Crosscurrents October 20/05
October 20/05
by Alan M. Newman
Emotional Intensity
Our principal measurement of emotion has turned positive, unconfirmed by the shorter 10-day and 15-day versions, neither of which achieved positions that would indicate excessive pessimism. In fact, Tuesday’s bottom was clearly less emphatic than any “bottom” dating back to early 2000. It’s probably best to assume a bounce here, rather than a “Buy” signal.
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Opaque Transparency
Hidden in the business section of the NY Post on October 1st was a brief Bloomberg article headlined, "SEC HIDES MOST SECRETS IN GOV'T." Predictably and to our shame, very few observers seem to have noticed and the thrust of the article continues to be ignored. According to a recent report, the Securities and Exchange Commission has rebuffed requests for information from internal records under the Freedom of Information Act more often than almost every government agency, including the CIA and Pentagon. Only 34% of the 3830 petitions processed last year were granted.
The report by the Coalition of Journalists for Open Government claimed that nearly one in five of the SEC's denials that were appealed were overturned and that its year-end backlog of 8635 requests was bigger than all but four agencies surveyed. Most interestingly, the overview of Edward Fleischman, 73, a former SEC commissioner, was that "The SEC has never applied the same standards to itself that it applies to the companies it regulates."
For what it's worth department: our own search for the truth, commencing with our series of articles on the huge problems of "naked" shorting that effectively counterfeits stock in the U.S. market, took a logical turn on August 31st, when we filed an Freedom Of Information Act request with the SEC. The request was for the total number of shares in failed deliveries of Overstock.com on August 1, 2005. We specified Overstock, since we had already identified the company as a "target" for destruction by short sellers. We also specified a single date of August 1st, both to ease the task for the SEC and to ensure "stale" data that could not possibly have any consequence on current trading.
Our answer from the SEC was drafted on September 27th, denying our request and citing Exemption 4 of SEC regulations as reasons, stating that the release of the data ".... could cause substantial competitive harm to the submitter." How that could possibly be the case with stale data is beyond our comprehension but the SEC simply does not care, nor do any of the other agencies or departments such as the DTCC, the NSCC, the NYSE nor Nasdaq. The stock market is not run for the benefit of the public. It is now run to spite the public. Yes, we can still invest or trade and make money but the arena is not your father's stock market anymore. Supposedly, transparency is the linchpin of a fair securities market. Unfortunately, opaqueness is the order of the day. We have appealed the SEC's decision to deny access to the data. We will keep you informed.
How long have we been harping on the problems of failed deliveries of securities in the U.S. markets? Close to a year. We have repeated all too often with near zero outside recognition of the circumstances, that the biggest story of the year was waiting in the wings. We have no way of knowing for sure, but Refco could be the tip of the iceberg. Refco's (RFX) initial public offering took place less than two months ago and the company may now be insolvent (see http://www.nypost.com/business/ 55422.htm). Looking for a catalyst for a huge market decline based on a derivative event? Can there be a greater confidence breaker than a huge IPO that busts in less than two months? RFX raised $670 million but those shares are now worth only $240 million and the market cap, recently as high as $3.8 billion, is now a mere billion. CEO Richard Bennett is blamed for hiding over $500 million in bad debts that one of his companies owed to Refco while Refco was paying Mr. Bennett $3.27 million to run RFX. Chalk up yet another episode of investors be damned. Trading in the shares have been halted while the mess is sorted out. Sadly, the U.S. markets are possibly less trustable and dependable now than they have ever been.
Although Refco is best known for providing execution and clearing services for exchange-traded derivatives and brokerage services in the fixed income and foreign exchange markets, they also deal in stocks. Please direct your attention to http://tinyurl.com/93qj5, where you will read about the involvement of Refco with naked short selling of Sedona Corp., a Pennsylvania software that was shorted out of existence a few years ago. Where the problems begin and end is not for us to tell you - we can only point out that they are occurring and that they are significant. Still not sure? Witness Dr. Patrick Byrne's revelation last week that his purchase of 25,000 shares of Overstock shares was not settled/delivered for more than 50 days from of all folks, Morgan Stanley. Dr. Byrne is the CEO of OSTK. How can anyone believe anymore that transparency exists in the U.S. market? Opacity? For sure.
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Crosscurrents has been on the warpath versus Program
Trading for a long, long time, actually since our newsletter was first
published in May 1990. Over the past year and change, we have probably
featured charts showing how programs were overtaking all other types of
traditional investment at least a dozen times. Unfortunately, the
trend towards automated trading continues to build momentum.
For the week ended September 16th, trading
totaled 9.33 billion shares on the New York Stock Exchange. Programs
accounted for 6.61 billion, or 70.9% of the total, the third largest percentage
of program trading ever recorded. And if that was not enough, it
was reported that brokerage firms executed an additional 4.2 billion shares
of program trading away from the NYSE. Are we the only observers
who are uncomfortable with the rapid expansion of this kind of trading?
By definition, program trading involves the "simultaneous purchase or sale of at least 15 different stocks with a total value of $1 million or more." It is clear that the execution of a trade for a single stock at any point in time - whatever the size of the trade - may be reasonably expected to reflect company fundamentals and an educated estimate of fair valuations. But the simultaneous purchase or sale of at least 15 different stocks cannot function under the same assumptions!
Our colleague, Jim Bianco (www.biancoresearch.com), has repeatedly linked the growth of program trading with the growth of Exchange Traded Funds (ETFs). Both are growing at phenomenal rates. NYSE program volume has expanded at a 32% rate over the last five years. ETF assets have expanded at a 29% rate over the last five years. Our featured chart amply illustrates the inclined path each takes.
But finally, recognition is appearing that the status quo may not be beneficial. Barron's Jack Willoughby recently quoted Bianco, "The majority of trading is no longer investors buying a stock based on a company's fundamentals, it's program traders buying groups of stocks and making macro plays."
From very modest beginnings in 1993, ETFs are now a huge business and have attracted more than one-quarter of a trillion dollars in assets. Although this represents less than 2% of total market capitalization, bear in mind ETFs have not been around all that long. Growth did not begin to accelerate rapidly until 2000, when assets rocketed from $36 billion the prior year to $71 billion. By contrast, mutual fund capitalization was as low as 6.4% less than 14 years ago, but has now grown to 22.5% of the whole stock asset pie.
Of course, much of the growth in mutual funds has come from indexing, yet another methodology in which fundamentals are not considered and a strategy that also drives a large part of programs. Although the S&P 500 Index is actively "managed" by a selection committee, the criteria used are faulted, inefficient and arbitrary, such as a move last year to remove all remaining foreign issues from the index. See Jon D. Markman's excellent piece at http://moneycentral.msn.com/content/P25387.asp for a perfect explanation of why the selection process fails.
Thus, we find ourselves ensconced in an environment where the majority of trading and investment have nothing at all to do with individual company prospects, just sophisticated trading strategies that hopefully, will take advantage of extremely small discrepancies in perceived pricing anomalies. If this is the path to riches, the road must indeed be paved with pitfalls.
We repeat for the umpteenth time, if the majority of transactions now effected on our major exchanges no longer reflect the fundamentals or prospects of publicly traded corporations, there cannot be a reasonable expectation that stocks are reasonably valued. Thus, we can only assume that stocks are not fairly priced. If this is the case, our $15 trillion market is as risky as it has ever been.
PLEASE NOTE: OUR BREAKING COVERAGE OF A POTENTIAL SHORT
SQUEEZE OF NOVASTAR FINANCIAL STOCK HAS FORCED US TO TEMPORARILY DISCONTINUE
FREE TRIALS. IF YOU REQUEST A FREE TRIAL,
YOU WILL BE GIVEN SEVERAL ALTERNATIVES. THE FREE TRIAL PROGRAM
SHOULD BE REINSTATED WHEN THE ARTICLE SERIES IS COMPLETED, PROBABLY IN
FEBRUARY 2005.
ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published 22 times per year and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.
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