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As of Tuesday afternoon, the stock market was struggling with "The Five E's". Traders were fretting about the potential impact of Ebola, Europe's sinking economy, the big dive in energy, the status of various monetary easing efforts by central bankers around the world, and what the outlook for the coming earnings season might be.

And after Tuesday's market didn't give way in the face of some pretty decent pressure, many analysts thought that it was time for a bounce. Perhaps even a bounce big enough to declare an end to the corrective action that has been in place for much of the past month.

But after three straight lousy economic reports in the U.S. Wednesday, there was suddenly a new "E" to worry about.

E is Also for Economy

First there was the report on inflation at the Producer level - aka the PPI - which fell -0.1 percent in September. While this doesn't sound that bad, the year-over-year gain also fell to 1.6 percent. The problem is this level indicates "weak inflationary pressure" and is well below the 2 percent level the Fed is targeting. Thus, some nervous-Nelly's contend that the U.S. could still be flirting with deflation if things don't perk up soon.

Next came the Empire Manufacturing Index, which had soared in September to the highest level since late-2009. But, in October the index nosedived to the lowest level in 6 months and indicated that "the pace of growth slowed significantly" in the region.

And then there was the report on Retail Sales in the U.S. This report is important because a core tenant in the bullish case for stocks is the idea that the U.S. economy is a "closed system" where Mom and Pop are responsible for more than 70% of economic activity. So, the fact that Retail Sales fell in the month of September and disappointed for the fifth time in the last six months was not a welcome sign.

All three reports were released simultaneously at 8:30 am eastern and before you could refill your coffee cup, S&P futures were down 20.

The problem was simple - there was a brand new "E" to worry about.

Remember, up to this point, the bulls had argued that despite all the other "E's" in play, the U.S. economy remained in good shape. Thus, any decline related to all the other stuff simply represented another "buy the dip" opportunity.

But... if the U.S. economy was suddenly at risk of hitting another speed bump, the bears suggest that the "escape velocity" theme as well as the "buy the dip" game were both in trouble.

Therefore, another decline at the open certainly made sense. But frankly, that was about the last thing that made much sense during Wednesday's very wild ride on Wall Street.

S&P 500 - Daily

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As expected, the S&P 500 dove as the opening bell rang. But the plunge wasn't the 20 points the futures had projected. The dance to the downside wasn't 30 points either. Heck, it wasn't even 40 points. No, the S&P moved down 50 points - in a straight line - in just 9 minutes.

Thus, it appeared that the sky was falling. Or that there was a "forced liquidation" (aka a hedge fund blow-up). Or that the millisecond algos were overly caffeinated at the open. Or any/all of the above.

Can You Say Volatility???

The talking heads spoke of "fear" and "capitulation." However, can a market really capitulate in 9 minutes? And for the record, what exactly were traders capitulating about? Ebola? Europe? The end of QE? The new weakness in the U.S. data?

To those that understand the way the game is played in Mahwah, New Jersey, the move looked like algos running amok, like millisecond trend-following at its best, and like a few players and their computers overwhelming the U.S. stock market.

You see, that initial 9-minute spike down was just the start of the fun.

Time to Go the Other Way

So, what do computer-driven trading systems do after a 9-minute, 50-point move? Go the other way, of course!

It is a fact that high-speed trend-following algos automatically reverse after a set number of minutes or a specific percentage decline each day. So just imagine how excited this gang must have been after that nasty open.

As expected, the rebound began. Bam! The S&P 500 popped 29 points (or 1.5 percent) in the ensuing 19 minutes. Thus, the venerable S&P, the index of stocks the represents the U.S. stock market to the world, had traveled 79 points in less than half an hour. Are we having fun yet?

From there, more "normal" market action ensued. Perhaps the humans jumped into the game as they weighed the latest "E" that had been added to the worry list. Not surprisingly then, the market wound up losing ground over the next two and one-half hours, to the tune of about 40 points.

So let's review. The S&P fell 50 points in 9 minutes, rebounded 29 points in 19 minutes and then fell another 40 points - all before lunch had ended. And believe it or not, that was NOT the end of the ride.

Cue the Rebound

Whether or not you believe in the "Plunge Protection Team," the afternoon action sure smacked of somebody making sure that an out-and-out crash did not occur yesterday.

The bulls argue that it was a combination of a Yellen headline saying the Fed Chair was confident about 3 percent GDP growth in 2014 and the release of the Fed's Beige Book report that got things moving higher.

However, the Yellen headline was actually from a weekend speech and it would appear that the three downright crummy economic reports ought to trump a backward looking Beige Book. To which our heroes in horns replied, QE4 is coming.

The next thing you know, the S&P is skyrocketing upward, the NASDAQ is threatening to move into the plus column, and both the small- and micro-cap indices are up more than 1 percent. Wait, what?

Before fading just a bit into the close, the bull algos had managed to push the S&P up 48 points - or about 2.6 percent off the low. Good work, boys.

Instead of the S&P being down -9.5 percent (where the decline from the recent all-time high stood at Wednesday's low) and at a loss for the year, the bulls had somehow found a way to limit the damage. Thus, the decline on the S&P for the current corrective phase is now -7.4 percent. And the index remains in the green for the year.

What's the Takeaway?

The key here is that while a decline of about 1 percent would seem to be in keeping with the surprisingly weak economic news of the day, the wild and woolly ride of 105 S&P points does not.

So what gives? Why the intraday insanity? In short, an unprecedented lack of liquidity seems to be the answer.

Eric, Hunsader of Nanex, who is a mouthpiece for exposing the vagaries of high-frequency trading, has been saying for the last couple of weeks that there is a new HFT algo in town that is simply overrunning the market and causing liquidity to crater. Hunsader has trotted out several charts showing that liquidity in the S&P futures is at its lowest level since 2011.

Hunsader told CNBC Wednesday, "There was no liquidity at all, so it doesn't take a whole lot of size to really move the price."

So there you have it. Another "E" to worry about and a market that is basically too "thin" to handle all the games the big boys and their fancy computer toys want to play. But don't worry, the Dow "only" fell 173 points yesterday and everybody on the planet is now saying that a rebound is ready to begin. So, it's likely to be up, up and away from here, right?

Turning To This Morning

One of the big questions after yesterday's roller coaster ride on Wall Street was which big move was "real" as both the opening thrashing and the afternoon rebound appeared to be completely algo-driven and as such, a bit exaggerated. This morning, the global markets and U.S. futures are suggesting that the early fears were the real deal. This morning there are three issues causing global stock markets to fret. First there is the fact that both Wal-Mart and Ebay effectively cut their outlook for the holiday shopping season after the bell yesterday. In short, this immediately brings Q4 earnings and GDP into question. Next, the worries about Greece and Europe's banking system are back in a big way today (see the big red numbers for European bourses below). And finally, there is another headline involving Ebola on an Air France flight. The good news is that traders will get more input on the U.S. economy this morning. The bad news - at least for now - is that futures are pointing to a drop of 200 Dow points at the open at the present time. So, fasten your seatbelts, it could be another wild ride on Wall Street.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
    Japan: -2.23%
    Hong Kong: -1.03%
    Shanghai: -0.74%
    London: -1.88%
    Germany: -1.90%
    France: -2.56%
    Italy: -3.40%
    Spain: -3.75%

Crude Oil Futures: -$1.72 to $80.06

Gold: -$1.90 at $1242.90

Dollar: higher against the yen, euro and pound.

10-Year Bond Yield: Currently trading at 2.0026%

Stock Indices in U.S. (relative to fair value):
    S&P 500: -24.74
    Dow Jones Industrial Average: -172
    NASDAQ Composite: -57.77

Thought For The Day:

To be old & wise, you must first have been young & stupid. -Unknown

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Positions in securities mentioned: None

Wishing you green screens and all the best for a great day,

David D. Moenning
President, Chief Investment Officer
Heritage Capital Research
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