The Mighty Machines

Machines were, it may be said, the weapon employed by the capitalists to quell the revolt of specialized labor.
-- Karl Marx

With some big gains in the second quarter of the year, money managers are under a lot of pressure to show good relative returns as things wind down. No one likes to be accused of missing out, so we usually see a strong propensity to try to add some performance before the quarter ends. Typically this is done by chasing some of the big, fast-moving stocks, but it also helps to create a generally buoyant atmosphere like we saw on Thursday.

After some unenthusiastic action following the Fed on Wednesday, the buyers were off and running on Thursday. Breadth was extremely strong all day and buyers even jumped in on a minor late-day bounce. There were some very big moves back up in momentum stocks that had broken down recently as the bears just stood aside and let things run.

Today we add another factor that should have a major impact on trading -- today's the day the Russell indices are rebalanced. This rebalancing has caused some very unusual action in the past. It isn't just a matter of buying and selling the affected stocks at the close. We will see a bunch of big blocks cross the tape at the close, but the shares that are being added to and subtracted from the Russell indices will have already been bought and sold to a great degree using various hedging and other strategies. The machines will be at work, and we'll be at their mercy to a great degree.

In the past I recall seeing some huge program trades kick in intraday that suddenly jerked around many of the small-cap stocks being added to the Russell 2000. You will see some unusual volume patterns in these stocks throughout the day, and they can be quite misleading as you review charts and look for trades.

A lot of folks try to game the rebalancing, so add to the volatility as well. For the Russell 2000, about 500 stocks will have lots of shares bought or sold; for the Russell 1000, about 100 stocks will be very active. You are going to see a lot of these names pop up on your screens due to the unusual action.

Keep in mind that when you combine the Russell rebalancing with the end-of-quarter window dressing, you end up with some very crazy action. Don't try to read anything significant into it -- it has nothing to do with big-picture fundamentals. There will be a lot of computer-driven action, and a lot of it will be very random. I would be surprised if we didn't have a major swing in the indices late in the day today.

We have a quiet start setting up, but it shouldn't stay that way. Be ready for some volatility, especially in the smaller-caps, and just remember it is the machines that are in control.

---

Know what you own: Stocks being added to the Russell indices include American Italian Pasta (AIPC - commentary - Trade Now), Benihana (BNHNA - commentary - Trade Now), Caribou Coffee (CBOU - commentary - Trade Now), Carmike Cinemas (CKEC - commentary - Trade Now), OpenTable (OPEN - commentary - Trade Now), Revlon (REV - commentary - Trade Now) and TravelZoo (TZOO - commentary - Trade Now).

ALL REV SHARK BLOG ENTRIES | POST A COMMENT | READ COMMENTS  

---

James "Rev Shark" DePorre is the author of Invest Like a Shark: How a Deaf Guy with No Job and Limited Capital made a Fortune Investing in the Stock Market. He is founder and CEO of Shark Asset Management, an investment management firm, and he also operates sharkinvesting.com, an interactive online community that serves and educates active investors. DePorre holds business and law degrees from the University of Michigan, is a member of the Michigan Bar Association and a former tax attorney and CPA. He lives in Anna Maria Island, Fla., with his wife and two children. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Rev Shark appreciates your feedback; click here.