On April 28th of this year, Carl Icahn (a billionaire hedge fund manager) announced that he sold his entire stake in Apple. He said, among other things, that he was worried about China and cautious on the U.S. stock market. No big deal you would say. Sure: it might be bad for investors’ confidence in Apple, knowing that a man with a history of successfully anticipating the stock market shows not to have confidence in their company. But it would certainly not affect an apparently totally unrelated European company, such a BMW, right?
Wrong. Via a complex set of relations, it does. Stocks worldwide are closely interconnected; even though the rationale behind these relations might at best be hard to find. Let’s for example track the chain of events that caused BMW to decline on the 29th of April.
Icahn announced him selling his Apple shares on the 28th of April, after European trading hours (i.e., when the European markets were closed). Following his statement, Apple’s stock fell from $97.5 to $94.5 – around 3%. Apple, being the biggest company worldwide and the largest component of the S&P 500 index, to a large extent determines the S&P 500 index. So if Apple goes down, the S&P 500 goes down. Hence, after the announcement, the S&P 500 index declined from 2095 to 2075.
Now we arrive in Europe. European algorithms detect the decline in the S&P 500, and – being programmed to arbitrage around a positive correlation between the S&P 500 and the German DAX index – sell the DAX index future (possibly while going long the S&P 500, so called ‘statistical arbitrage‘). The result of the selling? The DAX index future plunges from 10321 to 10038, or +- 2.7%, an extraordinary big intra-day decline for the DAX.
Other algorithms, detecting the DAX index future to fall, and arbitraging around a relatively stable premium between the future and the index, sell-off the funds making up the DAX index, thereby causing the DAX index (which is just a collection of stocks of big German companies) to plunge accordingly. Since BMW is part of the DAX index, algorithms sell the BMW share. This causes BMW to decline from 83.94 to 80.5, more than 4%, a significant decline.
Hence Apple causes BMW to decline. See figure 1 for a graphical depiction of this chain of events.
You might think this chain of events is too far-fetched. That it is some kind of conspiracy made up in a desperate attempt to explain what is in fact impossible to explain. But I doubt it. On the 28th and 29th of April, nothing exceptional occurred (besides the Apple event), or at least nothing that would justify a 2.7% fall in the DAX index. Usually, given a decline of this sort, there must at least be one relatively big event to which the decline can be ascribed. Hence in this case we have no better explanation for the plunge than Apple’s stock falling. Furthermore, assuming that algorithms do the tasks I described above, which are strategies known to be followed by algorithms, this chain of events is nothing but an utterly logical consequence.
Algorithms of course don’t care about Icahn’s opinion of the Apple stock, or the stock market in general. But what they do care about is relations between financial products, since this is where they make their profits. And it is by profiting from any significant deviation from historical relations between financial products that they keep intact such relations, and form the intricate web that is the stock market.