“The market structure is a disaster.”
That’s what Lee Cooperman said in a CNBC conversation yesterday with “Overtime” host Scott Wapner.
What he thinks is wrong is the amount of trading occurring off the exchanges in so-called dark pools and the amount of shorting and short-term trading by machines.
Mr. Cooperman, who was on my market-structure plenary panel at the 2019 NIRI Annual Conference, decries the end of the “uptick rule” in 2007. It required those shorting stocks to do so only on an uptick.
To be fair to regulators, there’s a rule. Stocks triggering trading halts (down 10% in five minutes) can for a set time be shorted only at prices above the national best bid to buy. It’s called Reg SHO Rule 201.
But market-makers are exempt and can continue creating stock to fill orders. It’s like, say, printing money.
Mr. Cooperman has educated himself on how the market works. It’s remarkable to me how few big investors and public companies (outside our client base!) know even basic market structure – its rules and behaviors.
Case in point. A new corporate client insisted its surveillance team – from an unnamed stock exchange – was correct that a big holder had sold six million shares in a few days.
Our team patiently explained that it wasn’t mathematically possible (the exchange should have known too). It would have been twice the percentage of daily trading than market structure permits. That’s measurable.
Nor did the patterns of behavior – you can hide what you own but not what you trade, because all trades not cancelled (95% are cancelled) are reported to the tape – support it.
But they’re a client, and learning market structure, and using the data!
The point though is that the physics of the stock market are so warped by rules that it can’t function as a barometer for what you might think is happening. That includes telling us the rational value of stuff.
You’d expect it would be plain crazy that the stock market can’t be trusted to tell you what investors think of your shares and the underlying business. Right?
Well, consider the economy. It’s the same way.
The Federal Reserve has determined that it has a “mandate” to stabilize prices. How then can businesses and consumers make correct decisions about supply or demand?
This is how we get radical bubbles in houses, cryptocurrencies, bonds, equities, that deflate violently.
Human nature feeds on experience. That is, we learn the difference between good and bad judgement by exercising both. When we make mistakes, there are consequences that teach us the risk in continuing that behavior.
That’s what failure in the economy is supposed to do, too.
Instead, the Federal Reserve tries to equalize supply and demand and bail out failure.
Did you know there’s no “dual mandate?” Congress, which has no Constitutional authority to do so, directed the Fed toward three goals, not mandates: maximum employment, moderate long-term interest rates and stable prices.
By my count, that’s three. The Fed wholly ignores moderate rates. We haven’t had a Fed Funds rate over 6% since 2001. Prices are not stable at all. They continually rise. Employment? We can’t fill jobs.
From 1800-1900 when the great wealth of our society formed (since then we’ve fostered vast debt), prices fell about 50%. The opposite of what’s occurring now.
Imagine if your money bought 50% more, so you didn’t have to keep earning more. You could retire without fear, knowing you wouldn’t “run out of money.”
Back to market structure.
The catastrophe in Technology stocks that has the Nasdaq at 11,700 (that means it’s returned just 6% per annum since 2000, before taxes and inflation, and that matters if you want to retire this year) is due not to collapsing fundamentals but collapsing prices.
How do prices collapse? There’s only one way. Excess demand becomes excess supply. Excess is always artificial, as in the economy.
People think they’re paying proper prices because arbitragers stabilize supply and demand, like the Fed tries to do. That’s how Exchange Traded Funds are priced – solely by arbitrage, not assets. And ETFs permit vastly more money to chase the same goods.
It’s what happened to housing before 2008. Derivatives inflated the boom from excess money for loans.
ETFs permit trillions – ICI data show over $7 trillion in domestic ETFs alone that are creating and redeeming $700 BILLION of shares every month so far in 2022 – to chase stocks without changing their prices.
And the Federal Reserve does the same thing to our economy. So at some point, prices will collapse, after all the inflation.
That’s not gloom and doom. It’s an observable, mathematical fact. We just don’t know when.
It would behoove us all to understand that the Federal Reserve is as big a disaster as market structure.
The economy? We COULD take control of it back, too.