January 15, 2014

MMI, not MMA

A good exit strategy. It’s always wise to have one.

With the polar vortex bearing down on the national midsection last week, our exit strategy, fortuitously, was sponsoring NIRI’s fundamentals of IR program in Santa Monica. Karen snapped this dusk photo in shirtsleeves from our 8th-floor balcony at the Loews Santa Monica Beach Hotel. Yes, we were smiling.

The letters “MMA,” as many of you know and equally many of you could hardly care less about, stands for “mixed-martial arts” and describes a contemporary take on Roman gladiators, except the people involved in it are probably less refined than their progenitors 1,500 years ago.

To us, high-frequency-trading is sort of the MMA of markets. It’s a brief, violent, high-speed contact sport. Having so uttered, I may expect now to hear from these traders’ new lobbying group called MMI – the Modern Markets Initiative – which seeks to cloak HFT in finer and more agreeable raiment.

Here’s what’s happening. Several HFT firms including Hudson River Trading and Quantlab Financial (I mentioned both in a recent MSM) have banded together, hired some former political strategists, and launched an organization intended to change public perceptions of HFT and flex HFT muscle in regulatory and political circles.

Claims the website: “High frequency trading firms and the market professionals behind them are harnessing technology to enhance price transparency and increase access to markets for investors that was previously only available to a select few.”

It’s an impressive effort to seize the agenda and refashion it. A flashy video at the site likens HFT to robotic mechanization in manufacturing – turning human tasks into ones driven by machines.

MMI recasts HFT not as arbitrage but as “automated trading technology” run by professional traders whose core purpose and function is to help everybody out by lowering trading costs, creating clearer prices and opening markets to more folks.

Well, shazam, let’s everybody hug! Right? Not exactly. We’re not criticizing the human ingenuity behind HFT. Traders didn’t create the rules requiring every node on the data network comprising the national market system to be connected in order to shuffle shares around the best price (imagine if the only differentiator in all products were price…human creativity would suddenly stampede off some permanent cliff into a gooey protozoan puddle).

Past the pomp and circumstance and the touchy-feely goodness, two basic truths are overlooked: If you want a good deal, eliminate the middle man. All HFT firms are middle men wanting to own nothing – but hoping we all believe that more of them between real buyers and sellers, all wanting to make money by being there, will somehow mean stuff costs less (this rationale typifies many pie-in-the-sky schemes). If that’s what the data seem to indicate, we’re measuring the wrong data.

And second, small spreads are never a measure of value. Value is about big spreads. Buy low, sell high. Much of the opportunity that accrues from patiently buying and holding is evacuated from today’s stock market because HFT offers instant gratification from second to second. Why endure the risk and uncertainty of waiting till the end of the day when you can sell right now!

HFT robs patient investors by arbitraging that spread, representing capital-formation, away – often entirely.

Remember early 2009? One of our favorite MLPs – master limited partnerships – traded for $5. Shares today are about $50 and have been near $60. In 2007, units traded above $50. Did the intrinsic value just – poof! – disappear in 2009? For everyone? Sure, there was a financial crisis – but should shares have lost 95% of their value? Of course not. Intermediaries didn’t want to own shares, and they were the top price-setters.

Intermediaries today price the entire national market system every second. You never want to depend on renters over owners, and these intermediaries aim to end each day owning nothing. That’s the market we’ve got.

We don’t fault HFT for defending itself. But public companies should too. It’s your market, your intrinsic value that hangs in the balance of every trade.

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