What this essentially does is place trading decisions in the algorithms of machines rather than the minds of active investors, ignoring the fundamental value of an asset.
“Basically, right now, you have large groups of investors who are purely mechanical,” Kolanovic said. “They sell on certain signals and not necessarily on fundamental developments, such as increases in the VIX, or a change in the bond-equity correlation, or simple price action. Meaning if the market goes down 2%, then they need to sell.”
As such, a sudden selloff of stocks could hamper liquidity as these algorithmic trading machines are typically designed to shun trading activity when these market drawdowns occur. This can cause what Kolanovic calls a “Great Liquidity Crisis” where the Federal Reserve would have to step in and purchase stocks to shore up the markets as a last resort.
This, in turn, would cause a bout of social unrest not seen since 1968 where the Vietnam War, assassinations of Martin Luther King Jr. and Sen. Robert F. Kennedy made headlines. Kolanovic says that this can be prevented if the Federal Reserve steps in and mandates floor prices for assets to prevent precipitous declines in value.
“If they don’t manage to,” Kolanovic said, “then you’re spiraling into depression, social unrest and a lot more disruptive changes that can negatively affect returns for a very long time.”
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