Archive for April, 2014

Wishful Thinking Does Not Create Economic Recovery

Wednesday, April 30th, 2014

This was going to be the year.  Remember the predictions of 3% economic growth?

More recently, the consensus was 1.2% growth for the most recent quarter.

It turns out, though, that the economy has flat-lined, growing at a puny 0.1%, quarter over quarter.  Even the 2% growth we’ve experienced throughout the 58 months of economic recovery we’ve had (see last week’s post) looks good in comparison to what we’re experiencing.GDP

Keynesians, undaunted by being wrong 100% of the time, have been predicting for years that prosperity is just around the corner.  The only thing around the corner, though, has been another corner, then another.  It’s time to realize that we’ve been going in circles.

Growth of 0.1% is, of course, just a whisker’s width away from recession.  Maybe that’s what’s around the corner.

Two areas of weakness were trade, which subtracted 80 basis points from GDP growth, and inventories, which subtracted 60 basis points.  You may recall that in Q4 of 2013, when economists were talking about strengthening growth, it was because inventories were increasing.

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The Economic Recovery That No One Noticed

Friday, April 25th, 2014

The average recovery since the end of World War II has been 58 months.  The current “recovery” has just reached that milestone.

So maybe we should be celebrating.  But what’s to celebrate?econ_expansion25_405

If you were to define “recovery” as a period when gross domestic project (GDP) increases from one quarter to the next, yes, we’ve been in a recovery.  But a recovery is typically reflected by a period that also includes, among other things, low unemployment, strong consumer spending, increasing income, higher inflation and strong manufacturing.

Most of those signs of recovery have been either barely visible or missing, and GDP has been growing about as fast as a bonsai tree.

This has been, and will likely continue to be, the recovery that no one noticed.  It’s a recovery in name only, as for most Americans it doesn’t feel much different than a recession.  Consider what’s been happening:

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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…)