What Corruption Does to the Markets

There’s sand in the gears of the world’s manufacturing machine.

No matter where we look this morning — Asia, Europe, the United States — the pace of “making stuff” is looking sluggish.

In a globalized economy, we now have a curious phenomenon: The synchronized release of manufacturing numbers, globally, on the first of the month.

Conveniently, they’re measured the same way: A number higher than 50 indicates an expanding manufacturing sector. Lower than 50, a contracting one.

The numbers for August? In a word: Meh.

  • China: Up slightly from 50.7 to 50.9, according to the China Federation of Logistics and Purchasing. A separate survey from HSBC is also up, from 49.3 to 49.9
  • Eurozone: Down from 50.4 into contraction territory at 49.0, according to Markit — a two-year low
  • United States: Down from 50.9 to 50.6 — the worst reading since July 2009.

In the uniquely bent logic of Wall Street, the U.S. number is fodder for a rally — because it beat expectations.

The “expert consensus” of economists polled by MarketWatch called for a contractionary reading of 48.8. The actual number of 50.6 was higher than even the most optimistic economist’s guess.

The resulting rally isn’t much to write home about: What was shaping up to be a down day before the open is essentially flat instead. The Dow hovers at 11,600.

Bent logic aside, you can’t say the stock market lacks a sense of irony.

After a sell-off in late July that turned into a rout early last month, the Dow ended August back in positive territory for 2011 — barely. The S&P 500 and the Nasdaq were not so fortunate; both remain down about 2.5%.

Now begins September — traditionally the market’s worst month of the year. Since 1928, there’ve been more down months in September than any other month. The worst was in 1931, when the Dow dropped 30%.

Heh… then comes October — when outright crashes seem to come. Think 1929, or 1987.

As if that’s not enough to give ordinary shareholders the willies, there’s the growing sense they’re playing a game of high-stakes poker… with marked cards.

“The fraud, the phony bids and offers and the high-frequency ripoffs have driven everyone away,” wrote financial blogger Karl Denninger, giving voice to this sentiment after he examined the negligent volume in S&P futures early in the trading day last Friday.

“Go ahead politicians,” he then said in a post that went viral this week, “tell us how important ‘Wall Street’ is to the economy and to you. Let the thieves and liars continue to pollute the markets and screw everyone. Volatility is as high as it is precisely because people are tired of getting buttraped and after a few instances of it they simply say ‘screw this,’ take their money and go home…

“Don’t even try to ‘invest’ in this market, folks, and if you decide to trade, realize that you’re playing in a rigged casino and the entire force of the government is not only behind rigging the casino but explicitly endorses and permits the rigging to go on and continue, despite being fully aware of it.”

“There will be no reason for subscribing to your publications,” writes a 5 reader who brought this blog entry to our attention, “if all of us, and mostly you guys, do not do all in your power to see that everyone is made aware of the fact that the game and casino you tout are crooked.

“I have been an investor for the majority of my 64 years on this Earth. As far as I know, there has never, in all of history, been a time when the markets have been so corrupted.

“The CFTC and the SEC are nothing more then gatekeepers for the thieves that are now in total control. You give advice that may overcome the thieves on occasion, but you will not, in the long run, overcome the bastards that are becoming more voracious every day.”

It’s a serious question, deserving serious consideration. We’ll hear from four of our editors today for perspective.

“I can’t help but think,” says Chris Mayer, “that these views echo those of the pre-World War II era about market manipulation.

“Especially as they relates to market ‘pools,’ which were usually piles of money put together by the well-heeled and connected with the intent of making money in the markets. Kind of an early hedge fund.”

Chris, whose bookshelves overflow with decades-old tomes about the market, cites a book by Fred Kelly, called Why You Win or Lose, published in 1930:

“There is widespread myth about a pool’s miraculous powers. In the minds of amateur speculators, every pool is rarely gifted at foreordination and omniscience and has a magic wand with which it can put the price of a stock wherever it sees fit.

“And so today,” says Chris, “every amateur plunger sees forces moving things around just so he can lose money. It’s a human reaction to make stories for things we don’t understand.”

“The market has always been rigged,” Chris goes on, “against the little man who thinks he is going to whip in and out of stocks and trade with the big boys.

“The only real advantage an individual investor has is his ability to sit on his hands. He doesn’t have to report to anyone quarterly or monthly about his results. He doesn’t have to play the performance game. He can buy what he likes at what prices he wants and wait to sell them at prices more favorable.

“I think there are many other stocks in which you could just sit and be much richer, say, three years hence.”

“Yes, it’s a miserable world out there,” says sympathetic Byron King. “The markets are rigged and the government is corrupt. There, I said it. Oh, wait… one more thing. Life’s a bitch and then you die!

“It’s not even like the regulators are crooked in the classical sense of taking bags of cash. It’s more like the old idea of ‘honest graft’ — the revolving door, where somebody graduates from law school and goes to work for the SEC, say. Then after a few years, it’s off to Wall Street and a nice payday.

“Then after a few years of doing deals, and on the side raising funds for a senator or presidential campaign, it’s back to the SEC or Treasury. Then a K Street job, lobbying the SEC, Treasury or Congress. Then with a new administration, it’s to a much higher assistant secretary of this or that job.”

“So if you don’t want to be part of the rigged marketplace,” Byron goes on, “supervised by crooked overseers, then what do you do? Put your money in the bank? At zero interest?

“Go offshore? You still have to report that, or the offshore bank will narc you out.

“Real estate? OK, but it’s all about location, location and location. Plus, you never really own it, because the government wants taxes and you have to pay to play.

“Buy gold and silver? Sure…. I discuss physical metals all the time.

“But I want to ride the broad trend in energy scarcity and tightening mineral supplies. That means I want to get in early, and at low share price, before the ‘quants’ and traders figure out that a company is a target.

“I want to be in the right sectors — energy and mining — during a global economic buildout. There is a rising tide out there, and energy and minerals are a big part of it.

“Over time, markets go up, markets go down. Over a long enough time, the good plays go up more than they go down. Good stuff is scarce in this world. Eventually, people will pay for the good stuff. This last point is your advantage in subscribing to Agora products. We pick out the good stuff.”

“Most investors don’t understand what program trading actually is,” says Jonas Elmerraji, turning our attention to the high-frequency trading (HFT) robots. “That includes professionals.

“The vast majority of program trade volume is one of two things: arbitrage (which is good because it keeps values in synch with each other) or algorithmic trade execution, which is all about getting big orders (like mutual funds) in at the best price without influencing prices (and resulting in poor fills).

“Both of those behaviors are essentially market neutral. There are very few cases in which computers are speculating with/against each other.

“When people lose money, they blame program trading. It’s been happening since 1987.

“Ultimately, for investors, stock prices have a fundamental backstop: a price below which equities look so cheap an investor can collect absurd returns from dividends, or dismantle the company for an instant gain.

“If it were really just computers left, anyone who tried would be able to get absurdly rich without any effort at all. The market doesn’t work like that.”

“Institutional advantages are nothing new,” says tech maven Ray Blanco, bringing us back full circle. “Decades ago, all retail investors could manage was to phone in a trade from halfway across the continent.

“Big institutional traders, however, sat right on Wall Street with immediate, intimate access to the best information and the most up-to-date pricing information. Later, when electronic trading was born, it was institutional traders that first had access to those resources. However, even in that environment, wise investors could still earn hefty profits and build fortunes over time.

“As long-term investors, we are scarcely affected by short-term high-frequency shenanigans. As small-cap technology investors, we are even less affected. HFT algos tend to lurk in larger, higher-volume equities.

“Yes, HFT unfairly stacks the deck against small retail traders sweating behind their computer monitors, but HFT doesn’t affect long term trends — or profits.”


Addison Wiggin,
for The Daily Reckoning