The Way The Game Is Played These Days May Surprise You

Call it a pullback, a pause, a consolidation, the beginning of a correction, a dance to the downside, an outside day, a failure at resistance, a near-term reversal, a pivot or a good old fashioned sloppy session.

But whatever label you prefer to slap on Tuesday's algo-induced decline, it appears that a test of near-term support is now in order and that the bears may have gotten up off of the mat Tuesday.

The problem with a day like Tuesday is there wasn't an obvious catalyst for the fill-in-the-blank session. The popular press blamed China, the Ukraine and worries about the action in the industrial metals for the decline (apparently Dr. Copper (NYSE:JJC) is having a really rough go of it lately as copper plunged to a fresh multi-year low on Tuesday).

Blame It On...

But before you agree with the assessment that it was the excuse du jour that caused traders to hit the sell button early and often on Tuesday, it is important to recognize that there were no new developments on either the China growth or Ukraine front yesterday.

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And for the record, the death spiral taking place in the industrial metals didn't exactly begin on Tuesday morning.

Fannie and Freddie...

Then there were Fannie and Freddie. Another problem cited for Tuesday's downside turnabout was the horrific action in Fannie Mae and Freddie Mac.

Federal National Mortgage Association (Fannie Mae) Daily

The above chart shows you what a 31 percent decline in what was once the country's most important mortgage financing institution looks like. Fannie Mae's stock was nearly cut in half in a little over an hour Tuesday after the Senate Banking Committee reached a bipartisan agreement on the framework to eliminate Fannie and Freddie, and to reform the U.S. mortgage financing system.

Given the lack of catalysts available Tuesday, one couldn't be blamed for thinking that this type of destruction in the financial sector might have triggered selling in the major stock market indices.

The funny thing here is that while the headline-reading algos do love a good news flash, the details of reforms coming out of the Senate Banking Committee couldn't really be considered news. According to reports, there was a broad consensus that the bill would call for the unwinding of Fannie and Freddie. So, sorry to say, even a dive of -46 percent in just 90 minutes isn't the reason the bears returned to the corner of Broad and Wall yesterday.

Or The Algos...

In fact, if you check the action on a one-minute chart of the S&P 500 (NYSE:SPY), it will become clear that none of the catalysts being promoted as the source to yesterday's decline match up with any of the persistent sell programs that began at 11:00 am eastern.

The first program hit the market for 12 quick points as the SPX fell from 1882 to 1870 in short order. This wasn't exactly surprising as the new game amongst the big HFT/algo players is to hit the index with sell programs each time a new high is made and/or attempted. So, with the SPX briefly moving above 1880 at 10:59 am, the sell algos arrived like clockwork and down she went.

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Given the success of the initial "attack" on the SPX, it appeared that the sellers gained some momentum. You could hear the word "reversal" being bandied about amongst the fast-money types. And from there, new sell algos hit the tape every half hour or so.

Who Really Cares Anyway?

What's the point in rehashing the blow-by-blow of a modest decline when the indices were overbought and sentiment was perhaps a bit frothy, you ask?

The answer is simple. Yes, stocks had become overbought. Yes, as we've chronicled of late, the sentiment indicators have been flashing warning signs. And yes, it appears that the market was set up for a pullback.

The problem is (a) there was really no obvious reason for stocks to decline on Tuesday and (b) the action was clearly algo-driven. So, either the big boys with their expensive computer toys knew something the rest of us didn't - or - the computers simply pushed the market around again yesterday.

The bears will argue that stocks simply fell of their own weight and that it was the technical reversal that was the real key to the pullback. And on that note, our furry friends weren't shy in offering the opinion yesterday that the action does not have positive implications for the near-term.

It's The Way The Game Is Played...

However, having been a player in this game for more than 25 years, I can say that stocks tend to reverse course for a reason - and there simply wasn't much of reason on display yesterday. So, while this is simply one man's opinion, yesterday's action may just be an example of the way the game is played these days. Sometimes that action means something and sometimes it just doesn't. As such, it will be interesting to see where we go from here.

Positions in stocks mentioned: SPY

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