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Alibaba, Fed, Scotland, Rule 575 send stocks over the cliff

Written By | Sep 15, 2014

WASHINGTON, September 15, 2014 – It’s another Blue Monday on Wall Street today where last week’s weirdness and uncertainty once again reign supreme. The tech-heavy NASDAQ is down a whopping 50 or so points around noon EDT, which seems weird, as Apple (AAPL), one of the biggest components of the Nazz, is up nicely today on record-breaking pre-sales of its new iPhone 6 models.

But any number of things are preying on this market, most notably the upcoming Alibaba [proposed symbol BABA] IPO, the wording (as yet to be issued) of this week’s Federal Reserve meeting summary, the impending Scottish independence vote. And, oh, yeah…today’s the day the Chicago Mercantile Exchange’s (CME’s) new Rule 575 goes into effect.

READ ALSO: Politics, new Apple [AAPL] products, Alibaba [BABA] IPO loom

Alibaba Adventures

But first things first. Alibaba, the Chinese e-commerce answer to Amazon (AMZN), Google (GOOG), and purportedly everything else in the known universe has turned out to be such a must-have IPO that they’ve gone and done what looks like a “Facebook (FB) maneuver.” Today, underwriters upped the number of shares they’ll be peddling to the public — er, the 1% — at an estimated $60-66 price range.

Bloomberg even says the IPO shares could be priced over $70, possibly making a repeat of the Facebook debacle even more plausible.

For more on the exciting and still-evolving Alibaba action, along with an update on our Yahoo! (YHOO) proxy investment, check out today’s special companion column over at our alter-ego, the Prudent Man’s HQ.

READ ALSO: Alibaba [BABA] creates more IPO shares. Facebook redux?

Federal Reserve

On other fronts, Monday’s Wall of Worry mostly involves speculation on what words the Fed will use Wednesday to outline just how much longer we’ll have to wait to see that threatened interest rate increase or whatever Washington will choose to call it.

For the average investor and consumer, it doesn’t really mean a thing, except that at some point, someone besides Warren Buffett and used car dealerships might be able to get a housing loan if they have a credit rating more than 5 points below a perfect 850 score.

But as for the bears, they’re looking for negatives in this statement that will finally put a fork in this year’s improbable market rally, hoping that enough people will get clobbered in an ensuing big-time correction that bearish bets might finally break them even on the year or even better. Maybe they’ll get their wish, but you never know.

Whatever the outcome, trading is likely to remain volatile and nervous until Wednesday’s statement comes out.

Scottish Independence. Or not.

There’s also that Scotland thing. The Scottish independence vote is slated for later this week, and by all accounts, it’s a squeaker.

Until just a couple of weeks ago, no one thought that the independence resolution had an iceberg’s chance in hell of passing. But then, for whatever reason or reasons, polls reported a pro-independence surge so substantial that it propelled that movement into a significant majority.

That, in turn, kicked 10 Downing Street, big British banks, and even the opposition parties to join in a massive lobbying effort to convince Scottish voters that voting for independence would be a very bad idea indeed for all concerned.

We’re not going to explore the vast ramifications of this vote in this column. Although the results either way will be based more on emotion and politics than they will be on money, money will end up being a big part of the results whichever way the voting ultimately goes.

Scotland, if taken as an independent country, is strongly socialist, in bad fiscal shape, and will likely end up worse off than it is now if it votes for independence.


That’s because, as an independent country, Scotland is where all of the UK’s North Sea Oil reserves live. Without those reserves, England itself will have issues. Meanwhile, north of what’s left of Hadrian’s Wall, Scotland, the way we read it, might be prone to do a Hugo Chavez and nationalize the oil fields. What fun for all concerned.

What it boils down to, though, is two things. First of all, what’s left of the UK may no longer be regarded as a world class power with all the international implications you can imagine, including consequences for both Scotland and England/Wales/Northern Ireland. The British pound, and whether or not Scotland will still use it, also becomes a big currency issue.

But political implications are also paramount. Part of the reason Europeans can’t even remotely solve their own fiscal crisis—aside from the persistence in most countries of a clearly failed Euro-socialism—is that when it comes to the Euro, clearly one size does not fit all.

It follows then that if Scotland splits, they may not want to be a member of the EU. Which could encourage longstanding separatist movements in Spain. And so forth.

As Yeats once observed, perhaps we’ll see that the “center cannot hold” in the Eurozone, which could lead to a cascade of consequences, including budding nationalist movements elsewhere in Europe.

Ditto even in the U.S. Although the press no longer reports real news, a successful Scottish independence vote could inspire several U.S. states to more actively speak of secession—especially Texas, which has some claim to opting out of the union under the agreements that brought them in.

What the press has not bothered to notice, either in Europe or in the U.S., is that a substantial number of voters have become quietly but very determinedly angry at bloated central governments that steal and redistribute their hard-earned money while forcing their increasingly out-of-touch views on a public that generally doesn’t share them.

In other words, a Scottish yes-vote on the independence issue could open up a massive can of worms by demonstrating that traditional national boundaries and ties are no longer viable or desirable.

And, as TV show promos like to say, “This changes everything.” It sure does. At least initially, markets will be very upset by this. VERY upset. That’s a big part of this week’s nervousness as well.

Rule 575

The most arcane thing influencing the market as we move ahead is a complex core-dump of verbiage known as CME Rule 575.

For the uninitiated, the company known today as the CME is the umbrella organization that owns and operates the CME, the CBOT, the NYMEX and the COMEX exchanges.

Their new Rule 575, developed to implement part of that hydra-headed Washington legal tome known as Dodd-Frank, is CME’s first stab at reigning in the Gucci-shod armada of high-frequency trading firms (HFTs) who’ve been happily destroying individual investors and many hedge funds alike over the last several years by using algorithms and supercomputer tricks to game the system.

Specifically—and again we won’t go into the mind-numbing details—Rule 575 is meant to put an end to the current barrage of disruptive trading practices and market rigging. Specifically, the rule is primarily targeting the practices of “spoofing,” “quote stuffing,” and the “disorderly execution of transactions.”

Long hostile to the unfair and almost certainly illegal actions of HFT pirates, we’ve done a fair bit of research on this issue, and find that the following definitions of these terms, borrowed from a site called RegulationTomorrow, are the easiest for both the average investor and the Maven himself to understand:

“The Advisory Notice states that Rule 575 prohibits, among other things:

  • Spoofing, including submitting or cancelling multiple bids or offers to create a misleading appearance of market depth, or with intent to create artificial price movements upwards or downwards;
  • Quote stuffing practices, including submitting or cancelling bids or offers to overload the quotation system of the Exchange or to delay another person’s execution of trades; and
  • Disorderly execution of transactions during the closing period.”

Effectively, HFTs overload the quotation systems by blasting in massive amounts of orders to buy or to sell within nanoseconds. Since our home computers are a lot slower with this, we may respond to these quotes with trades of our own—trades that, five minutes later, we may find hopelessly and inexplicably underwater.

Here’s a chart via ZeroHedge that shows how these bubbles of phony trades overload the system. The rightmost vertical illustrates today’s trading thus far, showing a significant though not complete reduction in those likely phony trades that prod we slower computer users into losing money by placing real trades against the phony ones.

HFT chart.

Size of bubbles in this chart indicate points where suspicious large trades or phony quotes from HFTs may be doing their dirty work.

That’s because these huge single or serial trades are frequently canceled before execution, again in nanonseconds. However, given network latency as information travels to our own Macs and PCs, quotes don’t update until all these bogus quotes have cleared the system. In other words, we’re trading against trades that don’t exist. They win and we lose. And we never know what happened.

At any rate, Rule 575 is meant to put an end to this, and we may be seeing the initial results in today’s massive declines, particularly evident in the tech-heavy NASDAQ and S&P 100 (not 500) averages, both of which are hugely down as we write this long piece. These have been the playgrounds of generally bullish HFTs for God knows how long. Now that the game is up, at least until the HFTs and algos figure out a way to circumvent Rule 575, trading in tech, in particular, could be iffier than ever, at least in the short term.

Today’s trading

What all of the above verbiage really means is that with all the money being held back for those Alibaba IPO purchases, fear of the Fed, fear of the Scottish independence vote, and the uncertain implementation of Rule 575 starting today, this week’s markets will be a treacherous mess.

So we’re mostly staying out, except for that YHOO proxy and our still building position in the S&P 500 short ETF (SH) which is meant as a hedge for the rest of our wobbly portfolio and not as an investment.

Terry Ponick

Biographical Note: Dateline Award-winning music and theater critic for The Connection Newspapers and the Reston-Fairfax Times, Terry was the music critic for the Washington Times print edition (1994-2010) and online Communities (2010-2014). Since 2014, he has been the Senior Business and Entertainment Editor for Communities Digital News (CDN). A former stockbroker and a writer and editor with many interests, he served as editor under contract from the White House Office of Science and Technology Policy (OSTP) and continues to write on science and business topics. He is a graduate of Georgetown University (BA, MA) and the University of South Carolina where he was awarded a Ph.D. in English and American Literature and co-founded one of the earliest Writing Labs in the country. Twitter: @terryp17