Flash crashes, market thrashes

Government, HFTs, in cahoots to redistribute wealth? Photo: Yahoo News

WASHINGTON, October 10, 2012 – Not much to say today, so we won’t. The market opened with a negative tone this morning, tried to go positive, but then gave up the ghost, with the Dow currently down about 70 points at 11:45 a.m. EDT. Fall earnings season started, as it traditionally does, with an anemic effort by perennial Dow also-ran, Alcoa (AA). The hapless aluminum producer reporter its usual anemic positive number which, as is also often the case, was actually negative taking everything into account. Obviously, the Federal government is not the only employer of spin-meisters in this country.

Meanwhile, little noted, except online, were the series of flash crashes in a number of stocks, including a number of REITs, which we still favor although they’re under attack by sellers. Which perhaps is what was happening yesterday when REITs like Two Harbors (TWO) and Annaly (NLY), two of the most respected outfits in this genre, rapidly tanked and soared approximately three times in roughly a 45-minute a.m. interval.

NLY remains under some pressure this morning, although TWO is marginally recovering. And neither stock closed very much changed yesterday. But flash crashes in any stock lead investors to pull back, at least for a few days, wondering if another shoe is going to drop, thus hampering near-term performance.

Chart from Yahoo News depicting a flash-crash in a Forex US Dollar contract in early 2011.

As usual, there wasn’t anything about this in the dead-tree media—at least not as far as we could see—although there was some coverage in the more alert and less advertiser-influenced blogosphere.

It’s precisely this kind of scheiss and shinola that’s driven small investors out of the market in recent years. It’s almost a certainty that some algorithm or HFT routine was probing those stocks involved in the mini-flash-crash action yesterday, stuffing the channel with phony quotes to create mini-arbitrage moments* that the average investor can’t even see, all the better to game the system and pocket undeserved profits. It’s a rotten trick, is patently illegal, but is never slapped down by the SEC and its corrupt government employee minions, all of whom are overpaid (involuntarily) by average taxpayers and investors.

The SEC either needs to start regulating or get out. If the decision has been made to turn over the market to frauds, charlatans, and those who can afford amoral MIT computing geniuses to game the markets and screw the average investor and his or her 401(k), well then, why even have an SEC? Dumping these lazy, policy-musclebound dolts would at least be a start in paring down or eliminating those areas of government—like the Departments of Energy (DOE), Housing and Urban Development (HUD), and Education (ED)—that pay legions of Federal workers to do absolutely nothing to improve the economic health of this country.

Chart from the Maven’s own account yesterday, illustrating the serial flash-crashes in Annaly. Note the four separate anomalies in this candlestick chart, all occurring between roughly 10:10-10:50 a.m. The skinny lines-the ones without an apparent color bar-may have been, in whole or in part, the result of phony orders, canceled a millesecond after they were issued to trick slower computers into erroneous quotes. The thick color bar illustrates the apparent results of this trickery-a panicked move down on minimal volume: the real trade, suckering in just enough investors to make it work. (Double click for larger view.)

With regards to the markets, if the Feds really feel so strongly that the inmates should run the asylum, they should say so, shut down the SEC, warn investors to invest their money in mattress ticking, and let the games begin. Heck, if it hasn’t become intuitively obvious already, income redistribution is already well underway in this country, with both the Feds and the HFT fat cats stealing money from the dwindling middle class (whom both purport to support), and shipping it off to the deserving rich (Democrats) and deserving poor (Democrats) respectively.

Point is, these games have already begun, and we need to decide whether we really want capital markets to do the job they’re supposed to do—raising and investing capital—or become a vast video game playground for the current generation of typically irresponsible, Ivy League-educated Playboys of the Western World. They’re already well on the way to making the latter choice.

Needless to say, steer clear of the markets today unless you have nerves of steel or a bank account that can afford to lose money. We’ve hedged off and on, with marginal success, by using the regular and double-speed S&P 500 short ETFs (SH and SDS, respectively). The latter vehicle is particularly treacherous and wasn’t tracking the action very well either when we put it on or took it back off, so we currently don’t own either.

Our precious metals ETFs also are not doing too well right now, as the dollar, perversely, has strengthened against the Euro which these days generally means the U.S. markets head down. And when the dollar strengthens, the precious metals get dicey, at least short-term.

On the other hand, the recent market action has gotten so ridiculous that we’re likely to get at least a short term bounce, perhaps as early as this afternoon or tomorrow. But with the market tone likely to be primarily negative as the year draws to a close, it’s probably a good idea to take profitable positions, or at least portions of them, off the table during any rally.

 *FOOTNOTE: Short, inadequate description of “arbitrage”: This term describes what’s usually a short-term market anomaly in which the bid-ask spread on a security or contract is out of whack with the spread of the same vehicle on a different exchange. Arbitrageurs, or “arbs” use computers to discover these anomalies and pick them off, buying on one exchange and selling on another to profit from the momentary anomaly. And that’s known as “arbitrage.” There are many flavors of this, but without high speed computers, home-gamers can’t really play this sophisitcated game of stock price scalping.

  There’s a good argument to be made that at least some HFT algorithms are adept at creating phony arbitrage spreads, exploiting them, and then exiting without anyone detecting what’s going on. The SEC, however, is apparently uninterested in learning more at this time, and the exchanges don’t want to lose the commisions this nonsense creates—mainly because the nonsense has scared most normal investors out of the markets.

Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate. He currently owns, among other investments, positions in DGP, IAU, ACQ, SLV.

Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.

Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.

References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any article under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.

Read more of Terry’s news and reviews at Curtain Up! in the Entertain Us neighborhood of the Washington Times Communities. For Terry’s investing and political insights, visit his Communities columns, The Prudent Man and Morning Market Maven, in Business.

Follow Terry on Twitter @terryp17

 


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Terry Ponick

Now writing on investing, politics, music, movies and theater for the Washington Times Communities, Terry was formerly the longtime music and culture critic for the Washington Times print edition (1994-2009) before moving online with Communities in 2010.  

 

 

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