Todd Harrison: Stocks Caught in the Crossfire

By Todd Harrison  APR 07, 2014 11:20 AM

The second quarter starts with a bang.

 


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I'm learning to fly, but I ain't got wings; coming down is the hardest thing.
-Tom Petty

The Dow Jones Industrial Average (INDEXDJX:.DJI), S&P 500 (INDEXSP:.INX), and Nasdaq Composite (INDEXNASDAQ:.IXIX) are a few percent from the flatline this year but you wouldn't know it given the recent volatility. 
 
Tech stocks, for instance, have been all over the place. On Friday alone, they opened higher and traded more than 130 points lower on the session.
 
Most of the recent carnage has been in the high-beta realm as stocks that were flying high came back to Earth:

Tesla (NASDAQ:TSLA) had rallied 740% since 2013 and is now 23% below that high.

Netflix (NASDAQ:NFLX) had rallied 370% since 2013 and is now 26% below that high.

Facebook (NASDAQ:FB) had rallied 188% since 2013 and is now 22% below that high.

GW Pharmaceuticals (NASDAQ:GWPH) -- the cannabis proxy -- was up a smoldering 855% since 2013 and has now given back more than 42%.
 
Some will paint this price action as bullish -- these stocks have self-corrected while the S&P remains above the all-important 1850 level -- but therein lies the rub of technical analysis: If that zone gives way, and it's being tested today, market-watchers will opine that the highfliers were leading indicators for the rest of the tape.
 
Away from the S&P, supportive sectors haven't been as fortunate; the banks (below BKX 71.50), transports (TRAN 7600), small-caps (RUT 1182) and NDX (NDX 3640) all lost their technical affirmation.  As the stock market is a market of stocks, we should pay attention to what these are telling us.
 
Yes, something has shifted, if only perception. Perhaps the specter of increased regulation of high-frequency trading has some folks spooked.  We've covered this topic over the years -- and more recently here, here,  and here -- so I will be brief as the conversation evolves.  As we said prior to the last crisis, credit of a different breed--that of credibility--is the issue at hand for markets at large.
  
As a big believer that you can't regulate what you don't understand, the question of whether high-frequency trading is legal will come down to the interpretation of the definition of front-running. And while there are clear benefits to HFT (e.g., transaction cost, liquidity), there are also disconcerting elements (95% order cancellation rate) that will be considered.
 
In the end, the market will be the judge, and the court of public opinion will serve as the jury, with the latter matter a hostile crowd. Given the widespread perception of Wall Street in a world where speculators are viewed as profiteers, the notion of risk-free trading results won't sit well with most people, even if it was technical innovation or a loophole in the system.
 
And as regulatory change begins to take shape -- and it will -- unintended consequences will manifest in kind (the "Flash Crash" comes to mind, but that's only the most tangible and obvious result). 

It's too early to know whether dot.com = subprime = HFT in terms of the perceived catalyst for stock-market tops, but one thing's for sure: We're going to find out.

Random Thoughts:
R.P.

Twitter: @todd_harrison

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Author holds position in GWPH.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.

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