I think it’s time we took a dispassionate look at what the markets are really telling us rather than what the financial media say they are telling us.
The meta story about the markets is that money has been flowing OUT of the stock market and into the Bond market for the last 17 consecutive weeks. So far this year $52 billion has flowed out of stocks. And the rate of outflow is accelerating. $2.7 last week $4.3 billion this week. These aren’t guesses. This is measured money we know about, that has been pulled from mutual funds.
This tells us quite a lot. It says that smaller investors are getting out of the market. This has been evident from the small volume of trades that have characterized this entire year. And we know from the inflow to bond funds that the investors are opting for the relative security of Bonds over Stocks.
So what else does it tell us that investors are pulling their money and getting out of the stock market? There is a tendency to look at the market almost as an infallible oracle. When in fact it is no more than the averaged sum of the actions of THOSE IN IT.
By definition the market does not and cannot reflect the sentiment of those already out of it. When the market is running ‘normally’ with everybody in it, then what the market ‘does’ is a very good barometer of over all sentiment. But as more and more traders get out, the market starts to reflect only the self-selecting group who remain. At the present moment it is a fact that the American markets in particular are dominated by a very few, very large players prominent among whom are the big banks.
These few players are sometimes buying and selling more stocks back and forth between them than the rest of the market put together. At these times the market is very often moved up almost vertically in minutes or seconds.
It doesn’t take a genius to realise that the market, as it is now, and the values it sets, reflect only the actions of a very few players. The market is not telling us what the broad spectrum of investors think at all.
The problem is, there is no ready indicator to represent the sentiment expressed by leaving the market. If there was, then the price being set by the few banks left trading, would be heavily off-set by those who have voted with their feet and left.
This is a very important short-coming of the information being ‘read’ in the market. Because, in the final analysis, a company is only worth what people will pay for it. If no one even wants to be in the market, they are essentially saying the company is worth nothing to them. And unless the remaining players could really buy up ALL the stocks and shares in the market, then sooner or later the excess of stocks available over the number of buyers who want them, will cause a price crash. I believe that is where we are headed.
In short the outflows are telling us that our present stock market is ‘fixed’ because it is a fiction created by far too few buyers for them to be able to sustain the prices they are setting.
If you have doubts about this just take the two ends of the spectrum to extremes. At one extreme everybody is in the market. This means the market absolutely does reflect what people are wiling to pay. At the other extreme, however, you get two idiots buying and selling, back and forth, each impressed with what the other was willing to pay and taking this as a sign that the value must be increasing. That is where we are now.
Of course the people involved aren’t idiots. But they are hoping that some other idiots will look at the prices going up and suddenly jump in and ‘buy the rising market’. Allowing those who have ‘ramped’ the price up and up, to take the idiot’s money and quietly leave the building. That last, lone idiot will then learn that when no one will buy something from you, then it’s ‘value’ has suddenly become nothing at all.
On a more practical level, the level of redemption’s also tells us the those mutual funds will be running out of cash soon. All Funds keep a certain percentage of their wealth in cash. It is there so the funds can return money to investors who want out. But they only hold so much. After 17 straight weeks of redemptions Funds are likely to be running out of cash. Once they do they will have to start selling assets. Once that starts it can feed on itself. Especially in a market that is being run by our two idiots.
That’s the stock market. The Bond market is simpler. Some of the new money going in is ‘flight to safety’ money looking for a port against the volatility of the stock market shenanigans. But some if it is money that is desperate to find big returns. That money has seen how currency speculation is proving so lucrative. There is a rising tide of more or less hot money looking to fund every speculative predation.
In the midst of all this dysfunction we have our governments.
I think it is time we were clear with ourselves that there is a world of difference between reviving a market and sustaining it. One is returning to health. The other is a morbid attempt to re-animate the dying.
Our leaders talk about and may even genuinely believe, they are reviving the markets with all their bail-outs. But two years of data should have told them otherwise. We have sustained something at death’s door that we should have allowed to depart.
It has cost us trillions withdrawn from our futures and it is going to cost us our democracy if we are not careful.
Hi Golem,
The figures on various sites that talk about this mass outflow from stocks are in dollars. Does that mean they are only talking about the American stock markets or is the same happening in the UK? Is HFT occurring in the UK or is it once again an American thing?
I read on one of the sites that the Fed will cause future crashes in the stock market when they sense that they cannot sell bonds, so as to scare more money into the safety of government bonds – do you think that is possible?
The central bankers and politicians are gambling that asset prices will recover to 2007 levels and that will help recovery. Do you think that is possible and if it happened would they be able to unwind the global leverage much more easily?
Hello Sleeper,
They are principally talking about the US stock markets Dow, S&P and NASDAQ. But that is also because those people tend to be American. I do not know if the out flows are similar from UK funds. My suspicion is that they will be similar.
As for HFT again most of the discussion is about US markets and US trading houses. If you watch the markets you note two things. First I have not seen a blatant ramp up occur on any of the European markets without it happening first on the Dow. Any ramp over there is mirrored very quickly over here. But I've not seen one originate here.
So I can't tell you if there the ramp up's here are machines here switching on in the wake of the Americans or if the rise is ordinary traders following the melt up by hand as it were.
It makes sense that manipulation and intervention will focus on American markets. They are bigger and are what everybody watches.
It's also that it's America's close which closes out the day. When Europe closes there is still half a trading day left in the US. The ramp comes at the end of the whole global day.
The Fed causing the crashes – this was much talked about early last year. The evidence was a suspicious coincidence between sudden dips it the market and large often unannounced withdrawals of liquidity (The so called slosh) from the US money supply engineered by the Fed.
This coincidence happened a handful of times. And also seemed to happen around when voices raised concerning US rates creeping up.
So it did seem that the Fed was using tightening of money supply to herd money out of stocks and back into Bonds whenever worries about US interest rates and bond sales reached an uncomfortable level.
It was also argued that the 09 crash was because one of these interventions got out of hand. I think you might well be able to argue that the precise day it happened was precipitated by such a Fed action. Scaring money from one market to another using money /credit supply is akin to trying to get a tiger to move by prodding it with a stick. It may move. It may also tear your head off. That said the underlying conditions which made the crash bound to happen were and still are systemic.
I don't think they have been doing this so much of recent in the US. Because there is no need. Back in 09 and before money would dry up for US bonds (relatively speaking). Since the start of this year that does not happen and the US has no trouble selling its debt because the situation globally has changed with the rise of European sovereign debt problems.
Concerns over European sovereign debts has put a constant bias towards US bonds. Essentially Europe does the Fed's scaring for it.
I think it is more accurate to say they WERE all gambling on asset prices 'recovering' up to 07 levels. The hope may still linger on in the back of their minds, but realistically they know it is very unlikely now. But they can't admit this loudly for fear it would undermine the fragile public acceptance of austerity measures.
It's one thing to accept austerity if you're told it will make everything perfect. Quite another to be told all it will do is just keep things in their current awful state. That is the truth they do not want to speak.
second part below
For bank assets and house prices to 'recover' to 07 is to inflate another bubble. People think 08 was the bubble. Actually we all knew the bubble was already huge for years prior.
I do not think it will happen. What can happen is IF austerity measure of large cuts, low spending, low wages and pension cuts are all maintained over the long term – at least 5-10 years – then ban debts will stabilize at a point where they meet the amount of those debts taken on the public purse. The bank 'assets' will never recover all their value. But the tax payers will have taken up the difference.
As for leverage levels and global debt levels. It is a pure public consumption fiction that they have any intention of reducing leverage by anything other than a token amount and even that will be for a short time only.
I can say this with comfort for two reasons. First any reduction in leverage will lesson their ability for profits to keep pace with loses. Such is our level of debts to earning capacity that ordinary levels of earning will not keep pace. If we don't intend on writing any of the debt down (and the wealthy don't intent to) then we need steroid levels of growth. That means leverage.
The second reason is that leverage levels always tend up because the financial player with higher leverage has more muscle. Thus it only takes one bank in one jurisdiction to have higher leverage and everyone insists on following. Our government's are simply too much in the pay and service of their respective financial classes to do anything to stop leverage creeping back up.
That is not even to mention the fact that the Fed and the US government mortgage servicers Fannie and Freddie themselves have insane leverage levels. SO they are not in a position to force anyone to a level lower than the one they themselves need in order to stay breathing.
There will be no unwind until it crashes. Just as there hasn't been and won't be any 'exit' from lose money either.
Hello again Sleeper,
Sorry, this has all got much longer than I'd intended. Just realized I shouldn't have so glibly said that now the US has no problem selling its debt.
With Europe's prpblems they do have an easier time because the Dollar is seen as the safe haven from Euro debt worries. That said however, it is difficult to tell what problems the US is having. There is certainly pressure on the so called yield curve. The measure of willingness to buy long term versus shorter term debt. It is also the case that the Various parts of the US government now hold more US debt than ever before and are buying it at a higher rate. The Fed buys a high proportion (basically monetizing the debt QE) of some issues while another very large chunk is being taken by the primary dealers We don't know who they are selling it on to, or if, as I suspect, they are depositing it right back at the Fed as collateral. If so then this is appears to be a way of back door monetizing.
And then another chunk appears to be being bought by central banks in return, as I have been arguing, for the Fed buying theirs.
Hi Golem, apropos this topic, I was reading in the FT about how they are moving the server data centres physically closer to stock exchanges so that trades are done quicker. In other words they reckon (and I am a bit dubious about the rationale as described below) the shorter distance means the trades happen faster. This is known as 'co-location'. There is a whole scenario named High Frequency Trading which can be used to block out competitors as well. In actuality, an electronic effect moves at about 1 foot per nanosecond (one thousandth millionth of a second). Having worked in electronics these scales are nothing special but the delay through the circuits must be far greater, in the order of milliseconds. So the distance between servers the data travels at more or less light speed, but inside the routers and hubs it must be manipulated by code that is far far slower. Just my opinion and I am happy to be corrected.
There as a 'flash-crash' on the Dow-Jones index in June attributed to this technique. That is automated fast trading using the slight differences between to quote
'…since it produces a variety of trading venues each with slightly different trading systems, speeds and fee schedules. This allows traders to exploit these differences by using computer algorithms to trade back and forth from one platform to another.'
I always wondered what would happen when they automated this and now we know. Frightening stuff and it is nothing to do with the inherient viability of a stock, simply playing the system to gain a margin.
Hi IanG
I think the most important benefit will be the higher data bandwidths available near the centre.
They are also reducing the number of routers that data has to go through before it reaches its destination. Each router will typically add a few milliseconds to the transmission time of the IP packet, assuming the router is not too occupied – transmission times are much greater when 'timeout' events occur.
Each router will also add a separately maintained connection, which may fail, resulting in the data being re-routed.
Another thing to consider is protection against foreign cyber attacks. Security is more easily managed if you can create a 'ring of steel' around your most important financial centre.
Hi RichGB, I hadn't considered that. However, there will not necessarily be a relationship between the network topology and the physical location. So even though you have a server next door to your destination the traffic may go by some round-about route not straight there using minimum switches and routers. But I am sure they know this and I agree it is probably easier to get a short limited hop connection if you are nearby.
The point about attacks is true of course.
But the worrying thing about this technique is that it has nothing to do with the worth of the underlying stocks. It is simply playing off different stock exchange costs to make a killing when doing enormous trades. So the various indexes look like there was a lot of activity (buying/selling but all it was doing was creaming off the transaction profits. At the end of the day the shares are probably back where they started.
Thanks for the detailed response Golem. I am still trying to get my head around all this stuff! Where did you learn about it all? Did you study finance or economics at uni? Was there a defining point or something that made you realise how messed up it all is? I am slowly piecing it all together but it is a slow process!
What do you think about Max Keiser and documentaries like money masters or secrets or oz? or are they too conspiratorial for you?
I think Michael Hudson has been reading Golems blog.
http://michael-hudson.com/2010/09/is-the-economy-as-broke-as-lehman-was/
Rob,
Great article. Thanks for posting it.
Sleeper,
I studies Bioanthropology and Hominid evolution at university. I started to take an interest in economics during the Uruguay round of the GATT. GATT is what did it for me.
I watched it's maturation with a rising sense of horror. When it was passed I declared my own war.
Yes, the Michael Hudson article was truly great. It brings hope that at least some main-stream academia can be brought on board.
I remember when I first read Golem's comments on the Guardian a couple of years back, I found in strange that virtually no-one in the Main Stream Media held the same opinions. What I have noticed recently is a drift towards Golem's views – slowly but surely.
I'm not sure that Michael Hudson is main stream, but I think his writing is great.
I have read a lot over the last two years. The main motivation has been simply to understand what is going on. I found this posting yesterday proposing some of the ultimate causes. It is definitely food for thought. It is a shame that the author is giving up blogging, but I can understand that it must take up an enormous amount of time!