Stock market calm is due to computer trading

I have remarked in the Control Panel posts that I’m surprised that the stock market is so calm, considering the potential debt ceiling crisis, Federal Reserve tightening which could cause a recession and a banking crisis that could return. Apparently it’s because computers have nerves of steel…or at least copper.

Why Are Markets So Calm? It’s Revenge of the Quant Funds

Firms that use computers to determine buy and sell signals have been loading up while other investors sit back

By Caitlin McCabe, The Wall Street Journal, Updated May 29, 2023

The U.S. stock market is surprisingly calm right now, especially in the face of the debt-ceiling fight. A key reason: a growing divide between mainstream investors, who have largely been sitting out the 2023 stock rally, and the machines whose buying has been driving it…

Quant funds, or those relying on computer models and automated trading, have been doubling down on equity markets as other investors have stepped back, citing high valuations and concerns about the likely course of the U.S. economy.

Quant-fund buying has pushed these funds’ net exposure to U.S. stocks to the highest level since December 2021, according to data from Deutsche Bank. Mainstream investors, in contrast, have been pulling cash from stock funds and pouring it into money markets…

Driving the quant funds is a self-reinforcing dynamic. When market volatility drops, they pile in more. Big stock-market moves subsided this spring after regulators rushed to stem the banking crisis and the Federal Reserve signaled it might stop raising interest rates soon…

The dominance of quants has helped explain previous periods of calm trading, including long stretches in 2017 and 2018. Those periods were punctured by rapid selloffs, including the 2018 selloff dubbed “Volmageddon” when the dynamics exerting calm on the market suddenly went away. Some warn a repeat could be ahead…[end quote]

Computers are programmed to mechanically follow market moves without considering Macroeconomics, valuations or other fundamental factors. So-called vol-control and risk-parity funds tend to automatically load up on riskier assets during calmer periods. Other quants, such as trend-following CTAs, or commodity trading advisers, simply follow a trend and reinforce it.

This makes me even more cautious about putting new money into the stock market at this time.

  1. VIX has spiked many times when the markets got nervous. It doesn’t take a world-shattering financial crisis to make VIX spike over 20. The same computers that bought high-risk stocks when VIX was low will dump them when VIX spikes. That could exacerbate a downdraft. If the debt ceiling deal that has been agreed “in principle” doesn’t get passed and signed within a week VIX will surely spike.
  1. The rise in the S&P500 and NASDAQ indices are due to rise in the price of a few tech stocks which have been volatile in the past. The support of stock market calm isn’t broad-based and could evaporate quickly.

  2. Stocks are still overvalued, core inflation is still high and not dropping, the Fed is still doing QT and the markets could be wrong about the Fed cutting rates by the end of this year.
    Shiller PE Ratio

As always, I will keep a close eye on VIX in the Control Panel. A VIX over 50 coupled with a St. Louis Fed Financial Stress Index over 2.5 is a sure sign of a generational-scale financial crisis (2009, 2020). A VIX over 30 coupled with a St. Louis Fed Financial Stress Index over 0.5 is correlated with significant stock market distress.

The St. Louis Fed Financial Stress Index hit 1.5 the week that SVB collapsed which is why the Fed took immediate action to set up a facility to protect the regional banks.



The markets can move upward on very little. This can be a bit of baby boomer selling of retirement assets picked up by Quants run by Millennials. In the long run the correct thing to do. That does not preclude another downward run in the markets. The Quants may sound like trading machines but buying into longer term asset positions can be on their radar as well. Buffett will buy the company often at any decent price not at the bottom as a necessity.

We are looking for yield. Odds are we get it.

How much capital, and whose capital is in these “quant funds”? Somehow I don’t think there is that much relative to the size of the markets.

I have a different theory about the general stability of the markets. I think it may be due to options markets become very efficient. Today, due to that efficiency, for every action in the market, there is the potential for an equal and opposite AND TIMELY reaction by those who feel that action is unwarranted. Therefore, if the market consists of rational actors, and it does for the vast majority of cases and times, then at any given time there are thousands, tens of thousands, hundreds of thousands, of such opposite reactions, and that leads to the general stability we are seeing. That said, it is indeed computers, and perhaps partially computer directed trading, that enables the timeliness.

Now, obviously, in times of widespread panic, there are rapid actions that don’t have opposite reactions, because almost everyone is panicking. For example, sudden exogenous events (9/11/01 for example) can cause this kind of thing.


That has all been true for a long time now. There are still varying degrees of extremes.

The problem is as true as it is it does not explain the valuations right now.

I do not fully believe we need that explanation. But I believe keeping a thumb on the pulse of the market matters a great deal.