Friday, March 30, 2012

America: a Nation of Cash Hoarders

The stock market has just finished its best quarter since 1998, with the S&P 500 up almost 12%. But retail investors keep exiting the market, stashing money in bonds or sidelining it in bank accounts and money market funds. Why are investors so skittish when returns seem so good? Because they've learned the hard way.

First, stock market gains are no longer seen as solid. That was the lesson of the 2000 tech market crash and the 2007-08 financial crisis. The lesson was reinforced by the May 2010 flash crash, and by the motion sickness caused by volatility from the European sovereign debt crisis. For Baby Boomers in particular, who are reaching retirement age, easing back on stocks and into more stable investments is eminently sensible. (For more on this point, see After all, it's pretty hard to retire on ethereal gains.

Second, financial assets derive much, if not most, of their value today from government policies and political maneuvering. Indeed, the world's second most important currency--the Euro--was created and is sustained by government policy and bailouts. Take the EU's governments out of the picture and there would be no Euro. Nothing is as unpredictable or unreliable as politics. And few investors want to bet their remaining retirement savings on the flightiness of politics.

Third, investors need only look at the smart money to see that cash is the preferred asset. Large corporations are hoarding cash like it was spring water in the Sahara. This cash hoarding reflects the breakdown of the banking system, which corporations in the U.S. and Europe know can't be relied upon. If big names in the corporate world are stuffing their mattresses with greenbacks, how many retail investors think they're so much smarter than major corporations that they should do something different? Okay, so Apple just declared a dividend. But that looks more like Apple is trying to prevent its cash hoard from getting larger rather than sending a lot of its current holdings of cash to shareholders.

Fourth, look at the banking system itself. Major banks borrow heavily from the Fed or the European Central Bank, only to turn it around and redeposit the borrowed funds with their central bank. Why? Because they're hoarding cash as well. They don't want to do something dangerous like invest in risk assets because they might lose money. Are investors to believe that risk assets are for them when the world's largest banks won't touch the cr . . . stuff.

Fifth, the Fed's longstanding suppression of positive interest rates net of inflation can only be viewed as an official statement that the economy is still deep in the septic tank and going nowhere fast. Its promise to stamp out positive interest rates until at least 2014 is tantamount to predicting that things won't get better any time soon. Who would want to invest in risk assets with the government so gloomy? When interest rates are effectively zero or less, you know you can't recover your losses from interest income. So it may be best not to take losses even if you get no gains. The Fed's blatant effort to arm twist investors into risk assets only pushes many of them away from taking any risk at all.

As regards economic recovery, we're basically in a stand off. Corporations aren't investing or hiring until consumer spending rebounds. But consumers won't spend because they're afraid of losing their jobs or have lost their jobs, and, for many, are underwater on their mortgages. The Federal Reserve's war on positive interest rates prevents savers from getting hardly a thimbleful of interest income. So retirees and others having savings dial back their consumption in order to preserve capital. The housing market remains a disaster area, with vast amounts of foreclosed properties and defaulted mortgages continuing to lurk. The losses in real estate (realized and unrealized) are so great that it will be years before this market recovers (for this writer's not inaccurate prediction made four and a half years ago, see

The biggest and most successful corporations hoard cash. The banks at the center of the financial system hoard cash. Cash feels good. (See Why wouldn't investors get on the bandwagon and hoard cash?

Sunday, March 25, 2012

The BATS IPO and the Stupidity of Computers

BATS's aborted IPO on Friday, March 23, 2012, is an excellent example of the stupid side of computerized trading. While the precise course of events isn't entirely clear, BATS (short for Better Alternative Trading System) tried to initiate trading in its own stock around 10:45 a.m., at a price of $15.25 per share, or $0.75 per share below the IPO price of $16. Not a good sign when an IPO begins trading below the offering price. But that wasn't the really bad news. Rather, trading in BATS stock stopped moments later for technical reasons.

Around 10:48 a.m., BATS announced it was looking into "system issues" concerning stocks having symbols between A and BFZZZ. Nine minutes later (10:57 a.m.) Apple stock, which was trading in the high 590's, suddenly traded on BATS at $542.80 a share for a single 100 share transaction. This was a 9% drop from the previous price, even though there was no intervening news or other public event. Trading in Apple stock was halted. Five minutes later, it resumed back in the high 590's.

Around 11:07 a.m., BATS informed other exchanges that it was having problems and they need not send orders to it. Since competition for order flow is the essential dynamic between exchanges, this instruction was like making an unexpected pit stop in a NASCAR race.

At 11:14 a.m., BATS resumed trading in its own stock with a large trade at $15.25 per share. Within seconds, BATS shares were trading for pennies per share. Trading in BATS stock was halted again, and didn't resume. Near the end of the day, BATS announced that it was withdrawing its IPO.

In essence, we had flash crashes in Apple (which rebounded within minutes) and BATS (which cratered in the most embarrassing way on its IPO day). These morasses were apparently the result of computer glitches. Both were plain stupid, perfect examples of stupid is as stupid does. It's inconceivable that a human trader would have sold 100 shares of Apple at $542 on no news when the market was in the high 590's. There's no way a human trader would have sold BATS stock for pennies seconds after BATS traded at $15.25. That these trades happened is because a computer has no way to tell when it's doing something stupid. It can only follow the instructions in its program coding. And if the coding is deficient, the computer will blithely plunge forward however stupid the result.

Of course, human traders are eminently capable of stupidity, and are stupid more often than not. But humans trade much slower than computers. And few humans control as much order flow as computers at the large high-speed trading firms. So when a computer does something stupid, it can do it really fast and perhaps in really large quantities. No human is fast enough to stop the computerized stupidity before it happens. And no computer has been programmed to have the judgment and common sense to realize that it's about to do something really stupid.

Friday's morass didn't affect the larger market, which ended the day up. But it serves as a reminder that the baseline problem in computerized trading--how to prevent it from having unexpected and undesired consequences--is hardly any closer to solution than before the Flash Crash on May 6, 2010. Unless high speed trading firms can find a way to prevent stupid trades, their animal spirits will likely be curbed. And it's hard to argue against constraining them when they produce results as ridiculous as last Friday's.

Friday, March 23, 2012

Are the European Central Bank and the Stock Market BFFs?

The suddenness of this week's stock market drop, coming after a meteoric rise this quarter, can't plausibly be attributed to the usual suspects. We are told that fears of slowing economic growth in China and a probable recession in Europe are the culprits. But those fears existed one, two, five and thirteen weeks ago. Why would the market drop now?

The 21st Century financial markets are all government, all the time. If you want an explanation for puzzling market activity, look at government activity. In the past three months, the European Central Bank has printed something like $1.3 trillion worth of Euros. Not that you'd get anyone at the ECB to admit it was printing money (an anathema punishable by torture on the rack in Europe). But the ECB would admit that it's been making a lot of three-year loans to European banks with interest set at 1%, while accepting as collateral all kinds of hinky paper (not necessarily excluding matchbook covers, burger wrappers and junk mail). The banks taking out these loans were facing potential credit crunches, so with the ECB making loans on terms that the private markets probably wouldn't extend, one needn't have a lot of imagination to conclude that the ECB has printed a lot of dinero in the past three months.

All that moola has to go somewhere. The borrowing banks deposited a lot of it back with the ECB, to boost their cash reserves against more handwringing over the European sovereign debt crisis. But one suspects that quite a bit of it may have gone across the pond into the U.S. financial markets, where stocks have been frothy because of improving economic data. And the fact that last year the U.S. Federal Reserve extended dollar-denominated credit lines to national central banks in a number of European nations would only make it easier to convert Euros into dollars that can be invested in U.S. stocks.

But recent signals from the ECB indicate that it won't be extending more of these three-year beauties. Since financial markets respond, first and foremost, to cash flows, the prospect of no more foreseeable money printing must be discouraging. All good things end eventually, and we know from recent financial history that no asset rises in value indefinitely. While money is fungible and definitively proving that the ECB's money print puffed up the U.S. markets isn't easy, the past twenty years demonstrate that the most reliable way to jack up stocks is for central banks to shovel money off their loading docks. And the same twenty years demonstrate that this isn't the path to lasting prosperity. So look both ways before diving into stocks.

Friday, March 16, 2012

Mr. Smith Is Going To Washington

Greg Smith, formerly of Goldman Sachs, is surely going to Washington. In an Op Ed piece published in the March 14, 2012 edition of the New York Times (, Mr. Smith lambasted his erstwhile employer for having a "toxic and destructive" environment in which making money for the firm mattered more than serving clients, who were sometimes reportedly called "muppets" by high-ranking Goldman executives.

Money managers who deal with GS may well find themselves having to assure clients that they're sophisticated folks who well understood that Goldman is out for itself. And to be sure, the heart of Mr. Smith's revelations isn't exactly news. The SEC's 2003 settlement with major underwriters about the way they deployed analysts to help promote stock offerings is an earlier example of how investment banks thought of themselves before they thought of clients. (See Going back to the 1930s, the Pecora Investigation trawled the slimey side of Wall Street and revealed that a lot of bankers are scum. And a couple thousand years ago, Jesus had a run in with some money changers.

But the problem for Goldman and other big banks is that the average Joe and Joan on Main Street (perhaps a/k/a "muppets") aren't cynically avaricious and don't care for those who are. The same Joe and Joan may have money invested in mutual funds, 401(k) accounts and pension funds that one way or another deal with Goldman. And they'd want some comfort that they aren't one way or another being ripped off by GS.

Goldman announced today that it was reviewing its conflicts of interest rules. One doesn't need a vivid imagination to suspect that Mr. Smith's essay had something to do with this announcement (although a Delaware judge's glance of askance at Goldman's conduct in a corporate acquisition played a large role in instigating the review). Perhaps this announcement will do something to ameliorate Goldman's image as the world's most notorious vampire squid, but GS shouldn't hold its breath.

The financial press is having a rollicking good time with this story, while members of Congress have donned Kabuki costumes and enthusiastically proclaimed their shock at discovering that venal things may have occurred at Goldman. No doubt Congressional hearings are in the works. Mr. Smith will surely receive an offer to testify on the Hill, where he can expect to be asked to confirm under oath that diverse and sundry senior personnel at Goldman are depraved, hypocritical, rapacious, swinish, ravenous, and wolfish, even as they continue to beat their significant others early and often.

In the Internet Age, in which instant celebrity is the life's greatest achievement and mud-slinging controversy paves the way to its attainment, Greg Smith may have limited future prospects on Wall Street, but a damn good chance for a lucrative book contract with gratifyingly valuable movie rights. But let's remember why Mr. Smith is now the best known young financier in the world. It's because people are hurting. Millions are unemployed. Millions are underwater on their mortgages. Mucho millions still feel the sting of losses in their 401(k) accounts from the 2007-09 stock market collapse. And all because of a financial crisis spawned on Wall Street. Mr. Smith's missive resonates. People want someone to blame, and Goldman's very high level of, shall we say, self-regard and self-confidence makes it an easy target.

It's de rigueur public relations 101 that when you screw up, you program the teleprompter for a profuse, sincere and unqualified apology. Many public figures have survived and even prospered by following this script. Others--most recently Rush Limbaugh--have learned that half-measures aren't enough. The one description that is most typically associated with Goldman is smart. But smarts consist not only of knowing a lot about calculus, differential equations, linear and nonlinear regressions, and other mathematical knowledge that can be applied to securities trading and financial engineering. It also involves having the good judgment to understand that you exist in a larger world and need to accommodate the concerns of that larger world. Mr. Smith won't be the only witness invited to testify before Congress, and we will probably soon see how good Goldman's judgment really is.

Tuesday, March 13, 2012

A Democrat Southern Strategy

Today's Republican primaries in Alabama and Mississippi open the way for a Democratic southern strategy to win the Presidential election this fall. A clear majority of Republicans in the South don't like Mitt Romney. He's getting only about 30% or less of the vote in these two primaries. He got 26% of the vote in the Georgia Republican primary earlier this month. Yet he is best positioned to win the Republican nomination.

Assuming, as do many political mavens, that Romney is the GOP nominee, the Democrats have an opening to skim off critically important electoral votes in the South. Romney, for all his recent rhetoric, is hard to distinguish in terms of policy from Barack Obama. He won't inspire the hard line conservatives that form the core of the Republican South. They, the true believers, might have a hard time remembering polling hours, and many might have to pick up the dry cleaning before they vote. And perhaps tend to 20 or 30 other errands.

Democrats, by contrast, with their large and growing war chest, can win over moderates, blacks and the growing Hispanic population of the South. Obama will lose in most of the former Confederate states. But he has a chance in Virginia, Florida and, who knows, maybe North Carolina or another state that once flew the bonnie blue flag. With the economy improving, Obama could be competitive in the Midwest, especially because Republican governors of Wisconsin, Ohio and Indiana have been vitriolically anti-union.

Republicans have become terribly PC, not in a liberal sense but in a rabidly conservative sense. And just as the mindless liberal PC of the Democratic Party of two and three decades ago drove out moderates, the bug-eyed, drool-at-the-corner-of-the-mouth ideologues of the Republican Party are alienating folks that just want a decent living and a good education for their kids. The Democratic Party of FDR dominated the South during the 1930s. Barack Obama is no FDR, but expect him to be making a lot of campaign stops in Dixie.

Wednesday, March 7, 2012

America's Political Dichotomy

America's most salient political dichotomy isn't Democratic vs. Republican, liberal vs. conservative, or Tea Partier vs. Occupier. It's that most Americans talk conservative but act liberal. They don't like Big Government. But don't mess with their Social Security and Medicare benefits. They see themselves as sturdy, self-sufficient individuals. But, when things go badly, they turn to unemployment comp, food stamps, and COBRA and HIPAA rights to health insurance. They don't like regulations limiting their investment options. But they love federal deposit insurance. And when the stock market plummets, they expect the government to do something.

This dichotomy explains much of the results of the Republican primaries. Many Republicans love the conservative talk coming from Santorum, Gingrich and Paul. Americans are dreamers (other countries don't dedicate themselves to the pursuit of happiness). And the idealistic talk of Santorum, Gingrich and Paul is appealing to many. But larger numbers of Republicans understand that the pragmatic, nuanced approach taken by Romney paves the way to the political middle, where general elections are won. Major right wing government shrinkers won't beat Barack Obama, who angles for the political middle by diligently working the angles of the dichotomy: instigate major reform of health insurance, but take out Osama bin Laden; block the Keystone Pipeline, but talk tough to Iran; target the 1%, but keep open the prison for terrorists at Guantanamo Bay.

Forty-five years ago, the Republican Party understood this dichotomy very well. Richard Nixon, a candidate with a lot less charisma than Mitt Romney (imagine that), beat cheerful Hubert Humphrey by talking tough about crime, the North Vietnamese, the Soviets, and the Chinese, while treading lightly on the benefits government provided to the citizenry. Nixon's 1968 victory initiated a 24-year period of Republican domination of the White House. It wasn't until 1992, when Bill Clinton triangulated the traditional Democratic platform in a major shift toward the middle, that the Democrats again became competitive for the White House.

Now, Republicans have become more and more entangled in the conservative talk part of the dichotomy, and less observant of the need to make voters feel comfortable with them. The dichotomy could easily continue to bifurcate Republican primary results all the way to the Republican Convention. If so, Obama's chances for re-election will increase all the more.