, the rally from the December lows has been impressive. However, I want to caution investors from extrapolating a deeply oversold bounce into something more than it is.

[...]

We noted previously that we remain long many of our core holdings and in November and late December added positions in companies which had been discounted due to the market’s downdraft.

This past week, we did reduce our equity exposure by 6% to remove some positions which have not been performing as well as expected. 

The risk to the market remains high, but that doesn’t mean we can’t make money along the way.

Until the bullish trend is returned, we will continue to run our portfolios with a bit higher level of cash, fixed income, and tighter stops on our current long-equity exposure. 

We are excited about the opportunity to finally be able to add a “short book” to our portfolios for the first time since 2008. It is too early in the market transition process to implement such a strategy, but the opportunity is clearly forming. 

Source.

Fed's Defensive Rate Cut Sign of Recession — Defensive Zinssenkung verrät bevorstehende Rezession

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Der verräterischste Vorbote für eine Rezession ist nicht das Anziehen des Leitzins, sondern die erste Leitzinssenkung nach einer längeren Phase, in der die Zinsen wieder gestiegen sind/angehoben wurden.

Over the weekend, we pointed out a concerning statistic: it's not the rate hikes that stifle economic growth and send stocks sliding that traditionally telegraph the start of a recession - it's the first rate cut following a tightening cycle that is usually the trigger. Case in point: the last three recessions were all preceded with the Fed cutting, i.e., the Fed loosened policy within three months before the previous three recessions, cutting by 0.25% in 1991, 1.5% in 2001 and 0.5% in 2007.

Source/Quelle.

What Drives Secular Bull Markets? — Voraussetzungen einer Hausse

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Lance Roberts umreißt die Bedingungen, die zu einer langfristigen Hausse führen. Das Bewertungsnievau spielt eine wichtige Rolle – zu Beginn einer Hausse liegt es typischerweise im Bereich eines Gewinn-Multiplikators von 10. Dieser Multiplikator schraubt sich gegen Ende des Bullenmarkts bis auf das 23-25-Fache oder sogar noch höher.

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Die Triebfeder eines lang anhaltenden Bullenmarkts ist valuation expansion oder multiple expansion: also ein stetiger Anstieg des durch eine Reihe von Indikatoren (Gewinn je Aktie, Dividendenrendite etc.) angezeigten Bewertungsniveaus (ausgedrückt als Vielfaches des Kurses – z. B. das 10-Fache des Gewinns je Aktie) der betreffenden Unternehmen.

Was benötigt wird, ist ein niedriges Niveau aller relevanten Einflussgrößen, wie das Beispiel des Bullenmarkts zeigt, der sich zwischen 1982 und 2000 entfalten konnte: Zu Beginn dieser Phase betrug der Gewinn je Aktie das 5-Fache der Kurse, die Dividendenrendite lag bei 5 %, die Inflation war außerordentlich hoch ebenso wie die Zinsen, die ein Hochplateau bildeten, wenn man so will, von dem aus sich über vierzig Jahre ein Abstieg vollzog, der wachsende Profitabilität bedeutete, begünstigt durch stetig abnehmende Produktions- und Finanzierungskosten.

Wir haben einfach nicht die Bedingungen heute, die einer langanhaltenden Hausse vorausgehen (im Gegenteil!): hohes Inflations- und Zinsniveau, eine hohe Sparrate, ein geringes (private) Verschuldungsniveau sowie ein hohes Wachstum der Einkommen. Die Bereitschaft und Fähigkeit, sich zu verschulden (releverage) ist ausgereizt.

Writes Lance Roberts:

Despite much hope that the current breakout of the markets is the beginning of a new secular “bull” market – the economic and fundamental variables suggest otherwise. Valuations remain at very elevated levels which are the opposite of what has been seen previously. Interest rates, inflation, wages, and savings rates are all at historically low levels which are normally seen at the end of secular bull market periods, not the beginning of one.

[...]  the consumer, the main driver of the economy, will not be able to again become a significantly larger chunk of the economy. With savings low, income growth weak and debt back at record levels, the fundamental capacity to re-leverage to similar extremes is no longer available.

Let’s also not forget the singular most important fact.

The breakout of the markets in 2013 was not one based on organic economic fundamentals but rather through massive monetary interventions by Central Banks globally. The previous secular bull markets in our history we ones which were derived from extreme undervaluations, washed out financial markets, and extreme negative sentiment.

Such is clearly not the case today.

While stock prices can certainly be lofted higher by further monetary tinkering, the larger problem remains the inability for the economic variables to “replay the tape” of the ’80s and ’90s. At some point, the markets and the economy will have to process a “reset” to rebalance the financial equation.

Quelle.

Passive vs Active in Bear Markets — Wenn der Bär brummt ... aktive Strategien im Vergleich zu passiven

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Schneiden aktive Strategien besser ab als Indexfonds – wenn Aktienkurse in südliche Richtung abdrehen?

Es sieht nicht danach aus. Wie die unten angesprochenen Studien belegen, erweist sich das passive Portfoliomanagement auch in Bärenszenarien als überlegen:

The studies aren’t perfect, but they do seem to provide useful down-market data.

What do they show?

An S&P Dow Jones report from 2009 might be a pretty good place to start.

This report showed that, “A majority of active funds in eight of the nine domestic equity style boxes” underperformed their appropriate indices in the 2008 down-turn and produced “similar outcomes” in the 2000 and 2002 bear markets.

In an arguably more robust fashion, in 2001, the Schwab Center for Investment Research also found the following in the study I referenced at the beginning of this post. After analyzing the performance of over 2000 actively managed funds and 120 index funds during market declines between December 1986 and March 2001:

• Index funds outperformed actively managed funds in 55% of the down markets
• In the worst downturns, defined as declines of 10% or more, index funds outperformed actively managed funds 75% of the time
• In the longest downturns, defined as declines of 5 consecutive months or longer, index fundsoutperformed actively managed funds 100% of the time

I’m sure this debate will continue in a robust fashion, but if you think Buffett, Munger and many other seasoned professionals are correct when they suggest that the key to success is avoiding mistakes, then the independent evidence seems to be clear.

Source/Quelle

Inside the Fed's Minds — Was die US-Zentralbanker wohl denken

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Lance Roberts vermutet, dass die US-Zentralbank

entweder

zu wissen glaubt, dass die nächste Rezession bevorsteht und ihr Eintreten durch die Anhebungen des Leitzins vorgezogen werden wird, entscheidet sich aber für das kleinere von zwei Übeln, nämlich: einem möglichst kräftig gefülltem Schießpulverlager (möglichst hohem Zinsniveau), um der beschädigten Wirtschaft durch Zinssenkungen wieder auf die Beine zu helfen,

oder

die volkswirtschaftlichen Daten (übertrieben) positiv einschätzt und daraus die Überzeugung ableitet, die Wirtschaft in eine Hochkonjunktur zu steuern, die Inflation in den Griff zu bekommen und langfristiges Wachstum auf hohem Niveau zu gewährleisten.

1. The Fed is absolutely aware the economy is closer to the next recession than not. They also know that hiking interest rates in the current environment will likely accelerate the next downturn. However, the “lesser of two evils” is to face the recession with the Fed funds rate as far from zero as possible, or;
2. The Fed believes the economic data is indeed trending stronger and are overly confident in their ability to guide the U.S. economy into a “Goldilocks” type scenario where they can control inflationary pressures and growth rates to sustain a lasting economic cycle. 

Freilich scheint die Zentralbank inzwischen „kalte Füße“ bekommen zu haben angesichts der prekären Lage am Aktienmarkt, aber auch weil höhere Zinsen Gift sind für die hochverschuldeten Verbraucher und die Investment-Grade Unternehmen des Landes.

With the Fed continuing to tighten monetary policy, the screws are being twisted further on both households and speculative-grade corporate debt. It appears the markets have already begun to anticipate more defaults and are repricing risk accordingly.

Shares and the Real Economy — Aktien und die Realwirtschaft

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In einem lesenswerten Artikel (siehe Ausschnitte unten) berichtet Lance Roberts, dass Analysten die Marktentwicklung systematisch überschätzen, bilanztechnische Schönfärberei selten aufdecken und meist weitergeben als entsprächen sie der Wahrheit. Seit 2009 sind nur 11% des Anstiegs der ausgewiesenen Unternehmensgewinne auf wachsende Umsatzerlöse zurückzuführen.

Die hohen Gewinnprognosen stehen auf einem zerbrechlichen Podest. Im Hintergrund braut sich das Gewitter einer Rezession zusammen.

These “gimmicks” to boost earnings, combined with artificially suppressed interest rates and massive rounds of monetary interventions, unsurprisingly pushed asset prices to historically high levels. However, as noted, the boost to “profitability” did not come from organic economic growth. As I showed previously:

“Since the recessionary lows, much of the rise in ‘profitability’ has come from a variety of cost-cutting measures and accounting gimmicks rather than actual increases in top-line revenue. While tax cuts certainly provided the capital for a surge in buybacks; revenue growth, which is directly connected to a consumption-based economy, has remained muted. 

Here is the real kicker. Since 2009, the reported earnings per share of corporations has increased by a total of 391%. This is the sharpest post-recession rise in reported EPS in history. However, the increase in earnings did not come from a commensurate increase in revenue which has only grown by a marginal 44% during the same period. This is an important point when you realize only 11% of total reported EPS growth actually came from increased revenues.”

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Way Too Optimistic

With share buyback activity already beginning to slow, the Federal Reserve extracting liquidity from the financial markets, and the Administration continuing their “trade war,” the risks to extremely elevated forward earnings estimates remain high. We are already seeing the early stages of these actions through falling home prices, automobile sales, and increased negative guidance for corporations.

If history, and logic, is any guide, we will likely see the U.S. economy pushing into a recession in 2019 particularly as the global economy continues to weaken. This is something both domestic and global yield curves are already screaming is an issue, but to which few are listening.

Currently, analysts’ forward earnings estimates are still way too lofty going into 2019. As I noted in the recent missive on rising headwinds to the market, earnings expectations have already started to get markedly ratcheted down for the end of 2019. In just the last 45-days the estimates for the end of 2019 have fallen by more than $14/share. The downside risk remains roughly $10/share lower than that and possibly much more if a recession hits.

2018

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That's all. Das ist es schon.

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Yen Carry Trade — Zinsarbitrage Yen-Dollar

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A Post in German and English.

Zinsarbitrage zwischen Yen und Dollar funktioniert zurzeit so: Man leiht sich Geld in Japan, wo die Zinsen niedrig sind, tauscht die geliehenen Yen gegen US-Dollar, die dann in den Vereinigten Staaten zu einem höheren Zisnsatz angelegt werden. Bei entsprechenden Devisenrelationen streicht man durch Ausnutzung des Zinsunterschieds (vielleicht auch noch zusätzlich durch eine vorteilfhafte Währungsbewegung) einen Gewinn ein.

Wenn allerdings der Dollar schwächer tendiert gegenüber dem Yen kann es sein, dass der Arbitragegewinn reduziert, egalisiert oder überkompensiert wird.

Oops:

"Picking up pennies ahead of a steam roller" and “up the escalator and down the elevator shaft” 

These are the two of the most commonly used expressions to characterise the dynamics of FX carry trades. That is, you steadily pick up small returns for months before you lose it all in one day. Today’s collapse in USD/JPY from around 109.5 to an intraday low of 104.9 can be seen in that light. That low essentially reverses the almost 10% spot gains seen since the eerily similar USD/JPY low of 104.7 in April 2018 (see first chart).

The source / Quelle

A good article here on the Yen carry trade:

The yen carry trade is when investors borrow yen at a low interest rate then exchange it for either U.S. dollars or a currency in a country that pays a high interest rate on its bonds. 

These forex traders earn a low-risk profit. They receive high interest rates on the money invested, but pay low interest rates on the money borrowed. The currency broker pays the difference into the trader's account each day.

Rotten Apple — Ankerwert Apple inzwischen ein fauler Apfel?

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Bröckelt Apple – einer der markttreibenden Hyperaktien, die unter der Abkürzung FAANG (Facebook, Apple, Amazon, Netflix, Google) zusammengefasst werden? 

Keine Absatzsteigerung (unit growth), sinkender Marktanteil, mangelnde Innovationen, zu hohe Preise – alles Defizite, die während der letzten zwei Jahre schon zu erkennen waren, und einige wenige dazu bewegt haben, schon seit längerem bei Apple Vorsicht walten zu lassen.

While Apple stock plunging this morning and dragging the market and the Nasdaq lower, there were those (few) analysts and traders who were not surprised by Tim Cook's "shocking" revenue guidance cut: “Warning flags were flying,” William Fleckenstein, a Seattle-based money manager who has shorted Apple for the last three months, told Bloomberg. “You could see the deterioration in the lack of unit growth over the last couple of years and the market share loss. It was only the mania that held the thing together and now that finally blew.” 

Fleckenstein warned that Apple may be a “value trap” if it fails to take steps to regain market share, such as lowering prices or innovating new products, especially if the global economy slows. 

“You’ve got them losing market share in a good period,” he said. “What’s going to happen in a bad period?” 

One reason the market is taking the news so badly: The technology giant’s warning was its first in almost two decades. “It’s hard to believe that a miss of this magnitude was not evident in December but we are dealing with a company that has no experience in how to guide down,’’ analyst Walter Piecyk at BTIG said via email.

The source.

More on Apple here.

Chinese Real Estate — Chinas Immobilienmarkt

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Der Artikel (siehe Link unten) verweist auf Anzeichen, dass der chinesische Immobilienmarkt stark überhitzt ist. Das Problem: Das Wirtschaftswachstum mag in hohem Maße auf einen weiteren Aufschwung des Immobilienmarkts angewiesen sein. Andererseits: Je länger eine Korrektur auf sich warten lässt, desto schmerzvoller und dramatischer dürfte der Kollaps dieses Sektors ausfallen, der nicht nur China, sondern die gesamte Weltwirtschaft bedroht.

The Chinese housing market appears to be in a precarious state, with 22% of total housing stock unoccupied, and prices so high, people must discount offer prices by 60% of what they had paid for apartments and houses only a year ago. 

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Of course, if that is the true clearing price to bring China's massive housing market into balance, a global economic crisis and global deflationary shockwave - launched by China's housing sector - is now inevitable, it is just a question of when Beijing will finally pull the pin.

The source. 

Value Line Geometric Composite (VALUG) Causing Worries — VALUG bereitet Sorgen

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Der Value Line Geometric Composite (VALUG) hilft, die Breite des Markts, also die Richtung, in die er sich bewegt, zu bestimmen. In Indizes, die nach der Marktkapitalisierung der in ihnen abgebildeten Unternehmen gewichtet sind, können besonders stark gewichtete Titel einen falschen Eindruck über den Zustand des Marktes hinterlassen – z. B. wenn sich ein einzelner, in der Gewichtung dominanter Wert positiv entwickelt, wohingegen die meisten anderen Titel sich in einem Abwärtstrend befinden. Für das Jahr 2019 verheißt der VALUG, wie es scheint, nichts allzu Erfreuliches, jedenfalls sieht es diese Quelle so:

... our favorite stock average, the Value Line Geometric Composite (VALUG). Once again, the VALUG tracks the performance of the median stock within a universe of approximately 1700 stocks. Its status as an extensive measure of the broad equity market is the reason it is our favorite barometer of the health of the overall U.S. market.

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So how ominous is this “false breakout”? We don’t want to make any specific predictions or prognostications, but the implications of a multi-decade triple top false breakout can’t be overstated. And combined with the high-risk status of our longer-term “background” indicators, this 4th quarter may have only been the first lap in a long-term bear market run. 

So as we wish everyone a very Happy New Year, we must do so against the backdrop of a potentially very difficult market climate. We wish we had better news, but we cannot pick and choose what type of market we have. And the reality is that 2019 may well be a very prosperous year — for the bears. For the bulls — or those passive investors just along for the ride — you might want to consider charting a different course.

20 Years of Low Returns — Zwanzig Jahre niedrige Renditen

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 A Post in German and English.

In den vergangenen 20 Jahren haben Aktienrenditen im historischen Vergleich schlecht abgeschnitten. Das hatte Folgen für das gesamte Marktumfeld: 

(1) aktives Portfolio Management wurde weniger erschwinglich – daher das verstärkte Interesse an passivem Management; 

(2) der Markt wurde in vielen anderen Bereichen zu größerer Kosteneffizienz gezwungen – Makler müssen mit ihren Gebühren "runter gehen", damit sich Geschäfte für ihre Kunden überhaupt noch lohnen; 

(3) Vermögensanlagegesellschaften müssen höhere Risiken in Kauf nehmen, um ihre Soll-Rentabilität zu erreichen; 

(4) Die Kapitalkosten der Unternehmen sind entsprechend niedrig. Aber es besteht eine Neigung, viele rentable Projekte liegenzulassen, in deutlich höher (als die tatsächlichen Kapitalkosten) rentierende Projekte zu investieren und darüber hinausgehende Erträge in Aktienrückkaufprogramme zu stecken, was unternehmenspolitisch opportun sein kann, makroökonomisch aber nachteilig ist. Kurzum: Das niedrigere Ertragsniveau verführt zur Suche nach hohen Erträgen am Kapitalmarkt, statt zu Realinvestitionen zu ermuntern. 

(5) Sollen bis 2038 bessere Erträge erzielt werden als in den zurückliegenden 20 Jahren, bedarf der Markt einer Auffrischung in Form neuer hoch rentabler Unternehmen.

Die Rede ist von rollierenden Erträgen („trailing returns“), also dem Durchschnitt von Periodenerträgen (Februar dieses Jahres bis März nächsten Jahres, März dieses Jahres bis April nächsten Jahres etc. statt eines einmaligen, für das Jahr möglicherweise weniger representativen Schappschusses wie der Ertragsentwicklung vom 1. Januar bis zum 31. Dezember.)

The bottom line: US stocks have just delivered some of their lowest 2 decades of compounded returns since the Great Depression, and that simple fact explains several macro business trends relevant to the financial services industry.

For example: Point #1: Low returns explain the rise of passive investing and the growth of exchange traded funds. 

...

Point #2: Low returns push equity market structure to become more cost efficient.

...

Point #3: Low equity returns force institutional asset owners to take more risk to make required rates of return (typically 7-10%).

...

Point #4: Low returns also imply a low equity cost of capital, which puts the current share buyback rage in a questionable light.

...

Point #5: In order to start seeing better long run returns, US stocks need a lot of new blood in the system.


The source.

A 865 Point Swing, Short Covering, and Normality

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I am intrigued by the massive volatility associated with the recent lapse into bull market territory. This is an exciting time to follow the goings when markets appear to be involved in a struggle that might descide between (1) a not so dramatic development reflecting slower economic growth and (2) a bearish retreat that will come either in a spurt or linger on for rather a long period.

Writes Michael Snyder:

An 865 point swing in less than two hours is not “normal”.

In fact, it is about as far from “normal” as you can get.

Let’s talk about short covering for a moment. During huge market downturns, speculators often try to make a lot of money very rapidly by shorting stocks. But if momentum suddenly shifts, those short sellers can be caught with their pants down and the consequences can be quite dramatic. The following comes from Marketwatch…

Indeed, market veterans warn that massive, one-day rallies are often more characteristic of downturns, occurring as selloffs lead to significantly oversold technical conditions that leave markets ripe for short covering only to give way to renewed selling once the frenzy of forced buying is exhausted. Investors who short a stock are essentially betting that its price will fall by first borrowing the shares, but those traders can be forced to buy shares back if prices suddenly swing higher, which, in turn, can amplify price swings.

In addition, it appears that on Thursday there was more of the “forced pension rebalancing” that Zero Hedge has been talking about…

It certainly has the smell of a massive pension reallocation as the moment stocks started to surge, bonds were dumped…

No stock market crash in U.S. history has ever gone in a straight line. There are always huge ups and downs during every market crash, and this market crash is no exception.

Ultimately, there is no way that you can possibly interpret the behavior of the market in recent days as “healthy”…

Are Markets Liquid Enough?

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Liquidity is no longer what it used to be. It's significantly down, at least since the beginning of 2018. One of the reasons — perhaps: market dualism. Crudely speaking, there is (1) a regulated but slow market where NBBO is supposed to rule and (2) an unregulated trading realm of alternative trading systems, which may exacerbate market fragmentation and chop up liquidity into unconnected flashes and slacks. 

Liquidity risk — the possibility markets will struggle to absorb selling demand without large price moves — has become a major concern.

Argues Bill Bain:

As the unwind continues, Financial Assets inflated by the free-money effects of QE are still finding new equilibrium valuations. Markets will remain volatile. Tech change and supply fundamentals will continue to shock us – look at oil prices for an example; turning a good year for oil and energy into a question market. Or look at how iPhone sales in India have fallen off a cliff as people buy cheaper phones that do the same – commoditisation! 

The thing that scares me most is liquidity – the lack of it.

While Brian Levine explains his nightmare scenario:

The data is wrong, everything trades at dislocated prices relative to the NBBO, and everyone—justifiably—widens their spreads. That happens almost every time there’s volatility, largely because message traffic increases dramatically. This is due to the fact that the opportunity set is greater and there’s no economic disincentive for sending messages to the market, so more electronic orders come in. This slows the system, widening spreads and generating price dislocations, which triggers even more orders and compounds the delays—a predicament that is only further exacerbated by the fragmentation of the equity markets. As this happens, stocks may trade outside of the NBBO briefly in millisecond or microsecond increments, constituting what I consider a genuine flash crash. All of this becomes a negative feedback loop that causes more volatility. 

Interestingly, if you define a flash crash by the percentage of executions that took place outside the NBBO, one of the largest ones occurred in 2008 after the first TARP bill failed, according to internal analysis we did a few years ago. And the market didn’t snap back, with the SPX closing down 10% on the day and on its lows. I think that may have been why there wasn’t talk of a “flash crash” afterward, but clearly the market structurally failed pretty badly that day, too. This suggests to me that, in a situation with actual bad news, the current US market structure may not be able to handle it, and there could be a downward spiral.

The source.