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We spent a lot more time going over the stats for
our usual lead focus on Dollar Trading Volume in this report. We're
a little more confident that our numbers are pretty accurate, likely well
within 1% of the actual total. That said, even a 1% difference when
considering total DTV of over $63.5 trillion is nearly meaningless at this
juncture. Over the last 15 years, DTV is growing at an annualized
rate of 15.3%, an insane path that puts it on target to overwhelm any systems
put into place and carefully designed to prevent calamity from another
"Flash Crash" or worse yet, a series of flash crashes one
As is, DTV now represents 416% of our gross domestic
product (GDP) and 423% of total stock market capitalization. These
relative comparisons have accelerated since the very first signs of a mania
appeared in 1996, an indisputable sign that the primary business of the
nation is in the electronic trading of financial instruments, the most
fundamental reason why economic growth is lacking, why unemployment is
still high and why Americans display less confidence about the future.
When the super bull market commenced in 1982, DTV
was only 18.1% of GDP and 40.8% of total market cap. Thus, the relationship
of trading to GDP is up 23-fold and to market cap is up more than ten-fold.
Can these relationships remain headed in the same accelerated fashion for
years to come? No!
Consider that exchanges are now offering rebates
for HFTs to provide liquidity, so they fill the system with bids and offers
that may be canceled within microseconds, essentially serving no purpose
at all, except to provide an illusion of liquidity. The "liquidity"
is vacuous and really does not exist as the Flash crash ultimately proved
in spades. Joe Saluzzi of Themis Trading (see www.themistrading.com)
recently wrote, "Oversized rebates have distorted the price discovery
process....HFT's can essentially make a profit by buying and selling a
stock at the same price due to these rebates." Mr. Saluzzi's
observation is easily the most pertinent and salient observation of 2011.
No wonder trading has achieved
the extremes of the last few years!
Below, while our estimate places DTV roughly 2.2%
below 2010, this year's estimate is likely far more accurate than last
year's, which we admit could conceivably have been overstated. At
some point, we will go over the data again to check the 2010 tally but
we're not anxious to take on more work. In any event, if we are anywhere
near accurate, DTV is up 22.2% over two years and that is a far more relevant
The churn continues at the most ferocious pace,
a mockery of our capital markets. The theme of investing
for the future is now meaningless as HFT distorts price discovery, resulting
in gross pricing inefficiencies. On a typical day in July 2011, trading
averaged $243.4 billion, according to BATs (http://bit.ly/zHd3jM
- month to date tab). Gross Domestic Product last year totaled $15.29
trillion. Divide by 365 days and you get $41.89 billion per day in
GDP. Yes, we understand that the markets are closed two days each
week but on days the markets are open, dollar trading volume is likely
to run six times the total values of goods and services generated
by the economy.
Somehow, the stats for August 2011 reveal an astounding
surge in DTV that we cannot even remotely account for. Volume picked
up dramatically for six days early in the month and then reverted to what
passes for normal nowadays but the surge was beyond comprehension.
Average DTV soared by 42.4% in August and was up 64.3% for the BATs "exchange."
Share volume rose 45.7% in
Options volume rose 85.6%.
Trading in the SPY Spyder
Trust ETF rose more than 100%!
All this is a month where volume
traditionally contracts by 10%!!!
None of this made the front
pages of the financial press,
let alone the mainstream media.
This fact alone paints the nature of our capital
markets as suspect. Simply put, no one really understands what is
going on and the status quo is accepted, no matter what threats exist,
because the business of transacting is now more important than a legitimate
We believe the two pictures above and below speak
for themselves quite well. The various U.S. stock markets are no
longer a place where investments can be made because so much business is
based on velocity.
Indeed, as pointed out earlier,
if "HFT's can essentially make a profit by buying and selling a stock at
the same price due to these rebates,"
velocity is far more
important than price.
Logically, since price has
far less relevance than before,
prices will tend to stray
away from FAIR valuations.
There's no point in taking our chart below back
beyond 1958, which will suffice for the modern era. That said, the
modern era does not compare to what occurred during the Roaring Twenties,
when stocks could be purchased for as little as ten cents on the dollar.
The power of extraordinary leverage meant the possibility of enormous profits
and gigantic losses and certainly, the Roaring Twenties provided both,
but importantly, the former followed by the latter.
The bar for 1987 was another example of concrete
proof how leverage can build wealth and destroy it in short order.
That bar was by far the highest leverage recorded since 1929 compared with
total stock market capitalization (and incidentally, GDP). Lest we
forget, stocks as measured by the Dow Industrials, were enabled to collapse
by 23% in only one day as participants fled for the exits at whatever cost.
As the tech mania took hold in 1999 and 2000, there
was some talk perhaps the Federal Reserve would raise margin requirements
to curb rampant speculation. Fed Chairman Alan Greenspan himself
claimed raising margin requirements was unnecessary, since investors could
take advantage of loans offered elsewhere to achieve the same result.
Thus, it appeared the Fed was not only excusing leverage but encouraging
same, taking no stance whatsoever on the possible risks involved.
If speculators were going to pile on, so be it, and the Fed did not much
care either way. In retrospect, this was likely Greenspan's greatest
failing (amongst many). The lesson history teaches us is if we do
not attempt to control leverage, it will most certainly go to excess and
eventually destroy wealth.
Thus, those who took the plunge near the top of
the mania were soon in very hot water and excess leverage proved unable
to sustain prices that were far, far above any realistic appraisal of the
future. The same circumstance prevailed into the 2007 peak in prices
as leverage became the only game in town. Margin as a percentage
of both GDP and total market cap went to levels only seen once before,
in 1929. It is instructive to understand that prices were cut in
half from 200-2002 and 2007-2008 as leverage was unwound.
Since the last surge in 2007, margin debt has remained
excessively high versus both GDP and market cap, at one point reaching
2.3% of market cap in 2011, the second highest level since 1929.
The three substantial peaks in margin for 1929, 2000 and 2007 all coincide
with the most important market tops in the last century.
Today, margin debt remains
at levels consistent with another major reversal in prices.
Excessive margin debt is proof
that valuations are excessively high.
As more proponents of HFT enter
the arena to play the game,
they simply do not care if
prices extend to grossly overvalued levels.
All that counts is transactional
Price doesn't even enter into
HFT can only provide an illusion
HFT has made a mockery of
our capital markets.
The following article was the
lead article in our November 7, 2011 issue.
- CHARTS UPDATED THROUGH THE
END OF JANUARY 2012 -
Let's Compare Apples To The
We believe this is one of the
most important articles we have ever written,
a confirmation of the complete
metamorphosis of the U.S. stock market from an investment arena to a casino.
We have been railing against high frequency trading
for quite awhile and the evidence continues to pile up that HFT has quite
effectively obviated the possibility of fair valuations for constituent
issues. It has been widely noted that correlation's between individual
stocks and indexes is now at an all time high. In other words, if
the averages move up, more stocks move up than ever before. If the
averages move down, more stocks move down than ever before. Why is
this so deleterious to investors? Traditionally, security analysis
has been utilized to discover value. In this fashion, shareholders
of companies with bright futures are rewarded while shareholders
of companies with suspect or dim futures are penalized. The result
is an efficient market, with securities priced relative to their prospects.
In today’s market, with correlation's this high, there is little reason
to do the analysis to discover value, just buy or sell the entire index.
Subsequently, we are experiencing what is likely the least efficiently
priced stock market in our history.
In this issue’s featured article, we will examine
this problem from several perspectives, and hopefully make our case that
while HFT reigns, those investors who have abandoned stocks will not return
and those still participating will eventually abandon the arena to the
algorithmic hyenas who feast on the remains of our once vaunted capital
At center, a fifty-day moving average of the TRIN
Index, coupled with all instances in which the daily reading was above
2.0. An explanation of the TRIN Index, invented by Richard Arms,
can be found at http://bit.ly/sfl4AM.
Suffice it to say that episodes of extremely high readings of 2.0 or higher
are indicative of overwhelming or even panic selling pressure. It
is extremely important that we view this chart in the light of the stock
market Crash of ’87, a full fledged collapse that didn’t just happen in
one day. From the August 25th print high for the Dow to the October
20th print low, there were 40 trading sessions. Thus, our 50-day
average is entirely relevant. Despite the evidence that crashes are
as rare as black swans, we have experienced three additional crash-type
phases since 2007. While the economic background and fundamentals
have clearly favored the downside, this crash behavior is apparent if only
for the reason that HFT has greatly increased correlation. Of the
two emotions that fuel price movement, fear is a far greater impetus for
action than greed. Thus, it is now considerably easier for stocks
to fall en masse and to decline precipitously. Does anyone truly
want to invest in this environment?
Below, we view lopsided days in which volume runs
9 to 1 on the upside or 9 to 1 on the downside. Overwhelming buying
or overwhelming selling. The first 22 years depict a history beginning
only three years after the inception of a super bull market, a stock market
crash and three bear markets, one of which cut stock prices in half.
In fact, except for the crash, this was entirely normal behavior.
In the 100 years leading to the new millennium, price declines of 20% or
more occurred on average every 3.8 years, price declines of 25%+ occurred
every 5.8 years and price declines of 30%+ occurred every 8.9 years.
However, the few years since 2007 have been marked by an incredible surge
in lopsided days, a behavior that has always been previously termed panic
buying or panic selling. Thus, we are looking at and experiencing
a radically different stock market than has ever existed before.
It is no wonder that investors have been fleeing stocks for the relative
safety and comfort of bonds and money markets. It may be a wonderful
experience to be in stocks on a tremendous upside day in which they all
move up emphatically, but it is truly horrific to experience the flip side
of the coin. What investors value most is their ability to sleep
comfortably at night. Volatility comforts no one.
And now (below), a 50-day moving average of lopsided
days shows precisely how the current environment compares with the Crash
of ’87—quite poorly. Note that our moving average quite often falls
to zero, meaning no instances of lopsided volume and thus, comfort for
investors. In fact, from the start of our chart to June 2007, shortly
before one of the most significant stock market peaks in history, our 50-day
moving average was at zero 58% of the time. Since then, there has
been one stretch of only six days in which our average resided at zero,
a paltry half of one percent. To say there is a dichotomy is completely
insufficient. We’re not comparing apples to oranges, more like comparing
apples to the planet Jupiter. Again, is it any wonder that investors
do not want to be in stocks? In the last 26 weeks, only one has seen
positive flows for domestic mutual funds. Never before have we seen
a methodology overwhelm the U.S. stock market as HFT has. Not portfolio
insurance, not even indexing has influenced stocks to the extent we are
experiencing at present. And never before have we seen outflows from
mutual funds as we see now.
Today’s regime is so patently rigged against investors
that the SEC has limited their actions to mere hand slaps to favor all
in an industry that rewards those who take every advantage. Yet another
piece of evidence recently surfaced (see http://on.wsj.com/s7w6no)
as the SEC fined Pipeline Trading Systems LLC. Pipeline was quoted
as “pleased” with their settlement, in which they neither admitted nor
denied wrongdoing. How many times have we heard that before?
Hundreds? Meanwhile, one pro who researches dark pools was quoted
in the article, “Judging from what's in the SEC allegations, this was a
grave violation of customer confidence and trust.” A grave violation
but no requirement of admission of wrongdoing. Just pay the fine
and walk away.
Is it any wonder that the public
is deserting the arena?
At center below, our table may more clearly illustrate
how swings are still actually increasing even though they were already
far in excess of any seen before in history. The statistics in the
first row are for an entire decade, thus we experienced huge swings less
than one-tenth as often as we do now. It is truly frightening to
consider that we have already surpassed the previous record of 26 huge
downside daily swings in 2008, when the financial system nearly collapsed.
Yet, in less than a month, the S&P 500, a very broad measure, recently
rallied by nearly 20% from print low to print high, in direct contradiction
to our thesis that the public is gone. But the evidence is clear
that we are correct. It’s not just the last 26 weeks of outflows;
since the end of April 2007, only six months before prices peaked, more
than $418 billion has flowed out of domestic funds.
THIS TABLE WAS UPDATED FOR THIS
Stocks are not rising for traditional
reasons, certainly not because they are undervalued.
The moves have become more
pronounced because correlations are increasing.
The broadening formations
(i.e., lower lows and higher highs)
we see today in the major
indexes are not to be applauded, they are to be feared.
Yes, upside momentum sometimes
seems strong, until it is not.
This is not a sane environment.
Expect more of the same in
The following article was published
in the December 19, 2011 issue.
This remains a key point never
addressed by a bullishly biased financial media.
The True Score.
We are amazed that after so many years under water
there are any stock bulls left at all, but this is a business that thrives
on bullish sentiment. Wall Street and the financial media both have
a vested interest in maintaining a bullish bias because that’s where the
money is. The bullish bias even extends to professional advisors
and newsletter writers. You can’t have a market when all the talk
is doom and gloom, even if the logical view is doom and gloom, thus the
outlook is typically promoted as bullish, whether short term, intermediate
term or long term. In other words, supposedly, you can’t lose.
In fact, the oldest saw in forecasting is never give both a price and time
target together. One is sufficient and eventually you will be proved
right with just a price target; all that is required is patience.
This permanent bias is one reason why the mania was so fully embraced;
all one needed to do was claim higher prices were ahead and somewhere down
the road, the forecast would doubtless prove correct and the forecasts
accorded greater confidence for the next upside forecast. We vividly
remember some of the most outrageous forecasts when the mania was in full
bloom, like those recounted at http://bit.ly/sYf20m.
Whatever you do, read the quotes. [Ed.
note: despite the popular wisdom, we wrote on February 28, 2000, that we
expected Nasdaq to crash 35% within six weeks and within six weeks Nasdaq
did indeed, crash by one-third]
The bullish bias is still very much in view.
While Europe teeters on the precipice and world financial markets remain
under incredible pressure, we see very little in the way of fear, only
complacency on a grand scale. While optimism is certainly nowhere
near the levels of last winter and spring, events since then have cast
one of the most memorable clouds on investing your Editor has seen in over
four decades of observation. The current bull to bear ratio as measured
by Investor’s Intelligence is roughly three bulls for every two bears.
The ratio has improved sharply and is now well above its 10-week, 13-week
and 26-week moving averages, indicating far less concern than earlier.
Incredibly, while the Dow Industrials tanked from 12,606 on July 7th to
10,719 on August 10th, the number of adviser bulls expanded from 40.9%
to 47.3%. Unfazed. An identical reading occurred on December
7th and last Wednesday’s number came in at 45.3% bulls. We can only
interpret these relatively minimal concerns of advisers as complacency.
Below, we admit our “true score” leaves out any
allowance for dividends that have been returned to investors over time
but in the last 12 years where we see market capitalization contracting
by 36.6% adjusted for inflation, dividends have also contracted.
From 1928 until 1995, dividends for the major indexes (the Dow and S&P
500) averaged almost 4.5% per year and were close to half of total returns.
Since then, dividends have averaged only 1.9%. For Nasdaq and other
stocks, the average dividend has been far lower or devoid of dividend entirely.
We estimate that even with
dividends included for the entire stock market,
investors still have 30% less
in total stock wealth than they had in 1999.
HFT comprises approximately
73% of all trading.
The evidence above is as solid
as it gets.
Trading and velocity cannot
"The stock market is now a
commodity market like any other.... .The world is more volatile because
stock-index futures exist"
-Robert N. Gordon, President,
"There has been a major shift
toward buying and selling aggregate portfolios all at once"
- Eric Seff, Managing Director,
Indexing & Hedging, Chase Investors Management Corp.
"There's a penalty for every
forward movement in technology... ..but the penalty can be intermittent,
-Warren S. Pyles, CEO, Market
"I think there is a tendency
today to substitute trading for investment"
- former U.S. Attorney General
"...our financial system is
gasping for capital because of....excess leverage and speculation....you
need capital to alight somewhere and build concrete things, rather than
buying things and selling things...,"
- John J. Phalen Jr., former
Chairman, New York Stock exchange
"It used to be you looked at
a company that had 10 million shares and you knew there were 10 million.
Now I wonder if there isn't an infinite number because of the use of these
- an anonymous institutional
"My gosh, what
are we doing with our markets?
If we don't learn from our mistakes,
we are condemned to repeat them"
- John W. Bachmann,former managing partner, Edward D. Jones
ALTHOUGH ONE MIGHT GUESS THESE
QUOTES ARE RECENT COMMENTS ABOUT OUR "INVESTMENT" MARKET, THEY ARE NOT.
EACH OF THESE WERE UTTERED
MORE THAN 24 YEARS AGO, SHORTLY AFTER THE STOCK MARKET CRASH OF OCTOBER
"The real danger is that volatility
will shake out the long-term investor"
- Richard Ross, Executive
Director, Center for the Study of Investor Behavior
THIS PROPHECY HAS COME TRUE
How Does 2015 Sound?
The following article was
published in the January 9, 2012 Year Ahead issue.
The chart is updated through
February 3, 2012.
How long can the secular bear possibly last?
In Japan, stocks peaked in December 1989, fully 22 years ago, and the Nikkei
closed 2011 an astonishing 78% lower than the all time high. This
is the third secular bear market in the U.S. in the last 82 years.
The first lasted 26 years, from 1929 to 1955. The second lasted 16
years from 1966-1982. While interim new highs were made in the Dow
in the second and most recent secular bears, the broader indexes either
remained well below their peaks or never convincingly broke out.
Since 2003, we have repeatedly shown three compelling charts; the regression
line for the Dow, 10-year rolling returns and 20-year rolling returns.
We utilized the first chart to forecast the eventual bear market bottom
of Dow 6400, check. We utilized the 10-year chart to forecast that
10-year returns would fall to zero, check. While we are not convinced
that 20-year returns will fall to zero (see chart at bottom right), on
a historical basis it is easy to see that rolling returns remain way higher
than normal at 6.82%. The average dating back 95 years is 5.15% and
that is with the benefit of a historic super bull market, wherein prices
rose more than 15-fold from 1982 to 2000. From 1917 through 1995,
a span of 79 years, returns were at the historic norm of 4%. We are
convinced that 20-year annualized returns must at some point fall to near
the historic norm and hasten to point out the three circled occasions in
which returns actually fell to below zero. We’ll feel a bit better
about the market’s longer term prospects when 20-year rolling returns fall
to 5% and will feel a lot better should they fall to 4%. These levels
can be accomplished with either a decline in price or by the passage of
time or a combination of both. For instance, at Dow 12,500, it will
be the end of June 2015 before the 5% level is achieved and early in May
2016 before the 4% level is touched. Heaven forfend if the Dow only
moves sideways until 20-year rolling returns reach zero, because that would
require extraordinary patience, out to January 2027.
Lower prices will enable stocks to achieve
historic norms more quickly, but don’t get too excited.
For instance, at Dow 10,000,
it would still take two years
for the 5% level to be achieved
and roughly three years and
five months to reach 4%.
Of course, there are many other
iterations but the two we cite are as good as any,
thus 2015 sounds just right
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We now have much greater confidence that the
bear market bottom of Dow 6400 that we first forecast back in 2004 and
that finally occurred in 2009, will wind up being the actual worst case
scenario. While we must accord a modest chance a retest is possible,
it appears a genuine retest need not even remotely approach the bottom
seen in March 2009. Our projected worst case low for 2012 would likely
be sufficient for us to turn bullish, provided the mutual fund cash-to-assets
ratio expands to more than 6% and margin debt is cut in half from today's
Projected Best Case
Highs for 2012
12,951-13,436 /// SPX 1356-1407 /// Nasdaq Composite 2927-3037
Case Lows for 2012
9600-9900 /// SPX 1000-1035 /// Nasdaq Composite 2170-2230
Ratio: Remains Extremely
volatility to begin to expand dramatically very soon.
volatility returns, prices will reverse sharply.
OF THE ENTIRE WEBSITE ARE COPYRIGHT 2012 CROSSCURRENTS PUBLICATIONS, LLC
I hope you have enjoyed your visit. Please
return again and feel free to invite your friends to visit as well.
Alan M. Newman, February 10, 2012
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prepared from data obtained from sources believed reliable, but not guaranteed
by us, and is not considered to be all inclusive. Any stocks, sectors
or indexes mentioned on this page are not to be construed as buy, sell,
hold or short recommendations. This report is for informational and
entertainment purposes only. Persons affiliated with Crosscurrents
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are subject to change without notice. We assume no responsibility
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