Trader’s Narrative

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• Banks fight to kill proposed consumer protection agency
• The Disconnect Between Pay & Performance
• Solar Power’s Ability to Free Western World
• Get a FREE Subscription to Futures Magazine (limited time for US residents only)
• The IPO market heating up
• Gold Mania Hits China
• CNBC interview with Julian Robertson
• What’s Really Wrong With Wall Street Pay
• Get a FREE 50-page eBook: The Ultimate Technical Analysis Handbook (limited time offer)
• Two Major Technical Forces Are About to Collide in the S&P 500
• Volcker Urges Reinstatement of Glass Steagall

That’s just an ‘amuse-bouche’ - for the main course, follow the graphic link below to news.tradersnarrative.com:

And remember to check back regularly since there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead:

Before the SEC could make their move, BATS and Nasdaq decided to ‘voluntarily’ stop flash orders. As alluded to before, this is a good development because it returns us to a state where all participants on the exchange have equal access to information, without any heavy handed regulatory action.

For more economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all go to news.tradersnarrative.com:

• Say goodbye to flash orders
• The Great Missed Opportunity of 2009
• No, The Price Is Not Right
• CNBC Concerned About Australian Camels
• Get a FREE Subscription to Financial Magazines
• Chinese markets have become a giant Ponzi scheme
• Kass: Dousing the Fire With Kerosene
• Has the Gold Bull finally arrived?
• Lessons From Irwin T. Yamamoto
• Get the “Best of Trader’s Classroom” eBook for FREE (limited time)
• Turtle Trading using Excel Spreadsheets
• What’s the beef with high-frequency trading?
• Old Banks, New Lending Tricks

For the complete list, follow the graphic below:

And remember to check back regularly since there are interesting links added throughout the week.

Week Ahead: Fed Meeting & Retailer Earnings

The big debate within Wall Street now is not over huge bonuses but instead over high frequency trading and flash orders. The issues surrounding HFT are complicated and require a careful balance to be struck between the need for continued innovation, liquidity as well as price improvement and on the other hand, equality, transparency and prevention of system wide risks.The issue is complex but it can be boiled down to one question: is the exchange ensuring that every single participant has equal opportunity and access to the same information?

I stopped watching CNBC years ago but every once in a while friends send me a link to one of their online videos like this recent one about high frequency trading and I’m reminded all over again why I don’t watch CNBC:

This is exactly what is wrong with CNBC. They spend more time designing and perfecting their chyrons and the makeup and hair of their hosts and seemingly none at all actually researching or understanding an issue. You know, that thing we used to called journalism. In the end what could be an enlightening and intelligent dialogue about an advanced function of the financial markets deteriorates into childish ad hominems.

The debate over high frequency trading reminds me of the controversy a few years ago when large institutions were able to transact in mutual funds units after the close. By getting yesterday’s price, that is buying after knowing the market close, they made millions of dollars. Until they were stopped.

Flash orders, per se, are not evil. Actually, they are quite useful and regularly allow large traders to get better prices than they would normally get. Here is a diagram illustrating how they work. The problem is that we now have opportunistic computer algorithms which out-trade the slower and larger institutional traders. And this segment of the exchange volume has exploded in recent years. The exchanges love it because it increases their volume traded and they get paid co-location fees for housing the computers that power the myriad instantaneous trades.

So it isn’t difficult to see the dilemma. It is the same one that faced the SEC recently when they looked at the regulations surrounding short sales. Finally, the SEC moved to fix naked shorting, a big problem. Hopefully the rest of their regulatory modifications will be the scalpel type - not sledgehammer swings.

Here are a few recently articles which explore the issue of high frequency trading:

• How to Understand High Frequency Trading
• Stock Traders Find Speed Pays, in Milliseconds
• We Fear What We Do Not Understand
• Demystifying High Frequency Trading
• High-Frequency Traders Say Speed Works for Everyone
• SEC Pressured to stop HFT

You can find many others at news.tradersnarrative.com (check in as interesting links are added regularly).

Here’s a short video discussing high frequency trading and flash orders, which is refreshingly nothing like the CNBC clip mentioned above:

Tabb is a contributing editor at Advanced Trading magazine and because of his day job, he comes at this issue with his own biases. Although the interview isn’t as polished and has lower production qualities, it is still infinitely more rewarding listening to Tabb than to the screechings from CNBC.

If we step back from the day to day movements of the stock market and take a very wide perspective, we notice some overarching cycles at play. One of these is the 18 year stock market. Some, like Art Cashin in the video below, express it as a 17.6 year cycle but in reality this is not a precise determination. The 18 year cycle is more an average than an accurate, regularly repeating cycle:

Since stock prices are supposed to be random, it is odd to find such an orderly pattern. Why equity prices follow this rhythm may not be so befuddling if we consider commodity prices as their counter balance. For example, zooming in, we can see the period from 1980’s to the present for the Reuters/Jeffries CRB Index, the most popular proxy for the commodity markets:

While the equity markets went on a generational bull market from the 1980’s to their top in 2000, the commodities markets were in a painful and protracted bear market. This wasn’t just a coincidence. Over the long term, equities and commodities are on a teeter totter: when one is up, the other down; when one wins, the other loses. Of course this relationship isn’t evident until you step back from the short term fluctuations.

The rationale for this is simple. The price of physical goods are expenses for corporations as they are the raw materials to produce things. When the costs increase, profits decrease. This trend continues until it reaches an inflection point where it can not continue. Profits decrease and a retrenchment takes place. Demand decreases for raw materials and their prices fall.

Then this trend continues until investments in the acquirement and production of raw materials is ignored. Mines take billions of dollars to develop and can take decades to ramp up production. Oil reserves likewise are expensive to find and exploit. As the current supplies are depleted, the prices of physical goods rises. It continues to rise until it reaches a tipping point when investment in the sector once again is lucrative. And the wheel turns again.

I was introduced to this cycle when I read Hot Commodities by Jim Rogers. This is a great introductory book to the commodities markets by the way. I highly recommend it.

According to economist David Rosenberg, we are halfway through the current bear market. This estimate is in keeping with the 18 year cycle if we assume that the top was in early 2000. And the counter estimate is that we have the same period of time left in the commodities bull market. But something is amiss.

The CRB index crumbled 57% from its top in 2008. We haven’t seen such a decline before in a commodity bull market. Those are serious deflationary forces at play right now in the world economy. Which is why central banks are throwing everything and the kitchen sink at it to prevent it from spiraling out of control. Here is a free 60 page book from EWI about the dangers of deflation and how to position yourself both defensively and offensively to benefit.

Rosenberg continue to believe in a healthy commodity bull market but I’m not so sure. What we saw last year was not a normal bull market but a speculative bubble caused by lax regulations which allowed large institutions to run roughshod over everyone else and walk prices higher. The aftermath of bubbles is always ugly and unpredictable to some degree so I have my suspicions that the regular cycle was tampered with, in a sense, by this.

Art Cashin on the 17.6 Year Cycle:

Yesterday’s Fast Money had an interview with Paul Desmond, president of Lowry Research:

He mentions the 90% downside volume we saw accompany Monday’s decline as well as the anemic volume behind the higher prices since April 2009 as reasons he thinks that this is not a real bull market.

Desmond thinks that we are heading lower and ultimately below the March 2009 because if that level didn’t attract enough strong hand buyers, then the market will have to go even lower (and get cheaper) to do so.

The discussion of 90% down days is interesting although the clip is too short to do justice to it. Although the seminal work of Paul Desmond on 90-90 days does rely on them, 90% down days by themselves are not necessarily all that bad news for bulls. Historically, the market doesn’t take a dive after 90% downside volume days (both in the short term and in the long term).

Bill Strazzullo of Bell Curve Trading is the other person being interviewed is a bit more ambivalent. He’s watching the 900 current level and thinking that the market will have a tough time climbing higher. I’m not familiar with him or his track record so if you are, let me know.