I, Robot

iRobotScience fiction has long been fascinated with the concept of robots.  The godfather of the genre, Isaac Asimov, even codified the rules of robot behavior as the “Three Laws of Robotics” (often shortened as the “The Three Laws”).  Many authors foresaw a time in the future where robots might become hostile to humans (the Terminator movies are based on this concept), and The Three Laws were Asimov’s way of assuaging this concern.

Here are the three laws:

  • A robot may not injure a human being or, through inaction, allow a human being to come to harm.
  • A robot must obey the orders given by human beings except where such orders would conflict with the First Law.
  • A robot must protect its own existence as long as such protection does not conflict with the First or Second Law.

Many science fiction fans are likely disappointed that our world does not feature robots as depicted in the popular stories.  Apart from the limited-use robot made by companies like Honda (see picture), most of our robots are on the factory floor making welds and fabricating metal components.  Concern over robots harming humans is not a top ten worry on anyone’s list.

Yet, I wonder….

When the market began its rapid decline in August, commentators were quick to assume that worries about China were driving share prices.  As volatility increased, further analysis uncovered additional fears about the timing of a Fed “lift off,” weakening corporate profits and so forth.  The prime assumption to all of this “analysis” was that human behavior was driving the action in the markets.

I was part of this chorus as well.  I opined that some investors in an abundance of caution may have sold just a little bit, just in case China becomes a bigger problem.  If many people sell just a little bit, it could lead to the downward pressure we saw.  We all crave a simple answer to something we see happen in the market.

We now find that the story is a bit more complicated than we thought.  At the heart of this recent spate of volatility may be robots, and they obviously were not heeding The Three Laws.

Investors and traders have been using quantitative analysis for many years.  Every investment bank, hedge fund and large mutual fund no doubt has many math PhDs working for them, trying to find some kind of edge.  Many of these schemes can be employed by a large number of investors, leading to massive pools of money being invested this way.  Because these decisions are largely driven by the software programs (robots?) embedded in them, they will buy/sell assets without much human input (other than the original programming).  These schemes come in many varieties, such as “volatility targeting strategies” or “risk parity,” but they all have the common goal of making money no matter what the market does.

It seems that as stock prices began to fall, many of these programs (robots?) responded by selling more stock.  This additional selling pressure no doubt encouraged human traders to join in the selling chorus.  Bam!  The Dow Jones goes down 1,000 point in one day.  Why then did the market turn so quickly and move higher so soon?  The robots concluded stocks had declined enough to buy again.  Here too the collective force of this buying propelled stock prices higher.  In calmer markets, these strategies are likely to provide some small amount of incremental gains to those who use them, but they can be the cause of increased volatility in unsettled times like these.

I am not suggesting that the market is somehow messed up by these trading schemes.  However, I do think that much of the recent volatility may be technical and not fundamental. This kind of market action is upsetting, but remembering one’s long-term goals can help us weather any kind of short-term storm.

And be sure to keep a careful eye on your iPad for any signs of sentient behavior…