See also Karl’s previous article Solving the HFT Dilemma, Barry Ritholtz’s Quote Stuffing and Strange Sequences, and JDA’s High Frequency Trading Gets Villainized (Again) and US Markets Spin Wildly Out of Control, and approx. one in four of Zero Hedge’s article – Ilene
Investors Flee "WOPR"
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Courtesy of Karl Denninger at The Market Ticker
Executives said volumes and profitability last month were even lower than during the sluggish second quarter, with hedge funds particularly reluctant to take big bets on equities and debt.
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Wall Street executives and analysts blamed the poor showing in July both on a fall in trading volumes as small investors, hedge funds and institutions sat on the sidelines, and on a squeeze in margins amid fierce competition among banks.
And why would that be, "Wall Street Exectives"?
It wouldn’t have to do with you destroying CONfidence in the markets with bid-rigging, various high-frequency trading games and similar nonsense, would it?
The Patsy is usually the individual investor, who winds up getting distributed to just before the floor disappears. But having been hosed twice in a decade by those Wall Streeters who continually appear in the mainstream media to tell us how "it’s a great time to buy stocks" (have you ever heard a salesman tell you it’s a bad time to buy whatever he’s selling?) it appears that Joe Q Public is wising up:
Equity funds had estimated outflows of $3.85 billion for the week, compared to estimated outflows of $1.32 billion in the previous week. Domestic equity funds had estimated outflows of $4.10 billion, while estimated inflows to foreign equity funds were $255 million.
It’s been a nice rally, but Americans don’t trust it.
Nor should they, in my opinion.
Indeed, in my 20+ years of market-watching and more than a decade of active trading, I’ve never seen a market as wildly distorted as the one we find ourselves in today. Then again, I’ve never seen a market in which 70% or more of all volume is simply computers trying to skim fractions of a penny from each other.
Yes, I understand the "full court press" to keep stock prices in the air – they’re literally the "final frontier" in trying to prompt people to spend money they don’t have based on false asset valuations, and thereby "promote" consumerism beyond earnings capacity.
But increasingly the American Public is coming to recognize the math:
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The rock we live on is finite in size, although vast.
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Our credit cards, individually as well as nationally, do have limits and do eventually have to be paid.
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Generating asset bubbles feels great on the way up. But each bubble must be larger than the last in order to keep the cycle going, and the last one we blew was in housing – one of the largest asset classes of all.
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Asset bubbles create ruinously bad economic dislocations when they pop.
And finally:
All exponential functions in a finite world eventually run to an unsustainable point, at which point the mathematics dictates that the corrective deflation of the bubble(s) blown must take place.
The politicians don’t want to face reality, because their actions are predicated on bubble economics as well – promising to spend money is a time-honored way to buy votes. But government is incapable of actually creating anything – at best it can direct the production that the private sector would otherwise have somewhere else, and at worst it wastes the funds it raises through corruption and fraud.
The public purpose of the capital markets is to permit the raising of capital by business from private investors. A public secondary market is necessary in order for those people to have a reason to invest, as without it liquidity would be non-existent and their capital trapped.
But when the secondary markets become the plaything of computers trying to game each other with "Wargames-style" bid and offer manipulation (an unlawful activity), when the public good of price discovery becomes subsumed by millisecond-level computer activity designed and intended to skim off portions of the order flow by distorting that price-discovery mechanism, and when rampant insider-trading and other fraudulent activity gets to the point of being "in your face" and yet is ignored by the authorities that have allegedly made these acts unlawful, then the individual investor, who both has no access to these "technologies of theft" and in addition believes in the rule of law (and lacks the protection of having the employees of the government charged with enforcement all coming from their companies!) have no reason to continue "invest" in what they have (correctly) deduced is a rigged casino.
Bluntly, we no longer have a secondary market and actual liquidity, and as individuals and corporations (ex those playing with their computer algorithms) increasing come to recognize this the level of violence in the markets increase, actual liquidity evaporates, and true investors – that is, people who actually are intending to buy and sell instead of trying to steal from everyone else within electronic view – flee.
In short, without broad participation by actual buyers and sellers all that’s left is the computers playing "WOPR" with each other, and the game they’re playing is not "Chess."
And that, in the end, is how market disintegrate.
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Photl courtesy of Jr. Deputy Accountant
