How Big was the Trump Rally?

After the U.S. election on November 8, the U.S. stock market began to rally.  Many called this the Trump rally, though it's not clear how much had to due with Trump's vague grand proclamations, and how much had to do with the fact that Republicans had also taken both branches of Congress.

How much value did the market gain after the elections?  According to the Wilshire 5000 index, which tracks the total value of the U.S. stock market, the market's value increased from 22,133 on November 8, to a peak of 23,756 on December 21 -- an increase of 7%, or about $1.6 trillion in market value.

To put that in perspective, that's somewhere around the 2016 GDP of Canada, about half of the 2016 budget deficit, or $5,000 for every man, woman and child in the U.S.

Which sectors in the market went up the most?  Financials, by far.  According to this article at marketwatch.com, financials went up by 10.7%, with industrials a distant second at 5.7%.  Ostensibly, the financials went up because of talk of repealing some or all of the Dodd-Frank regulation--especially the Volcker rule that limits the amount of trading a bank can do for its own account-- as well as rate increases by the Fed that came in December.

Interesting that a market that we're told values "certainty" should go up on the election of an untested leader with no political experience, promoting fiscally irresponsible and protectionist policies.  But the post-crisis regulatory regime has been a huge burden on the banks, and the inertia of Congress has been a fiscal burden on the whole country.  If the Republicans can get through popular improvements like tax simplification and sensible infrastructure spending it will be an improvement.  Let's see what happens after January 20.

High Frequency Trading: Have Transaction Costs Gotten Too Low?

Article: Wall Street Journal, A Call to Pull Reins on Rapid-Fire Trade, Scott Patterson

This article from today's paper is about Thomas Peterffy, chief executive of Interactive Brokers, and one of the inventors of high frequency trading.  Now he's turned against the practice which he helped invent, and says it's bad for the market.  (It also hurts his business.)  He blames high frequency trading for the flash crash of May 2010, when the market dropped by 1,000 (10%)  points before rebounding a few minutes later.

There is an orthodoxy that practices like high frequency trading make markets more efficient through an arbitrage mechanism.  As traders exploit inefficiencies to make a profit, they tend to squeeze those inefficiencies out of the market, thus making trading more efficient (cheaper) for everyone else.

But I wonder...

Transaction costs in the stock market have been dropping for decades.  Technology enables huge numbers of shares to be bought and sold with very little human intervention--cheaply.  Over the years this has caused the loss of lots of middle-class Wall Street  jobs.  But this has been the way of the world at least since the industrial revolution.

But at the same time, a small number of people have enriched themselves to an unprecedented degree by exploiting every informational and technological advantage they could find.  From big trading desks at companies like Goldman Sachs whose alumni staff the Fed and the Treasury Department, to hedge funds which somehow in an "efficient market" are able to charge many times more than what the average mutual fund manager charges --because their rich clients must believe they know something or someone that no one else does-- to high frequency traders, who somehow manage to turn a profit just by trading faster than anyone else.

It seems to me that if Wall Street is fatter than ever (in absolute terms, and as a percentage of GDP), then markets must be less efficient than ever--because after all, Wall Street is just a middle man between savers and borrowers.  The less money the middle man gets, the more efficient the market is, right?  Is "market efficiency" just a shibboleth that those who exploit an unfair advantage utter to defend their racket?

It's not really a mystery how high frequency traders make money.  They act as "market makers", taking the opposite side of the trade for all who are ready to buy or sell, as long as you're willing to accept their spread,  which is a market maker's legitimate source of profit.  Market makers provide a service; they are always there if you need to sell quickly to raise cash.  They earn a spread in return for taking the risk that they will get stuck with a toxic inventory of plummeting stock.

But in most markets, at least traditionally, market makers are regulated, and expected to step up as buyers of last resort in times of market stress.  As I read, high frequency traders are different because they stop trading and leave the market as soon as conditions get rocky.  So they really are not market makers in the traditional sense.  They make a market when it suits them, then step away when it doesn't.  This might be OK if they were small players, but high frequency trading is now over 50% of U.S. equity volume.  So they have an undue influence on the equity markets, and contribute nothing but this so-called "market efficiency" which mysteriously manages to produce more super wealthy individuals than ever before.

There are various ways to deal with this problem.  Thomas Peterffy proposes putting a 1/10 second delay on all exchange orders, which would eliminate the high-frequency houses' speed advantage, and stop their orders from getting in front of legitimate regulated market makers' orders (like Interactive Brokers).

Another solution that occurs to me is to raise transaction costs by imposing a modest tax on each trade.  Those off us who buy shares because we actually want to have them will hardly notice.  But those who churn the market for profit will have to slow down.  And the tax could be used for something good, like fighting off bank lobbyists and splitting up some of the big players, so they have less influence and pose less systemic risk.

But I think the best solution is for the SEC to simply do its job.  If you are pumping thousands of trades through the market each day, then you are a de facto market maker, and need to be regulated as such.  The SEC's mandate is to ensure fair and orderly markets.  If certain players are making profits through activities which destabilize markets and create more risk all around, then they need to be warned, and then banned from the markets if they continue.

To my loyal readers, I apologize for the 17 days that have passed since my last post.  After a wonderful, though truncated visit to the island of Shikoku, Japan, I am now gainfully employed which is interesting, but makes out-sized claims on my time.

What is Going on in the Eurozone?

Fiscal problems in the euro zone have been a primary cause for the gyrations in the U.S. stock market this year and last.  There is an element of panic that a default by one or more countries (ie, Greece) and/ or financial institutions (Societe Generale?) will cause a cascading "contagion" in the markets, similar to what happened with the bankruptcy of Lehman in 2008.  Whenever the euro zone countries step up to do something, often through the efforts of the European Central Bank, or ECB, the market goes up.  When they are seen as hanging back, markets go down.

This week, we have seen markets go up on what seems to be a concerted effort by the ECB along with other major central banks.  Today it was announced that 3-month USD loans will be made available to European banks who have been having problems placing their commercial paper, which has traditionally been an important source of US dollar funding for them (See AP Story, ECB to Provide Banks with Dollar Loans).  And in a CNBC interview yesterday, U.S. Treasury Secretary Tim Geithner was unambiguous in his statement that Europe would not allow its major financial institutions to default a la Lehman -- Europe is by and large less market oriented than the U.S., and not so concerned about "moral hazard".  (See No European Lehman-Like Collapse?)  

There seems to be a growing consensus that Greece will default and probably exit the euro--its bonds are now yielding 25%-- that this will not be the catastrophe some have been fearing, and that Germany will eventually face the inevitable choices that it has to make in order to save the euro experiment--more central planning of fiscal policy, including some kind of central euro treasury.    (See George Soros' article in The New York Review of Books, Does the Euro Have a Future?)

Nothing is decided yet, but markets have been moving up this week on these less-than apocalyptic assumptions.  As of this writing, the Dow is up over 100 points today (1%) and over 350 points since Wednesday (about 3%).

There will surely be more ups and downs on this roller coaster in the future, but as an investor, it is nice to see gains.  Hopefully they will last.

Yesterday's Market Excitement

In case, you haven't heard, the U.S. stock market was down big time yesterday.  The Dow Jones Industrial average dropped 634.76 points, or 5.5%.  This had something to do with Standard & Poor's downgrade of the U.S.'s credit rating from AAA to AA+ on Friday evening, but exactly how much is an open question.  The Wall Street Journal's front page headline this morning was: Downgrade Ignites a Global Selloff, but the unavoidable irony is that prices of Treasury bonds were up yesterday (yield on the 10-year note, which moves inversely to price, was down to 2.339%, its lowest rate since January 2009).  And repo markets, the main wholesale funding market by which Wall Street banks lend each other money using U.S. securities as collateral, were largely unaffected.

The sell-off seemed to be caused by a general flight from risky assets into safer ones, such as U.S. treasuries, gold and Swiss Francs, which in the past has been the result of fear of a double-dip recession and default and contagion in Europe.  Perhaps the downgrade just added an extra element of panic to the equation.  Or perhaps large market participants were afraid that the downgrade would cause politicians to do something stupid in reaction to what should be a non-event, what philosophers call an epi-phenomenon, like the smoke from a passing train, or the after-the-fact commentary by a sportscaster.  President Obama's speech certainly did nothing to stem the downturn.

Based on the Wilshire 5000 Total Index, which represents the total value of the U.S. stock market, the market has lost about $2.6 trillion since late July.  Unless you are an S&P sovereign debt analyst, this is quite a chunk of change--about $8,500 for each man, woman and child in the U.S.

data from finance.yahoo.com

Certain stocks were especially hard-hit in yesterday's sell-off: Bank of America and Citi were both down over 15%.  I lost quite a bit on the latter, not to mention Caterpillar, a Germany ETF and others.  Despite stern warnings from CNBC commentators --like lifeguards at Jones Beach--  that it is extremely risky for individuals to trade in such market conditions, I nibbled, and bought a bit more Citi at its new marked-down price.  Of course it dropped as soon as I bought it.  This morning, I saw that Citi was trading at less than half of its book value, and bought some more, using up the bulk of my available cash.   As of this writing, Citi is back up 12% on the day, so maybe I made a good decision -- for now.

Stock Market Revisited

Following up on Wednesday's post, How to Lose $1 Trillion in Nine Days, let's take a look at how much wealth was destroyed as a result of yesterday's "interesting" market --a gut-wrenching drop of over 500 points (4.3%) in the Dow Jones Industrial Average. (See WSJ's, Stocks Nose-Dive Amid Global Fears)

Data from finance.yahoo.com

The grand total is ... a loss of $1.6 trillion in the U.S. stock market -- approximately $5,000 for each man, woman and child in the country, to give some kind of idea.

The good news is that gold and T/Notes have increased in value -- I wish I had more than a sliver of my portfolio in these instruments.

As of this writing, the market is down again, after beginning the day with a sizable increase on the back of the weekly jobs report.  The main concerns that are causing people to sell are weak economic news, and worries about fiscal deterioration in Italy and Spain.

How to Lose $1.1 Trillion in Nine Days

As I started writing this, it seemed clear that the U.S. stock market would be down for its ninth consecutive day. However, by the time I finished the market was nearly flat for the day, and it remains to be seen if the losing streak will be 8-days long, or 9+ days long (the latter not being seen since 1978).

There are numerous articles and commentaries about the reasons for this downturn (see today's WSJ: Economic Fears Hit Global Markets), some key ones being:

•  low numbers in several economic indicators (the ISM Manufacturing Numbers, ADP payroll figures, recent lowering of GDP growth figures)
• seemingly endless worries about the fiscal situation of several European countries
• growing inflation in emerging markets.

Those of us who were expecting a jump in the market as a result of the debt compromise at the beginning of the week have been disappointed; the markets seemed to have expected this to happen all along, and any positive effect was overshadowed by the weak economic data.

data from finance.yahoo.com

In an attempt to get a handle on exactly how much wealth is involved in this market downturn, I put together the above chart with Excel, using data on the Wilshire 5000 Total Market Index, which is a good proxy for  the size (i.e., market cap) of the U.S. stock market.  Bottom line: just over $1 trillion in value lost (much of it on paper only) in just over 1 week.  This is in the U.S. alone -- globally I would guess it is closer to $2 trillion.  Numbers that get kicked around during Washington debt negotiations aside, $1 trillion is a LOT of money -- think $3,000 for each man, woman and child in the U.S.  

Of course, the market could bounce back up just as fast as it fell, which would be nice, though I doubt it.  Meanwhile, such a loss cannot be good for the economy; people with money in the market will tend to spend less as they see their wealth diminished.