The Wall Street machine is brokenAugust 2, 2012: 12:12 PM ET
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.
Technology is a great thing until it runs amok. That's the plot line of scores of good (and bad) sci-fi novels and movies. But it's also the sad reality for investors.
The Knight Capital Group trading glitches Wednesday are just the latest example of how an increasingly short-term oriented market can fall victim to colossal computer screw-ups. Knight said Thursday it had removed software responsible for erroneous orders. But the damage is done. The company reported a $440 million pre-tax loss tied to the snafu. Shares of Knight (KCG) lost half their value Thursday, raising some doubts about the firm's future.
I wish that this Long Day's Journey into Knight was an isolated incident. But it's not. Ironically enough, Knight is one of the many firms that were burned by the Nasdaq's (NDAQ) mishandling of the Facebook (FB) initial public offering. Earlier this year, a smaller stock exchange known as BATS was forced to cancel its IPO -- because of technical problems on its own exchange the day it was set to go public.
And we all still remember the infamous Flash Crash of May 2010. The Dow plummeted nearly 1,000 points in a matter of minutes. It's still not entirely clear what caused this event, but many argue that computer algorithms and so-called high frequency trading programs exacerbated the problem.
Technology is supposed to help improve our daily lives and make things more efficient. But it's become Frankenstein's monster for many investors. So many market makers and brokerages are touting ever-faster ways to trade. Knight even has a product with the amusing name of Sumo. (Aren't most sumo wrestlers too big to be fast?) There's an insatiable need for people to execute an order a picosecond faster than the next guy or gal. Every penny counts!
It's hard not to look at the insane volatility on Wall Street and conclude that some of the more sophisticated trading programs are doing more harm than good for average investors. Why should people put money into stocks if they have to worry that some rogue computer (call it HAL if you are child of the 60s or Skynet if you're a Gen X-er like yours truly) can easily malfunction and cause a market crash.
It is understandable why there is a growing sense of distrust regarding the stock market, a sense that Wall Street is a rigged casino where the house always wins. And even though Bill Gross, the bond king of investing firm Pimco, can rightfully be accused of being self-serving after opining about the dying "cult of equity" in his latest letter to investors, he has a point.
Many investors are no longer willing to accept the notion that stocks should outperform other assets over the long haul. And that's unfortunate. I think most people would be foolish to exclude high-quality stocks from any long-term portfolio.
Of course, bonds, commodities like gold, and real estate can all be good things to own for a period of years as well. If history has taught us anything, it's that diversity is key. The easiest way to lose a lot of money is by having a lot of exposure to a small group of similar investments.
There is nothing wrong with the idea of buying strong companies and holding onto them for a period of decades -- as long as these companies continue to grow of course. You probably won't find too many disgruntled shareholders who've owned blue chip stocks like Apple (AAPL), Starbucks (SBUX), Wal-Mart (WMT) or Walt Disney (DIS) for many years.
It is unfortunate that the increasing number of technical trading glitches may scare away investors for good. I can't blame them --- even though I think it's the wrong decision to shun stocks entirely.
What's the solution? I'm not advocating that we turn the machines off and go back the old days of doing everything by phone. Or manually with pen and paper. But Wall Street firms clearly have to take a hard look at themselves and figure out if technology has come too far. Instead of striving for quicker trades, companies should aim to make sure their systems are less prone to fail and bring down entire markets.
Unless the Knight debacle is treated as a true wake up call on Wall Street, we're likely to see another incident like this again in the not-so-distant future. Heck, it may even be Flash Crash 2: Electric Boogaloo.
For the brave few of you out there who still invest with a time horizon beyond the next half hour -- Wait. Did someone in Spain just cough? Sell sell sell! -- I wouldn't blame you for completely abandoning the market for good if you get screwed yet again. Enough is enough.