September 27, 2011

Stocks, dollars and Newtonian physics

Isaac Newton posited 334 years ago in his third law of motion that mutual forces of action and reaction between two bodies are equal.

I wonder what he’d think of the relationship between the US dollar and equities, where this small action produces that decidedly unequal reaction.

After the Federal Reserve acted to shore up bank balance sheets by buying long bonds and mortgage-backed securities last week, the dollar trampolined and markets dropped like Newton’s apple.

Pundits blamed dismal economic data. Yet we saw money market-wide shifting from equities September 16 with quad-witching. Before the Fed offered a dim economic portrait. If money was reacting, it sure had a funny, proactive, organized way of showing it.

Today and Monday, the dollar weakened and stocks zoomed skyward in a Newton-flummoxing frenzy to reclaim paradise lost. How many believe this is rational investment behavior? If you do, there’s a solar-panel plant in California that might interest you.

Also today, the SEC proposed reducing trading-halt thresholds and calibrating them to the S&P 500. Circuit breakers would interdict trading if the index falls seven percent. That’s down from current triggers tied to the Dow Jones Industrial Average at 10% off.

Monday, the Securities Technology Monitor, a trading periodical, reported that 72% of fund managers surveyed by Lodestar Research were concerned about their methodologies for calculating risk-exposure in markets.

All these things are related. Stocks and dollars are a laboratory example of the butterfly effect from value uncertainty in both. The gap between actions and their reactions are growing alarmingly disparate because uncertainty must be hedged by something unseen. Yin moves from yang to double- or triple-yang.

It should be no surprise that institutions are most concerned about managing risk with automated systems. What’s it say about our markets when the resonant timbre is not opportunity but threat?

And regulators. They don’t know what’s happening because their data are fragmented. Welcome to the public-company club, SEC. Somehow it’s acceptable for regulators to propose spending billions on their monitoring systems while the participants whose fair treatment regulators exist to ensure labor with a shattered and inchoate view of who trades their shares and where – thanks to rules.

Does this seem dissonant? Like the market?

Last week we sent a group note to key folks at FINRA and the SEC and a couple congressional staffers saying there are 5,500 volunteer policemen out here who’d like markets to function properly. Public companies. After 18 months of talking and talking, we now know that FINRA can authorize exchanges to provide the missing data to public companies through a simple rule filing.

The good news is that we need no act of Congress to modernize trading data for public companies. And yet here labor on public companies in dark chaos still, as regulators flail about trying to control the movement of stocks.

What’s so hard here? The apple is lying there, right by the tree. Toss it over, or at least throw public companies a bone.

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