Markets

Where are the Circuit Breakers?

Black August wasn't supposed to happen until much later or even at all. That's what Wall Street's gurus have been telling us. They certainly didn't see this coming and how could they? They've been on vacation in the Hamptons.

Meanwhile, precious metals (NYSEArca: GLTR) and long-term U.S. Treasuries (NYSEArca: TLT) are surging. Why hasn't the violent sell off in stocks (NYSEArca: VTI) been interrupted with any circuit breakers or trading halts? Before we answer that, let's delve into the unimportant topic of corporate earnings. (We say 'unimportant' because that's how the stock market is treating the subject of earnings right now.)

Do Earnings Matter?

Despite a 17 percent drop in 15 trading sessions for the S&P 500 (NYSEArca: SPY), Chief Strategists remain bullish. Goldman Sachs ( GS ) and Barclays (NYSE: BARC) expect the index to end 23 percent higher (from 1,140) to around 1,400 by the end of 2011. Last year they stuck to their guns and we're proven right, but will this year be different?

The primary thesis behind S&P 1,400 by year-end is that good earnings will lift stocks. For third-quarter results, 75 percent of reporting S&P companies have topped profit expectations on increasing sales, according to Bloomberg.

Despite this, the stock market is signaling a double dip recession. Oddly, this urgent memo still hasn't yet reached any of the desks at the National Bureau of Economic Research. According to their members' slide rulers, we haven't been in a recession for a few quarters. Are they serious?! That's why it's best to listen to the mother of all leading indicators (the stock market) and to tune out the out-of-touch academic mumbo jumbo.

Is the South Korea 'Solution' coming?

Financial regulators like the Securities and Exchange Commission (SEC) are closely watching the stock market's erratic behavior. And if stocks keep sinking, don't be surprised to see them implement the South Korea 'solution.' What is it?

In response to falling stock prices, South Korea's Financial Services Commission just banned the short sale on all stocks until November 9. The country's regulators already had bans against short selling in publicly traded financial companies.

If a similar move happens in the U.S., it would ape the South Koreans and be a repeat incident of 2008. It was then that the SEC placed a temporary ban on shorting financial stocks. At that time, the intense selling was on banking (NYSEArca: KBE) and financial shares (NYSEArca: XLF). But this time around, the selling has reached global proportions (NYSEArca: VB). Could we see a situation where the SEC bans short selling on a broad swath of stocks?

Q3 Circuit Breaker Levels

The reason trading curbs haven't yet kicked in, is because none of the stock market's declines have violated single day thresholds. Each quarter, the New York Stock Exchange (NYSE) calculates and sets circuit-breaker levels as 10, 20 and 30 percent of the DJIA (NYSEArca: DIA) average closing values of the previous month, rounded to the nearest 50 points.

For the third quarter, the 10-, 20- and 30-percent decline levels, in the DJIA are the following:

Level 1 Halt (10% drop)

A 1,200-point drop in the DJIA before 2 p.m. will halt trading for one hour; for 30 minutes if between 2 p.m. and 2:30 p.m.; and have no effect if at 2:30 p.m. or later unless there is a level 2 halt.

Level 2 Halt (20% drop )

A 2,400-point drop in the DJIA before 1:00 p.m. will halt trading for two hours; for one hour if between 1:00 p.m. and 2:00 p.m.; and for the remainder of the day if at 2:00 p.m. or later.

Level 3 Halt (30% drop)

A 3,650-point drop will halt trading for the remainder of the day regardless of when the decline occurs.

Remember: Circuit-breaker points represent the thresholds at which trading is halted marketwide for single-day declines in the DJIA and by that measure, we're not there.

The percentage levels were first implemented in April 1998 and the point levels are adjusted on the first trading day of each quarter. The final adjustment to these levels for this year comes on October 3.

Conclusion

In a market with successive declining days of 2-6 percent like we've had over the past 15 trading sessions, trading halts won't save you. And neither will temporary measures to artificially boost stock prices. ETFguide's ETF Profit Strategy newsletter outlines how to successfully navigate the market's rough waters. In the end, there is no substitute for having a rational and executable investment plan in any environment, especially this one.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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