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Observations On The Psychology Of A False Market Rebound

Tyler Durden's picture


A recent note out of permabullish ward of the state BofAMLCFC (makes sense why they would be permabulls: after all nobody asks why CNBC is a non-stop propaganda mouthpiece for pro-market, pro-GE, pro-stimulus policies... everyone makes fun of it, everyone cracks up at Kudlow and company, but nobody questions it - it does, after all, make complete sense when one considers their agenda is to have all their ever diminishing viewers purchase however many shares of their soon to be former employer GE, even if it means said viewers financial ruin in a month or a year) shares some interesting perspectives on what would happen if a market that is priced for absolute perfection does not end up occurring (or, scarier, does). The note below out of Sadiq Currimbhoy, Merrill's Hong Kong strategist should be kept in mind any time readers enjoy the rosy propaganda from Merrill's David Bianco, which has the form, consistency and texture of two-ply Charmin'.

We thought we would break [down how markets trade after traumatic events] into 3 stages.

Stage 1: The bounce from the low

After what appears to be a monumental collapse, it is met with monumental policy response. With different stimulus and rescue packages plus extremely easy monetary environment, and almost certainly market overshoot, there is a strong recovery rally.

Stage 2: The data improves

Stage 2 is where we think we are now, as the economic data initially surprises on the upside and then the data continues to show incremental improvements. In the coming months, we will see just how much export growth will be following the near -50% base effect. This we think will grind equities higher. Our global team is very bullish global equities and thinks there will be a “bond/cash to equity” switch. [Again, nobody is surprised... Just gigglish]

Stage 3: “Its sustainable” – but of course, it is not

Stage 3 is when investors think that the rally is sustainable and there is a new paradigm of recovering growth. This is of course rarely the case. Policy makers’ typical objectives are not to set a new stage of progress but rather to prevent a collapse of the previous one. Everything is done to keep the old system as much in place as possible to avoid a much larger economic collapse. Eventually reforms have to be put in place.

“You can’t fight a debt problem with more debt”

In this cycle, we do think the key issue preventing a sustainable upswing is that you cannot fight a debt problem with more debt. Japan did try that and unfortunately has yet to show any signs of success. Furthermore, there is greater political pressure to create a different regulatory environment to correct what has been a massive moral hazard created. There is still no sense that this is getting any way near being resolved. 

Watch breakevens

One factor that could bring forward any top or indeed drag out the rally is how inflation expectations are moving. We do think given the levels of unemployment and output gaps, controlling inflation expectations is almost more important than inflation. These expectations are, given where we are in the cycle, we think elevated. We look at US 5year5year forward breakevens (calculated from the TIPS markets) and these remain stubbornly high despite the higher unemployment rate and output gaps (see the chart to the left). In the last recession 10 years ago, these breakevens were 80-100bps lower. We think that this represents some concerns over the Fed’s credibility. The good news is that they remain somewhat below the 2.5% level. However if we are right and the economy continues to recover, then the Fed may have to respond by raising rates sooner than investors might think. All of these suggest to us that the outlook in the coming quarters is that policy risk remains very high and the outlook remains murky.

So there you have it: when even the permabulls at the successors of a bankrupt Merrill Lynch say be careful what Kool Aid you drink, the bottom line is that every day's market move is the same as flipping a coin. The truth is that nobody knows what is happen one day down the line, let alone one year. Which is why as less and less people trade with a market increasingly disjointed with fundamentals and inflation expectations, the only ones who profit from equities, are the intraday momentum traders, whose market impact is felt ever more strongly, now that traditional market players are solidly out. The complete lack of direction is the only reason why the market keeps melting up on ever lower volume: it has worked in the past, so why screw with it. And every time there is even a hint of a correction, the volume spikes to the downside, unitil the same small volume momentum manipulators can step in after hours courtesy of leveraging futures positions break any increasing volume reverse momentum and reposition the market for the same old low volume creep ever higher. And this is precisely the environment in which both good and bad economic news get translated into exclusively good market news. The problem is, of course, all the gains on the ever decreasing margin, are paper. And when the conviction of the true direction of the economy (ironically better would be worse for equities) is uncovered, watch out below as one after another every "dumb" money manager hits the sell button.


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Sat, 11/07/2009 - 23:22 | 123711 Anonymous
Anonymous's picture

So participate, and time your exit well. Convert that paper wealth to assets as quickly as possible, preferably ones that provide a decent view of the carnage. A good boat comes highly recommended.

Arguing the supposed morality of the marketplace is a fool's errand. Better to understand and win the game.

Sun, 11/08/2009 - 00:57 | 123742 Papasmurf
Papasmurf's picture

Do you figure Cuba is a safer bet?

Sun, 11/08/2009 - 05:40 | 123787 SRV - ES339
SRV - ES339's picture

I trust you have a "rock solid" empty chair reservation (backed by Goldman CDS) in place when the music stops.

Sun, 11/08/2009 - 08:47 | 123809 Anonymous
Anonymous's picture

A 30' Sailboat even a coastal cruiser can with planning get you to a safe destination to ride out the chaos that would happen in the US. Worst case scenario you could go borrow one when the SHTF from one of the Banksters as they will be in complete denial over the collapse.It would be bigger but with a crew of two should still be manageable. Avoid the new high tech ones with all the new electric furling systems as they need diesel to run the Genset to power a lot of the systems. Make sure it has a ridged Dingy with a good set of oars to be able to make landfall along with paper charts of at least the eastern seaboard down to the Carribean.The last place you want to be is in a major city when all hell brakes loose.
Happy Sailing everybody.

Sun, 11/08/2009 - 14:15 | 123956 Anonymous
Anonymous's picture

With no one running the "fool's errand", it doesn't get done; leaving all participants assholes and pricks. You suck.

Sun, 11/08/2009 - 17:34 | 124059 Anonymous
Anonymous's picture

The "greater fool" approach you suggest can only work reliably if you have inside information. Otherwise there is high likelihood that you're confused about who the fool is.

Sat, 11/07/2009 - 23:45 | 123721 wackyquacker
wackyquacker's picture

Well, yeah. We do know which way the market is going- UP. Too much at stake now for it to do anything else. After Friday, the downside is dead, period. I guess you can either hop aboard the hope and change express or get run over. My limited sphere indicated that all those who stayed in were going to bail when they got back a fair amount of their loss. Seemed to me that point was reached week before last but I guess not. What to do but pile aboard and ride higher. Who/what is going to right this thing?


Sat, 11/07/2009 - 23:48 | 123724 Cognitive Dissonance
Cognitive Dissonance's picture

And when the conviction of the true direction of the economy (ironically better would be worse for equities) is uncovered, watch out below as one after another every "dumb" money manager hits the sell button.

This is exactly what worries me. Low up volume, high down volume, happy talk everywhere, bad news is good news, no news is good news, everyone sees, feels and smells the manipulation.

Have not most of the major market circuit breakers been pulled over the past few years? Can't this market suddenly take the express elevator down with all the stops pulled? When few traders feel comfortable carrying very much risk overnight, that spells potential trouble with a capital "T".

Yes I know that markets can and will climb a wall of worry. But please don't tell me fundamentals are getting better when the only entity spending is the government, and then only on borrowed and printed money. Yeah, I'll play on the upside but call me a reluctant

Sun, 11/08/2009 - 00:58 | 123743 FischerBlack
FischerBlack's picture

The decline in implied volatilities over the last many months would seem to suggest that the equity market has returned to its 'normal' functioning state. The problem is that none of the usual indicators or statistical relationships across asset classes seem to be re-asserting themselves. There is an air of artificiality permeating every tick. Floor traders like Art Cashin seem to legitmately have no idea where the bid is coming from. Algo guys like Jim Simons are watching decades of code evaporate into uselessness, and choosing retirement. Even careful guys like Dennis Gartman seem to be getting consistently stopped out of well reasoned fundamental and technical trades.

I'm not saying the market should be going down. I'm not smart enough to know that. I'm just saying that up or down, the indicators traders have used since time immemorial are no better than coin tosses right now. And this is how it has been for months. And this how it will be until it isn't.


Mon, 11/09/2009 - 09:53 | 124522 Anonymous
Anonymous's picture

How does GS win almost every day? I've been scratcing my head as well. I've worked in energy for over a decade and I know how the markets work. It's not easy to turn the entire portfolio of that size each time without causing some adverse market reaction. But I might be wrong, after all we have dark pools these days. This rate of success reminds me of Enron. I remember that these guys were right every quarter and with ever increasing profits. And we all know how real these profits were.

Sun, 11/08/2009 - 02:29 | 123758 msorense
msorense's picture

Chris Martenson has some excellent posts on his blog that convinces me that the market is rigged in the sense that any and all sell-offs are quickly reversed before they get out of hand.  As he points out, how does GS win almost every day?  It's not possible unless they have something that other market participants do not (i.e. HAL 9000 + Printing Press = 100% success!)  Everything is rigged in this country it disgusts me.

Sun, 11/08/2009 - 00:54 | 123740 zeta
zeta's picture

It's at least nice to know that, as long as there are Fed-aided manipulators, the stock market won't go down.

Sun, 11/08/2009 - 00:54 | 123741 zeta
zeta's picture

It's at least nice to know that, as long as there are Fed-aided manipulators, the stock market won't go down.

Sun, 11/08/2009 - 01:19 | 123748 Anonymous
Anonymous's picture

Buy metal (your favorite kind, be it Au,Ag,Pt or Pd or...) and take your money off the table, away from the cabal, and sit there with a smirk and your middle finger raised to the corrupt system.

I still don't know why the "market" stopped going down in March.

Sun, 11/08/2009 - 02:58 | 123760 Daedal
Daedal's picture

I can speak from personal experience, having listened to various mutual fund managers; they are all covinced (or at least pretend to be convinced so they get more money to manage from gullible investors, and thus more income) that we are at a beginning of a new bull market. Having listened to conference calls from those very same people in 2007 and 2008; they had no clue what was happening and repeatedly stated that the 'worst is over' (all before Lehman collapsed FNM & FRE got nationalized, etc).

Most of these managers and their CFA analysts are simpletons. They can value stocks, fine any idiot can discount estimated cash flows, but they don't understand macroeconomics -- I think this is primarily b/c most of them are Keynesian. I recall my CFA instructors stating that "Keynesianism has pretty much been established as the best economic system", while hoards of my classmates nodded in ignorant obedience. Listen to the traders Bloomberg interviews on a daily basis -- they rehash same nonsense. "Stimulus is working", etc. Listen to projections made by companies, about future growth. Here's how companies make projections: They take recent numbers and project them forward with an upward bias if the trend was up. That's it. They have no insight about sustained growth -- How does Ford conclude that they will be profitable in 2011? Same absurd guesswork.

The problem with the current bubble, on top of the stuff Tyler lists, is that most people (while acting irrationally) think they are being very rational. This bubble will collapse eventually, there will be another round of blamestorming, and then we'll get a 5th and 6th stimulus of some kind.

Pardon my blathering... I'm drunk, I'm tired, and Pelosi can suck it.

Sun, 11/08/2009 - 05:22 | 123785 Anonymous
Anonymous's picture

You rock. I'm registering an S/N because of you.

Sun, 11/08/2009 - 06:49 | 123797 dza
dza's picture


Sun, 11/08/2009 - 08:36 | 123808 Anonymous
Anonymous's picture


Sun, 11/08/2009 - 10:37 | 123842 Cognitive Dissonance
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"I can speak from personal experience, having listened to various mutual fund managers; they are all convinced (or at least pretend to be convinced so they get more money to manage from gullible investors, and thus more income) that we are at a beginning of a new bull market."

Daedal, you make a good analysis because you're applying both logic and common sense (and alcohol) to this issue. But I think it's even simpler than the managers drinking the Kool-Aid or wanting more money to manage.

I think they want to keep the money they have "under management" where it is, under their management, and not lost to another manager. Since assets under management provides their income, they must not only tell you the money is reasonably safe but psychologically they must also convince themselves the money is reasonably safe.

Believe it or not, most clients won't fire their money manager if the manager was "caught" in the same market decline as everyone else. I call it the Titanic syndrome. Everyone is in the same sinking boat and since most people measure their own situation against the next guy or gal, there is some comfort in shared misery.

I do believe that most money managers have some moral character and ethics (the amount is open to debate) so in order to continue to dispense advice to their clients, in particular the larger client meetings that are face to face, they go through a process of confirmation bias (usually on an unconscious level) where they seek out information that confirms what they wish to believe and what they will be telling their clients. The more complicated and exhaustive the process is, the more comforting it is for the manager. Remember, our brain releases extremely powerful and pleasurable drugs when we hear what we want to hear.

The inherent conflict of interest all money managers have (keep the money in house) precludes most from making statements, and thus establishing personal opinions, that would result in their professional and economic suicide. I have yet to hear any money manager tell their clients to pull their money out of their fund.

While it is usually obvious when some TV talking head is "talking their book" in reality, all money mangers talk their book. This is why the measure of egregious behavior by a money manager is compared to the consensus view, which is then scrubbed to look like it's in the clients best interest.

If all the money managers are headed for the cliff, no one money manager can be held responsible for their behavior as long as it conforms with the herd. BUT if one manager takes a contrary view and the herd out performs, that manager can, and will, be held responsible. The system encourages herd behaviour with small deviations allowed only around the edges.

I don't wish to make broad sweeping statements. There are always exceptions to any "rule" but for the most part, because most managers are paid (read bonus) based upon how they perform compared to their peer group, herd mentality is the rule, not the exception.

I always try to remember the following statement. It's nearly impossible to convince a man to do one thing if they are paid to do another.


Sun, 11/08/2009 - 14:31 | 123949 Oso
Oso's picture

CD, i am continually astounded by the sheer eloquance of your prose.  +1 to the confirmation bias reference.  In most of these shops (including hedgies), to dissent against the popular (/asset gathering conducive) opinion is to be labelled a pariah (personal experience).

Daedal - I have not read your posts before, but perhaps you should get drunk more often.  You are spot on with the comments on the legions of CFA's who can model anything and everything but have zero common sense in their heads.


Soros' thoughts on currency movements, wrt virtuous and vicious cycles, i believe are most applicable to where we find ourselves in all asset classes.  The speculative component of everything has completely over-whelmed any sort of "fundamentals", whether it be USD, equities, or precious metals, and this has fed on itself.  All of these money managers are making the exact same speculative bet.  Short dollar is the world's most crowded trade (even Chavez is short, and we know how brilliant he is).  Coupled with anemic/anorexic up-side volumes, multiple distribution days, and seeming break-downs of formerly rock-solid correlations, the end of treasury QE, and constantly being berated for not being long precious metals - i for one believe strongly that we are near the point of a sudden movement in the exact opposite direction.


anyway, am very excited to see how this week's treasury auctions go.  Even if banks use agency/mbs QE money to support treasury purchases, it still means it cant go into risk assets.  Frankly, without further direct Treasury QE, i cannot see a plausible way for risk to move higher.


my 2.3 cents (using a case-schiller adjusted CPI number)

Sun, 11/08/2009 - 15:15 | 123995 Daedal
Daedal's picture

CD -

Reading your post was like having my thoughts transcribed into concise, eloquent, impactful, and sobering understanding of reality. My first order of business will be to raise a glass, or two, in regards to your post. And now, I must encourage you to mail a copy of your post to every manager who runs a mutual fund (just for amusement purposes -- you can omit John Hussman from mailing list) and to those chumps that have money with said managers (for a much-needed wake-up call/slap in the face).

Sun, 11/08/2009 - 12:48 | 123913 Anonymous
Anonymous's picture

As an MBA professor, CFA examiner and just regular guy, I can say absolutely you are correct. All financial "theory" is nonsense. Only one thing matters: credit. People will spend whatever money they have, buy assets at any price as long as they have access to credit. Until...

Sun, 11/08/2009 - 15:59 | 124006 Cognitive Dissonance
Cognitive Dissonance's picture

It's interesting you say this for I fully agree from a practical point of view. I've been "in the business" for over 20 years. At the 3 year point, I began the process of acquiring my professional planning designations and 5 years later had some important ones (CFP, CLU, CFA) and many of the more minor ones.

Ironically, during this process I was steadily becoming more inept at my primary job of managing money. While my ego was being burnished, the condition of my client's wealth was not quite as bright. I became mediocre at best and probably worse than I care to admit.

I could have very easily remained in denial because my new professional designations attracted very large clients. Because of this, I enjoyed a higher income despite my performance, which speaks directly to investor herd behaviour as well.

I'm still trying to shake off all the technical and theoretical silliness and garbage I learned along the way. In fact, I'm convinced the proper term is not that I learned but that I was indoctrinated and conditioned to act as part of the herd. I've been learning a lot about myself and others as I regurgitate (projectile vomiting is probably a better term) all the shit I willingly ingested. It's been a painful process.

Sun, 11/08/2009 - 20:20 | 124136 Anonymous
Anonymous's picture

Back in the day I used to structure CMOs, CMBS and CDOs. I pretty much had no idea what I was doing, but I made a lot of money for a 26 year old kid with a BS in engineering. I knew what to do and how to do it and I more or less followed orders. Even still I got a little bored intellectually and I started to ask questions like where did these high returns come from and so on. No one could ever explain this; in fact, I was discouraged by my supervisors to think about this kind of stuff. Then I switched jobs, the yield curve flattened and that was that.

So I went back for my MBA/CFA to find the answers to these and other questions. I was naive enough to think that if I actually understood what I was doing, I would be more useful to clients and the Bank. But the more I learned, the more questions I had. I learned about swaps and FX and CAPM and then more complicated things like digital options, correlation trading etc. And as I learned I started teaching people at the University how these things really work, but to earn a living I had to pretend to teach people at the Bank how to sell this stuff. I wrote some questions for CFA exams to learn more about that. I traveled the world seeking answers to my questions, trying to understand it all.

To "invest" my hard-earned money I analyzed thousands of mutual funds and bought the best ones on a risk-adjusted basis. Most were "small cap value" so I figured out which stocks they held, built a model and started buying the "cheapest" ones. When the market went up, I made money and when the market went down I lost money, though not as much as I had made. Sometimes the cheapest stocks went up a lot, sometimes not at all. So I built another model to value every liquid US stock and try to time my buys/sells. That worked for awhile and then I discovered the market followed a pattern so I started trading futures to bet on that. But on July 20, 2007 the pattern ended. So I tried to find another pattern but just ended up losing money, betting against the market waiting for the "fundamentals" to kick in. I was too early.

Ok, so what's the point? Finally it all hit me. I can save every MBA and CFA candidate a lot of time and money. Don't bother going for an "advanced" degree. Here is what matters:

1. Derivatives serve one purpose - leverage. Leverage is just another word for credit.

2. Banks make money one of two ways - selling expensive long-dated options (usually naked) or buying cheap long-dated options. Of course selling options is just another way to add leverage ie credit. Sometimes they do it overtly in the form of loans, mostly it is more disguised through "structured products", which of course are just option-embedded loans, or leveraged credit.

3. Prices of any asset are 100% correlated to the availability of financing (credit) for that asset. CAPM and other models are worse than useless as they are backward looking, circular and yet still do not work when you need them to. So, there is no such thing as "fundamental valuation" when every theoretical model is based on assumptions and the assumptions don't hold. And "relative valuation" is an oxymoron, its just another term for market pricing, which is just related to credit as explained.

4. Risk management is just another term for justifying credit purchases.

5. The only skill that anyone really needs to make money is the ability to sell products without conscience.

Thanks to all for the postings, comments, contributions and in general, the inspiration to persevere knowing I am not alone out there and going out of my mind.

Sun, 11/08/2009 - 21:24 | 124176 Daedal
Daedal's picture

Interesting story. You mentioned you're a professor -- I'm curious as to how you teach this material to your students?

Sun, 11/08/2009 - 21:58 | 124193 Anonymous
Anonymous's picture

Good question! We (the class not the royal we) start every class by understanding fundamentals of credit, financial statements and the only thing that really matters: the yield curve.

For valuation we then go through the necessary "theories", discuss the limitations and applications. Then we build CF models. At this point it becomes quite clear that the numbers we get from models do not jive with current market prices. So we go back and try to understand why.

For corporate finance we do the same things only backwards, starting with transactions and trying to determine the economic rationale behind the financing, if any.

For derivatives we start with basic forwards and options and build from there, developing pricing models etc. Sometimes I teach people how to "position" these products if I am inspired.

For securitization, well, that's just a refinancing so its some combo of corp fin + derivatives.

All topics are virtually the same. Prices are determined by risk/return, supply/demand, and TVM. The end conclusion is always the same: finance is more art than science. Most any model will do, it's the inputs/assumptions that matter. There is no right answer, but some are less wrong than others.

I probably shouldn't disclose all this but I don't care anymore.

Mon, 11/09/2009 - 02:47 | 124395 Mark Beck
Mark Beck's picture

Good stuff. Ford can probably make a profit with a 14 Million SAAR or better, at its current market share. Fords Q3 profit was due to cost cutting and Cash For Clunkers (CFC). If SAAR is at about 10 Million, Ford will have to increase market share just break even. Most believe that CFC just pulled ahead demand at tax payer expense. Q4 should show a huge decline in SAAR off the CFC high.

Ford has to be very positive about future guidance, and you are right, it is absurdly optimistic. But, what else would the CEO say? You can only cut so deep without gutting the corporation, and Ford has cut deep. I put Ford in the walking wounded category. Most Ford watchers are looking closely at quality and product launch success, especially an all electric car. Electric car projects, like the Chevy Volt, are very expensive unless there is a market. So it is a good indicator of how much capital is available for new product design. For Ford, historically, the EV is usually the first to fall off the list when there is no viable business case.

Sun, 11/08/2009 - 03:59 | 123775 Anonymous
Anonymous's picture

We'll soon get a day when the Dow drops 1000 points in a day. Those fuckers will lose control eventually. When that happens, look out below.

Sun, 11/08/2009 - 04:45 | 123778 Anonymous
Anonymous's picture

Law of nature is the determining limit as essential goods and services reach maximum stagflation pain threshold...A Volkeresque figure steps in ....probably 2012 and rings the bell on interest on instant depression with overall over nature wins....oil will reach over 100 a barrel before this happens....oh yeh its comin.....

Sun, 11/08/2009 - 05:49 | 123789 Pondmaster
Pondmaster's picture

Keynesianism- maybe this economic philosophy is the "Big Lie" . When 99% of all marketeers believe the same thing , it can't be right . If marketeers are out to rob all they can , slowly , like a growing tumor, Keynesianism seems to be the play to use , till patient dies . Its obvious it is a great ponzi schmeme which lasted less than a century so far , and may well not see a good end .

That said , and in keeping it simple stupid .

One must not analyze , but utilize . Tweak stops , but have them in place .

Sun, 11/08/2009 - 07:47 | 123800 Anonymous
Anonymous's picture

Austrian School economics gives you useful tools for predicting what happens next. Keynesianism gives you useful tools for deception theft and manipulations by governments. Choose your sides, light or darkness. If you choose light, read Von Mises, Rothbard, Hoppe. It is about time for those who are productive to hit the reset button on this global system and get us back on the track of progress (classical liberal style) of the 18th century that got kidnapped by statisim. Only voluntary exchanges without fraud or force are valid. The sheer weight of the parasitism in place now is about to kill the present system globally.

Sun, 11/08/2009 - 08:11 | 123804 Apocalypse Now
Apocalypse Now's picture

OK, I think I have a few ideas here we should explore further:

  • The PPT steps in on large downside slides, backstopping the market which provides a level of comfort as a support level (like India's purchase of gold at $1,045) to encourage others to jump in at these levels (less risk with support).  If they ever pull support they should pre-warn, wouldn't want the rug to be pulled out from under positions - but just like screwing those that bought puts they will probably not provide warning except to the connected.  This is a problem because they are meddling and that's why correlations don't work, it's mind boggling - like making chitty chitty bang bang (the main street economy) fly (equity markets).
  • With naked shorting no longer allowed (theoretically?) and a permanent support level on the part of the ppt, capital can't really be used for normal shorting or put buying based on fundamentals or technicals (as we have all learned here).  Because the majority of the capital is applied to long only strategies (primarily trained) the cash flow alone from 401K's could be enough to keep increasing the market under low volume.  The truth may be that there are too many paper fiats chasing too few assets.  There are more paper assets than physical assets, if everyone pulled their current paper values and tried to buy up hard assets there would not be enough to go around.
  • With the uncertainty in the market between high inflation & cash being worth nothing versus deflation, individual investors generally don't make decisionsand will instead play wait & see (studies on this show that most people won't make a major decision in the face of significant uncertainty, even if the decision does not relate to the uncertainty), so when investment advisors tell their clients to sit tight, they do that.
  • The way that HFT is structured is to pocket the spread between what they can get you to pay for it and the real price they pay for a stock (with 15 minute delayed quotes this could be significant).  THEREFORE the system is actually structured BECAUSE OF THE DESIRE TO POCKET A SPREAD to drive prices up through HFT - possibly unintended but a side effect of HFT market makers.  I would like to know if the exchanges or market makers implemented a PRICING SOFTWARE PROGRAM (thinking of securities they are holding as inventory for sale) as it would appear when looking to buy, the tickers typically go up (testing to see how much you might pay for a stock as long as you are already interested in it in low volume).  I have experience working with a pricing engine in manufacturing but it could work for securities and accidentally distort the market.  This is an important point I haven't heard, and it's possible that the pricing engines also work the other way on selling (trying to get you to accept the lowest price and pocketing the difference), and theoretically the buy and sell spreads should theoretically offset each other unless:
    • More buy volume goes through pricing engines promoting spread than selling engines - this could be possible if different buy & sell entities
    • Buying volume is done more on market price and selling is done at specific price
    • The spreads on buys are larger than the spreads on the sell side
    • Imagine new buy volume that has no sale to transfer
      • Deepcapture talked about fungible share #'s only "reconciled" by the DTC
      • If market makers don't have inventory (like short held for delivery) for longs
      • If these aren't reconciled by security #, selling would be like printing money

With backstopped government ppt support levels, more capital is being applied for long only strategies because all the prior capital that went towards naked shorting and puts has to be redirected to the long side strategies, high uncertainty leading to postponing decision making and keeping the majority of portfolios static with 401K funds still flowing, and finally the pricing engines of the market makers that bias upside prices to pocket spreads (NEW IDEA) are all contributing to this levitating market.

I think the pricing engine concept based on spread capture for market makers is a very important angle I just thought of and I suspect was designed for both buys and sells to pocket the difference.  Because the government interferred by providing support, it redirected capital away from short strategies and all into long strategies that flow through the market maker pricing engine that encourages upticks to collect a spread.  Either the flow isn't even between the entities buying and selling through HFT pricing engine spread optimizers, there is more use of market orders on buys that enables a greater spread and more specific sell price orders (stop limits with less spread). 

Under the worst scenario there is no original sale to transfer the security to a market maker, and so without a sale going through the pricing engine to optimize the spread and decrease price equally in proportion with the rise on the buy side going through the pricing engine spread optimizer - the bias would be a cost plus approach that would only apply on the long side - skewing price up.  Now if there is no reconciliation of every security by # issued, this could result in printing money on the part of market makers.  If long securities not in a market makers inventory are allowed to be sold by that market maker and are either not delivered or delivered late it would be the equivalent of check kiting with a constant float! 

When enough securities buys go through the HFT security price + 3x spread pricing engine without the same securities going through the equivalent last securities price - 3X spread selling price engine, the result is ever increasing prices.


Sun, 11/08/2009 - 09:38 | 123819 Hansel
Hansel's picture

I'm going to disagree with your notion that there is too much fiat and too little physical assets.  I think there is very little fiat.  People are holding lots of assets which they believe to be convertible to fiat at market prices, but it's not cash.  We constantly need bailouts and ppt interventions so that people's paper profits are convertible to cash.  Base money now at around $2T is a pittance compared to global asset market capitalization.  $2T leveraged and releveraged again creates the system we have where assets are expensive and no one has any money.  401k contibutions cannot support the entire market.

Sun, 11/08/2009 - 11:58 | 123880 andy55
andy55's picture


Mon, 11/09/2009 - 08:33 | 124248 Apocalypse Now
Apocalypse Now's picture


By fiat I meant the coordinated global liquidity injection - paper or digital not just physical cash (a smaller portion of our money supply these days), but I understand the distinction you are making.  The fiat comment is a side note and not really the thrust of my comment - I was primarily making a hypothesis on the market maker HFT pricing engine optimizers which I believe are skewing the market up for spreads and distorting prices. 

Because of securitizations and derivatives we have trillions in "digital assets" that are many multiples of the physical assets themselves.  As an example, if you were to take all of the paper gold certificates and exchange them for actual gold, you would find there are more paper receipts than physical gold bars.  The base of the upside down asset pyramid is gold which supports all other asset classes.

The PPT, lack of fund flow applied to short strategies because of PPT and re-allocated to the long side, with zero interest rates the rates can only go up so long term bonds are not an option as they can only go down, and 401K funds flow every 2 weeks that are still buying into the market at any price (to prevent managers falling behind the market average benchmarks) are providing an upward bent.  Gov liquidity, the artificial ppt support level reducing risk (for how long?), lack of profitable alternative income generating investments, coupled with the HFT engines that are biasing stocks up because of the spread optimizers is keeping the market up.

So, my primary questions for further inquiry are:

  • HFT spread optimizing pricing engines - how do these work, and could buy side flow through market makers that use this be driving the market up through higher spread?
  • When market makers are selling stocks to investors, do they have to have the stock in their inventory - if not, how long do they have to deliver?  This is important because if they don't deliver or if delivery is a long period of time without reconciliation these firms could be minting money through the float like check kiting
    • A sub point here is that if the market is structured so that the sales to investors go through the pricing engine to create a spread (GS) but there is no sale of the security first going through a spread optimizer on the other side, the thousands of transactions on securities going through the engines in one direction (sold to investors) would bias up just to capture the spreads - unless the same # of securities were going through a pricing engine and capturing the same spread when securities are sold to market makers.

Does anyone have feedback on the pricing engines promoting higher spreads for all order flows through those market makers - structural problems due to unbalanced flows?

Does anyone know about market makers being able to sell securities they don't have in inventory?  They could make a fortune on selling what they don't have or at least significant cash flow due to the float between selling and delivery (check kiting). 

Does anyone know what the accounting entries are for the PPT? Do they have the securities themselves owned by an offshore entity? Or is their exercise merely a debit/credit type of a transaction between the last price on a security and the desired price on a security X # of securities?  Where is the other side of their accounting entry - could a portion of the trillions in derivatives really be the other side of their ppt entries?

Because of the SEC not knowing what traders are doing as evidenced by the other post today (and therefore not knowing what systematic issues there might be), these issues need to be investigated.


Sun, 11/08/2009 - 09:27 | 123816 Anonymous
Anonymous's picture

Apocalypse Now: 15min delays in public reporting are not the issue.

Sun, 11/08/2009 - 23:33 | 124253 Apocalypse Now
Apocalypse Now's picture

I don't think there is enough transparency to state that confidently.

We all know order flow doesn't appear to be exclusively first come first serve with the two tiered system including dark pools.  What is the purpose of having a 15 minute delay on security quotes.

Sun, 11/08/2009 - 09:46 | 123823 Invisible Hand
Invisible Hand's picture

Could the health care vote be the final straw?  Will people recognize that deficits are going to be much higher even than the enormous numbers already projected, that small businesses are going to have huge costs (and disincentives to hire), individuals are going to have huge cost increases as premiums go up, etc., etc.  Could this push the bond market to revolt against the tiny risk premium paid for (inevitable) US default?   I plan to get all my assets out of US to saner (safer?) countries, will others do the same?  I guess we'll see. 

Sun, 11/08/2009 - 11:06 | 123855 Winisk
Winisk's picture

The classic stages of grief after a traumatic event as described by Kubler-Ross.

     Denial:  a conscious or unconscious refusal to accept the facts

     Anger:  nuff said

     Bargaining: an attempt is made to soften the blow of the trauma

     Depression:  first signs that the person is accepting reality

     Acceptance:  letting go of what was lost

I submit that most money managers are still in denial.  The general population is somewhere between denial and anger.  Day traders are bargaining.  Zero Hedge readers are depressed.  No one is even capable of acceptance yet.    

Sun, 11/08/2009 - 11:09 | 123856 Grand Supercycle
Grand Supercycle's picture

How come so many of these fund managers don't seem to understand what a trend is ?

It's either up, sideways or down.


Sun, 11/08/2009 - 15:04 | 123990 Anonymous
Anonymous's picture

We are slipping further and faster into socialism. As unemployment hits 10.2%, many believe the economy will be in a slow growth period which will keep unemployment at high levels for a prolonged lenght of time. With more people out of work for longer peroids of time, politicians will feel compelled to "do something." We are seeing this now with extended unemployment benefits, healthcare, and subsidies for cars and real estate.

Once we start seeing stories in the media about the worker who used to make $200K per year, losing his job, defaulting on his mortgage, and now having to work at McDonalds, we will see the politicians hit high geer on social programs. And as we know, once these programs are implimented, there is no going back.

We are in the process of trading growth for a safety net.

Sun, 11/08/2009 - 15:28 | 124001 Mark Beck
Mark Beck's picture

Why are equity markets a barometer of economic health? the US sound policy health-o-meter. Why does the FED embrace equity market direction and dismiss their mandate of full employment? could it be that they find it is easier to manipulate markets rather than fix a collapsing fiat based economy? I wonder?

When do investment fundamentals no longer apply? perhaps when the word economy (in the US capitalistic free market sense) no longer applies.

So what do we have? a debt defaulting neosocialistic state. 





Sun, 11/08/2009 - 19:26 | 124103 hidingfromhelis
hidingfromhelis's picture

It's far better to do something meaningless exceedingly well than to accomplish nothing.  Really, there's a difference.  Feel better now?

Sun, 11/08/2009 - 15:50 | 124008 Anonymous
Anonymous's picture

A fizzle fo' shizzel?

Sun, 11/08/2009 - 20:42 | 124148 Anonymous
Anonymous's picture

It is very disappointing that you have not published my comment. I must now consider everything I read here with a large grain of salt.

Sun, 11/08/2009 - 21:34 | 124179 Tyler Durden
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Anonymous commentary is delayed. You should register and all your comments will appear immediately.

Sun, 11/08/2009 - 21:24 | 124177 Anonymous
Anonymous's picture

Call it a false market rebound when we make new lows - say 600, that would truly be an indication of weakness in the market as SP constituents got stronger. Perhaps this will be the greatest market as it will be range bound for a long period.

Sun, 11/08/2009 - 21:52 | 124188 Anonymous
Anonymous's picture

You speak of The PPT, the FED, HFT, GS, SEC and the FDIC and will not print the one simple obvious truth. A cabal has commited a coup within our government. McCain figured it out the day he saw Paulson and Bernanke with Bush in the middle, but it was too late.

So stay quiet stupid Goyim. Your government, your media, your economy, and your military are under their command and they did it in plain site.

Mon, 11/09/2009 - 08:14 | 124480 Anonymous
Anonymous's picture

I like this site, but the occasional casual racists and people who think the government are giant Zionist lizards in disguise do piss me off sometimes.

Do NOT follow this link or you will be banned from the site!