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Over the last year, we have complained repeatedly
of the problems securing accurate data for Dollar Trading Volume (DTV).
There are now so many "exchanges" that collating data has become nearly
impossible and additionally, there is every reason to believe that sufficient
black box trading off the exchanges muddles the picture significantly.
Simply put, there may now be no way to accurately quantify transactional
Nevertheless, we are committed to presenting the
best view we can for this report, what amounts to a best guess. What
we see is staggering and utterly depressing.
In the last report, our charts assumed - according
to the common wisdom - that the New York Stock Exchange accounted for roughly
25% of all transactional volume. For the basis of this report, we
are increasing the denominatorto 30%, since there is no real hard evidence
for either percentage.
Determining DTV for the New York Stock Exchange
is not particularly difficult and below is a link to view the most recent
data. From January 1st through July, DTV on the NYSE totaled $11
trillion and at this pace, DTV would total about $18.86 trillion over the
course of the year. This is a considerable increase from our last
FOR NYSE TRADING]
As we did last time, we sought confirmation and
found same from the BATs
exchange. While we only examined a brief history as our sample due
to time constraints, we believe the sample is reasonable and infers a decent
grasp of the overall picture. Transaction volume has slowed significantly
in August, typical of the summer "doldrums" and is expected to pick up
again into the autumn. However, even in this slow month, total notional
volume (DTV) averaged $200 billion per day.
FOR BATS TRADING]
Thus, our estimate places total DTV at a pace approaching
$63 trillion for the year. Bear in mind if we used a denominator
of 25% for NYSE trading versus our 30% assumption, it would place our DTV
estimate at over $75 trillion and would necessitate extending our charts
further. Given GDP of $14.6 trillion, DTV is more than 4.3 times
GDP, the highest ever (by a wide margin). Using the 25% denominator,
DTV would be more than 5 times GDP.
Amazingly, the 2000 lunacy
and the 2007 bubble echo have been eclipsed.
Another record breaking year
is in progress.
Below, Dollar Trading Volume is measured in
terms versus total stock market capitalization rather than GDP.
Although in the 2000 tech lunacy, DTV fell slightly
shy of the manic top in 1929, DTV has since exploded. Over the last
four years, beginning with the bubble echo in 2007, the ratio
of trading to market cap has simply gone what can only be described as
bonkers and is now more than ten times the average ratio from 1926 through
To repeat from our previous report; "the two most
significant distinctions in this chart stem from our line marked "MANIA!"
After the first occasion, stocks took 26 years to recover. Since
the second occasion, a decade has elapsed and prices are still lower.
Each tall bar has resulted
in disaster for investors.
We expect the same now.
Below, we have not shown Speculative Fervor all
that often but clearly, the phenomenal increase in trading this year deserves
another perspective. While far shy of the lunacy of 2000, the current
echo clearly measures closely with that of 2007 and will likely play out
in somewhat similar fashion.
As transactional volume increases,
"fair price" as determined
by traditional valuation methods decreases.
As transactional volume increases,
investors have less sway,
traders have more sway.
In the current environment,
"fair price" is no longer
a major consideration.
From the August 23rd issue
"The stock market you used
to know and love has totally disappeared and has been replaced by an arena
in which the long term not only doesn’t count, it does not exist."
The following article was the
lead article in our July 26, 2010 issue.
We typically cover the efects
of derivatives several times per year in the Crosscurrents newsletter.
The charts below have not
been updated from the July 26th issue.
However, they will be updated
the next time we cover derivatives, probably no later than November 2010.
[CLICK TO SUBSCRIBE]
Greenspan Was Wrong, We Were
We last looked at derivatives in the April 5th
issue, categorizing the environment as “Not Safe, Not Sound.” Nothing
has changed to sway our point of view and in fact, if anything, the world
is likely a more dangerous place since notional values of derivatives are
still growing at a clip approaching 20% annualized. As of the end
of the first quarter, the Office of the Comptroller of the currency (“OCC”)
tallied a grand total of $216.5 trillion for commercial banks and an astounding
total of $293 trillion when the top 25 bank holding companies were included.
These are new records by wide margins and well more than double the
tally from the end of 2005.
Former Fed Chairman Alan Greenspan assured us for
years that rapid growth in derivative products was necessary for sustained
robust economic growth. Our position was that the phenomenal increase
in notional values was equivalent to risk taking on a scale never seen
before, a circumstance that would surely lead to one derivative bust after
another. Greenspan was wrong. We were correct. The Crash
in 1987 was catalyzed by derivatives in the form of portfolio “insurance”
and index arbitrage. Then in 1998, Long Term Capital Management managed
money but could not manage risk, increasing their leverage to the breaking
point. The markets went against LTCM and their positions imploded.
The LTCM daisy chain of derivatives covered fully 6% of all notional values
outstanding at the time. Had the Fed and major banks not stepped
in to rescue the situation, there would likely have been a total collapse
of our financial system.
In 2008, there was a similar disaster triggered
by credit derivatives and swaps, plus the utilization of extraordinary
leverage and in the end, several firms that were household names for generations
went the way of the Dodo. Bear Stearns and Lehman Bros. collapsed
in spectacular fashion and Merrill Lynch was swallowed up. While
the system survived, it did so barely and only as emergency bail out legislation
was enacted. Again, Greenspan’s assumptions that derivatives would
lead the way to increased economic growth were proved horrendously wrong.
In the 15 years leading up to 1994 when derivatives had a far smaller impact,
GDP averaged 6.9% growth annualized. In the last 15 years, notional
values have grown close to 19% annualized (slightly higher than that over
the last five years). Over this period, GDP has nudged ahead at only
a 4.7% annualized pace and less than 4% annualized over the last five years.
Derivatives have given us slower economic growth and have afforded three
spectacular busts. Inevitably, another disaster remains waiting in
Greenspan’s folly is readily visible in our featured
chart below. GDP plods on higher in an almost sideways slant while
notional values explode. Worldwide, we have seen estimated totals
of notional values, including those the OCC is not able to tally, as high
as $1.5 quadrillion. While we cannot vouch for the estimate, the
Bank for International Settlements tallied $681 trillion at the end of
2007 and the same pace would put us at roughly $1.2 quadrillion at the
end of this year. The uncounted amounts are a huge problem.
Each contract must have at least one counter party. Derivatives are
now so sophisticated, so complex, convoluted and so prevalent that it is
virtually impossible to track them all and to quantify the risks to the
players. Most disturbingly, as the Goldman Sachs debacle clearly
showed, they exist mostly because as financial and mathematical constructs,
they are products that can be created, developed and sold.
To a large degree, derivatives are alleged to be
developed to lay off unwanted exposures or risks. But as we have
commented on so many occasions, overall systemic risk is never alleviated
in the slightest degree by derivatives. Risk simply passes from one
party to another for a price. However, in the final analysis, because
so many assumptions are made about reduced exposure to risk, firms wind
up taking on far more risk than they can actually wisely accommodate.
The proof is in the 2007-2008 debacle. As derivative growth exploded
in 2005 (up 30%) and 2006 (up 26%), it didn’t matter one bit how risks
were laid off. Everyone was playing the same game and playing it
to the hilt. In some cases, leverage reached 30-1 or even higher
and eventually, it all had to come apart at the seams. That it took
as long as it did to implode had nothing to do with the veracity of the
contracts, instead it likely had to do with precisely the opposite; concerted
efforts to conceal just how bad things were about to get, in order for
certain parties to be able to short the system, placing it on the brink.
As seen below, credit exposures as a percentage
of risk based capital for our largest banks have grown to astonishing levels.
The average for the five largest banks, now 256%, has grown over the years
and was recently as high as 324%. Despite our conviction that much
of the exposures can be netted to zero, we can easily posit that too much
risk is still being assumed. The top five banks account for 96.7%
of all derivatives. Bear in mind our front page chart simply shows
the tally for insured commercial banks. If we add bank holding companies
to the mix, the top five account for $280.2 trillion of a total of $293
trillion in notional values.
Our next chart now displays the five largest holding
companies, rather than the five largest banks, if only to include Morgan
Stanley, proprietor of $40.7 trillion in notional values of derivatives.
Below, a new chart, illustrating derivative products
by type. More than a decade ago, Swaps and credit derivatives were
a bit more than half the total but now account for seven of every ten dollars
in notional values. Growth in credit derivatives for the period shown
is an astounding 46.5% annualized. While swaps and credit derivatives
continue to grow at these elevated levels, dangers will continue to accumulate
and it will be increasingly difficult and perhaps impossible for our markets
to handle the next disaster.
Do we have any doubt at all
on that score? None, none at all.
From our very first mania report
in January of 1999,
we have railed against the
potential harm from
unregulated growth of derivative
Prior derivative busts are
one of the many reasons
that the long term no longer
exists for investors.
Sadly, derivative implosions
remain an ongoing threat.
Below, also reprinted from
the July 26th issue of Crosscurrents.
HFT is one of the principal
reasons why DTV has expanded at such a furious pace.
The metamorphosis we have cited as the cause for
investor’s woes over the last six years continues unabated and in fact,
has worsened considerably with the expanded utilization of high frequency
trading (HFT). The “flash crash” of May 6th was a sickening reminder
of just how irrelevant the valuations of individual corporate prospects
have become. All that counts is the price of shares at the moment,
however brief that moment may be. Recently, Sen. Ted Kaufman (D-Del.)
said “People are voting with their feet. Why would they not be concerned?
We are playing with dynamite here.” If the market can move 10% in
mere minutes, trust cannot be forthcoming.
The less reliance we place on real decision making
by human beings, the more dangerous our stock market will become as purely
mechanical factors overtake reason. Zero Hedge’s Tyler Durden recently
penned a must read piece (see http://tinyurl.com/37qwpl2)
about the effects of “quote stuffing.” The assumption that quote
stuffing caused the flash crash and “threatens to destroy the entire market
at any moment” should not be dismissed. The evidence provided by
certain stocks trading down to mere pennies on May 6th should suffice as
a condemnation of HFT. Ironically, we expect the subsequent rules
change to institute “circuit breakers” to eventually result in a situation
where liquidity dries up even faster than it did on May 6th and therein
lies the threat of destruction for our market. HFT is another accident
waiting to happen and another dereliction of fiduciary responsibility by
HFT participants and regulators.
If all goes wrong, they will
simply blame it on computers.
Humans can no longer make mistakes
but they are able to earn “management” fees
based on the total avoidance
of the human decision making process.
We should also direct your attention to a recent
WSJ article on artificial intelligence (see http://tinyurl.com/2udqe3a),
evidence that we are not learning from our mistakes. As the very
savvy Jim Bianco of Biancoresearch
points out, “Let’s take a look at the checklist
for possible disaster striking on ideas like this:
with little trading experience…check
sums of money…check
its virtues based on three years of performance…check
While Rebellion Research’s methodology is not HFT,
it is clearly not value investing in the traditional sense either.
In fact, the article states that Rebellion “tends to hold stocks for long
periods—on average four months.” It is astonishing to read that “long”
periods now equate to only four months. At the end of 2009, we estimated
that total dollar trading volume had reached $52 trillion versus total
stock market capitalization of $13.5 trillion. That would place average
hold times overall at 95 days. Thus, Rebellion does indeed hold stocks
longer than the average, but not by much.
Below, the radicalization of the U.S. stock market
is painfully visible and is testament to the alienation of investors.
The most recent trip to the top of the chart is the third in less than
three years, and all were in excess of the volatility seen when the stock
market experienced a veritable crash in 1987. Volatility is not only
measured by excess movement in price but can be ascertained by continued
whipsaw action, such as we see in our chart. We have chosen a 50-day
moving average to allow some element of calm to enter the picture as markets
do tend to roil over the short term. Still, in the last two-years-and-change,
there is almost no respite for investors and even precious little time
to react for traders. In one recent three week period, there were
six episodes of manic depressive activity as upside volume swamped the
downside twice and downside volume swamped the upside four times.
While 9:1 upside days may seem great to bulls,
the best periods for investors tend to be
where prices plod onwards and upwards
in a constant and unspectacular fashion.
Simply put, a sustained resumption of the
is most improbable under the circumstances
seen in our chart.
Unfortunately, before the bear
we believe this picture will
WE ALSO COVERED THE ABOVE SUBJECT
IN DEPTH IN THE JUNE 28th ISSUE WITH THREE CHARTS, ONE OF WHICH WE TERMED
OUR CHART OF THE YEAR.
IF YOU SUBSCRIBE, YOU WILL OBTAIN
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IN THE MAY 19th MANIA REPORT,
OUR FINAL ARTICLE WAS TITLED "AN IMPORTANT LONG TERM PERSPECTIVE"
TODAY, WE PRESENT.....
An Important Short Term
This is all you need to know about the stock market
today. The picture below highlights a 5-minute period on May 6th,
the day of the so-called "Flash Crash," a chart we showed in the June 7th
issue of Crosscurrents. From that issue, we quote in part....
"Despite the best efforts of
regulators and the self regulators (read so-called investment banks, brokers
and exchanges), no one has any explanation for the five minute journey
taken by U.S. stocks on May 6th, shortly before 3pm. If you feel
like having your confidence in the system shattered, see the Reuters article
and note the comment of Jill Sommers, a CFTC commissioner. When asked
if we might never know what happened that day, Sommers opined, “I think
that's possible.” We’re satisfied to cite high frequency trading
as the likely catalyst and the NY Times story at http://tinyurl.com/29gaulg
is certainly grist for the mill, especially this part; “What all high-frequency
traders love is volatility — lots of it.” Volatility is the enemy
for stocks and equates to the opposite of certainty. May 6th was
proof that the liquidity promised by HFT is an illusion and has always
been an illusion. The trading abilities of firms such as those mentioned
by the NY Times story add nothing to our economic well being."
"Instead, what HFT offers is the inevitable
eventuality of an enormous systemic collapse one fateful day as liquidity
completely evaporates in the course of milliseconds."
"Technology has enabled us to create an environment
where financial Frankensteins roam the markets with the potential to wreak
"As we have reiterated so many time before
and will continue to remind readers,
the next cataclysm for stocks is not a matter
of if; it is a matter of when."
"Don’t look behind you, it
is coming. Again."
The long term no longer matters....
To see a free sample copy
of the Crosscurrents newsletter, CLICK
USED TO BE OUR FORECAST SECTION
our readers may be aware of a recent "study" of stock market forecasters,
published by an internet blogger. In our case, this blog reported
accuracy ratings that we can only describe as devised and so far from accurate
as to be laughable. Needless to say, our forecasts were interpreted
incorrectly and denigrated. We have no desire to direct any traffic
to this blog and if you are interested in seeing the "study," you will
have to search for it.
admits "The Crosscurrents forecasts/targets frequently include qualifications/embellishments
that makes testing difficult," yet the ratings were undertaken as if gospel.
The blog further admits that "a few very bad forecasts make the average
absolute error high." Ironically, and most disturbingly, those very
same forecasts begin and end with our initial forecast of a secular bear
market bottom at Dow 6400, originally published on our website as far back
as 2003 and published in our Washington, DC speech before the International
Federation of Technical Analysts in November of 2003. However, as
our initially cited time target was pushed out with each new forecast,
the aforementioned study considered the entire forecast before it to be
utterly wrong and in some cases, awarded us a rating of minus 80% accuracy.
That is a stunning misapplication of statistical science, in that the actual
bear market low to date was Dow 6469 print basis on March 6, 2009.
On a number of occasions, we also specified an SPX low of 680, about as
close as one can get to the actual 683 closing low. We not only forecasted
the actual price bottom with pinpoint accuracy, we did so six years before
and most importantly, we have usually cited the upside parameter as "potential"
and the downside parameter as "risk," in order to highlight both the best
and worst possible cases. The study incorrectly interprets each of
these parameters as actual forecasts, which must, by definition, make one
or the other of our parameters hopelessly wrong. The market cannot
move in both directions at once. If an actual forecast has been issued
in the past, it is typically not accompanied by a disclaimer, such as upside
"potential" or downside "risk."
It has always
been accepted wisdom in our business that one does not forecast both price
and time together. If a time is specified, never specify a price.
If a price is specified, never specify a time. It is sufficiently
difficult to forecast one of the two aspects alone. Most forecasters
follow this golden rule. When we issue a forecast, we typically do
not follow the golden rule. However, the denigration of our forecast
results by this faulted study has cast a serious pall on our desire to
continue publishing price and time forecasts for the benefit of the public
on the free portion of this website. The Crosscurrents website has
had more than three-and-a-half million visitors since it was established
in 1999 and we are quite proud to display just a few of the many kudos
accorded us by readers at http://www.cross-currents.net/kudos.htm.
We did not earn these kudos by publishing wrong forecasts time after time.
our desire to continue serving the public, we will no longer expose our
analysis to faulty studies and inadequate math on the free portion of our
website. Therefore, our policy is now changed. While we will
continue to publish the very popular Pictures of a Stock Market Mania feature,
we will no longer provide any price and time forecasts or parameters as
have accompanied this feature in the past. The subscriber portion
of our website will have the same article accompanied by price and time
forecasts and other parameters as we deem significant, as it always has.
If you wish to see these forecasts and or parameters, we suggest you subscribe
or purchase a copy of the full article for $20 [CLICK
OF THE ENTIRE WEBSITE ARE COPYRIGHT 2010 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, September 4, 2010
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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
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