Market Talk

Apologies for the light posting, I’ve been really consumed in getting the live Markets Hub off the ground. Hopefully soon we’ll settle into a  steady pattern, and I can get back to some writing.

What caused May’s flash-crash? Is another one possible? The SEC is set to release its highly detailed look at the crash, the causes of it (some going back a decade) and what it could possibly do to prevent another one.

For the record, I think the flash-crash was extreme, but not an aberration. This is the way markets work now, and another one is certainly possible.

- “The Fed’s current policy is grossly inadequate, logically bizarre, and slightly — but only slightly — encouraging,” Paul Krugman says. By maintaining the balance sheet’s size rather than shrinking it, the central bank “has gone from a completely crazy policy of monetary tightening in the face of massive unemployment and incipient deflation, to a policy of standing pat in the face of same,” Krugman says. “Whoopee.”

- Fed’s decision to reinvest proceeds of maturing MBS into Treasurys signals the central bank’s “continued willingness to throw money at the flagging economy,” Yves Smith writes at naked capitalism. “The problem, of course, is that with the Fed having failed to clean up bank balance sheets, all these efforts to throw money at the economy look an awful lot like pushing on a string.”

- When analyzing the “flash crash” and what should be done to prevent it in the future, NYT’s Floyd Norris says the solution is to fix markets, not tell investors they need to protect themselves against bad markets. “Markets are fragmented and depend on ‘liquidity providers’ who have no obligation to hang around when the going gets tough. We have somehow taken markets that worked and substituted markets that do not.”

- “It is important to remember that the Fed did not ease monetary policy yesterday,” former Dallas Fed chief Bob McTeer writes. “It acted to limit the tightening that would automatically have taken place with the run-off of mortgage backed securities.” And he cautions that the central bank’s recent actions may not be enough. “We need gradual growth in the balance sheet to support gradual growth in the money supply.”

- Google’s (GOOG) holding press event tomorrow where it will “unveil a couple of cool new mobile features,” which prompts All Things D blogger Kara Swisher to wonder what GOOG has up its sleeve. Some speculate integrated video calling will be released, but according to Swisher’s sources, that won’t be the case.

- That surging trade deficit number “was simply so awful that almost no one in the mainstream was ready for it,” Josh Brown writes at The Reformed Broker. “The implications of this number will work their way into GDP calculations and recalculations and the end result will not be pretty.”

- The Fed is failing in two aspects: Policy is too tight and it’s communication has been miserable, Ryan Avent says at The Economist’s Free Exchange blog. Stocks and commodities tumble, while safe havens, like the dollar, rise. Perhaps FOMC members are realizing they have “reinforced the economy’s disinflationary, pessimistic mood,” Avent adds. “The question is: come September, what are they going to do about it?”

- “I don’t buy the idea that so many of the unemployed are stupidly and stubbornly holding out for a higher wage than they can get, while at the same time they can be reemployed by a mere bit of money illusion,” Tyler Cowen writes.

- “Part of what propels stocks is confidence that they will do better than other investments,” Stephen Gandel notes. “That’s what created the equity premium in the 1980s and 1990s. And that has slowly slipped away. That’s bad news for the stock market. But it might not say anything about the economy.”

- WSJ’s Juliet Chung writes about “the shrinking second home” as the affluent turn to smaller, less expensive homes.

Wait a minute. I thought stocks were only supposed to go up...

From the “flash crash” to deepening worries over Europe’s debt crisis, May was one nasty month for investors.

With the stock market closed Monday in observance of Memorial Day, today is the month’s final trading session. And investors can’t flip the calendar quick enough. The Dow was off 6.8% heading into today’s trading and on pace to finish May with its biggest monthly point and percentage drop since February 2009.

It’s also poised to register its biggest May point drop ever and largest May percentage decline since 1962, when it fell 7.8%. The slide snaps a string of three straight monthly gains.

The broader S&P 500 and Nasdaq Composite have actually fared worse. S&P 500 was off 7.1% heading into Friday and Nasdaq was down 7.5%.

A Fitch downgrade of Spain’s debt flames some worries about Europe after yesterday’s respite, putting a final negative coda on May. DJIA earlier off as much as 163, but has bounced off the lows and recently down moderately on light volume ahead of the holiday weekend.

Continue reading…

- “When you hear about corporate insiders emailing undercover FBI agents with insider information in this day and age, you can only shake your head and ponder the utterly pathetic intellects of the people involved,” Josh Brown writes at The Reformed Broker. “As we hear more details about the investigation, I suspect there will be even more head-scratching over how it could be possible that these people haven’t learned better by now.”

- While pursuing financial regulatory reform, the Obama administration chose new regulations over structural change, an easier outcome but not necessarily the best choice. Mark Thoma has the details.

- Number of workers who voluntarily quit in February actually surpassed amount of folks who were fired for first time since October 2008, a positive for weak labor market, especially since turnover essentially froze during the height of the recession, Barry Ritholtz notes at The Big Picture. “The backlog of ‘workers waiting for better times to make a move to better jobs’ is now acting like pent-up consumer demand — only for employees.”

- April durable goods surged 2.9%, well ahead of analysts expectations, which is “just the thing to blow away the deflation blues that have been poisoning the party over the past few weeks,” James Picerno writes at The Capital Spectator.

- Why is Steve Ballmer still Microsoft’s (MSFT) CEO? “Microsoft still has a dominant market share in PC operating systems and office applications, but it’s managed to take that massive competitive advantage and waste it everywhere else over the past decade,” James Kwak says.

- Yahoo (YHOO) CEO Carol Bartz’s potty mouth generates ton of attention in blogosphere, but Reuters blogger Rob Cox says investors should be wary of executives who spout expletives at critics. Bartz used some questionable language in an interview yesterday with TechCrunch’s Michael Arrington, which “smacks of desperation,” Cox says. “Shooting the messenger is never a sign of strength.”

- Yahoo’s chase to the bottom. “The bottom line is that turning around a decline at an Internet company is tougher than elsewhere. That is at least partly because of the ease with which consumers can switch to a different website. Once a site’s image is impaired, it is very hard to repair,” Martin Peers writes at WSJ’s Heard on the Street column.

- Google says it generated $54B of economic activity in 2009. Digital Daily John Paczkowski believes the purpose of Google’s report is to show regulators it’s not anticompetitive. “What better way to counter perceptions that Google merits antitrust scrutiny than to highlight its positive effect on the national economy?”

- Google’s (GOOG) investment case getting muddled? “Most of [Google's] time nowadays seems dedicated to releasing products that don’t make a dime,” writes Chad Brand of Peridot Capital, who discloses his firm has a small position in Google. Downside looks limited based on declining P/E ratio, but “I have mixed feelings as to whether it warrants the commitment of new capital,” he says.

- Facebook attempts to appease privacy advocates by redesigning its privacy controls.

- “Whatever little trust Wall Street might have regained in the recovery since 2009 was surely dashed back to square one on May 6,” Ray Pelleccia writes on the Exchanges blog. The “flash crash” continues to defy easy explanation, and that only adds to the public’s widespread bafflement and distrust of what happens in our financial markets.”

Boy, that happened fast.

More and more it appears the flash crash wasn’t some aberration, some error, but just the normal workings of a highly automated, lightning-fast stock market. The problem for the regulators is, there is no problem. This is the way the market works now. It may be scary, but it isn’t broken. It’s just fast. Incredibly fast. From the Journal:

As regulators struggle to forge a clear picture of the events that led to the stock market’s slide on May 6, another piece of the puzzle has come together.

Waddell & Reed Financial Inc., an Overland Park, Kan., brokerage and mutual-fund firm, was identified as the mystery trader that sold a large amount of futures contracts during the decline. Commodity Futures Trading Commission Chairman Gary Gensler, without identifying the firm, has cited the trading as one of many factors that contributed to the Dow Jones Industrial Average’s nearly 1,000-point intraday decline.

So Waddell apparently started the whole thing, selling a large block of e-mini futures contracts. Fine. But nowhere it is suggested that Waddell was doing anything nefarious, or even just simply mistaken and somehow threw a big spanner in the works. CFTC’s “Gensler described the trading as a ‘bona fide hedging transaction’ by ‘one large investor’ and not a trader trying to manipulate the market.”

Are they kidding? If the financials markets can’t handle that, then we have a real problem on our hands. Because Waddell was just executing its strategy. The company responded, with this statement: ”Quotes attributed to executives at the CME and the CFTC note that Waddell & Reed has executed trades of this size previously, and indicate that we are a ‘bona fide hedger’ and not someone intending to disrupt the markets.”

The upshot of all this, as far as I can tell, is that we can pretty safely conclude that the crash wasn’t the result of a mistake. Fine, Waddell sparked a cascade of sell orders with its e-mini strategy, which plunged the market more than 700 points in 20 minutes. It also, incidentally, came back 700 points just as fast. That doesn’t seem to be bothering people. That rally also shows the market was working, because buyers came back.

The fact of the matter is the markets were extremely jumpy on the 6th, already in the middle of a sharp selloff before the flash crash began, ready to sell off even more at the first sign of trouble, and they did. That it all happened inside of an hour is just a result of the automation of the markets.

If nobody anywhere is saying anybody did anything deliberately or accidentally wrong, then you have to conclude that the markets were working correctly. Faster than anybody’s ever seen before, faster than anybody expected possible, and that terrified some people (and it should.) But still, the market ran the way it’s been set up to run in an age of faster-than-lightning supercomputers. The powers that be are either going to have to get used to that or change the system.

I’ve heard plenty of people suggest Thursday’s mid-afternoon crash was a glitch, an error, a mistake. Nobody knows why or how. It’s filled the papers for days. Congress, always with the people’s safety and welfare in mind, is investigating. ‘Course, if it’d gone up 700 some-odd points in 20 minutes, Congress would want to amend the Constitution so Obama could run for a third term, but that’s another story.

But I’ve heard only a few suggest the crash was merely the way the system now works; Chris Whalen at Institutional Risk Analysis comes to mind, a trader Barry Ritholtz cited at The Big Picture (“that is what we like to call trading.”) Another is the anonymous blogger who writes the Cassandra Does Tokyo blog:

And one watches with awe and wonderment, at the edifice which has evolved, quite certain that this is the shot across-the-bow exposing the inherent systemic instability of the machines, who are only as good their young masters.

A shot across the bow. Remember that. And like I said, Chris Whalen makes the point, too:

You can blame last Thursday’s market collapse on the unhappy creditors of the members of the Euro federation, or the equally tortured and loathed program traders, but the multiple loosely connected execution venues for the same NYSE listed stock worked as planned — and that fact lies at the heart of the perceived problem last week. We don’t see a problem. The system worked. The problem was a lack of investors.

I keep thinking back to what that one executive in “The Quants” said, about the next LTCM happening in five minutes. This is the way things work now. The fact that nobody can find the “cause” for the “glitch” leads one to this conclusion. There wasn’t a glitch. It was just the market. The new market.

And I’ll tell you what, movie fans, that was no boating accident. It wasn’t a propeller, it wasn’t coral reef and it wasn’t Jack the Ripper.

It was a shark.

- Prosecutors investigating Morgan Stanley’s (MS) CDO practices are going to have a hard time getting to the bottom of things. “It is likely going to take continued investigation by prosecutors and lawsuits from private parties to unearth a good bit of what happened in this market,” Yves Smith writes at naked capitalism.

- Verizon Wireless working with Google (GOOG) on an iPad rival “sounds sexy,” Dan Frommer says at Silicon Alley Insider. “But let’s take this for what it really is. This is just Verizon trying to get leverage in its negotiations with Apple for the iPad and iPhone.”

- The haves and have-nots in last week’s flash crash.

- It appears Apple (AAPL) has lost another next-generation iPhone prototype. Digital Daily blogger John Paczkowski reports photos of the purported device were posted to the Vietnamese forum Taoviet yesterday. “They look to be genuine, though obviously there’s no way of knowing for sure.”

- Baltic Dry Index is on one wild ride.

- “Regardless of your directional bent, respect — but never defer to — the price action and define your risk as there are powerful players moving markets with deep-rooted agendas,” Todd Harrison says at Minyanville. “Financial stability is, in the words of global leaders, a matter of national security. As the war of words heats up and the monetary mortars fly overhead, we would be wise to keep some powder dry.”

- Did Dow actually drop 1250 in ‘flash crash?’

- “Certainly, the cause of the recession was not the usual run of the mill factors,” Barry Ritholtz says at The Big Picture. “Nor was depth or duration. “However, it appears — at least according to the charts I see — that this recovery is following a fairly normal script.”

- This isn’t a ripe environment for the retail investor, Reuters blogger Felix Salmon says. “Volatility is good for traders, not
investors: just check out the spectacular trading results at the money-center banks last quarter.”

- The parallels between Greece and US

- When should a company disclose a Wells Notice?

Some things never change.

SEC Chair Mary Schapiro remains baffled as to why the market dropped roughly 700 points in about 16 minutes last Thursday. But maybe the answer isn’t that complicated. From WSJ:

Regulators haven’t found evidence of a single cause for the May 6 stock-market plunge, but the lack of unified rules among stock exchanges played a role, Securities and Exchange Commission Chairman Mary Schapiro said Tuesday.

Ms. Schapiro spoke at a congressional hearing where officials described early steps being taken to prevent a recurrence, including stronger market-wide circuit breakers and new brakes on single securities.

The lack of clarity surrounding last week’s “flash crash” not only highlights the market’s problems, but the SEC’s inability to monitor markets in real-time, Stephen Gandel writes at Time’s Curious Capitalist blog.

The SEC’s historically been a slow-moving agency, but this has the potential to be another black eye for the battered agency, especially since market watchers have been warning about dark pools for years.

“The fact that the SEC can’t determine who bought or sold what during a mere 16 minutes of trading proves that there is a lot more that needs to be done to shed light on the shady corners of the market,” Gandel says.

So as the witch hunt continues for what caused last week’s plunge, maybe the true culprit was just “good old fashioned fear,” the Pragmatic Capitalist speculates.

“Fear is a boring excuse for a market crash, but it’s always the cause and it always will be,” the blogger says. “After all, psychology will always drive markets regardless of how many computers we have up and running. At some point, raw human emotion always plays into the equation and that is the primary reason why markets are inefficient and will always be so.”

It's been one wild ride for the VIX.

The stock market’s volatility gauge has been on one helluva ride over the last week. And while it’s settled down a bit today, it’s nearly impossible to know where it’s headed next.

The Chicago Board Options Exchange’s VIX jumped 86% last week, its highest-ever weekly spike, amid the “flash crash” that saw the Dow drop almost 1,000 points intraday on Thursday before settling with steep losses Thursday and Friday. The gauge closed above 40 on Friday, its highest level in more than year.

“While I do not expect the VIX to remain over 40 in the days and weeks ahead, I am aware that the current crisis will leave deep economic and psychological scars on the landscape that will take months and years to heal in full,” VIX watcher Bill Luby wrote Sunday on his VIX and More blog.

His call was spot on. Just as quickly as the VIX dropped last week, it staged a remarkable recovery yesterday. Amid the Dow’s 400-point gain, the fear gauge dropped 30% yesterday, setting a record for the largest single-day drop in its 17-year history, on news of the EU’s nearly $1 trillion package to relieve Europe’s debt crisis.

And just as stocks moved between gains and losses throughout much of today’s session, the VIX has been relatively quiet, recently trading down 3.1% to 27.95. While still high compared to recent weeks, when it waffled in the teens, the index now sits around levels at which it closed one week ago.

Unfortunately, investors shouldn’t expect things to stay this calm in the near-term. The VIX has experienced at least 20% single-session drops in eight previous instances, Luby notes. And, in the short-term following those declines, stocks have typically underperformed.

“All things considered, small sample size and all, I would have to conclude that [Monday's] action translates to a mildly bearish outlook going forward — at least based on historical data,” Luby says.

(Tennille Tracy contributed to this post.)