Thanks for all the bright comments and questions you’ve contributed lately.
Please, keep them coming.
You can share your own thoughts with me by posting them to the bottom of any article, or emailing them to email@example.com.
Okay, who’s up first this time?
Q [re: "What I See Ahead for the Economy"]: I generally agree [with your wagon analogy], but allow me to play devil’s advocate. If we are so connected, why haven’t the U.S. markets been struggling as much as Europe? Sure we have our problems too, but so far equity markets seem to have shrugged off Europe… ~ Dom
A: The U.S. – to use Mohammed El-Erian’s phrase – is the cleanest dirty shirt in the laundry.
Corporate earnings have generally been stellar, and that’s what drives the market, underneath the macro headwinds. But a lot of those earnings are global revenue streams, accounted for in terms of a weak dollar when they are translated back home into quarterly reports.
The markets also look “cheap” on a relative, historical price/earnings multiple basis. I have argued both fronts. If the dollar strengthens, because global growth weakens and capital flight out of emerging markets (China in particular, not that’s it’s emerging, it is HERE) heads into the U.S., that would be indicative of weakness where U.S. companies have been shining. Then, when weaker global earnings streams get translated into a more expensive dollar, earnings reports could vastly underperform expectations at first, then quarter over quarter and year over year trends more dangerously.
As far as historic PE multiples, I’ve argued, empirically, that the old benchmarks don’t apply any more. My work says the new normal might be 12 times, not 14 to 15 times. Why? Things like technology’s impact on productivity, paradigm shifts as a result of productivity changes due to technology, and volatility dynamics due to a global marketplace. These are just a couple of things we have to watch out for in terms of valuing markets, especially U.S. markets.
Q: One of the only ways the global economy can survive now is [if] the debt reset button is pushed, forcing prices down to real value rather than a notional one. But as this is not going to happen, then I guess it’s the cabin in the hills. ~ Alex G.
A: It can’t happen on a global scale; the hills would be too denatured of trees for want of so many tiny cabins. It could happen on some rolling basis. But, once that kind of ball starts rolling, it could snowball, and we’d be facing another 2008 look over the abyss. Only the next time could see the precipice collapse from the weight of leveraged sovereigns and overly leveraged central banks.
Come to think of it, where’s my little axe?
Q: “Been Down So Long It Looks Like Up To Me” is the name of a book by Richard Farina, published in 1966 – before The Doors plagiarized the phrase in the 1970s. ~ John D.
A: Thanks, John. I always appreciate learning the true origin of the things we think we know about. I never said I was smart, just a smart*$%.
Q: Jefferson said something to the effect that no generation should be able to indebt future generations. I agree in principle. I suggest that the each indebted nation and its citizens should declare universal bankruptcy here and now. Thereafter each of us is granted an equal financial stake in the new economy from which we proceed to build our respective fortunes with a new clean currency. I can hear the screams now, but what other alternative is there? ~ Ashley G.
A: Wow. Ashley, did you know that Thomas Jefferson amassed a huge debt enhancing his home and properties? Not just to keep them up, but to live like a king – that is, before he was President. Jefferson knew what leverage was. But, as much as I wouldn’t bridle anyone’s ambition to live a better life, in any way, I don’t think that the answer to our collective debt is to all roll over, play dead, and shackle ourselves into our own debtor’s prison Hell.
Ashley, I have a feeling you would make a lively conversation partner and somehow, by the nature of your last sentence being a question, reveal yourself to be a capitalist (à la Jefferson) at heart.
Now let’s see your comments on “Obamatirement”…
Q [re: "Here Comes Obamatirement"]: The next “right” or “entitlement” will be free retirement accounts for the poor and lazy, paid for by the blood, sweet, and tears of the hardworking people in this country. Come on, retirement is a right, isn’t it? LOL, I guess the argument could be made that they’ve been “retired” since day one… living off handouts. Maybe Obama could put that in his campaign… it’d probably buy him a few more votes. ~ Rob
A: Rob, I used to like Obama and had high expectations for him, like a lot of people. Now I’m disgusted with him. On the other hand, I thought Ronald Reagan was going to be the beginning of the end of this country, and I came to love him. I thought the Republicans had it right until they screwed us all with their too greedy paymasters exacting too much from the free markets they unhinged to leverage at taxpayers’ expense. I also thought Bill Clinton was going to undermine the dignity of the Office; he ended up being a stupid man for his dalliances but a great American when it came to balancing the budget and working with a divided Congress.
Democrats, Republicans… They’ve both gone too far to the left and too far to the right. We need some king of an amalgam of Reagan and Clinton; they both got it right for the good of America and were willing to hear each other’s side out.
Where can we go from here? I’m sick over the two choices facing us now.
Q: Power to Politicians! Strap them in the chair and pull the switch. ~ Noel F.
A: Ouch. That’s harsh… BUT I LIKE IT. “It’s only rock and roll, but I like it, like it, yes I do… I like it.”
Next up: the Knight Capital fiasco.
Q [re: "What Really Happened at Knight Capital"]: So do I understand this right? They are betting (investing) against their own customers and using our orders to predict which way they should go (long or short), all without providing us with the “advice” we are paying for… or are we? ~ Steve L.?
A: In a word, yes. Behind the scenes, these firms and the most active bank trading desks act as market-makers.
Making a market in a stock requires posting a bid and an offer. You are willing to buy and are willing to sell, depending on the prices you post. Needless to say, if you don’t really want to buy that stock, you post a low bid, knowing there are higher bids ahead of you and you won’t get filled. If you have tons of orders coming to your shop, because you “pay for order flow,” you see all those customer bids and offers and can adjust your market (your bid and offer prices) accordingly.
Sometimes market-makers execute orders against other customer orders; that’s an “agency” trade. If they take one or other side for themselves, it’s a “proprietary trade.” At least that’s what it used to be. Now the argument is being made that when a firm like Goldman takes the other side of a customer trade (instead of matching it against another customer order on their desk or out in the marketplace), it is not prop trading, but merely market-making, by making a better market and filling their customers’ orders quicker, and, they argue, at better prices. But that IS prop trading.
If you take the other side of my trade and don’t immediately match it up, you are taking a position. How long will you hold it is anybody’s guess; maybe a few seconds, maybe a few weeks. But you’re holding the bag. You are at risk. Call it what you want, but there’s obviously risk, and Knight’s losses prove that.
This is the muddy water of the Volcker Rule; what is prop trading, anyway?
As far as betting against customers, oh yeah, that’s part of the game by its nature. That’s what happens if they take the other side of your trade. Now, you both want to win on your positions. Who do you think has the advantage? Can you see all that other order flow coming in? Are you getting advice to maybe hold the position, so maybe “they” can trade against you? Maybe.
Q: As a Wall Street veteran with nearly 40 years of experience, it seems to me that we have to re-examine some of the core concepts that underlie Wall Street. No one trusts the Street anymore and for good reason. Individuals and even institutions do not feel that the market is fair in the way prices are formed and transactions allocated – the most basic functions of a market. Maybe it is time for a “Constitutional Convention” for the financial markets to debate the most basic concepts of what a market is and how it is supposed to function before the people lose faith in the system entirely. Or is it already too late? ~ G.
A: It’s never too late in the Land of Lincoln and Washington and the other great men and women who made and make America the greatest nation in the history of the world. But it is getting dark out there.
I love the idea of a “Convention.” It would work if all the delegates were academics, and there were no politicians and no bankers or traders with any voting power. Sure, let them have their say. We all believe in freedom of speech. But we’re done being bound by their lies, schemes, and greed. We need free markets – not a free-for-all for the bankers and traders who have bent our capital markets to the point of breaking. We need to be breaking bad.
Q: Shah, over the last 20 years, I have worked with Edward Jones, Merrill Lynch, UBS, and for the last year I have my own firm. Your statement: “Your broker routes your trade for execution to some destination, because he is paid to send it there. That’s right; your broker is paid to send your order somewhere” is completely incorrect. The client’s broker has zero to do with that. ~ N.
A: N., you’re right and you’re wrong. The actual broker (customer’s man) doesn’t make that decision, you’re correct there. Routing orders is a decision out of the broker’s hands. But orders have to be executed somewhere, and if you don’t have your own market-making desk that can execute the orders, or don’t have direct Floor or exchange access, guess what, those orders have to go somewhere where they can be executed. You have your own firm, how do you execute your customers’ orders? Maybe you route them through your clearing firm. If you didn’t know it, I have news for you, they are routing your orders for payment. Check it out. Let’s continue this conversation.
By the way, I had my own brokerage, too. We handled thousands of orders every minute of every day, and we sold some of that order flow. You have to get execution somewhere, so why not get paid to route your orders? It’s just part of the business. Don’t blame me, or anyone else, blame the “system” that saw to it that a proliferation of trading venues could materialize, fragment the markets, and this new business within the business could flourish – and with it many of the problems it has spawned. Mind you, these are public problems, they are not problems for the new opportunists; for them they are ways of making money. The business has spread its field of schemes.
Q: The only guys “making a killing” on the market today are the guys actually “killing” the market to do so. That’s bad business. ~ Philip H.
A: Exactly. It works for them now, and has worked for a long time. But there will come a time when they will have scared off all the fools, and there won’t be enough of a public pool of patsies to prey on. Then we’ll see how badly our capital markets have been damaged.
Q [re: "This is the Definition of "Regulatory Capture'"]: This has been one of my favorite posts, because it tells more in three minutes than Benny Bernanke can tell us in an afternoon. And it tells the truth more. ~ Kevin B.
A: Thank you Kevin. Whenever I can shine a light on some dark place and you thank me for it, it shows me that you got the insight I hoped to illuminate; and by taking the time to let me know you appreciate some of what I write… well, that’s like pouring sunshine all over me.
Q: “Too big to fail” also means “too big to prosecute.” American justice… Best justice money can buy! ~ Aaron C.
A: Aaron, can I steal that line from you?
Q: Truth is, many voters (45%) don’t vote and most taxpayers don’t care about “politics” (or anything they can not readily understand and relate to). Believe me, most suburban households are too “busy” to participate or inform themselves anyway. They don’t really want to bother. It’s not a priority. So, who “captured” who? America wasn’t “captured,” it surrendered. ~ H.C.B.
A: Heavy-duty stuff. It’s heavy because you reveal the truth about what’s weighing us down. “We The People” have succumbed, we haven’t surrendered yet. We need a revolution. It worked before.
Q [re: "How Wall Street is Destroying American Exceptionalism"]: The people in the US are exceptional. I agree. There are more murders than anywhere else, there are more people incarcerated than anywhere else, the country is more backward on social issues than any other country, and people think, when it comes to science as if they were living in the 19th century by using inches and pounds and gallons, and so on. If that is the “American Exceptionalism” you mean you are right. The country is heading for darkness. ~ Sailor Jo
A: Yes, Sailor, we have problems. All the more reason to attack them and be part of the solution, as I’m sure you are willing to do wherever you live, as long as you don’t slip yourself into darkness and stop believing in your own exceptionalism.
Q: How about public banking, as an alternative to Wall Street manipulation, modeled after The State Bank of North Dakota? ~ Michael
A: I’m not sure what their business model is; I’ll look into it, thanks. But one thing is for sure. Too many banks are too big to fail, too big to manage, and worst of all, so big that they are the power behind the throne.
Q: You are absolutely correct. This is the very point made in detail by [Joseph] Stiglitz in his book “The Price of Inequality.” Everyone should read his timely book. ~ Bill S.
A: I’ll read it as soon as I’m finished with “The Creature from Jekyll Island” (about the Fed) that another reader suggested I was remiss in not having already read. And, he was right; so, I’m on it. Speaking of which…
A: Unfortunately, everything you lament is directly attributable to a day in 1913: December 23rd, to be exact. It was the day that sound money was killed. The reason the financial sector now makes up between 17% and 20% of GDP is because money can be created out of thin air from debt. Because the Federal Reserve and bankers have the right to print money that is worth nothing and backed by nothing at will, we are now owned by them. And so is Congress along with the president. ~ Phil S.
A: Yes, I’m aware of that date and what happened on Jekyll Island. We all need to be made aware and start our revolution with its goal of free markets, and a free whack at the institutional insanity of central banking.
Q [re: "Just Another Summer on Wall Street"]: And yet voters put up with it, a congress paid for, an SEC that collects pennies in fines, a Justice Department that prosecutes no one. I wonder if bankers even get traffic tickets. Are they immune to those as well? ~ Jay C.
A: No, silly, they don’t drive… they are driven.
Q [re: "Where Would We Be Without the Fed?"]: I would like to know how far out to sell the calls. Just to the next month? It sounds like a great idea, and I’m really needing more income. ~ Allen N.
A: I like selling three-month-out calls and keeping rolling them.
Q: Do you find that you have a couple friends that you can carry on a completely, 100% sarcastic conversation with, and everyone else around you thinks you’ve lost your mind? I think you would fit right in with us. ~ Tas
A: You have to first have a mind to lose one. In my case, it’s more like conversations with myself. And when I’m too sarcastic, my good friends usually just tell me to shut up and have another beer.