Do you remember the famous “Ballad of John Henry?” According to folklore, John Henry, the greatest steel driving man alive in the late 1880’s, took on the new steam steel drilling machine to show that no machine could beat a man. Unfortunately, John Henry lost and died. The ballad was an allegory to the rise of machines and perhaps the descent of man. It was a pretty sad day when John Henry keeled over, and to me, it’s a pretty sad day to see that Paul Tudor Jones, the proverbial Babe Ruth of macro trading, is giving into the machines. This week, Tudor Jones laid off 15% of his fund’s employees and made significant changes to the management of his main fund. Mr. Jones wrote this in a letter to investors:
“We have to think outside the box. I firmly believe the changes we have made put us in a position to be successful even in this desultory macro environment.”
Mr. Jones’s fund will, according to Bloomberg News, pair some of its traders with scientists and mathematicians to bring new analytical rigor to their trading as part of a quantitative revamp of the firm.
This is sad day, indeed. I can’t think of stronger evidence that the fundamentals of the financial markets are completely broken than this news from Tudor Jones. Mr. Jones has made himself a billionaire by trading the fundamentals of the macro economic and financial environment for at least 30 years. His description of the macro environment as “desultory,” or disconnected, is spot on. For macro traders, there used to be a marketplace where a “disconnect” was viewed as a trading opportunity. Traders like Tudor Jones were once the shock absorbers. If a particular market was going too far, too fast, and too soon, they would step in and take the other side. They were important. Dealers had some degree of confidence that there was somebody big on the other side when things got out of hand. Now? Anyone who was trading bonds October 15, 2014 when the infamous “Flash Rally” occurred knows the utter shock and horror when “the machines” take over.
On that morning, an economic report came out that the economy wasn’t perhaps as strong as many market participants thought. Many (including myself) were set up for lower prices (I was short 10-year notes), so when a slew of data came out weaker than expected, traders who were short, prepared to buy back bonds. However, the machines beat humans to the punch. The only participants selling were the poor dealers whose electronic trading platforms were getting lifted out of bonds faster than the trading desks could pull the plug on them! The 10-year Treasury note dropped about 40 basis points in about three minutes. Jamie Dimon, CEO of JPM Chase, said this about the Flash Rally, “Treasury securities moved 40 basis points, statistically seven to eight standard deviations, an unprecedented move, an event that is supposed to happen only once in every three billion years or so.” Events like the Flash Rally shook the dealer community to its core. The amount of capital and liquidity market makers provide has dropped significantly. Moreover, market makers now talk openly about deploying their own algorithmic trading programs to counter their algorithmic clients.
This does not bode well for financial markets in my opinion. Combining the manipulation of the world’s most important markets for bonds, stocks, and commodities by central bank monetary policy, with a marketplace increasingly dominated by machines, can make financial markets susceptible to unacceptable levels of volatility. Eventually, extremely volatile financial markets seep into the real economy. The financial markets were always partially a high stakes game. However, the markets main reason for existing is to serve as the circulatory system for the world’s economy. It seems the trend now leans strongly toward the markets being a game, and that is not a good thing for the global economy.
Member SIPC & FINRA. Advisory services offered through SWBC Investment Company, a Registered Investment Advisor.
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