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Magic Show Returns to Wall Street

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Quantitative easing is back.  For those of you who still aren’t familiar with what quantitative easing is, I have provided a link to this short, funny cartoon, which explains everything.

The first two phases of quantitative easing brought enormous gains to the stock market.  In fact, that was probably all they accomplished.  Nevertheless, if there had been no QE or QE 2, most people’s 401(k) plans would be worth only a fraction of what they are worth today.  The idea was that the “wealth effect” provided by an inflated stock market would both enable and encourage people to buy houses, new cars and other “big ticket” items – thus bringing demand back to the economy.  Since the American economy is 70 percent consumer-drivendemand is the engine that creates new jobs.

It took a while for most of us to understand quantitative easing’s impact on the stock market.  After the Fed began its program to buy $600 billion in mortgage-backed securities in November of 2008, some suspicious trading patterns began to emerge.  I voiced my own “conspiracy theory” back on December 18, 2008:

I have a pet theory concerning the almost-daily spate of “late-day rallies” in the equities markets.  I’ve discussed it with some knowledgeable investors.  I suspect that some of the bailout money squandered by Treasury Secretary Paulson has found its way into the hands of some miscreants who are using this money to manipulate the stock markets.  I have a hunch that their plan is to run up stock prices at the end of the day before those numbers have a chance to settle back down to the level where the market would normally have them.  The inflated “closing price” for the day is then perceived as the market value of the stock.  This plan would be an effort to con investors into believing that the market has pulled out of its slump.  Eventually the victims would find themselves hosed once again at the next “market correction”.

Felix Salmon eventually provided this critique of the obsession with closing levels and – beyond that – the performance of a stock on one particular day:

Or, most invidiously, the idea that the most interesting and important time period when looking at the stock market is one day.  The single most reported statistic with regard to the stock market is where it closed, today, compared to where it closed yesterday.  It’s an utterly random and pointless number, but because the media treats it with such reverence, the public inevitably gets the impression that it matters.

In March of 2009, those suspicious “late day rallies” returned and by August of that year, the process was explained as the “POMO effect” in a paper by Precision Capital Management entitled, “A Grand Unified Theory of Market Manipulation”.

By the time QE 2 actually started on November 12, 2010 – most investors were familiar with how the game would be played:  The New York Fed would conduct POMO auctions, wherein it would purchase Treasury securities – worth billions of dollars – on an almost-daily basis.  After the auctions, the Primary Dealers would take the sales proceeds to their proprietary trading desks, where the funds would be leveraged and used to purchase stocks.  Thanks to QE 2, the stock market enjoyed another nice run.

This time around, QE 3 will involve the purchase of mortgage-backed securities, as did QE 1.  Unfortunately, the New York Fed’s  new POMO schedule is not nearly as informative as it was during QE1 and QE 2, when we were provided with a list of the dates and times when the POMO auctions would take place.  Back then, the FRBNY made it relatively easy to anticipate when you might see some of those good-old, late-day rallies.  The new POMO schedule simply informs us that  “(t)he Desk plans to purchase $23 billion in additional agency MBS through the end of September.”  We are also advised that with respect to the September 14 – October 11 time frame,  “(t)he Desk plans to purchase approximately $37 billion in its reinvestment purchase operations over the noted monthly period.”

It is pretty obvious that the New York Fed does not want the “little people” partaking in the windfalls enjoyed by the prop traders for the Primary Dealers as was the case during QE 1 and QE 2.  This probably explains the choice of language used at the top of the website’s POMO schedule page:

In order to ensure the transparency of its agency mortgage-backed securities (MBS) transactions, the Open Market Trading Desk (the Desk) at the New York Fed will publish historical operational results, including information on the transaction prices in individual operations, at the end of each monthly period shown in the table below.

In other words, the New York Fed’s idea of transparency does not involve disclosure of the scheduling of its agency MBS transactions before they occur.  That information is none of your damned business!

Return of the POMO Junkies

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Most investors have been lamenting the recent stock market swoon.  The Dow Jones Industrial Average has given up all of the gains earned during 2012.  The economic reports keep getting worse by the day.  Yet, for some people all of this is good news  .   .   .

You might find them scattered along the curbs of Wall Street   . . .  with glazed eyes  . . .  British teeth  . . .  and mysterious lesions on their skin.  They approach Wall Street’s upscale-appearing pedestrians, making such requests as:  “POMO?”   . . .  “Late-day rally?”  . . .   “Animal Spirits?”  These desperate souls are the “POMO junkies”.  Since the Federal Reserve concluded the last phase of quantitative easing in June of 2011, the POMO junkies have been hopeless.  They can’t survive without those POMO auctions, wherein the New York Fed would purchase Treasury securities – worth billions of dollars – on a daily basis.  After the auctions, the Primary Dealers would take the sales proceeds to their proprietary trading desks, where the funds would be leveraged and used to purchase high-beta, Russell 2000 stocks.  You saw the results:  A booming stock market – despite a stalled economy.

Since I first wrote about the POMO junkies last summer, they have resurfaced on a few occasions – only to slink back into the shadows as the rumors of an imminent Quantitative Easing 3 were debunked.

The recent spate of awful economic reports and the resulting stock market nosedive have rekindled hopes that the Federal Reserve will crank-up its printing press once again, for the long-awaited QE 3.  Economist John Hussman discussed this situation on Monday:

At this point, the S&P 500 has achieved a cumulative total return of less than 10% since April 2010. Meanwhile, of course, there remains a great deal of faith in the “Bernanke put,” because even though it’s fairly obvious that QE has done nothing durable for the economy or the financial markets over the last couple of years, a hit of QE might at least be good for a few months of “risk on” delirium.  If the American public can’t get thoughtful economic leadership, at least Wall Street’s speculative junkies can hope for a little taste of Q from Sugar Daddy.

One of the problems with QE here, however, is that it would essentially represent fiscal policy for the benefit of speculators, at taxpayer expense.  To see this, note that the 10-year Treasury yield is now down to less than 1.5%.  One wonders how Bernanke would be able to argue, with a straight face, that this is not low enough.  Nevertheless, a 10-year bond has a duration of 8 years – meaning that each 100 basis point fluctuation in interest rates is associated with a change of about 8% in the price of the bond.  So if you buy the bond and hold it for a full year, an interest rate change of of 1.5/8 = .1875, or less than 20 basis points, is enough to wipe out the annual interest and leave you with a negative total return.

*   *   *

“QE3 – subsidizing banks and bond speculators at taxpayer expense” – there’s a pithy slogan.  That doesn’t mean the Fed will refrain from more of its recklessness (which will be nearly impossible to reverse when it becomes necessary to do so), but does anyone actually believe by now that QE would improve the economy, durably elevate risky assets beyond a few months, or materially relieve global debt strains?

Obviously, the POMO junkies have no such concerns.  Beyond that, the Federal Reserve’s “third mandate” – keeping the stock market bubble inflated – will be the primary factor motivating the decision, regardless of whether those asset prices hold for more than a few months.

The POMO junkies are finally going to score.  As they do, a tragic number of retail investors will be led to believe that the stock market has “recovered”, only to learn – a few months down the road – that the latest bubble has popped.


 

Trouble Ahead

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Forget about what you’ve been told by the “rose-colored glasses” crowd.  We are headed for more economic trouble.  On September 17, economist Lakshman Achuthan gave his prognosis for the economy to Guy Raz, of NPR’s All Things Considered:

Achuthan, co-founder and chief operations officer of the Economic Cycle Research Institute, says all of his economic indicators point to more sputtering ahead.

“The risk of a new recession is quite high,” he says.

In Toronto, Michael Babad of The Globe And Mail saw fit to focus on the latest forecast from “Dr. Doom”:

Nouriel Roubini, the New York University professor who forecast the financial crisis, went further today, warning that “we are entering a recession.”   The question isn’t whether there will be a double-dip, he said on Twitter, but rather how deep it will be.

And the answer, added the chairman and co-founder of Roubini Global Economics, depends on the response of policy makers and developments in the euro zone’s ongoing crisis.

As Gretchen Morgenson reported for The New York Times, the European sovereign debt crisis is already beginning to “wash up on American shores”.  The steep exposure of European banks to the sovereign debt of eurozone countries has become a problem for the United States:

Some of these banks are growing desperate for dollars.  Fearing the worst, investors are pulling back, refusing to roll over the banks’ commercial paper, those short-term i.o.u.’s that are the lifeblood of commerce.  Others are refusing to renew certificates of deposit. European banks need this money, in dollars, to extend loans to American companies and to pay their own debts.

Worries over the banks’ exposure to shaky European government debt have unsettled markets over there – shares of big French banks have taken a beating – but it is unclear how much this mess will hurt the economy back here.  American stock markets, at least, seem a bit blasé about it all:  the Standard & Poor’s 500-stock index rose 5.3 percent last week.

Last Thursday, I expressed my suspicion that the recent stock market exuberance was based on widespread expectation of another round of quantitative easing.  This next round is being referred to as “QE3”.   QE3 is good news for Wall Street because of those POMO auctions, wherein the New York Fed purchases Treasury securities – worth billions of dollars – on a daily basis.  After the auctions, the Primary Dealers take the sales proceeds to their proprietary trading desks, where the funds are leveraged and used to purchase high-beta, Russell 2000 stocks.  You saw the results during QE2:  A booming stock market – despite a stalled economy.

I believe that the European debt situation will become the controlling factor, which will turn the tide in favor of QE3 at the September 20-21 Federal Open Market Committee meeting.

Most pundits have expressed doubts that the Fed would undertake another round of quantitative easing.  Bill McBride of Calculated Risk put it this way:

QE3 is unlikely at the September meeting, but not impossible – however most observers think the FOMC will announce a program to change the composition of their balance sheet (extend maturities).  It is also possible that the FOMC will announce a reduction in the interest rate paid on excess reserves (currently 0.25%).

Tim Duy expressed a more skeptical outlook at his Fed Watch website:

Even more unlikely is another round of quantitative easing.  I don’t think there is much appetite at the Fed for additional asset purchases given the inflation numbers and the stability of longer-term inflation expectations relative to the events that prompted last fall’s QE2.

On the other hand, hedge fund manager Bill Fleckenstein presents a more persuasive case that the Fed can be expected to react to the “massive red ink in world equity markets” (due to floundering European bank stocks) by resorting to its favorite panacea – money printing:

So, to sum up my expectations, I believe that not only will we get a bold new round of QE from the Fed this week, but other central banks will join the party.  (The Bank of Japan and Swiss National Bank are already printing money in an attempt to weaken their currencies.)  If that happens, I believe that assets (stocks, bonds and commodities) will rally rather dramatically, at least for a while, with the length and size of the rally depending on the individual idea/asset.

If no QE is announced, and we basically see nothing done, it will probably be safe to short stocks for investors who can handle that strategy.  Markets would be pummeled until the central planners (i.e., these bankers) are forced to react to the carnage. Such is the nature of the paper-money-central-bank-moral-hazard standard that is currently in place.

The Fed will announce its decision at 2:15 on Wednesday, September 21.  Even if the FOMC proceeds with QE3, its beneficial effects will (again) be limited to the stock market.  The real American economy will continue to stagnate through its “lost decade”, which began in 2007.


 

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Federal Reserve Bailout Records Provoke Limited Outrage

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On December 3, 2009 I wrote a piece entitled, “The Legacy of Mark Pittman”.  Mark Pittman was the reporter at Bloomberg News whose work was responsible for the lawsuit, brought under the Freedom of Information Act, against the Federal Reserve, seeking disclosure of the identities of those financial firms benefiting from the Fed’s eleven emergency lending programs.

The suit, Bloomberg LP v. Board of Governors of the Federal Reserve System, 08-CV-9595, (U.S. District Court, Southern District of New York) resulted in a ruling in August of 2009 by Judge Loretta Preska, who rejected the Fed’s defense that disclosure would adversely affect the ability of those institutions (which sought loans at the Fed’s discount window) to compete for business.  The suit also sought disclosure of the amounts loaned to those institutions as well as the assets put up as collateral under the Fed’s eleven lending programs, created in response to the financial crisis.  The Federal Reserve appealed Judge Preska’s decision, taking the matter before the United States Court of Appeals for the Second Circuit.  The Fed’s appeal was based on Exemption 4 of the Freedom of Information Act, which exempts trade secrets and confidential business information from mandatory disclosure.  The Second Circuit affirmed Judge Preska’s decision on the basis that the records sought were neither trade secrets nor confidential business information because Bloomberg requested only records generated by the Fed concerning loans that were actually made, rather than applications or confidential information provided by persons, firms or other organizations in attempt to obtain loans.  Although the Fed did not attempt to appeal the Second Circuit’s decision to the United States Supreme Court, a petition was filed with the Supreme Court by Clearing House Association LLC, a coalition of banks that received bailout funds.  The petition was denied by the Supreme Court on March 21.

Bob Ivry of Bloomberg News had this to say about the documents produced by the Fed as a result of the suit:

The 29,000 pages of documents, which the Fed released in pdf format on a CD-ROM, revealed that foreign banks accounted for at least 70 percent of the Fed’s lending at its October, 2008 peak of $110.7 billion.  Arab Banking Corp., a lender part- owned by the Central Bank of Libya, used a New York branch to get 73 loans from the window in the 18 months after Lehman Brothers Holdings Inc. collapsed.

As government officials and news reporters continue to review the documents, a restrained degree of outrage is developing.  Ron Paul is the Chairman of the House Financial Services Subcommittee on Domestic Monetary Policy.  He is also a longtime adversary of the Federal Reserve, and author of the book, End The Fed.  A recent report by Peter Barnes of FoxBusiness.com said this about Congressman Paul:

.   .   .   he plans to hold hearings in May on disclosures that the Fed made billions — perhaps trillions — in secret emergency loans to almost every major bank in the U.S. and overseas during the financial crisis.

*   *   *

“I am, even with all my cynicism, still shocked at the amount this is and of course shocked, but not completely surprised, [that] much [of] this money went to help foreign banks,” said Rep. Ron Paul (R-TX),   .   .   .  “I don’t have [any] plan [for] legislation …  It will take awhile to dissect that out, to find out exactly who benefitted and why.”

In light of the fact that Congressman Paul is considering another run for the Presidency, we can expect some exciting hearings starring Ben Bernanke.

Senator Bernie Sanders of Vermont became an unlikely ally of Ron Paul in their battle to include an “Audit the Fed” provision in the financial reform bill.  Senator Sanders was among the many Americans who were stunned to learn that Arab Banking Corporation used a New York branch to get 73 loans from the Fed during the 18 months after the collapse of Lehman Brothers.  The infuriating factoid in this scenario is apparent in the following passage from the Bloomberg report by Bob Ivry and Donal Griffin:

The bank, then 29 percent-owned by the Libyan state, had aggregate borrowings in that period of $35 billion — while the largest single loan amount outstanding was $1.2 billion in July 2009, according to Fed data released yesterday.  In October 2008, when lending to financial institutions by the central bank’s so- called discount window peaked at $111 billion, Arab Banking took repeated loans totaling more than $2 billion.

Ivry and Griffin provided this reaction from Bernie Sanders:

“It is incomprehensible to me that while creditworthy small businesses in Vermont and throughout the country could not receive affordable loans, the Federal Reserve was providing tens of billions of dollars in credit to a bank that is substantially owned by the Central Bank of Libya,” Senator Bernard Sanders of Vermont, an independent who caucuses with Democrats, wrote in a letter to Fed and U.S. officials.

The best critique of the Fed’s bailout antics came from Rolling Stone’s Matt Taibbi.  He began his report this way:

After the financial crash of 2008, it grew to monstrous dimensions, as the government attempted to unfreeze the credit markets by handing out trillions to banks and hedge funds.  And thanks to a whole galaxy of obscure, acronym-laden bailout programs, it eventually rivaled the “official” budget in size – a huge roaring river of cash flowing out of the Federal Reserve to destinations neither chosen by the president nor reviewed by Congress, but instead handed out by fiat by unelected Fed officials using a seemingly nonsensical and apparently unknowable methodology.

As Matt Taibbi began discussing what the documents produced by the Fed revealed, he shared this reaction from a staffer, tasked to review the records for Senator Sanders:

“Our jaws are literally dropping as we’re reading this,” says Warren Gunnels, an aide to Sen. Bernie Sanders of Vermont.  “Every one of these transactions is outrageous.”

In case you are wondering just how “outrageous” these transactions were, Mr. Taibbi provided an outrageously entertaining chronicle of a venture named “Waterfall TALF Opportunity”, whose principal investors were Christy Mack and Susan Karches.  Susan Karches is the widow of Peter Karches, former president of Morgan Stanley’s investment banking operations.  Christy Mack is the wife of John Mack, the chairman of Morgan Stanley.  Matt Taibbi described Christy Mack as “thin, blond and rich – a sort of still-awake Sunny von Bulow with hobbies”.  Here is how he described Waterfall TALF:

The technical name of the program that Mack and Karches took advantage of is TALF, short for Term Asset-Backed Securities Loan Facility.  But the federal aid they received actually falls under a broader category of bailout initiatives, designed and perfected by Federal Reserve chief Ben Bernanke and Treasury Secretary Timothy Geithner, called “giving already stinking rich people gobs of money for no fucking reason at all.”  If you want to learn how the shadow budget works, follow along.  This is what welfare for the rich looks like.

The venture would have been more aptly-named, “TALF Exploitation Windfall Opportunity”.  Think about it:  the Mack-Karches entity was contrived for the specific purpose of cashing-in on a bailout program, which was ostensibly created for the purpose of preventing a consumer credit freeze.

I was anticipating that the documents withheld by the Federal Reserve were being suppressed because – if the public ever saw them – they would provoke an uncontrollable degree of public outrage.  So far, the amount of attention these revelations have received from the mainstream media has been surprisingly minimal.  When one compares the massive amounts squandered by the Fed on Crony Corporate Welfare Queens such as Christy Mack and Susan Karches ($220 million loaned at a fraction of a percentage point) along with the multibillion-dollar giveaways (e.g. $13 billion to Goldman Sachs by way of Maiden Lane III) the fighting over items in the 2012 budget seems trivial.

The Fed’s defense of its lending to foreign banks was explained on the New York Fed’s spiffy new Liberty Street blog:

Discount window lending to U.S. branches of foreign banks and dollar funding by branches to parent banks helped to mitigate the economic impact of the crisis in the United States and abroad by containing financial market disruptions, supporting loan availability for companies, and maintaining foreign investment flows into U.S. companies and assets.

Without the backstop liquidity provided by the discount window, foreign banks that faced large and fluctuating demand for dollar funding would have further driven up the level and volatility of money market interest rates, including the critical federal funds rate, the Eurodollar rate, and Libor (the London interbank offered rate).  Higher rates and volatility would have increased distress for U.S. financial firms and U.S. businesses that depend on money market funding.  These pressures would have been reflected in higher interest rates and reduced bank lending, bank credit lines, and commercial paper in the United States.  Moreover, further volatility in dollar funding markets could have disrupted the Federal Reserve’s ability to implement monetary policy, which requires stabilizing the federal funds rate at the policy target set by the Federal Open Market Committee.

In other words:  Failure by the Fed to provide loans to foreign banks would have made quantitative easing impossible.  There would have been no POMO auctions.  As a result, there would have been no supply of freshly printed-up money to be used by the proprietary trading desks of the primary dealers to ramp-up the stock market for those “late-day rallies”.  This process was described as the “POMO effect” in a 2009 paper by Precision Capital Management entitled, “A Grand Unified Theory of Market Manipulation”.

Thanks for the explanation, Mr. Dudley.


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Searching For A Port In A Storm Of Bad Behavior

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August 20, 2009

Since I began complaining about manipulation of the stock markets back on December 18, I’ve been comforted by the fact that a number of bloggers have voiced similar concerns.  At such websites as Naked Capitalism, Zero Hedge, The Market Ticker and others too numerous to mention —  a common theme keeps popping up:  some portion of the extraordinary amounts of money disseminated by the Treasury and the Federal Reserve is obviously being used to manipulate the equities markets.  One paper, released by Precision Capital Management, analyzed the correlation between those days when the Federal Reserve bought back Treasury securities from investment banks and “tape painting” during the final minutes of those trading days on the stock markets.

Eliot “Socks” Spitzer recently wrote a piece for Slate, warning the “small investor” about a “rigged” system, as well as the additional hazards encountered due to routine breaches of the fiduciary duties owed by investment firms to their clients:

Recent rebounds notwithstanding, most people now are asking whether the system is fundamentally rigged.  It’s not just that they have an understandable aversion to losing their life savings when the market crashes; it’s that each of the scandals and crises has a common pattern:  The small investor was taken advantage of by the piranhas that hide in the rapidly moving currents. And underlying this pattern is a simple theme: conflicts of interest that violated the duty the market players had to their supposed clients.

The natural reaction of the retail investor to these hazards and scandals often involves seeking refuge in professionally-managed mutual funds.  Nevertheless, as Spitzer pointed out, the mutual fund alternative has dangers of its own:

Mutual funds charge exorbitant fees that investors have to absorb — fees that dramatically reduce any possibility of outperforming the market and that are set by captive boards of captive management companies, not one of which has been replaced for inadequate performance, violating their duty to guard the interests of the fund investors for whom they supposedly work.

Worse yet, is the fact that mutual funds are now increasing their fees and, in effect, punishing their customers for the poor performance of those funds during the past year.  Financial planner Allan Roth, had this to say at CBS MoneyWatch.com:

After one of the most awful years in the history of the mutual fund industry, when the average U.S. stock fund and international fund fell by 39 percent and 46 percent respectively, you might expect fund companies would give investors a break and lower their fees. But just the opposite is true.

An exclusive analysis for MoneyWatch.com by investment research firm Morningstar shows that over the past year, fund fees have risen in nearly every category.  For stock funds, the fees shot up by roughly 5 percent.

*   *   *

Every penny you pay in fees, of course, lowers your return.  In fact, my research indicates that each additional 0.25 percent in annual fees pushes back your financial independence goal by a year.

What’s more, the only factor that is predictive of a fund’s relative performance against similar funds is fees.  A low-cost domestic stock fund is likely to outperform an equivalent high-cost fund, just as a low-cost bond fund is likely to outperform an equivalent high-cost fund.   . . .  As fund fees increase, performance decreases.  In fact, fees explained nearly 60 percent of the U.S. stock fund family performance ratings given by Morningstar.  Numerous studies done to predict mutual fund performance indicate that neither the Morningstar rating nor the track record of the fund manager were indicative of future performance.

Another questionable practice in the mutual fund industry — the hiring of “rookies” to manage the funds — was recently placed under the spotlight by Ken Kam for the MSN TopStocks blog:

In this market, it’s going to take skill to make back last year’s losses.  After a 40% loss, it takes a 67% gain just to get back to even. You would think that mutual funds would put their most experienced managers and analysts to work right now.  But according to Morningstar, the managers of 28 out of 48 unique healthcare funds, almost 60%, (see data) have less than five years with their fund.  I think you need to see at least a five-year track record before you can even begin to judge a manager’s worth.

I’m willing to pay for good management that will do something to protect me if the market crashes again.  But I want to see some evidence that I am getting a good manager before I trust them with my money.  I want to see at least a five-year track record.  If I paid for good management and I got a rookie manager with no track record instead, I would be more than a little upset.

Beyond that, John Authers of Morningstar recently wrote an article for the Financial Times, explaining that investors will obtain better results investing in a stock index fund, rather than an “actively managed” equity mutual fund, whether or not that manager is a rookie:

For decades, retail savers have invested in stocks via mutual funds that are actively managed to try to beat an index.  The funds hold about 100 stocks, and can raise or lower their cash holdings, but cannot bet on stocks to go down by selling them short.

This model has, it appears, been savaged by a flock of sheep.

Index investing, which cuts costs by replicating an index rather than trying to beat it, has been gaining in popularity.

Active managers argued that they could raise cash, or move to defensive stocks, in a downturn.  Passive funds would track their index over the edge of the cliff.

But active managers, in aggregate, failed to do better than their indices in 2008.

So …  if you have become too frustrated to continue investing in stocks, be mindful of the fact that equity-based mutual funds have problems of their own.

As for other alternatives:  Ian Wyatt recently wrote a favorable piece about the advantages of exchange-traded funds (ETFs) for  SmallCapInvestor.com.  Nevertheless, if the stocks comprising those ETFs (and the ETFs themselves) are being traded in a “rigged” market, you’re back to square one.  Happy investing!

DISCLAIMER: NOTHING CONTAINED ANYWHERE ON THIS SITE CONSTITUTES ANY INVESTING ADVICE OR RECOMMENDATION.  ANY PURCHASES OR SALES OF SECURITIES OR OTHER INVESTMENTS ARE SOLELY AT THE DISCRETION OF THE READER.

Doubts Concerning The Stock Market Rally

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August 6, 2009

As of today (Wednesday night) the current “bear market rally” continues to surprise people with its longevity.  On the other hand, many news outlets, including The Washington Times and CNBC are declaring a “New Bull Market”.  There seems to be no shortage of commentators proclaiming that the market indices will continue to climb forever.

Back on planet earth, there is a good deal of commentary about the suspicious activity behind this rally.  In my last posting, I discussed the “Plunge Protection Team” or PPT.  Rather than repeat all that, for the benefit of those unfamiliar with the PPT, I will quote the handy definition at the Hamzei Analytics website:

Plunge Protection Team has been the “Working Group” established by law in 1988 to buy the markets should declines get out of control.  It is suspected by many market watchers that PPT has become far more interventionist than was originally intended under the law.  There are no minutes of meetings, no recorded phone conversations, no reports of activities, no announcements of intentions.  It is a secret group including the Chairman of the Federal Reserve, the Secretary of the Treasury, the Head of the SEC, and their surrogates which include some of the large Wall Street firms.  The original objective was to prevent disastrous market crashes.  Lately it seems, they buy the markets when they decide the markets need to be bought, including the equity markets.  Their main resource is the money the Fed prints.  The money is injected into markets via the New York Fed’s Repo desk, which easily shows up in the M-3 numbers, warning intervention was near.  As of April 2006, M-3 is longer reported.

Many of us have looked to the PPT as the driving force behind this rally.  News sources have claimed that the rally is the result of money “coming into the markets from the sidelines” — implying that crisis-wary investors had finally thrown caution to the wind and jumped into the equities markets to partake in the orgy of newfound wealth.  The cash accumulating in the investors’ money market accounts was supposedly being invested in stocks.  This propaganda was quickly debunked by the folks at the Zero Hedge website, with the following revelation:

Most interesting is the correlation between Money Market totals and the listed stock value since the March lows:  a $2.7 trillion move in equities was accompanied by a less than $400 billion reduction in Money Market accounts!

Where, may we ask, did the balance of $2.3 trillion in purchasing power come from?  Why the Federal Reserve of course, which directly and indirectly subsidized U.S.banks (and foreign ones through liquidity swaps) for roughly that amount.  Apparently these banks promptly went on a buying spree to raise the all important equity market, so that the U.S. consumer whose net equity was almost negative on March 31, could have some semblance of confidence back and would go ahead and max out his credit card.

Similar skepticism was voiced by Karl Denninger of The Market Ticker website:

So once again we have The Fed blowing bubbles, this time in the equity markets, with (another) wink and a nod from Congress.  This explains why there has been no “great rush” for individual investors to “get back in”, and it explains why the money market accounts aren’t being drained by individuals “hopping on the bus”, despite the screeching of CNBC and others that you better “buy now or be priced out”, with Larry Kudlow’s “New Bull Market” claim being particularly offensive.

Unfortunately the banksters on Wall Street and the NY Fed did their job too well – by engineering a 50% rally off the bottom in March while revenues continue to tank, personal income is in the toilet and tax receipts are in freefall they have exposed the equity markets for what they have (unfortunately) turned into — a computer-trading rigged casino with the grand lever-meister being housed at the NY Fed.

*   *   *

No, real buying is just that – real buying from real retail investors who believe in the forward prospects for the economy and business, not funny-money Treasury and MBS buying by The Fed from “newly created bank reserves” funneled back into the market via high-speed computers.  The latter is nothing more than a manufactured ramp job that will last only until “the boyz” get to the end of their rope (and yes,that rope does have an end) as the fractional creation machine does run just as well in reverse, and as such “the boyz” cannot allow the trade to run the wrong way lest it literally destroy them (10:1 or more leverage is a real bitch when its working against you!)

Is it coming to an end now?  Nobody can be certain when, but what is certain is that over the last week or so there have been signs of heavy distribution – that is, the selling off of big blocks of stock into the market by these very same “boyz.”  This is not proof that the floor is about to disappear, but it is an absolute certainty that these “players” are protecting themselves from the possibility and making sure that if there is to be a bagholder, it will be you.

Many commentators, including Joseph Saluzzi of Themis Trading, have explained how the practice of computer-driven “High-Frequency Trading” has added approximately 70 percent of “volume” to the equities markets.  This is accomplished because the exchanges pay a quarter-of-a-penny rebate to High-Frequency Trading firms for each order they place, waiving all transaction fees.  As a result, the “big boy” firms, such as J.P. Morgan and Goldman Sachs, will make trades with their own money, buying and selling shares at the same price, simply for the rebates.  Those pennies can add up to hundreds of millions of dollars.

I recently came across a very interesting paper (just over eight pages in length) entitled:  A Grand Unified Theory of Market Manipulation, published by Precision Capital Management.  The paper describes a tug of war between Treasury Secretary Ben Bernanke and the New York Fed, that is playing out in the equities and Treasury securities markets.  The authors suggest that if Bernanke’s biggest threat is high long-term Treasury yields (interest rates), the easiest way to prevent or postpone a yield ramp would be to kill the stock market rally and create a “flight to safety in Treasuries” – situation that lowers long-term yields.  The paper describes how the New York Fed facilitates “painting the tape” in the stock markets to keep the rally alive.  For those of you who don’t know what that expression means, here’s a definition:

An illegal action by a group of market manipulators buying and/or selling a security among themselves to create artificial trading activity, which, when reported on the ticker tape, lures in unsuspecting investors as they perceive an unusual volume.

After causing a movement in the security, the manipulators hope to sell at a profit.

Instead of accusations that the PPT is the culprit doing the tape painting during the final minutes of the trading day, we again see a focus on the New York Fed as the facilitator of this practice.  Here’s the explanation given in the paper by Precision Capital Management:

The theory for which we have the greatest supporting evidence of manipulation surrounds the fact that the Federal Reserve Bank of New York (FRNY) began conducting permanent open market operations (POMO) on March 25, 2009 and has conducted 42 to date.  Thanks to Thanassis Strathopoulos and Billy O’Nair for alerting us to the POMO Effect discovery and the development of associated trading edges.  These auctions are conducted from about 10:30 a.m. to 11:00 a.m. on pre-announced days.  In such auctions, the FRNY permanently purchases Treasury securities from selected dealers, with the total purchase amount for a day ranging from about $1.5 B to $7.5 B.  These days are highly correlated with strong paint-the-tape closes, with the theory being that the large institutions that receive the capital interjections are able to leverage this money by 100 to 500 times and then use it to ramp equities.

As for the all-important question of how the authors expect this to play out, they focus on what might happen at the market close on August 5:

And, while it is a bit early to favor one side or the other, we are currently leaning toward a nervous Bernanke and the need to ramp Treasuries at the expense of equities into August 9.  Equities have had more than a nice run and can suffer a bit of a correction.  Key will be watching the close on Wednesday.  A failed POMO paint the tape close could signal that an equities correction of at least a few weeks has gotten underway.

What we saw on Wednesday afternoon was just that.  At approximately 3 p.m. there was an effort to push the S&P 500 index into positive territory for the first time that day, which succeeded for just a few minutes.  The index then dropped back down, closing .29 percent lower than the previous close.  Does this mean that a market correction is underway?  Time will tell.  With the S&P 500 index at 1002 as I write this, many experts consider the market to be “overbought”.  Fund manager Jeremy Grantham, who has been entrusted to invest over $89 billion of his customers’ hard-inherited money, is of the opinion that the current fair value for the S&P 500 should be just below 880.  Thus, there is plenty of room for a correction.  The answer to the question of whether that correction is now underway should be something we will learn rather quickly.