Monday, May 05, 2014 - Riggers’ Propaganda

Financial Review with Sinclair Noe

DOW + 17 = 16,530
SPX + 3 = 1884
NAS + 14 = 4138
10 YR YLD + .02 = 2.61%
OIL - .38 = 99.38
GOLD + 9.10 = 1310.70
SILV + .13 = 19.69

Last week we told you about prosecutors and regulators preparing to criminally prosecute Credit Suisse and maybe BNP Paribas, and the slap on the wrist enforcement efforts of the past decade, and especially under the mis-guidance of Attorney General Eric Holder’s “Too Big to Jail” policy. The Swiss finance minister met Holder on Friday to discuss a US probe into Swiss banks that allegedly helped Americans evade US taxes, which includes Credit Suisse. Today, Holder posted a video on the Justice Department website saying that the DOJ is pursuing criminal investigations of financial institutions that could result in action in the coming weeks and months, and adding that no company was “too big to jail.”

A criminal conviction of an entity regulated in the United States could lead authorities to potentially revoke a charter, essentially a death sentence for a bank. In his video, Holder said prosecutors are working closely with regulators to address the issues before taking action, "Rather than wall off banks from prosecution, the potential for such severe consequences simply means that federal prosecutors conducting these investigations must go the extra mile to coordinate closely with the regulators that oversee these institutions' day-to-day operations."

It’s starting to sound like Holder is going after criminal charges without the consequences of criminal charges; maybe he can collect a slightly bigger fine, but still leave the bank charter in place. Otherwise, this is a big pile of baloney. And the proof will be in the putting. Until we see a banker jailed and a charter revoked, AG Holder is just spouting propaganda.

The propaganda mill is spinning fast in Washington DC these days. Securities and Exchange Commission Chair Mary Jo White flatly rejected claims that retail investors are being fleeced by high-frequency traders who can use their speed to jump ahead with buy and sell orders that fetch better prices.

White told a US House of Representatives panel last week, "The markets are not rigged." White reiterated that her agency's investigators are actively pursuing probes into high-speed traders and dark pools, or anonymous trading venues, but she also sought to dispel the notion that using high-speed technologies to trade ahead of others using stock quotes disseminated on public data feeds could meet the legal definition of "unlawful insider trading." She acknowledged at one point that the market is not "perfect" and told lawmakers that the agency's "data-driven" review of market structure issues surrounding areas such as order types, dark pool trading and data feeds was still ongoing. Even though the SEC has not concluded or barely even launched the investigation, White already knows the facts, saying: "I want to be very clear that the market metrics suggest that the retail investor is very well-served by the current market structure."

The rather unusual reason why SEC Chair White and Congress are suddenly concerned about rigged markets is because of Michael Lewis' latest book Flash Boys and HFT (high-frequency trading) and whether the markets are manipulated. What they're not talking about is how the markets have been set up for institutionalized rigging. And they are rigged; have been for a long time.

It goes back to the time when the NYSE was the only game in town, and prices were quoted in fractions: a half, a quarter, an eighth. Buyers and sellers of listed shares used brokers to send orders to the NYSE Floor for execution. On the Floor, "specialists" are in charge of every stock. Their job was, and still is, to match up buyers and sellers and "keep a fair and orderly market" as they facilitate "price discovery."

The specialist used to see all orders for the stocks they were in charge of because all orders had to come to them. Besides matching up buyers and sellers, specialists can also trade for their own account. That means they can try and make money trading the stocks where they are specialists. Here's how the specialist makes real money, besides getting paid a small fee for matching up orders.

The key to being the specialist is seeing all the order flow. Because specialists have knowledge of who is buying, who wants to buy and how much and at what prices, and the same is true for knowing the sell side, the specialist essentially gets to trade on inside information. The specialist could raise the bid if he wanted to buy stock because he knew there were more buy orders coming into his book, and if he was right and the stock moved higher, he could sell his position for a nice profit.

And that is pretty much how the system works today. Eventually, investors grew weary of having the specialists slice off profits on insider information. Even though we got rid of the fractional system, we still have the insiders slicing off small profits on each trade. Now the Nasdaq doesn’t have a specialist system because there is no central trading floor where dealers meet and call out prices, but in the automated, cyberspace world, each dealer is his own specialist.

Eventually, electronic communications networks (ECNs) sprang up. ECNs were and still are networks where dealers who weren't part of Nasdaq could place their quotes and buy and sell with each other. From there it wasn't long before Nasdaq dealers wanted to get onto all the ECNs and demands were made to trade NYSE and AMEX stocks on the computer networks. That's how technology changed the old specialist system into a mass of different trading venues that now includes entirely new exchanges like BATS, and dark pools where banks and crossing services trade for clients demanding anonymity.

The problem now is that there is no longer any one central place where all orders go to be executed. Orders are spread around based on cost, and services, and, most importantly, "payment for order flow." So, now the online brokerage firms like Schwabb, and Etrade, and whoever, don’t have their own traders to execute trades and they don’t have their own trading desks, so they have to route those orders to an exchange or a couple of exchanges to match up buyers and sellers. In order for exchanges and networks that offer execution of orders to be successful, they have to have orders coming in so they can match up buyers and sellers. Otherwise, if there aren't enough orders to allow matching of buyers and sellers at prices where customers want to transact, that exchange would have no "liquidity" and it would lose business.

So how do all these competing exchanges get orders? They pay for them. They pay Schwab, and Ameritrade and Scottrade for their "order flow." That's right; your order at your discount brokerage is sold to someone so it can be traded on their exchange. Who gets paid for your order? Not you. Your brokerage gets paid.

So, after the switch to decimalization in 2001, we had the rise of the market makers. Market makers are the same as specialists, except they are mini-specialists in the stocks they trade electronically for their broker-dealer or bank trading desk who trade on Nasdaq or on the ECNs or anywhere where an intermediary can interpose himself into a trade, and they will impose their trade ahead of your trade. That’s why they buy order flow, so they can create an internal “book” so they can have their own inside information on the order flow, so they can trade against it, or sell it to other traders.

HFT operators are looking at all the order flow going into all the different exchanges and trading venues they can peer into. They look into the total flow of orders, which no single exchange can see, and with their empirically modeled time sequencing of orders, spreads, and depth that they run through reinforcement learning algorithms, they come up with a trade that steps in to buy or sell shares before someone who intended to transact there gets a chance to.

Speed is critical to high-frequency trading. Exchanges rent HFT shops space next to their servers (co-location) so they get their data faster than everyone else. That's legal. They couldn't do it if there weren't so many exchanges and trading venues competing for orders. You can thank the SEC for making that a reality without sensible limits. They couldn't do it if there was no such thing as payment for order flow; yes, they get paid for their order flow too. You can thank the SEC for allowing that neat little scheme.  HFT shops can buy and sell at the same price (that's a zero profit or loss), but because they provided some venue "liquidity" by sending their super-fast order there to be executed, they get paid. That's not arbitrage in the traditional sense; that's just playing the game. They couldn't do it if they didn't have all the information at the speed they get it at from the exchanges the SEC regulates.

And so you pay whenever you make a trade; you lose about a penny per share, sometimes more, and you’re expected to accept this little slice in the name of liquidity, but it isn’t really liquidity, it’s really just volume. High-frequency trading has nothing to do with what liquidity is, what liquidity means to the market. Volume is not liquidity.

Everything is usually fine when markets are moving up or are relatively stable. We won't really notice HFT. But, in a wicked downdraft, when HFT players turn off their computers, we will see that there are no bids on any specialists' books or parked with market makers. There will be no stopping stocks from falling for that reason. We saw it in the May 2010 flash crash. That's what HFT has done to the market. It has made it a dark pool, and a dark pool is not required to yell out a price like the old-school specialists; instead prices come in at a more leisurely pace, when it suits the ECNs, after they scalped their share. What this means is that we don’t really know what the price is, and you can’t have a market without prices, which means one day we could have a catastrophic market failure; despite the propaganda otherwise.

Wednesday, April 02, 2014 - Speak Your Mind by Blowing Your Wad

Financial Review with Sinclair Noe

DOW + 40 = 16,573
SPX + 5 = 1890
NAS + 8 = 4276
10 YR YLD + .04 = 2.80%
OIL – 33 = 99.29
GOLD + 10.10 = 1290.90
SILV + .22 = 20.08

The S&P 500 closed at another record high.

The Commerce Department reported that orders to US factories rose 1.6% in February, the most in five months. January's durable goods orders were revised to show a larger drop of 1.0% instead of the previously reported decline of 0.7%. Yesterday, the Institute for Supply Management said its manufacturing index rose in March.

A private survey showed that US companies stepped up their hiring in March. Payroll processer ADP said private employers added 191,000 jobs. ADP also revised February's job creation up to 153,000 from the 139,000 figure reported earlier. The report comes ahead of the government's monthly jobs report, scheduled to be released on Friday; the over-under number for Friday is 200,000 net new jobs.

We know the Federal Reserve will be watching the jobs report. St. Louis Fed President James Bullard speaking to reporters at his branch of the central bank, said a formal rate rise is "still a considerable distance away." Federal Reserve Bank of Atlanta President Dennis Lockhart said today: “Based on my working medium-term outlook, I see the latter half of 2015 as the likely time frame for the first move to higher rates,” but if the economy doesn’t grow as he current expects, Lockhart thinks, “a later liftoff date… will likely be appropriate.”

Lately bad weather was cited as the reason that Walmart and FedEx and Delta’s earnings were disappointing.  If it isn't one-time charges that happen every quarter being removed from reported results, it's the weather being blamed. Of course, even if the weather truly was awful enough to prevent people from shopping, or buying a house, that demand should simply show up in a later month. A certain amount of productive capacity is lost, but pent up demand should rev things right back up again. The March jobs report won’t be the final word on the weather and the economy, but if we don’t see some sort of significant improvement, then we are running out of bad weather excuses.

Russian, American, and European diplomats continue to talk about settlement talks that might halt further Russian military action in Ukraine; Crimea is a done deal, but Ukraine is another matter. NATO will suspend "all practical civilian and military cooperation" with Russia because of its annexation of Crimea, saying it has seen no sign that Moscow was withdrawing troops from the Ukrainian border.

Meanwhile, Gazprom, the Russian energy company has fired a shot across the bow, raising the price it charges Ukraine for natural gas. The price jumped from $268 per 1,000 cubic meters of gas to $385, or about a 44% increase. Gazprom execs attributed the price increase to an unpaid debt for gas. This is not the first time energy has been used as an economic weapon, nor will it be the last.

The US has been undergoing an oil and gas renaissance; the White House has promoted exploration and drilling, and output has jumped. When it comes to natural gas, the US is being compared to Saudi Arabia, or Saudi America. Of course, that provided no advantage to thwart Putin’s aggression in Crimea. One reason Saudi America has failed to instill fear in Russia is that we lack the capacity to export LNG to Europe, and probably won’t be able to export in any significant quantities for a few more years; and then it would probably be a few more years before Ukraine could build facilities to receive such exports.

Meanwhile, we ran into a rash of reports in the past week or so, all telling us that our reliance on fossil fuels is killing us. The American Association for the Advancement of Society, the Intergovernmental Panel on Climate Change, and the World Meteorological Organization all confirmed that the planet is getting hotter; 13 of the past 14 years have been the hottest ever recorded. The Antarctic ice shelf is melting, Greenland too; the rain forests are dying and the Gulf Stream is collapsing. It’s not just the melting ice and the poor polar bears; the reports warn of very human problems of hunger, disease, drought, flooding, refugees, violence, and war.

Necessity is the Mother of Invention, and the time is now for innovation; and the good news is that there are inventors who have been working on these problems and have created solutions; the bad news is that the status quo and the powers that be are entrenched. This is a defining moment, and energy is being used as an economic weapon, and that weapon is pointed directly at our own foot.

And the entrenched powers just became more entrenched. The Supreme Court has struck down the aggregate campaign contribution limits, opening the gates for even more money to flood into the political system. The good news is we have the best politicians money can buy. The bad news is we have the best politicians money can buy. The 5-4 ruling in McCutcheon v. Federal Election Commission was penned by Chief Justice John Roberts and joined by justices Anthony Kennedy, Samuel Alito and Antonin Scalia; Justice Thomas went a step further and called for a complete end to campaign finance reform.

The decision relies heavily on the assertion in the 2010 Citizens United ruling that influence and access are not a corruption concern. This means that a single donor will soon be able to contribute millions of hard dollars in limited contributions, to political parties, candidates and political action committees.

Federal law sets certain limits, so you can't just go write a candidate a check for a million dollars and call it a day. That means you can't give more than $2,600 to any one candidate per election. Even if you were to donate once in the primary election and again in the general, the absolute most you could give to an individual candidate's campaign is $5,200. And you can’t, or couldn’t just spread money across the board. For the 2013-2014 election cycle, Federal Election Commission rules state that a donor can give no more than $123,200 to all political committees, with two sub-limits of $48,600 to candidates and $74,600 to political parties and political action committees. In other words, there was a limit, a cap on aggregate spending. Those limits are no more.

 Now, a single donor can now give more than $5 million in individually limited contributions to every House candidate, every Senate candidate, every state party committee, every national party committee and every leadership PAC connected to one political party. The McCutcheon ruling also did away with the aggregate limit on donations to political action committees, or PACs, which can give money directly to candidates. While there's a limit on how much PACs can give to each candidate, there's no limit on the number of PACs that can exist. Without the aggregate limit, one donor can now give $5,000 each to 1,000 different PACs. And those 1,000 PACs can turn around and funnel that money straight to one candidate. Which means that one candidate could haul in $5 million in direct contributions from one donor, funneled through a network of PACs.

So, if you have a big wad of money that you would like to waste on buying politicians, the Supreme Court has just ruled that you can blow your wad just a freely as you can speak your mind.

The new Michael Lewis book, “Flash Boys” looks at High Frequency Traders front running trades, using technology to jump in front of a trade and skim some profits. The uproar from Wall Street has been hilarious. There are claims that front running isn’t really bad; it doesn’t hurt ordinary investors; it may actually add to liquidity, blah, blah, blah. This is kind of like saying a mafia hit man is good for the neighborhood because he spends his money at the local grocery store and he hasn’t killed anybody on my street.

As we said the other day, High Frequency traders front running the market is not new; it has been going on for years, but the book and the 60 Minutes interview and the publicity finally caught the attention of otherwise somnambulant sleuths at the FBI who are investigating front running, which is a criminal offense. Where this could get interesting is that the High Frequency Trading firms set up shop in close proximity to the stock markets in New York, and they pay for high speed access to the exchanges’ computer systems and data.

The New York Stock Exchange calls it “fully managed co-location space next to the NYSE Euronext’s US trading engines in a new state of the art data center”. The NYSE is the landlord. And they can set up the “super high density” fiber optic connections for an initial fee of $7,000, or a onetime upgrade fee of $9,200. In other words, the New York Stock Exchange and the Nasdaq are complicit in the skimming operation. I didn’t hear Lewis or 60 Minutes talk about that, but that is the ugly truth.

The other funny thing about the Michael Lewis book and interview is the notion that some clever fellows, backed by hedge fund guru David Einhorn and a few other Wall Street big dogs, had come up with a clever technical fix in a new and better exchange called IEX.  Protected by a spool of fiber to ward off the high frequency traders like garlic against vampires. Free market triumphs, mission accomplished. Don't even think about a minimum transaction tax, a speed bump rule such as a minimum order duration, or anything more comprehensive than that.

Monday, March 31, 2014 - Hope for the Best, Prepare for the Worst

Financial Review with Sinclair Noe

DOW + 134 = 16,457
SPX + 14 = 1872
NAS + 43 = 4198
10 YR YLD + .01 = 2.72%
OIL - .18 = 101.49
GOLD – 10.10 = 1285.80
SILV - .06 = 19.86

Wrapping up the first quarter let’s go to the scorecard. The Dow Industrials lost 121 points in the quarter but gained 136 points in the month of March; the S&P 500 finished the quarter up 24 points and up 13 points in March; the Nasdaq Comp gained 22 points in the quarter and lost 110 points in March; oil prices are up $3.50 a barrel since the start of the year and down .42 in March; gold gained $74.80 for the quarter but lost $41.90 the last month; silver added .33 for the quarter but down $1.44 for the month of March.

The first quarter marked the fifth straight quarter of gains for the S&P 500 and the Nasdaq Composite indices. Last week’s drop of 2.8% in the Nasdaq Comp was the first such drop since October 2012, or the first time the Nasdaq dropped by 2.8% in 77 weeks.

Did you see 60 Minutes last night? They interviewed Michael Lewis, who is an excellent financial writer; he has a new book called “Flash Boys” and it deals with high frequency traders on Wall Street. They tried to present the idea that they had just discovered the market is rigged. It is rigged, and it has been rigged for quite some time; this is not a new discovery. The high frequency traders scalp as many trades as possible; they add no value; they do not make markets; they do not provide liquidity; they steal from everyone who buys and sells stocks. Good for Michael Lewis for writing a book about this, but it is not new.

And it is not the only market that’s rigged. Switzerland’s Competition Commission announced today that it had begun a formal investigation into eight financial institutions, over potential collusion to manipulate the currency markets. The regulator opened a preliminary investigation into the foreign exchange market last year. Regulators in Britain, the United States and other countries have begun investigations into whether traders tried to manipulate benchmark currency rates. The financial institutions being investigated include: UBS, Credit Suisse, Zurcher Kantonalbank, Julius Baer, Royal Bank of Scotland, JPMorgan Chase, Citigroup and Barclays.

And of course, this follows investigations into the Libor rate rigging, ISDAfix derivatives rigging, gold rigging, mortgages backed securities rate rigging, robo-signing, and the shorter path is to find markets that haven’t been rigged and manipulated. Earlier today, a district judge said shareholders could pursue a securities fraud lawsuit against JPMorgan for the London Whale trading scam. The financial sector dips its beak into everything, everywhere. The Bank of England recently admitted in its Quarterly Bulletin that banks don’t actually lend the money to the depositors; they lend bank credit created on their books. In the United States the finance charges on this credit amounts to approximately 30% to 40% of the economy. So, in effect, everything is rigged.

Janet Yellen, made her first public speech as the new Federal Reserve chairwoman, today in Chicago. Perhaps the takeaway line from Yellen’s speech was when she said: “There remains no doubt that the economy and the job market are not back to normal health. The recovery still feels like a recession to many Americans and it also looks that way in some economic statistics.”

And this is the very reason why the economy is not experiencing normal health; the Fed has been pushing money to Wall Street, so the Wall Street bankers and traders can dip  their beak into everything, but QE1, 2, 3, and the Twist, and ZIRP haven’t produced jobs, because the money never made it to Main Street; and because the money never made it to Main Street, there is only weak demand, not enough demand to spur the economy into a virtuous cycle of growth and prosperity. 

Employers don’t hire people to save the American economy; they don’t hire people because the Fed is buying Treasury bonds. Employers hire people because if they didn’t, they wouldn’t be able to meet the demand for goods and services they produce, and they’d be leaving profit on the table, and some competitor would step in and take that profit. Employers hire because of demand, not QE.

Consumers create demand and demand creates jobs and the steady income from a job creates consumer demand; if that sounds like a death spiral, well it can be, unless there is some way to spur demand. What we have learned over the past 6 years, is that QE is not the answer; allowing the financial sector to dip their beaks and suck out finance charges to the tune 40% of the economy is not the answer.

Simply growing corporate profits is not the answer. US companies outside of the finance industry are holding more cash on their balance sheets than ever, with $1.64 trillion at the end of 2013. The profits have been growing for the past 5 years but income has dropped and employment growth, while steady has been anemic. Typically, profits recover before jobs, but the money doesn’t seem to be trickling down. One way corporations have been maximizing profit is by cutting labor expenses. And compensation has dropped to just over 60%, the lowest level since 1951.

So today Chairwoman Yellen talked about how the economy and job market are not back to normal health; she said the Fed had an “extraordinary” commitment to boosting the economy and adding jobs and that commitment will be needed for some time to come. The problem is that the Fed has been prescribing the wrong medicine.

The United Nations Intergovernmental Panel on Climate Change, the IPCC, issued its report on climate change today, and as we talked about on Friday, the report concludes that climate change is already having effects including: melting sea ice and thawing permafrost in the Arctic, killing off coral reefs in the oceans, and leading to heat waves, heavy rains and mega-disasters. And the worst is yet to come. Climate change poses a threat to global food stocks, and to human security.

The report is a three year project. The volume of scientific literature on the effects of climate change has doubled since the last report in 2007, and the findings make an increasingly detailed picture of how climate change poses a much more direct threat to life and livelihood. The warning signs about climate change and extreme weather events have been accumulating over time, but this report struck out on relatively new ground by drawing a clear line connecting climate change to food scarcity, and conflict.

"We're now in an era where climate change isn't some kind of future hypothetical," said the overall lead author of the report, Chris Field of the Carnegie Institution for Science in California. "We live in an area where impacts from climate change are already widespread and consequential."

The report was pretty straightforward and to the point; if the world doesn't cut pollution of heat-trapping gases, the already noticeable harms of global warming could spiral "out of control". Here are some of the key points of the report:

Climate change is already taking a sizeable chunk out of global food supply and it is going to get worse. Increases in crop yields – which are needed to sustain a growing population – have slowed over the last 40 years. Some studies now point to dramatic declines in some crops over the next 50 years – especially wheat, and to a lesser extent corn. Rice so far is unaffected. The shortages, and the threat of food price spikes, could lead to unrest.

Climate change poses a threat to human security, and could lead to increased migration. Potential shortages of food and water, because of climate change, could be drivers of future conflicts. These won't necessarily be wars between states, but conflicts between farmers and ranchers, or between cities and agriculture industry which wants water for food.

Some are more vulnerable than others. Poor people in poor countries, and even the poor in rich countries, are going to bear an unfair burden of climate change. Climate change is going to exacerbate existing inequalities, and it is going to make it harder for people to claw their way out of poverty. Still, no one is immune, or according to another contributing author Princeton University professor Michael Oppenheimer, “We’re all sitting ducks.”

As temperatures rise beyond 2 degrees to 4 degrees – our current trajectory – there are limits to how far society can adapt to climate change. The only way out is to cut emissions now – and buy some time by slowing warming – and at the same time make plans for sea walls, relocations, and other measures that can keep people out of harms' way.

The scientific data is now completely overwhelming. It is not easy or comforting to imagine the negative consequences, and this does not mean we can’t make some very important and meaningful changes. Indeed, this will probably be the most important issue for all of us for the next 30 or 40 years. It will dominate business activity as well as most other aspects of our lives. Hope for the best, prepare for the worst.