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U.S. stock index futures were pointing to a lower opening on Friday.
Rumors about European banks having problems with derivatives are setting
a negative tone even before the employment report. Wild Friday likely
ahead.
News For Thought
It pays to give.. to Congress. According to The Washington
Post: "House and Senate lawmakers have received nearly $2 million in
campaign contributions this election cycle from organizations for which
they had sponsored earmarks, according to a new report by two nonpartisan
watchdogs."
The report added: "Over half of the members of the House and Senate accepted
money for the November elections from recipients of their earmarks, according
to the report, released Thursday by the Center for Responsive Politics and Taxpayers
for Common Sense. Thirteen senators and nine House members received more than
$20,000 from companies and organizations that were beneficiaries of their earmarks."
And finally: "Sen. Daniel Inouye (D-Hawaii), chairman of the Appropriations Committee,
was the top recipient of money overall with $140,700 in contributions from beneficiaries
of his earmarks," while "Rep. Jim Moran (D-Va.) received $70,000 from earmark
recipients, the most of any House lawmaker. Moran sits on the House defense appropriations
subcommittee and received most of that money from defense interests." No comment
from either camp.
Mutual fund investors are bailing out. According to Marketwatch.com: "individual
investors' comfort with stock investing seems to have been short-lived. After
registering steady inflows in March and April for the first time in almost a
year, market turbulence in May led to large outflows for stock mutual funds." Again,
it seems as if the little guy bought the top. According to the report: "Investors
still scarred by losses in late 2008 and early 2009 seem to have been spooked
by a price correction and the spike in stock-market volatility last month, as
concerns about European sovereign debt, the so-called flash crash, geopolitical
tensions on the Korean peninsula and the troubles surrounding the oil spill in
the Gulf of Mexico roiled the markets." And "In the week ending May 26, U.S.-focused
funds saw $13.4 billion head out the door and international funds lost $3.9 billion
-- the largest outflows in each category since the week ending March 11, 2009,
according to the Investment Company Institute, a fund industry trade group. Stock
funds saw consistent outflows through May. In the week ending May 5, U.S. funds
lost $2.4 billion while international funds saw $992 million of net inflows;
the week ending May 12 saw $7 billion pulled out of domestic funds and $3 billion
from international, and the week of May 19 saw net outflows of $745 million and
$339 million from domestic and international funds, respectively."
And wait until they read today's Market IQ. |
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High frequency traders have access to data and put it
to use before the rest of the market, which explains how the practice is
changing the entire stock market and raises questions of fairness, if not
legality, says a report in The Wall Street Journal.
If you're wondering how the market can rise and fall a thousand points in an
hour and get most of it back in a couple of hours, you're not alone. And now,
there are some more answers as to how the stock market works in 2010.
According to The Wall Street Journal: "Some fast-moving computer-driven investment
firms are getting an edge by trading on market data before it gets to other investors,
according to market players and researchers who have studied the trading."
How do they do it? They pay for it and buy it straight from the exchanges, the
Journal reports. Her'es the lowdown: "The firms gain that advantage by buying
data from stock exchanges and feeding it into supercomputers that calculate stock
prices a fraction of a second before most other investors see the numbers. That
lets these traders shave pennies per share from trades, which when multiplied
by thousands of trades can earn the firms big profits." In fact, as The Journal
points out: "Critics all the practice the modern day equivalent of looking at
share prices listed in tomorrow's newspaper stock tables today."
So, the market is rigged eh? Whodda thunk it? Big money getting the advantage
on little money with help from more big money guys like the exchanges? Look,
we're not being naive. It's clear that big money has its advantages. But, this
is just a little less tasteful than even the Credit Default Swap con ran by the
big houses with Suprime mortgages. This is looking at prices, in what we can
describe only as "pre-real time," betting on them, knowing that you're right,
and then making money when the herd follows the trend that you started because
you knew the way prices were headed.
And, oh yeah, some of this stuff goes on in dark pools, you know the private
exchanges that only those who have membership have access too. According to The
Journal: "While legal, the practice pushes the envelope of what is fair, critics
say, and raises questions about the advantages some fast-moving traders are gaining
in the market. The SEC roundtable convened executives from trading centers and
firms across Wall Street as the agency continues to probe high-frequency trading
and the growth of dark pools, trading venues where trades take place away from
the main exchanges."
This stuff is called "latency arbitrage." Clever these guys are. After all, they're
the same guys that call insurance policies "swaps" and groups of bonds "tranches." Nice.
And yes, as always, some of this stuff is legal, mostly because it's so clever
that the SEC and Congress don't know about it, much less understand it until
it's been in practice for so long that it's part of the market. And when there
are laws to prevent it, the clever guys that think of these cons are already
well underway with their new caper, as the old ones become illegal, or obsolete.
So, the Journal reports that "Some firms pay tens of thousands of dollars a year
to individual exchanges for premium access to their price feeds, industry players
and exchanges say," while 'The SEC, in a broad review of market structure earlier
this year, said information from trading-center data feeds "can reach end-users
faster than the consolidated data feeds."'
And what's the object? Aside from knowing the way things are going to turn out
and taking money from the unsuspecting traders who use clunky old "real time" rigs "The
latency arbitrage trade aims to game the so-called national best bid and offer
price on a stock, which sets the price most investors use to trade."
In other words 'The ability to estimate price moves ahead of the national best
bid and offer price, which is consolidated electronically from exchanges, can
give traders an advantage of about 100 to 200 milliseconds over investors who
use standard market tools, according to a November 2009 report on such trading
activities by Jefferies & Co. An advanced look at exchange data and order
flow can provide firms "the ability to forecast future prices" and "make adjustments
to their orders in the market or send new orders which are based on this information," the
report found.'
And it goes on all the time. The Journal reports how one firm "baited" a broker
and a dark pool into a trade that proved that the other party knew the way things
would shake out before they did.
According to the report: "TFS, which manages about $1.1 billion in mutual funds
and hedge funds, devised a method to essentially bait firms into engaging in
the trade." And here's how it went: "On a March afternoon, a TFS trader sent
an order to a broker to buy shares of Nordson Corp., a maker of fluid dispensing
equipment. The trader sent an instant message to the broker: "please route to
broker pool #2," a request to send the order to a specific dark pool. The trader
told the broker not to pay a price higher than the midpoint between what buyers
and sellers were offering, which at the time was $70.49. Several seconds after
the dark pool order was placed, the market price didn't change. Then the TFS
trader set a trap: he sent a separate order into the broader market to sell Nordson
for a price that pushed the midpoint price down to $70.47. Almost immediately,
TFS was sold Nordson for $70.49—the old, higher midpoint—in broker pool No. 2,
which didn't reflect the new sell order. TFS got stuck paying two cents more
than it should have, suggesting that some seller knew the higher price was a
good deal to nab quickly."
Conclusion
In the book "Reminiscenses of a Stock Operator," the legendary speculator Jesse
Livermore talked of bucket shops, places where "off the book" bets on stock prices
took place. It was in these "bucket shops" where Livermore learned the trade
of speculating on stocks, and where he figured out how to manipulate prices and
how to detect manipulation by other players.
The existence of "dark pools" and now "latency arbitrage" is, in our opinion,
a hark back to those days, where market manipulation was commonplace and accepted
as part of the daily business. You can call it whatever you want, and you can
debate the legality of it, but if you knew the score of a baseball game before
everyone else did, and you bet on it and made money, you'd be in a lot of trouble
if someone found out about it and reported to the cops.
It's hard to see how "latency arbitrage" is different than that, although we're
sure that someone, somewhere is thinking about how to do just that at this time.
To be sure, we're not accusing anyone of manipulating the markets. And we are
not alleging anything beyond what the Journal reports says. Yet, it seems that
a mere two years after a huge economic crash, this is a rather inoportune time
to learn that yet another "off the books" scheme is ongoing, and that the SEC
and the regulators don't really know what to do about it.
Of course, this is the same government that has spent wildly beyond its means
for decades, has gotten the U.S. into two controversial wars, and is now watching
the Gulf of Mexico turn into the Dead Sea.
At least, we now know what many of us have suspected, or known in our gut without
being able to prove it. The stock market is more than dangerous, it's just as
wild and crazy as any casino. And it seems to be "rigged" as Sal Arnuk, co-founder
of brokerage firm Themis Trading, told the SEC on Wednesday, according to The
Journal.
If you want to know how this turns out, we recommend the 1970s classic "Network," where
the world seemed to be upside down, because it was.
We'll be on Twitter
some time today before the market closes with some updated comments.
Know when to sell and how to make money when the market falls. Get
a detailed trading plan in your pocket. Read Dr. Duarte's All
NEW Books "Market Timing For Dummies." and "Trading Futures For Dummies." The Trading Manuals for
All Seasons. Also Available As Kindle Books. |
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The Select Sector
SPDR Financial ETF (NYSE: XLF) is, along with the rest
of the market, having trouble climbing above its 200-day
moving average.
Chart Courtesy of StockCharts.com
Banks have improved their balance sheets, and their financial
performance after sinking precipitously during and after
the subprime mortgage crisis. But the recent rebound is
running into trouble.
And as we head into the weekend, two major developments, aside from the employment
report are worth noting. One is the slide in the Euro. And the other is the major
reason for the slide in the Euro, rumors that a big French bank Societe General
is having problems related to derivatives.
It's not surprising that there are rumors. What is surprising is that there aren't
more of them. Off the book bets, including credit default swaps and other esoteric
derivatives were at the center of the market and economic meltdown spurred by
the subprime mortgage mess. But what is litte known, as we have pointed out here
before, is how many of those instruments are still in place, waiting to be unwound.
Some of those credit default swaps were good for thirty years, according to sources
familiar with the way they work. So, it is theoretically possible that some of
those things, like time bombs, are coming back to haunt a big bank like Soc Gen,
and perhaps others.
We have no way of knowing, and Soc Gen isn't commenting. Yet, it is very plausible
that another wave of credit default swap related volatility is on the way.
Follow Dr. Duarte on Twitter |
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