Monday, May 05, 2014 - Riggers’ Propaganda

Riggers’ Propaganda

by 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. 

Monday, April 14, 2014 - Blood Moon and More

Blood Moon and More

by Sinclair Noe

DOW + 146 = 16,173
SPX + 14 = 1830
NAS + 22 = 4022
10 YR YLD + .02 = 2.64%
OIL - .11 = 103.63
GOLD + 8.20 = 1327.60
SILV un = 20.07

Here’s what you can expect; the Earth will eclipse the moon tonight about 10:58PM pacific time, adjust according to your time zone. The eclipse will take some time, a few hours. The moon will shift color from orange to blood red to brown, again depending on you locale and the weather. It should be interesting.

The stock markets started the day in positive territory and as trading dragged on, the major indices moved lower on the very cusp of turning red, almost as if they were being eclipsed, and then positive again, right at 3:15 PM eastern time, everything just picked up. Now, you might think the markets are rigged. You might.

A group of traders has sued CME Group Inc, accusing the operator of the world's largest derivatives exchange of selling market data to high frequency traders, cheating other investors who lacked such access. The suit says the CME and its Chicago Board of Trade unit have been giving high-frequency traders early access to buy and sell orders.  They said this deprived other investors of the transparent, real-time data on futures and interest rate contracts that they thought they were getting, and were paying for.

Volume was down from Friday; that’s a nasty trend, lighter volume on up days, heavier volume on down days.

The economic calendar includes the March Consumer Price Index tomorrow; Wednesday brings an update on housing starts and building permits, plus the Federal Reserve will release its Beige Book; Friday, the markets are closed for Good Friday.

This morning the Commerce Department reported retail sales increased 1.1% last month; February’s sales numbers were revised higher to 0.7% from a previously reported 0.3%. An important subset of the report showed retail inventories, excluding automobiles, rose 0.2% in February. You will recall that businesses accumulated too much inventory in the fourth quarter of last year, and we have seen fewer orders as the businesses work through unsold goods and try to clear their shelves. That has left the inventory to sales ratio at its highest level since September 2009. Now, it looks like the buyers are back.

A separate report from the New York Fed showed people grew more confident in the labor market last month, with younger workers in particular seeing a greater chance of finding work should they lose their current job.

Earnings reporting season continues with Citigroup posting better than expected net income under of $3.9 billion, or $1.23 per share, from $3.8 billion, or $1.23 per share. Citi Holdings, which holds the bank's portfolio of troubled assets left over from the financial crisis, posted a loss of $292 million, down from $798 million a year earlier. For all of Citigroup, adjusted revenue dropped 2% to $20.1 billion. Citi still has problems with its Mexican unit, which is accused of making fraudulent loans. Also, Citi flunked the recent Fed stress tests for capital reserves. So, here we are nearly 6 years after the financial meltdown and Citi is still cleaning up its books, still exhibiting signs of structural damage, and unable to put money to productive purpose.

The Congressional Budget office says the deficit isn’t as bad as they thought. For the fiscal year 2014 ending September 30, CBO said, the deficit would fall to $492 billion from a $514 billion February estimate - and nearly a third lower than last year's $680 billion deficit. And CBO lowered its cumulative deficit forecast for fiscal years 2015 through 2024 by $286 billion, to a mere $7.6 trillion; the reason for the lower deficits, is that subsidies for health care costs will be less than previously guesstimated.

Deficits will reach a low point of $469 billion, or 2.6% of US gross domestic product, in fiscal 2015, then gradually start to rise, topping $1 trillion again in 2023 and 2024, a level that would be near 4% of GDP.

Last week the IMF and the World Bank held their Spring Meeting in Washington DC. Here’s a snippet from a panel discussion featuring Federal Reserve Bank of Chicago President Charles Evans and Citigroup chief economist Willem Buiter.

Charles Evans said: “In the U.S. monetary policy is using the standard transmission mechanism. We’re trying to reduce financing costs. Auto rates are down and the auto sector is way back compared to where it was. Housing is better. Mortgage rates are down. And if you have the ability to refinance, or get a mortgage – it’s tougher these days because of the standards - then you can do that. So it’s the standard transmission mechanism. And we are indeed trying to get inflation up because we’re below target. What comes with that is wage increases, also up to where they ought to be. Wages are a symptom of inflation – using a lagging indicator – and they’re down around 2 to 2.25% right now. When they’re at a steady growth part of the cycle they ought to be about 3.5% - 1.5% productivity and 2% inflation target. So getting everything up – and getting inflation up to where it is supposed to be is an important part of all of this. So that benefits everybody.”

Citigroup chief economist Willem Buiter responded: “Monetary policy works with asset prices. By boosting equities, raising bond prices, weakening the currency and that’s exactly how it has happened. Not very effectively, because we have poor man’s monetary policy. Which is what unconventional monetary policy is. But it’s all we have. I would have preferred to see some additional measures on the fiscal side, which could have mitigated some of the income distributional consequences…”

Over the weekend we saw the investment game plan detailed on Sunday morning talk shows. Did you catch it? The climate is changing; we can still fix it; it will require massive investment. According to the most recent Intergovernmental Panel on Climate Change report, keeping global warming down to a level people can live with means cutting carbon emissions to "near zero" by the end of the century, even in an increasingly industrialized world. That may be doable, but it will take "substantial investments" in everything from planting more trees to replacing fossil fuels with low-carbon power sources like solar, wind and nuclear energy. The report clearly shows that the challenges to resolve the global common problem are huge, but also this report shows that there are some steps to resolve this issue.

And the longer we wait, the more expensive it becomes, and if we wait too long, the Earth and all of us who are too miserly to invest now, will cook.

Any hope will require more than tripling the share of electricity produced by renewable sources or nuclear power, along with refining the still-evolving technology of capturing carbon emissions and storing them underground. And it will take a coordinated global effort, likely including taxes on emissions. No direct price tag was attached to that scenario, but the IPCC authors indicate it would require "substantial investments," and more delays just drive up the expected cost. The impact could amount to shaving the projected average growth of the global economy by six-hundredths of a percentage point, from about 2% per year to 1.94%, over the coming century. The total global economy was about $72 trillion in 2012, according to World Bank figures.

Secretary of State John Kerry, who in February called the issue "the greatest challenge of our generation," said Sunday's report is an economic opportunity.

Kerry said in a written statement: "So many of the technologies that will help us fight climate change are far cheaper, more readily available, and better performing than they were when the last IPCC assessment was released less than a decade ago. These technologies can cut carbon pollution while growing economic opportunity at the same time. The global energy market represents a $6 trillion opportunity, with 6 billion users around the world."

Despite more than two decades of efforts to restrain carbon emissions, not only are emissions still going up, they're going up faster than ever. Though there's been an increased emphasis on generating power from renewable sources, the use of coal has gone up in the past 10 years.

The Washington Post and the Guardian captured coveted Pulitzer Prizes for public service for their revelations about the US government's massive surveillance programs. The newspapers' stories were based on thousands of secret documents obtained from Edward Snowden, the former National Security Agency contractor who is living in Russia after fleeing the United States. The Post also won a Pulitzer this year for explanatory reporting. The New York Times won two Pulitzers, both for photography. No award was handed out for feature writing. The Boston Globe won for breaking news for its coverage of the Boston Marathon bombing. Reuters won an award for its coverage on the persecution of a Muslim minority in Myanmar who in efforts to flee often fall into the hands of brutal human-trafficking networks. The prize for investigative reporting went to The Center for Public Integrity for reports on how some lawyers and doctors rigged a system to deny benefits to coal miners stricken with black lung disease. The prize for explanatory reporting went to the Washington Post for work on the prevalence of food stamps in post-recession America. The prize for local reporting went to the Tampa Bay Times for an investigation into squalid housing conditions for the city's homeless population. The prize for national reporting went to The Gazette in Colorado Springs, Colorado, for his examination of how wounded combat veterans are mistreated.

I know what you’re thinking; this is a shocking development. Who knew there were still newspapers?

Friday, October 19. 2012 - Sometimes I Forget What I'm Supposed To Remember

Sometimes I Forget What I'm Supposed To Remember

by Sinclair Noe

DOW – 205 = 13,343
SPX – 24 = 1433
NAS – 67 = 3005
10 YR YLD -.06 = 1.77%

OIL – 1.96 = 90.14
GOLD – 21.10 = 1721.50
SILV - .75 = 32.17
PLAT – 29.00 = 1625.00

Today is the 25^th anniversary of Black Monday, and the markets paid homage with a 205 point drop, nothing close to the 508 point drop in 1987. On a percentage basis, 1987 was 16 times worse than today. The Crash of 1987 would be about a 3,100 point drop in today's markets. That would get your attention. Still, the more things change the more they stay the same.

Back in 1987, the Crash was blamed, at least in part, on program trading, based on portfolio insurance and a process called dynamic hedging. I remember computers back then that weren't fast enough to play Pong, much less cause a crash. Maybe the Wall Street crowd had really fast floppies. Today we have high frequency trading or HFT, and they can whip out trades in milliseconds; and if you're looking for a market crash in the future, don't be surprised if it comes from HFT. The whole idea of HFT is legalized theft and it doesn't add to market liquidity, stability or efficiency. They are not market-makers. They are market-manipulators. They have no obligation to make a market in any stock. The never have to post a market or ever honor the bids and offers they post. In fact, their game is to post fake bids and offers that they have no intention of honoring.

High-frequency traders send out tens of millions, if not billions, of orders to exchanges that are never meant to be executed. They are fake orders designed to manipulate prices on the nation's exchanges. And while other market participants are not actually forced to adjust their bids and offers or engage in any of these trades, allowing access to the exchanges to manipulate anybody in any way is something that ought to be outlawed. The main advantage of HFT is that the traders are fast and they are so fast they can jump in front of your trade and skim off a tiny fraction

The SEC allows exchanges to serve high frequency traders by leasing them co-location space next to the exchange's servers. It's kind of like allowing pickpockets to come into the bank and stand at the tellers' window and steal from the customers, as long as they only steal pocket change and not folding money. The problem is that all that pocket change adds up the real money. HFT activity is responsible for at least half of the daily 6.8 billion shares traded across America's exchanges, and may be as much as 80% by some measures. And when HFT accounts for more than 50% of trades it means the high frequency traders are playing with themselves. This means liquidity is an illusion.

Remember the Flash Crash of 2010? The Dow dropped 1,000 points in 10 minutes. Remember the Knight Capital fiasco a few months back? Remember Kraft Foods a few weeks ago? A computer algorithm has a minor glitch and in the blink of an eye tens of millions of dollars is wiped out; trillions could vanish in the time it takes to stir your coffee. So, do you trust the stock market?

The problem today was largely blamed on earnings. Of the 116 S&P 500 companies that have reported results so far, 58 percent have missed on revenue expectations. Note, we're not talking about bottom line profits, we're talking top line revenue; and in some ways that is far more frightening. Today it was GE, McDonald's and Microsoft. Yesterday it was Google, with premature earnings. Google is groping for ways to grow revenue. That puts Google in the same position as Microsoft, trying to find a way to extend its reach.

Google and Microsoft together have over $100 billion of cash on their balance sheets. Judging by the earnings misses that both turned in last night, Google and Microsoft are both willing to take a step back on earnings to invest in the "next big thing." The question for investors is whether or not either or both companies can find that elusive second act. The problem is not the prowess and expertise of these two high tech giants. They continue to create and refine. The problem is demand. We've seen it before.

Remember back in the 80's when Japan was known for its electronic prowess? In 1990 Japanese products represented nearly 30% of the world's total export value. Now that figure is closer to 14%. Remember back in the 80's when the Japanese started an aggressive expansion, buying up all things American. Now, they're on the hunt for growth anywhere they can find it and in any sector that grows. For example: Talkeda Pharmaceuticals has been on a $15 billion buying binge, scooping up Swiss, Brazilian, and a couple of US companies. Daikin Industries just spent nearly $4billion to buy the US airconditioning manufacturer, Goodman. In the financial services sector, Mitsubishi UFJ Lease and Finance is purchasing Jackson Square Aviation for $1.3 billion.  Tokio Marine & Nichido Fire Insurance bought Delphi Financial Group last year for $2.7 billion. And earlier this week, Softbank said it would purchase a 70% stake in Sprint Nextel for $20 billion. That's the biggest M&A deal of the year.

Japanese companies have more than $2 trillion in cash on their balance sheets and some very powerful motivation. The Japanese economy is lousy; the demographics are old; private, corporate, and government debt is 500% of Japanese GDP; and Japanese companies just can't seem to drum up business in Japan.

Of course, back in 1987, the economy recovered pretty quick after the Crash. I don't think that would happen today. The main reason is that the financial sector has changed. Back then we had traditional banks and there were investment banks; and there was a brick wall between them. Back then we had Glass-Steagall. We should resurrect it. It was good policy.

Five years ago Wall Street’s excesses almost ruined the economy. Bankers, hedge-fund managers, and private-equity traders speculated on the upside, then shorted on the downside — in a vast zero-sum game that resulted in the largest transfer of wealth from average Americans to financial elites ever witnessed in this nation’s history.

Average Americans lost big; including over $7 trillion of home values, a $700-billion-dollar bailout of Wall Street, and continuing high unemployment. The top one-percent, the financial elites made out fine. The rich get richer and the poor get poorer; maybe some things never change. The stock market has about caught up to where it was before the crash of 2008; this time it was a far different rebound than the rebound following the Crash of 87. The pay and bonuses on the Street are once again sky-high. So are the pay and perks of top corporate executives. This country has had a hard row to hoe, but some folks have made out like bandits. The problem is that there just aren't enough of them to increase demand. That should be one of the lessons we learned from the Japanese.

In the 1980s the ten biggest banks had less than 30 percent of bank depositary assets. Now they have 54 percent. And the four biggest now dominate the Street almost completely. Because lenders and investors know they’re too big to fail, the four biggest banks have a competitive advantage over smaller rivals that pose larger financial risks. That means they’ll only get bigger.

Breaking up the biggest banks and capping the size of all banks is hardly a radical suggestion these days. There's a long list who think we should. We need to restore trust to Wall Street, and that means we should outlaw the High Frequency Trading bandits; that's one of the lessons we should have learned back in 1987. We need to break up the biggest banks and resurrect Glass-Steagall. That's one of the lesson we actually learned back in 1929. And then we forgot it. "Those who cannot remember the past are condemned to repeat it.”