Watching the Clock
If you broke every hour of the trading day into quarters, none is quite as important—or as vulnerable—as the final 15 minutes. The period just before the U.S. stock market shuts at 4 p.m., when official end-of-day prices are set, is an Achilles’ heel in the otherwise fairly muscular $29 trillion market.
An entire exchange can go dark during normal trading hours without more than a hiccup for the rest of the market, because stocks can trade on any one of 12 official public venues. But at the end of the day, stocks return to their home-listing exchanges, where closing auctions determine final prices that affect millions of trading portfolios and retirement accounts. If a listing exchange fails during that auction—whether by internal error or an outside cyberattack—the backup system gets slippery.
There’s an official Plan B in the event this ever happens. It calls for two of the New York Stock Exchange’s sister venues to back each other up, with Nasdaq in reserve as an additional fail-safe. Likewise, if Nasdaq goes dark, the NYSE would step in as a reinforcement. (The exchanges organize periodic tests of the arrangement.)
But that plan hasn’t been put to the test in a period of extreme market stress, which means unanswered questions remain. Just one example: The NYSE has a group of human floor traders who play a role in the market close, but that system doesn’t exist on the all-electronic NYSE Arca or Nasdaq. (Representatives from the NYSE and Nasdaq declined to comment.)
A mishap in setting final stock prices could spin out to other types of securities, including options and over-the-counter derivatives, says Joanna Fields, principal founder and CEO of consulting firm Aplomb Strategies Inc. “There’s a ripple effect that could happen,” she says.
A couple of recent wobbles have snapped this vulnerability into focus. An almost three-and-a-half-hour outage at the NYSE in 2015—now the subject of regulatory scrutiny—left traders fretting over what would happen if the problem stretched through the close. The NYSE got its exchange running by 3:10 p.m. that day, escaping catastrophe. But this year another error snarled trading on NYSE Arca, the largest exchange-traded-funds-listing venue, derailing closing auctions for some products.
The playbook for handling problems around the close hasn’t been tested enough to be bulletproof, according to Bryan Harkins, head of U.S. markets and global FX at Cboe Global Markets Inc. “We’re certainly not there yet as an industry,” he says. — Annie Massa
The Index Trap
Diversification isn’t always the safety net it appears to be. So says Jared Dillian, who ran the exchange-traded-funds desk at Lehman Brothers in 2008 and is now editor of the market newsletter the Daily Dirtnap, an investment strategist at Maudlin Economics LLC, and a Bloomberg View contributor. “Retail investors who are buying ETFs or indexed funds are being sold on the idea that they’re diversified,” he says. “So if you buy an S&P 500-indexed fund, it’s like ‘Oh, I own 500 stocks—I’m diversified.’ ”
What most retail investors don’t realize, he says, is that the trade is very crowded—like 20 million-other-people crowded. According to Dillian, you need only look back to when commodity indexing became popular a decade ago for a sense of how things could go wrong. “When money goes indiscriminately into an asset class, valuations don’t make sense anymore,” he says. “What happened in the commodity markets is those flows reversed, and that entire trade unwound—and it unwound very quickly.”
Crowded indexes don’t bring about a financial crisis, of course. You have to differentiate between what happens in the stock market and what happens in the economy, Dillian observes. And he says he’s not a “doomsday” guy; he’s just trying to point out that a selloff is a possibility—and that it could be 1, 5, or even 10 years away. “You could have a scenario where this trade unwinds, the stock market is down 30 percent, and we’re still not in a recession—that’s possible,” he says. “I would hesitate to call it a financial crisis, but I would call it an unwind, and if it unwinds, it has the potential to be on the scale of some of the big market crashes.” —R.E.