Thursday, September 6, 2007

Be Wary of the Allure of Short Term Trading

The financial markets eagerly await the federal government's August jobs report, due to be released on Friday, September 7, 2007. If the number for job growth is low--less than 100,000, for example--the markets will probably rally. If job growth is high--200,000 or more--the markets will probably tank. The thinking is that a low number indicates a flagging economy, one in need of the fed funds rate cut that the market badly wants from the Federal Reserve. A high number, on the other hand, indicates a strong economy with the potential for inflation. That would very possibly lead the Fed to stay the course on interest rates.

Rate cut proponents point toward the subprime mortgage mess and the stagnant real estate market as reasons to expect lagging job growth. Mortgage bankers are being laid off with abandon, and real estate brokers are checking out new lines of work. Suppliers to the construction business are seeing revenues fall, and will cut employment. Manufacturers of home appliances are in the same fix. Even some investment banker and hedge fund types are getting pink slips, as deal flow and securities trading recede.

There are also reasons why job growth might be strong. Exports, helped by the falling dollar, have done well. The service sector has remained healthy. Wage pressure has eased and worker productivity has risen, making it more cost effective to hire workers. Not all of the predicted fallout from the real estate bust might happen. Some construction workers, like the skilled trades, can simply shift over to other building projects, such as hospitals and nursing homes. Unskilled construction workers can work on road projects. Many people that hold real estate broker's licenses have day jobs, and were brokers only on weekends and in the evenings. They can give up real estate without affecting job statistics. Or they can resume other careers they had set aside.

So how will the job growth number come out? We don't know. But we do know that the number really won't matter. Even if it pushes the market up or down 150 points on Friday, it won't matter. Within a few days, new statistics and news will have pushed the market to another level (maybe up; maybe down). At best, job growth in August 2007 will be one small datum in a sea of information that, in the aggregate, will determine what the Fed and other central banks do.

So why the fascination with the jobs growth number?

Because it will induce short term trading. People who hope to make money quickly will attempt to ride the volatility created by the job growth number. That sounds like day trading, a practice discouraged for individual investors because of its comparatively high expenses and low returns. But hedge funds, managed mutual funds, and institutional investors are often enthusiastic day traders. Professional money managers handle the investments for these entities, and must beat market averages if they are to keep their jobs. They can't beat the market by buying and holding. They could try to find investments that perform better than average. But, for every Warren Buffett or Peter Lynch, there are 10,000 Toms, Dicks and Harrys managing money who won't get to Lake Wobegon. Or, they can try to trade short term and generate some quick profits that boost their returns above their most dire competitors, the index funds.

Most of the trading in the financial markets today is done by institutional investors. The Norman Rockwell-ish image of the frugal individual, hunching over thick volumes of Moody's or Standard & Poor's in the public library reference room to uncover an investment diamond in the rough, is about as timely as the Edsel. An individual attempting to day trade can easily be overrun by the institutional tractor trailers barreling through the markets. (See our blog about stock market volatility at While some institutional investors may beat market averages, many and probably most don't. It's well known that most portfolio managers for managed mutual funds don't beat market averages. Statistics about hedge funds are harder to get, and perhaps less definitive. Certainly, after the subprime mess, hedge fund returns probably will not glow quite as brightly as they might have a year or two ago.

So what, then, is the appeal of short term trading?

It benefits Wall Street stock brokerage firms. Short term trading generates income for them. They get commissions from the buyers, as well as commissions from the sellers. They get commissions when a short term trader buys. They then get commissions when the short term trader sells. For some stocks, where the brokerage firm (or an affiliate) makes a market, they may also get trading profits (which you might see disclosed on a trade confirmation as a "markup" or "markdown"). If a customer buys on margin, they also get interest income from the margin loan. Excess cash balances in the customer's account are often invested in money market funds operated by an affiliate of the brokerage firm.

The brokerage firms have a lot of incentive to make the jobs growth, inflation, trade deficit, manufacturing sector, non-manufacturing sector, jobless claims and GDP data, and a host of other statistics, appear significant for a day. If they can get investors ginned up, they will make a bunch of money from transactional charges. It doesn't matter whether the market goes up or down, as long as investors trade.

Friday's Data Queen for the Day will be the jobs growth report. But the investor planning for a 25-year retirement that will start 20 years from now, or for a child's college education that will start 12 years from today, shouldn't give a rat's left ear what the report says or how the market reacts. An investment strategy of diversified long term investment remains the best move--see our blog about why the average investor does well, at That probably doesn't involve any trading tomorrow.

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