Bloomberg’s Dawn Kopecki talks about JPMorgan Chase & Co.’s $2 billion trading loss after what Chief Executive Officer Jamie Dimon calls an “egregious” failure in the firm’s chief investment office. Kopecki speaks with Erik Schatzker and Stephanie Ruhle on Bloomberg Television’s “InsideTrack.”
Source: Bloomberg, May 11 2012
I love these Nanex charts showing some recent “anomalies” in markets.
Not many people really understand HFT and how the Flash Crash happened. Thefirms that have given me my best understanding of what happened are Nanex and Themis Trading.
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Click to enlarge:
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More charts after the jump
The disclosure by once future Treasury Secretary and current JP Morgan CEO Jamie Dimon of a sudden and previously undisclosed $2 billion dollar derivative loss should be a wake up call. It unwittingly reveals much about the present state of finance:
• The inherent tension between traders using leveraged risk with Other People’s Money in the pursuit of enormous bonuses is still weighed heavily towards excess risk taking;
• There is no bank in the United States that has demonstrated the ability to manage proprietary trading risks — if they use derivatives and/or leverage;
• It took less than 3 years after the financial crisis peaked for traders to engage in the same sorts of highly leveraged reckless speculative bets that helped crash the economy last time. Imagine the sorts of risks these mis-incentivized desks will be doing when the memories of the crisis fade 10 years after.
• Trades that are so enormous as to be “credit index distorting” are not hedges, but pure speculation. Within banks, apparently the word “Hedging” loosely translates as “speculation.” Actual hedging of existing positions appears to be nonexistent.
• VaR remains a mostly useless concept as applied by banks today. It is a false model of reality whose deviations have devastating consequences. (Call it physics envy)
• At these size trades, the asymmetrical preference for bonuses over risk management is such that even clawbacks won’t work;
• Jamie Dimon, formerly praised as the Capo di tutti capi of bank CEOs, apparently has been more lucky than brilliant. This quarter, his luck ran out.
• Derivatives, because of their enormous built in leverage, are inherently dangerous. They are still financial weapons of mass destruction;
• Too big to fail banks remain a threat to the stability of the global economy.
While this was “only” a $2 billion loss it easily could have been much greater. That banks such as JPM are still putting on trades that distort indices is quite bluntly, astonishing.
The solution to this risk is very very simple: The USA should reinstate Glass Steagall, and repeal the Commodity Futures Modernization Act.
Until that occurs, the risk of catastrophic failure remains present in the financial system.
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Disclosure: Long JPM
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Jim McTague explains why this is the unhappy anniversary of the flash crash:
From Jan. 1 through April 30, 2010, investors put $668 million into stock funds, says the Investment Company Institute, the mutual-fund trade group. By the end of 2010, they had withdrawn about $96 billion. In 2011, there were $135 billion in outflows. This year, there have been more than $15 billion in outflows.
The hazards posed by the new robots were detected not by the regulators but by Sal Arnuk and Joe Saluzzi, partners in a small proprietary trading company. They blew the whistle in December 2008, accusing some of the owners of these high-frequency trading machines of manipulating the market. (They tell all in a book out next month called Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio.)
Eric Hunsader of Nanex, a small data firm, uncovered real-time evidence of market manipulation and also showed up the regulators. His Twitter feed tracking machine misbehavior has become must-reading for investors.
Nothing has changed since May 6 2010. The odds of another co-located, algo-driven, dislocation remains as high as ever.
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Source:
Happy Flash Crash
Jim McTague
Barron’s, MAY 5, 2012
http://online.barrons.com/article/SB50001424053111903935304577376060415615588.html
Joseph Saluzzi (jsaluzzi-at-ThemisTrading.com) and Sal L. Arnuk (sarnuk-at-ThemisTrading.com) are co-heads of the equity trading desk at Themis Trading LLC (www.themistrading.com), an independent, no conflict agency brokerage firm specializing in trading listed and OTC equities for institutions. Prior to founding Themis, Sal and Joe worked for more than 10 years at Instinet Corporation, pioneers in the field of electronic trading, and at Morgan Stanley.
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This Sunday will mark the 2nd anniversary of the May 6th Flash Crash of 2010. As we all trade in this extremely low-volume environment, it is fitting that we recap where we stand today.
Listening to NYSE Euronext’s 1st quarter conference call yesterday, we shook our heads in dismay as management described a trading environment where volumes fell to a four and one half year low – the lowest levels since Reg NMS was implemented in late 2007, in fact.
NYSE’s Duncan Niederauer explained his 44% profit decline was due largely to a 25% decline in revenues from transactions from a year earlier. The culprit: An unfriendly environment for high frequency trading firms. From his point of view, regulators and folks in the media hyped the HFT bogey man too much, creating uncertainty, causing an HFT migration into other asset classes and geographies.
Niederauer doesn’t get it. He is mistaking the symptoms for the underlying problem. HFT volumes are down because investor volumes are down. Investor volumes are down because traditional retail and institutional buyers and sellers of stock have been steadily waking up to the dangers of drinking at the increasingly dangerous ”stock market watering hole.”
Like the animals on the Serengeti, who for years were accustomed to sipping long and heartily at their favorite spot, retail and institutional investors now see what’s beneath the surface. And they are deciding that the drink they crave is just not worth the risk.
More than $250 billion in long term equity funds has retreated from the markets since May 6th, 2010 – despite a slow but steady improvement in the economy and a stock market that has nearly doubled since the 2009 lows. It isn’t that these investors don’t have confidence in the economy. They don’t have confidence in our markets.
It isn’t hard to blame them. They have witnessed a radical transformation of the best capital allocation market system in the world, into one where:
- 13 stock exchanges cater to hyper traders who game the system, chasing exchange rebates, and leveraging speed for the purpose of a nanosecond scalping dance.
- More than 40 dark pools together trade more than 1/3rd of all shares.
- Conflicts of interest abound as exchanges own stakes in dark pools, and HFT firms own stakes in exchanges.
- Brokerage firm internalization of trades feeds the HFT financial modeling of investor orders.
- Exchange data feeds act as a veritable DVR of investor orders and behavior, the recording of which is then sold to HFTs.
- Rogue exchange traded products break down, trap unsophisticated investors, and only enrich the issuers, exchanges, and HFT firms that make markets in them.
- HFT firms in the last decade have achieved wondrous profitability (double-digit Sharpe ratios) while investors at best have clawed back to even.
- More than $1 billion in customer-segregated monies goes missing from MF Global, with not a single prosecution, nor a hope of redress.
As they witness all of the above, traditional retail and institutional investors see that our regulators must be having a challenging time acting as effective policemen in the marketplace:
- Flash orders, which give HFTs a quick peak at retail and institutional orders, are still alive and well, under many different names, despite a proposed banning of them in 2009.
- Dark pool regulation, also proposed years back, has not materialized.
- Internalizing brokerage/HFT firms, which clearly played a huge role in the market melt-down on May 6th (perhaps as well in the financial crisis in late 2008 and 2009) still practice the same way, with additional help from dark pools and exchanges who have all embraced “liquidity provider” programs.
- And finally, payment for order flow (PFOF) is alive and well on numerous levels throughout the system – from retail, to maker/taker exchange pricing, to free dark pool executions.
Investors know that the markets are broken. And they desperately want it fixed.
Our outrage over the transformation of the best capital markets in the world to this conflicted and fragmented web of chaos led us to write our book, Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio, which is being published by Financial Times Press.
When the book comes out June 3rd, it will find no shortage of critics from within our industry. However, we needed to write it. For years we have spoken about all of these issues in trade magazines and the financial media, and at industry conferences and panels, as well as with our regulators.
We wrote Broken Markets so that Main Street could understand what happened to our markets, to inspire change, so we can once again have the best capital markets in the world.
So, Happy Anniversary to everybody who made the Flash Crash happen. We hope you are enjoying yourself.
Because we, and millions and millions of other retail and institutional investors around the world, are not.
Click to enlarge:
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However, the chart below shows just how fickle these seasonality charts can be. Looking at the seasonal return for stocks during election years shows a vastly different picture.
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While investors are not likely to make investing decisions based solely on a catchphrase such as, “Sell in May and go away,” the charts above illustrate the degree to which seasonal data can be manipulated to fit one’s bias. For this reason, we have always viewed seasonal charts as interesting eye candy and nothing more.
Source: Bianco Research
Comment: As the chart above shows, May typically ends a seasonally strong period for stocks.
US Funds Sell In May And Go Away?
Not This Year One catchy investing maxim that’s popular this time of year is “sell in May and go away,” the notion that investors should cash in their investments and take the summer off. Historically, this hasn’t been a bad strategy…Last year, investors who employed the “sell in May” strategy averted an almost 17 percent drop in the S&P 500 and a nearly 25 percent drop in the MSCI Emerging Markets Index from June-September. Summer of 2010 was a similar experience…May has historically been a strong one for markets. Since 1988, the median return for the S&P 500 and MSCI Emerging Markets during May has been 1.22 percent and 1.28 percent, respectively. In fact, May returns rank in the top half for both indices. This is also a presidential election year in the U.S., which has historically produced positive returns. Since 1972, the stock market has rallied in 5 of the 8 election years, according to J.P. Morgan, with market gains of 12-26 percent. Only during recession years (2000 and 2008) did the S&P 500 provide negative returns.
As of 2010, 50-70% of all stock trades were done by high frequency trading computer algorithms.
And many other asset classes are dominated by high frequency trading as well.
High-frequency trading distorts the markets. And see this and this. And it lets the big banks peak at what the real traders are buying and selling, and then trade on the insider information. See this, this, this, and this.
Morgan Stanley has just shown (via the Financial Times) that the percentage of high frequency trading in the stock market has skyrocketed to 84%:
Trading by “real” investors is taking up the smallest share of US stock market volumes [since Morgan Stanley started keeping track 10 years ago.]
The findings highlight how US trading activity is increasingly being fuelled by fast turnover of shares by independent firms and the market-making desks of brokerages, many using high-frequency trading engines. [actually all of the market-making desks are using it.]
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The proportion of US trading activity represented by buy and sell orders from mutual funds, hedge funds, pensions and brokerages, referred to as “real money” or institutional investors, accounted for just 16 per cent of total market volume in the form of buying, and 13 per cent via selling in the final quarter of last year, according to analysis by Morgan Stanley’s Quantitative and Derivative Strategies group.
It’s not just the U.S. High frequency trading dominates in the U.K. as well.
As mentioned previously, to avoid confirmation bias, I force myself to read some folks whom I disagree with. When Doug Kass and I are out of phase, as happens now and again, he is the perfect foil for me.
Which is why this works so well: A perspective from Dougie which lists potentially disruptive factors that might impact markets:
1. US Politics
2. Euro Politics
3. Interest rates
4. Economic deterioration
5. Fiscal issues
6. Deflation
7. Strategists excess bullishness
8. Housing
9. Black swans
10. Fund flows
11. The nothing but Apple (AAPL) market.
12. Technical deterioration
You can see the full run over at Real Money Pro (subscription). (Update:Moved to free site)
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Previously:
Consolidation versus Crash (April 10th, 2012)
Source:
Dirty Dozen
Doug Kass
Real Money Pro, April 19, 2012
http://www.thestreet.com/story/11501302/1/dirty-dozen.html
For all you chart watchers and stock bellwether spectators, Apple is back at Friday’s close of 605.23, thus getting back all of yesterday’s loss. The intraday high on Friday was 610.28. What happens next?
The best way to keep money in perspective is to have some. —Louis Rukeyser
"It's the end of the world as we know it and I feel fine" say the French as consumer confidence in May rose to the highest since Nov '10 as they welcome and get excited about new Pres Hollande. Also, the French 10 yr bond yield touched the lowest on record this morning. June consumer confidence in Germany held at 5.7, just .2 pts off the highest since Mar '11. To the euro bond debate which is now taking on greater rhetoric with those with high bond yields wanting them and those with low ones saying no way, ECB member...
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