Archive for the ‘Stock Market’ Category

The Fed Goes Long

Friday, April 18th, 2014

Few investors today would consider investing in long-term Treasury bonds.

The yield curve, which measures the spread between interest rates for short-term and long-term bonds, is not as flat as it has been in recent years, but that’s faint hope for investors.

A 10-year Treasury is still yielding less than 3% interest.  If the Federal Reserve Board achieves its goal of pushing inflation up to 2%, the real interest on a 10-year bond purchased today will be under 1%, payable at maturity.yield-curve-investwithalex

If the Fed overshoots its goal and inflation moves higher, which is highly likely, a 10-year bond would produce a negative yield.  What’s the probability that inflation will remain lower that the current yield on a 10-year Treasury over that entire period?

The U.S. has not had a period when inflation remained below 3% for a 10-year period since the days of the Great Depression.  During the period of recession then slow growth that we’ve experienced since the financial crisis began in 2008, inflation has remained low and the Fed’s focus has been on fighting deflation.  But when the economy improves and normal growth returns, inflation is likely to move significantly higher, as higher inflation is a byproduct of a healthy economy.

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Shining a Light on Dark Pools

Friday, April 11th, 2014

“Unless there are some changes, there’s going to be a massive crash, a flash crash times ten.”                                            Ron Morgan and Brian Levine, Goldman Sachs

As recently as 2005, dark pools made up 3% to 5% of trading activity.  Today, it’s 12%.

Dark pools are like fraternal clubs, but without the secret handshake.  No one talks about them, so they’re a mystery to the world at large.  Many were unfamiliar with dark pools until this past week, when The Wall Street Journal announced that Goldman Sachs is planning to close its Sigma X dark pool, which is one of the industry’s largest and darkest pools.  (Goldman has not confirmed that action.)Dark Pools 2

So what is a dark pool?  It’s a stock exchange where trading takes place in the “dark,” which means the size and price of orders are not revealed to other participants.

To some extent, dark pools are a reaction to high-frequency trading (HFT), which we discussed last week and in other previous posts.  When trades take place in the dark, algorithmic traders can’t take advantage of them.

Theoretically, if dark trades, which are typically high volume trades, took place in the light of day, high-frequency traders would amplify the impact of such trades and potentially cause another flash crash.  Or worse.

But on Wall Street, of course, nothing is ever that simple.  There’s more to dark pools than that.  Consider some of the questions that dark pools raise:

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Good Market Rigging vs. Bad Market Rigging

Friday, April 4th, 2014

“The markets are rigged. … These firms make their money by front-running trades. They’re using their speed advantage to buy shares first and then selling them back at a higher price. The result is higher prices for investors in those shares. That’s rigged.”                                                                                                                                      Michael Lewis

Based on the Federal Reserve Board’s actions of the past five years, you may have thought that “market rigging” was a good thing.  After all, a great deal of wealth has been created from the Fed’s bond buying – although, granted, almost all of it went to those who were already wealthy.

But suddenly, high-frequency trading is being charged with rigging the markets and it’s creating a bit of a furor.  Apparently the Fed is responsible for good rigging and HFT is responsible for bad rigging.  Consider this week’s HFT-related news:

  • Michael Lewis, author of Moneyball, was interviewed by “60 Minutes” in advance of publication of his book, Flash Boys, in which he makes the case that HFT rigs the markets against the small investor.

  • There was the heavy backlash from those who disagree with his conclusion … that is, the people who make money off of high-frequency trading.  Supporters contend that HFT has created liquidity and reduced the cost of trading for small investors.  In other words, the market is rigged against small investors, but it costs them less to make a trade.  Yippee!!
  • Then there’s The Wall Street Journal’s announcement this week that HFT is being investigated by the FBI – not the Securities and Exchange Commission (although it is participating in the investigation), the FBI.  You know, the guys who investigate bank robberies, money laundering, drug cartels and the Mafia.  And now you can add high-frequency trading to that list.  Apparently, insider trading was already taken. (more…)

Think Like a Rat

Friday, March 28th, 2014

Experiments show that if you put rats in a maze and give them a jolt of electricity when they go the wrong way, they will eventually go the right way.

Apparently, humans may not be that smart.Two white laboratory rats in a maze

OK, we’re smarter than rats.  We know better.  But we believe what we want to believe.  And right now, a majority of those who invest believe the “trend is our friend.”

We forget that what goes up must come down, regardless of how many bonds the Fed buys.  It’s a scary world and no amount of irrational investor confidence can keep the market aloft forever.

In the first decade of the new millennium, we lived through two difficult bear markets, each of which chopped stock prices nearly in half.  The bear market of 2000 to 2003 was caused by the irrational belief that tech stock prices moved in only one direction.  The bear market of 2007 to 2009 was caused by the irrational belief that housing prices moved in only one direction.

So here we are just five years removed from the last bear market and investors are acting as though stock prices move in only one direction.  Investors have already forgotten that bubbles burst.

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Fundamentally Flawed

Friday, March 14th, 2014

Imagine if the outcome of a football game depended more on the weather than on the talent of the players.

Weather, indeed, can have an impact and should, but its role is usually to test the talents of the players, not to be the primary factor in the outcome.  When it is the primary factor, anything can happen.  In such cases, would you put money on the game?

The weather is not the number one factor affecting the performance of the stock market these days, but neither is the talent of the players – that is, the fundamental performance of publicly held companies.

In recent years, The Federal Reserve Board has held sway over the market’s performance via quantitative easing, although under former Chair Ben Bernanke, it was somewhat more predictable than the weather.AUDJPY

Now, with tapering under way, that may change (we’ll see, as many expect plenty of bond buying ahead).  Yet other world events may replace QE in determining the performance of the market.  That means potentially greater volatility than we’ve experienced in the easy money era.

It doesn’t take much to affect today’s global economy, especially when the impact of events is amplified by high-frequency trading.  Consider, for example, the impact of the falling yen and Australian dollar on the S&P 500.

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We Told You So

Friday, January 24th, 2014

Sometimes the best investment advice is to do the opposite of what everyone else is doing.

When the stock market was in free fall during the financial crisis, many investors who had hung on for as long as they could take it finally gave up and sold their stocks, locking in huge losses and missing out on a historic rally.

Last summer, with the first hint that the Federal Reserve Board would be tapering its bond purchases, interest rates began to rise and investors sold bonds in record numbers.  In many cases, investors moved more money into stocks, as the market continued to set records throughout 2013 after a brief drop that was fueled by taper talk. Bond Chart

That’s proven to be a mistake, as bonds have so far outperformed stocks in 2014.  In fact, 10-year Treasuries have outperformed the S&P 500 by about 620 basis points.

We’ve suggested that investors not give up on bonds and likewise suggested that gold may shine again, in spite of its tarnished 2013 performance.  Recent trends suggest that it’s worth repeating this advice.

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No Records This Month

Friday, January 17th, 2014

Markets go up and markets go down, so maybe it’s not surprising that January’s stock market performance has less exuberance to it than the performance to which we’ve become accustomed.

As of yesterday’s market close, the S&P 500 was down 0.13% year to date, which is not a big deal, especially considering that the S&P 500 Index finished 2013 up 32.4%.  Even with the recent downward trend, the S&P 500 is up 25.35% for the past 12-month period.

The Dow Jones Industrial Average has been a bit creakier, down 0.96% year to date, but still up 21.51% for the past year.

It’s doubtful, then, that the markets will break any records this month.  But if you believe the hype, good things are headed our way.  The unemployment rate has slimmed down to 6.7%, gross domestic product (GDP) was revised upward to 3.6% for the third quarter of 2013 and, with Janet Yellen’s appointment to head the Federal Reserve Board, quantitative easing can continue ad nausem.

So why worry?

To begin with, as we explained last week, the falling unemployment rate is an illusion.  The rate dropped only because so many people have stopped looking for work.  The number of non-working Americans exceeds 102 million, which is a record.

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Bully for 2013 … But What About 2014?

Friday, January 3rd, 2014

2013 markets were full of bull.

The economy continued to sputter along, growing at about 2%, unemployment remained high and corporate profits were mediocre.  Yet the S&P 500 index rose a staggering 29.6%, its best performance since the go-go-days of 1997.

So what sort of bull drove this bull market?  The Federal Reserve Board’s quantitative easing (QE) program, high-frequency trading and exuberant investors who shifted into stocks with renewed confidence.

Investors Intelligence SurveyWhen Fed Chair Ben Bernanke hinted in May and June that The Fed might start pulling back on its bond buying soon, the market initially fell and interest rates rose.  But ironically, rising rates drove investors out of bonds and many invested further in stocks, pushing the market even higher.

More Bull in 2014?

As 2014 begins, the bullish sentiment continues.  More than 60% of those surveyed by Investors Intelligence are now bullish and the bull-bear ratio is at a record level of more than four.

Bullish sentiment at this level is typically a good thing, though, as high investor enthusiasm typically leads to a drop in the market.  When investors are at their most bullish, that’s when the stock market usually drops.

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When Common Sense Is Senseless

Friday, December 6th, 2013

What was I thinking?

Over the past couple of years, I’ve preached caution.  Corporate profits were down and unemployment was up.  The economy wasn’t growing, but the federal debt was.  Iran was developing nuclear capabilities while the entire continent of Europe was going bankrupt.  And investors were still shell shocked from the 2008 financial meltdown.

Not a good time to invest in stocks.  Not a good time to invest, period.  Common sense dictated restraint.Bungee Jumping

And the federal government’s answer was to spend as much as possible, while printing more money and buying more bonds than at any time in history.  After record stimulus spending and $4 trillion in bond buying, common sense would suggest high inflation and a sagging stock market; a good time to invest in gold and other hard assets.

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One Man’s Ceiling Is Another Man’s Floor

Friday, September 27th, 2013

“There’s been some hard feelings here
About some words that were said …
Remember, one man’s ceiling is another man’s floor.”
                                                         Paul Simon

Here we go again. Hold on to your wallets, taxpayers. It’s time for another debt ceiling “negotiation.”

We use the term “negotiation” loosely, as it’s now extinct in Washington.

On one side, we have House Republicans waging an unwinnable battle, saying they’ll agree to suspend the debt ceiling limit for a year in exchange for a one-year delay of the individual mandate for ObamaCare, tax reform, approval of the Keystone pipeline and other concessions. While such changes would potentially provide a huge benefit to the economy, they have zero chance of passing in the Senate, which is controlled by the Democratic majority.Debt ceiling

On the other side, we have President Obama and Senate Democrats saying the Republicans are trying to shut down the federal government, because they are not willing to lift the debt ceiling without concessions from the President.

There will be no concessions by the Democrats. As President Obama put it, “I will not negotiate on anything when it comes to the full faith and credit of the United States of America.”

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