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The good news is that we have reduced our earlier
estimate of Dollar Trading Volume (DTV) for the U.S. stock market.
The bad news is the reduction amounts to the following; instead of the
markets being grossly and insanely overwhelmed by high frequency trading,
they are now merely grossly and insanely overwhelmed by high frequency
trading. The difference between $62 trillion in dollar volume and
$56 trillion in dollar volume is inconsequential. The markets can
no longer function as an arbiter of fair value for the price of individual
companies because holding periods have evaporated.
Put another way, if stocks
can be held for as little as a second,
it makes no difference
whether the company even has a future,
because the future is only
one second away.
Again, we must admit our statistics for total Dollar
Trading Volume (DTV) are not 100% accurate but should not be off by more
than a very modest amount. It is likely that a precision tally is
not even possible at this point. The BATs
exchange data supposedly reports all (see links below) but there is no
way to determine if it does indeed capture all trades, a small portion
of which we see as likely to be away from any oversight. We repeat
from our last report, Wikipedia's article (see http://en.wikipedia.org/wiki/Dark_liquidity)
states that so-called Dark Liquidity trades are "....usually visible
after the fact in the market's public trade feed" for so-called "Iceberg
Orders," but "usually" is the same as "not always."
Furthermore, regarding dark pools, the Wiki states that ".... detailed
information about the volumes and types of transactions is left to the
crossing network to report to clients if they desire and are contractually
obligated." Can there be any doubt that some information is withheld?
information can be withheld, some information can be assumed to be withheld.
FOR TOTAL TRADING 10/1/11 THROUGH 10/20/11]
Note that even our newly reduced estimate places
total DTV at 386% of the country's entire Gross Domestic Product (GDP).
From 1930 to 1998, a 69 year period in which no veritable manias occurred,
DTV averaged less than 23% of GDP. Even at the insane peak of 1929,
DTV was only 133% of GDP. In 2000, when tech stocks went to the moon
(and back) and CNBC became prime time television fare, DTV averaged 328%
of GDP. Since then, the public has for the most part, pared back
participation significantly. Indeed, over the course of the last
six years, mutual fund inflows have been negative.
Yet, DTV now stands at 386% of GDP, much
higher than in 2000.
Why? High Frequency Trading
Professional estimates have placed HFT's influence
at 73% of all volume as of 2009 and we can fairly assume the percentage
is higher today. Possibly significantly higher. While proponents
of HFT have claimed many benefits for the markets, especially and including
vastly increased liquidity, the proof is in the pudding. There are
and will inevitably be times when bids and offers are pulled as uncertainty
affects algorithms and during those periods, volatility will increase,
causing further uncertainty and affecting more algorithms to the point
where there is no liquidity at all. The result is a vacuum.
One such vacuum occured on May 6, 2010, wiping out over a $1 trillion in
wealth in a matter of a few minutes. It is no wonder that the public
wants no part of the stock market.
The "benefits" of HFT are not
only illusory, they are a total fabrication. They
do not exist.
For HFT to succeeed, participants must find ways
to respond more quickly, or else the competition will and take the advantage.
Quote adjustments have now made the leap from milliseconds (one-thousandth
of a second) to microseconds (one-millionth of a second) and laughably,
we are now at the point where it can be inferred that it is possible for
trading to occur at faster than light speeds (see http://bit.ly/nPfX7K).
Despite any protestations by HFT proponents, there is no possible way in
which recent developments can support any notion that HFT benefits the
market, the public, or the fair value pricing of individual companies.
Above: we illustrate the "benefits"
There are none.
This market observer has been involved in the stock
market since 1964 and the most oft heard refrain and sage advice for many
years was to "buy for the long term." Over the long haul, stocks
should return approximately 5% per annum ex-dividends. If inflation
remains under 5%, the nest egg must grow. However, the emphasis has
clearly shifted and the theme of investment has been completely replaced
by one that focuses almost exclusively on the short term. The average
holding period for U.S. stocks is now a little more than three months.
The takeaway is a fickle arena, where there can be no loyalty to an inverstment
idea, thus good ideas are routinely ignored just as easily as bad ideas.
As a result, all stocks suffer.
As a result, all investors
Non-HFT trading now amounts
to roughly $15.1 trillion.
HFT trading now amounts to
roughly $40.9 trillion
The public cannot possibly
receive the best price any longer.
Our stock market serves only
The following article was the
lead article in our October 17, 2011 issue.
Headlong On The Path To Ruin
Never before have we published
an article from our most recent issue on this website,
but we felt it was exceedingly
important to get this story out where as many can see it as soon as possible.
No surprise, we remain convinced that derivatives
are the principal cause of the country’s economic ills and likely the world’s
as well. Sans the forced and unnecessary creation of a market for
derivative crap like the RMBS (residential mortgage backed securities)
bundled by banks and later packaged into all kinds of pathetically faulted
products, it is nigh unto impossible to discern how so many billions of
dollars in mortgages could have ever been available to those who could
not possibly afford them or to those who were purposely deluded by salesmen
and brokers into accepting terms that had to equate to an eventual default.
There, we said it, albeit indirectly. The
industry was built upon a house of cards, run by greedy crooks, aided and
abetted by a financial industry that only knew one rationale; take advantage,
do it now and do it as often as possible. And again, we hasten to
remind that no one has yet to go to jail for the frauds perpetrated upon
the public and between the housing stock and the stock market, total wealth
has evaporated to the tune of at least $10 trillion. We began covering
the subject of derivative securities privately after the stock market crash
of 1987, and expanded our newsletter coverage dramatically when annualized
growth in derivative products began skyrocketing over a decade ago.
We predicted on numerous occasions that the reliance on these constructs
would eventually and repeatedly wreak havoc on our markets. In December
of 2008, we wrote of “The Inevitable Dénouement,” an article that
can be viewed at http://www.cross-currents.net/archives/dec08.htm.
At the time we forecast a maximum downside of SPX 670 and the actual bottom
arrived exactly three months later at SPX 667.
Although our maximum downside projection held and
still appears to be all the bear wrote, we cannot be certain. Simply
put, the continued growth of derivatives places any presumption of outcomes
in doubt. In 2003, when we first addressed the possibility of a Dow
6400 bear market bottom target (the actual low was 6469) before the International
Federation of Technical Analysts, notional values of derivatives were $70
trillion. Notional values are now $249.3 trillion. That’s almost
a quarter-of-a-quadrillion dollars. When was the last time you saw
the word “quadrillion” in print?
Growth since 2003 is 18.2% per year, a compound
rate that must assure the repetition of disaster. Consider the following;
just as an asteroid is 100% likely to eventually hit the Earth, every market
must eventually face a worst case scenario. When it does, conventional
wisdom goes out the window. The success of the derivative markets
is highly dependent upon what is termed “netting benefits,” meaning each
bank’s exposure to risk is theoretically balanced and almost perfectly
hedged. As our prior meltdowns have shown, netting benefits can and
will typically evaporate in the blink of an eye. When one big firm
makes a bet that proves to be disastrous, it can impact a huge daisy
chain extending trillions of dollars, as actually occurred in 1998 with
Long Term Capital Management and as occurred in 2008 with several high
profile banks and brokers. It will occur again and the iterations
are quite likely to arrive at a far more rapid clip as derivative growth
continues at this insane rate of growth.
It seems every time we show our featured chart,
we have to extend it to accommodate the continuing growth in derivatives.
The scale has more than doubled in only four-and-a-half years. Notional
values are now equivalent to 16.6 times gross domestic product (GDP).
Thus far this year, notional values are growing by roughly $144 billion
per day, an absolutely mind blowing number when you realize that the nation’s
GDP averages only a bit over $41 billion per day.
Notional values are now more than 17 times total
stock market capitalization. Market cap was higher in mid-1999, over
12 years ago. At the time, notionals were less than $34 trillion,
one-eighth of what they are now. Thus, we can easily make the assumption
that the country’s focus has all been about derivatives. The stock
market is no longer important and began the long road to irrelevance years
ago. It is no wonder that another recession is on the horizon for
the third time in recent memory, why the unemployment and underemployment
rates remain disturbingly high, why job creation remains quite sluggish,
why 45 million Americans are on food stamps, why so many are patently
dissatisfied with legislators of all stripes and why there is a growing
movement that despises the greed that Wall Street has sponsored for so
Below, we illustrate how credit exposure for the
five major banks dwarfs their risk based capital. While some take
comfort that the Volker Rule will take some risk out of the overall equation,
it is clear that the bank/broker lobby is too powerful and the Plutocrats
will have their way. For more on the Volker Rule and Plutocrats,
we strongly suggest readers view a brief Paul Krugman NY Times essay at
Worse yet, consider the implosion of Morgan Stanley, cut in half since
February, and the attendant speculation that something must be wrong.
We can tell you what is wrong. I'll tell you what is wrong.
Morgan Stanley's assets are $831 billion. Their derivative portfolio
has $56.4 TRILLION in notional values. Not that everything can possibly
go wrong, since netting benefits cancel out much of the risk, but that's
it. Netting doesn't cut out all of the risk. However, if you
light enough matches, there is no question that eventually you will light
And now, here’s a picture of how assets line up
against notional values for the 5 largest bank holding companies.
The third and fifth largest are acutely aware of the restrictions the Volker
Rule will impose and are now clamoring to change their status (see http://buswk.co/qMKRrb,the
epitome of temerity. Now, bear in mind how much taxpayers had to
pay to bailout banks for their profligacy. Somewhere north of a trillion
dollars. In any event, the Volker Rule is already in the process
of being drastically watered down as banks have two years from next July
to comply and can request three one-year extensions.
The annual rates of growth for selected types of
derivative constructs boggles the mind. Again, consider the paucity
of restraints and regulations for this industry and that much of the over-the-counter
derivative market is still an unfathomable and unaccountable mystery.
We are again headlong on the
path to ruin and destruction.
America is no longer a country
that manufactures tangible goods,
but instead manufactures mathematical
constructs capable of mass financial destruction.
At current rates of growth,
notional values will surpass
a quadrillion dollars by the end of 2019
an utterly impossible 50 times
our gross domestic product.
Hopefully, our economy can
survive the inevitable shocks that are sure to occur but we’re not at all
confident it will....
Below, an article reprinted
from the May 23rd issue of Crosscurrents.
subject is slated to be updated in the November 7, 2011 issue.
The new charts
are even more stunning and spectacular than the two we illustrate below.
How's This For Liquidity?
The arguments in favor of high frequency trading
(HFT) typically begin and end with the assumption that HFT provides liquidity
for the stock market. As technology progressed to allow those who
used to trade in seconds to shorten their timeframes to hundredths of seconds
and then milliseconds, HFT gained in favor. But now, even microseconds
are long term in the scheme of things. A reasonable explanation of
what HFT is all about can be found at http://tinyurl.com/3wbw8sk.
How any of this can possibly help investors is a puzzle. Since much
of the HFT activity stems from rebates offered by exchanges such as the
NYSE for “supplemental liquidity providers” (SLP), it is no wonder some
of the larger banks and brokers can sail through an entire quarter without
even one losing day. Simply get in and out at the same price and
collect a rebate of $.0015 times 100 million shares and you’ve made $150,000.
The algorithms rule. Is it any wonder 73% of all volume is now devoted
to HFT and timeframes have compressed to microseconds? The game has
grown so profitable that every effort is now made to increase the speed
at which trades can be transacted. The situation is so bizarre that
HFT computer servers far from New York are nowhere near as valuable as
computer servers near New York since electrons cannot move faster than
the speed of light. In the HFT game, distance is the enemy.
We can now make a fair assumption that much of
HFT activity equates to a zero sum game, since rebates ensure profit even
when shares are sold for the same price they are purchased. But in
a zero sum game, for every winner there must be a loser and in this case,
the rebate system likely ensures that the public are the ones taking it
on the chin. In any event, May 6th of last year was all the evidence
you needed that the system was broken. And while we have not had
a 1000 point drop in one hour since, we have had equivalent percentage
declines many times over for single stock issues (see http://tinyurl.com/66rnnsl.
Below, the pattern of a way too often distressed market is still in view.
It is no mere coincidence that HFT has blossomed in recent years just as
lopsided volume days have appeared with startling frequency. At center,
the TRIN or Arms Index (see http://tinyurl.com/3qdsjol)
shows an unmistakable trend towards higher numbers in the HFT era.
glance back to the spike in 1987 is all the more disconcerting when you
realize that episode was a veritable and genuine stock market crash.
...And yet the spike was exceeded
twice in recent memory.
DATA UPDATED ONLY THROUGH MAY 23, 2011
7th ISSUE OF CROSSCURRENTS WILL HAVE CURRENT DATA
One need look no further to
domestic mutual funds suffer
The stock market is rigged
for the benefit of the big boys.
the algorithms have absolutely
for the direction stocks take.
Fair Value For The Dow
Over the course of history, the Dow Jones Industrial
Averages have put together some fauirly spectacular gains intersperced
with several horrific losses and very long periods of sideways movement.
The logarithmic chart below accentuates these movements but also illustrates
quite clearly that the normal expectation over time is 5% annualized gains,
While stocks can rise dramatically in price, as
they have in the three bull markets highlighted by our green labels, the
market can resemble sludge for many years at a time, as our three rectangles
show. Note all three rectangles are the same length of time and if
the current phase is to resemble the first two, it will be another five
years before the Dow breaks out above the former highs.
As our regression line clearly
illustrates, fair value today for the Dow is 11,263.
Fair value is 9% below
today's Dow Jones Industrials Average.
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The easy answers for us are to restate what we
though obvious in our last update; "Although the odds for a full retest
of the March 2009 bottom are now quite low (perhaps less than 10%), stocks
never fully tested the July 2010 bottom at Dow 9614. The circumstances
necessary to once again force another capitulation phase are present and
risk now extends to at least the levels of the July 2010 bottom."
In essence, nothing has occurred to
mitigate our forecast in either direction.
At the very least, the continued growth of
derivatives presents the same ugly face it did from 2007-2009.
It is still quite possible
headlong on the path to ruin
through remainder of 2011 (same as March update forecast)
12,600-12,700 /// SPX 1370 /// Nasdaq Composite 2900
Downside risk through
9600-9900 /// SPX 1000-1050 /// Nasdaq Composite 2000-2100
Ratio: Extremely Poor
of an eventual of the March 2009 lows is still possible next year.
December 2010 update, we said
will likely spike dramatically very early in the year."
March 2011 update, we said
expect volatility will again spike even more dramatically, perhaps quite
future, we expect no respite other than quite temporary.
expect volatility to spike before the end of the year.
is now the normal state of the stock market.
OF THE ENTIRE WEBSITE ARE COPYRIGHT 2011 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, October 30, 2011
The entire Crosscurrents website has logged
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All information on this website is
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
Publications, LLC may be long or short the securities or related options
or other derivative securities mentioned in this report. Our perspectives
are subject to change without notice. We assume no responsibility
or liability for the information contained in this report. No investment
or trading advice whatsoever is implied by our commentary, coverage or