Jay Powell was Spot On - the AI/Algo's Over-React & Throw a Temper Tantrum, Good for the Investor

What You Need to Know Today

• Jay Powell was SPOT ON– even though some think otherwise

• Algo's over react (again)

• Cooler heads will prevail – Markets need to hold right here to calm down

Ok – so today we have to have a broader conversation......in this piece ‘they an them' are the next generation AI/Algo traders and not ‘gender neutral' people that use they and them as their pronouns.

When rates go up ‘they' throw a temper tantrum and sell the mkt and now apparently when rates don't go down at ‘their' insistence then ‘they' sell the mkt again.....never happy nor never satisfied – so how do you calm ‘them' down? How do you get ‘them' to grow up and act like men (or women). So here is where I have to date myself just a bit – the problem is that ‘they' have become way to dependent, way too comfortable, ‘they' think that the FED works for ‘them' in fact ‘they' think ‘they' ARE the FED. Back in the 20th century -and I am talking about the late 1900's (think 80's and 90's) – the FED would come out on Thursday mornings at 8:30 am, they would open the door, step out on the podium, make THEIR announcement about what rates were doing (or not) and then they would turn around, step back behind the door and CLOSE IT.....they wouldn't ask for anyone's permission to change rates, they wouldn't ask you to lay down on the couch and take a Xanax to ‘talk about it', they wouldn't ask your opinion, it was not the FED's problem at all.

Wall St and all of the participants were supposed to listen, understand and then make a thoughtful, methodical, balanced decision about what the policy meant and how it would affect the economy. PM's and traders would then make the next decision and either buy or sell stocks based on this thoughtful process. The mkt would not have had such a reaction because there were humans involved, humans who made decisions on what to sell and what to buy, humans that then handled those ‘decisions' and executed them accordingly. Stock orders were then transmitted to the NYSE – the nations premier public mkt – where buyer and seller met out in the public square, announcing bids or offers and making a mkt...... (let's leave the Nasdaq mkt for a later discussion – because that structure had its own problems... – but that is a story for another day). Orders were fully and properly represented at the point of sale where anyone with an interest in that stock had an equal opportunity to buy or sell it. Increments of 12 1/2 cts or 1/8ths of a dollar kept trading in line as there were only 7 price points between full figures......so between say $20 and $21 there was an 1/8th, ¼, 3/8,ths, 1/2, ,5/8ths, ,3/4's & 7/8ths , brokers actually thought about their next move and didn't haphazardly just ‘hit the button' causing chaos and destruction. In today's sub-decimal massively fractured environment – there are essentially 1000 price points between $20 and $21. 1000 price points! .0001 , .0002, .0003, .0004...........all the way to .9999. A structure that nurtures and allows this ridiculous and ultimately chaotic AI/algorithmic behavior. Which begs the question – how many exchanges is enough? Currently we have 10 ‘exchanges' and about 40 or 50 ‘dark pools or venues that are NOT exchanges that still allow for transactions to happen causing undue stress and chaos on the system – but that is a story for another day.

Back to the yesterday....

None of ‘them' would have challenged the FED or publicly admonish the FED for their work and leadership – it was an institution that operated independently of Wall St – The brokers on the street were supposed to just deal with it and move on...the problem today is that everyone apparently thinks they are the FED Chair – that they get to make the call and drive the economy – the problem is that the artificial intelligence (AI) and the automated algorithmic trading robots that exist today have completely destroyed the system (point in fact – October 2018 – December 2018) and in fact the ‘super' rally that has since taken place is also a direct result once again of AI and automated trading – which has taken the averages up a years' worth of moves in just 4 months – because ‘they' assumed now that the FED's next move was a CUT - which appears to be another problem..... and ....so the mkt treaded water most of the day.....I mean take a look at the chart – from the opening bell until basically 2 pm – the S&P traded within a 9 pt range and for most of the morning remained between +6 and +9 pts....until the 2 pm press conference.....and that's when you see the algo's and the automated HFT crowd throw a temper tantrum....when Jay Powell didn't CUT rates in the opening statement – that was it......they had enough and BOOM – let's hit the sell button – "We'll show him!"........and by the end of the day the Dow gave up 162 pts or 0.61% - the S&P lost 22 pts or 0.75%, the Nasdaq lost 46 pts or 0.57% and the Russell 2000 gave up 15 pts or 0.93% and in a real show of disgust the Transports lost 185 pts or 1.71%!

Now let's also put it in perspective.....the nearly 1% move in most of the indexes is NOT the end of the world by any stretch – but what should concern everyone is that the algo's and the AI that drives them are now in control of the process and if ‘they' create enough pain the FED will cave.... Does the 22% mkt meltdown in 2 months last year suggest that just maybe we should take a look at mkt structure? Or are we now so immune to the lunacy that this is what we get?

Look CNBC runs with a piece this morning....."Here's the ONE word that has people raising their eyebrows" TRANSITORY vs.PERSISTENT – so as CNBC points out that one word caused the AI that runs these programs to go from loving the mkt at these valuations to hating it? It is what ‘they' call SMART ALGO LOGIC –(I might have another name for it – but let's not go there right now) And here is the other issue with this whole thing........

"Traders have been speculating that recent weaker inflation readings would concern the FED so much that it would CUT interest rates later this year"

This is the latest driver that has pushed mkts up double digits in %age terms – the expectation that ‘they' speculated and wanted the FED to cut rates vs. leaving them alone or God forbid raise them. Because the FED considers low inflation as transitory – they are crazed....so they stamp their feet, and scream and yell that the FED doesn't know what it is doing.....Enough already......grow up and deal with it. The US economy is running on all cylinders, job creation is good, wages are rising, manufacturing is growing, macro data is robust, trade deals are happening, interest rates remain at HISTORIC lows, the internet has changed the world, and automation of production and services has changed the very structure of the economy so maybe this IS the new normal, maybe this is what it is and maybe inflation is under control.....maybe..... and maybe the FED should not have caved back in January and announced "NO HIKES" maybe they should have just left it and then just not hiked when the time came, maybe the FED should stop being so transparent and explaining their every move....but the problem is now that ‘they' think they control the FED – if they scream and yell enough, then the FED will cave – its like the ‘terrible two's' all over again.....just sayin' ‘THEY' would never have survived in the 20th century. Period.

OK – now I'm done with that.....so what's next....under this scenario – Will the street still assign a 17 multiple to the mkts going forward on S&P 500 earnings of $181 (consensus 2020 EPS)? Maybe not, so what is it? 16 x's and if so that means that the target is more like 2,896 or about 40 S&P points lower from where we are right now....which would still the leave that index up nearly 14% and if ‘they' decide to assign a 15 multiple to the mkts then the target is 2,715 – or 7% lower from here.....cutting the years gain to only 9%.....so you see what I mean....what happens to the mkts if the FED does nothing and remains neutral? And if they get more hawkish? (raise rates) And if they get more Dovish? (lower rates). Those are the questions to ask and answer....and like I said in yesterday's note....

"Now look, though, let's be realistic here......you have to expect that the mkt will turn a bit, consolidate, sell off, re-group, which only means you shouldn't chase stocks even higher....now the algo's will, because they are programmed to follow a mathematical formula, and when the tone changes, watch how fast the algo's will turn"

and case in point? Yesterday's reaction to Jay Powell. And for the record, I think Jay Powell did exactly as he should have, he defined the issue and then explained the FED's thinking and executed it – it is NOT his problem how ‘they' react. So again – as a long term investor I would tell you to remain dynamic (active vs. passive), peel money out of names that have now overweighted your portfolio and put it to work in names that remain underweighted and remember – you can remain patient until the storm passes as well, but when some names get unnecessarily punished – don't let that slip away.....again recall how the algo's created chaos AND OPPORTUNITY for those who were patient.

US futures are mixed this morning.... Dow futures are down by 13, the S&P is up by 3, Nasdaq is up 11 and the Russell 2000 is flat. Eco data today includes Init Jobless Claims of 215k, Cont Claims of 1,660k, Unit Labor Costs of +1.5% (this will be a key one to watch), Factory orders +1.5%, Durable Goods and Capital Goods Orders and Capital Goods Shipped.

With no FED speaker events today – we can expect the media to dissect and spit out everything that was ‘wrong' with the press conference yesterday....and how Jay could have or should have said what he said....whatever....The key today is if the mkts can hold onto the closing level last night – S&P 2,923. If it fails here then expect ‘them' to pile on and send the mkts lower.....buyers will be around but they will not stand in place to get run over.....and the move lower always happens faster...just sayin... If the mkt holds here then we might get cooler heads to prevail and recognize that holding rates is not the horrendous decision ‘they' made it out to be. But again – remember the S&P is UP 16.6% ytd.....where do you really think its going? Food for thought.....