The Hardy Boys and the case of the missing zero
A "slight" error in Lyft Earnings caused the stock to move +67% in minutes and then crash back down once the CEO realized his "mistake", highlighting the serious problem with algorithmic trading.
LYFT ERROR CAUSES EXTREME STOCK FLUCTUATION
A very interesting thing happened on Tuesday. A “typo” in the earnings report by ride-share company, LYFT. The report stated that the gross margin increased by 500 bps or 5%, when in reality it was 50 bps, or .5%. This error caused the Algorithmic trading programs to immediately bid up the share price to astronomical levels. Then crash back down once the CEO corrected the information. One missing zero on a report created billions of dollars in fake gains, and losses.
Here is how it was reported in the New York Post:
A typo in Lyft’s earnings report overstated a key profit metric by a factor of 10 — sparking a 67% spike in its stock late Tuesday before management corrected the goof and sent the shares tumbling.
Late Tuesday after the close of regular trading, the ride-hailing app told investors in an investor slideshow that its gross margin was expected to rise by 500 basis points — or 5% — this year.
On a conference call later, Lyft CFO Erin Brewer quickly backtracked on the forecast, telling analysts there was an extra zero in that figure and that the increase actually would be just 50 basis points — or 0.5%.
“This is a debacle of epic proportions,” Dan Ives, managing director at Manhattan-based wealth management firm Wedbush Securities, told The Post.
This error and subsequent rapid market reaction begs the question of how human traders can compete with algorithmic trading. Here, they were programed to bid the stock based on the numbers presented, however, a human trader could have seen that a 500bps increase in gross margin was likely an error. A savvy trader could have capitalized and shorted the ride from +67% all the way down, or at least could have stayed out of the way.
THE MARKETS ARE BROKEN
In my opinion, algorithmic trading and passive investing are leading to extreme discrepancies in the markets. The wild fluctuations on every minor piece of news and the very simplistic model of “if x, then do y”, is causing severe distortions in the market place that can be taken advantage of.
A lot of money has been made by taking the opposite trade on the overreaction of algorithmic trading programs. There have been many instances of company earnings being pushed into extreme losses or gains that have been amazing buying/ shorting opportunities if you took the opposite side of the extreme move created by algorithmic trading programs.
In addition to algorithmic trading programs, the popularity of passive investing has severely distorted markets. Generally, the idea of a “market” and “value”, is that investors buy stocks they think are undervalued and sell stocks they think are overvalued. Passive investors however, purchase an index and do this every month without looking at what stocks they are buying or their value. This forces the largest stocks to get even larger and grow outside of their actual value. This is why the so-called “Mag-7” stocks are making almost all the gains in the s&p 500. Historically this concentration of stock growth in a few companies has precipitated severe stock market crashes.
David Einhorn, famous hedge fund manager agrees with my assessment that passive investing and algorithmic trading are fundamentally skewing the market.
“I view the markets as fundamentally broken. Passive investors have no opinion about value. They’re going to assume everybody else has done the work.”- David Einhorn, February 8. 2024.
It has been an interesting week as CPI and PPI, both measures of inflation have come in much HIGHER than expected. The CPI report issues Tuesday morning caused a steep correction in markets leading to the first -2% drop in months. However, traders, assuming the Fed will have to cut rates regardless of high inflation, bought the dip and the market replaced the correction in just two days.
The market is assuming that the Federal Reserve will lower rates regardless of the inflation prints. I think this assumption is incorrect. The market had priced in a total of seven rate cuts at the beginning of the year, that has now corrected to only three. However, with the price of oil rising, yields increasing, and markets flying to all time highs in what can only be described as a mania, I find it difficult to see how the Federal Reserve has any credibility to lower interest rates. If anything, interest rates will INCREASE absent the Fed’s ability to keep inflation down. The market has not priced this in yet.
With record high valuations, concentration in a just a few high-flying stocks, and inflation increases tampering the Fed rate cut chances, I cannot shake the feeling that we may be setting up for a serious disaster. However, this time may be different.
Enjoy Your Weekend Everyone!