Wednesday, August 4, 2010

Market Dislocations Hit All Time Highs

No charts or videos tonight folks.  Just some thoughts.

The market we are currently witnessing really is a once in a lifetime event.  I am convinced that everyone is confused at this point.  The bulls are as insecure as the bears.

One moment we get bullish data then the next moment something comes out that makes you think the economy is collapsing such as a bad jobs report.

The retail investor is absolutely petrified at this point.  The money flows continue to fly out of stock funds and into bonds.  The 10 year remains under 3% as a result.  This tells you all you need to know if you are wondering where the big money is headed.

Many are now asking this question:  Why is the market rising at the same time treasuries are?  Great question.

I have talked to a few market makers about this over over the course of the last few days.  One of them blames the propped up equity values on the HFT's(high frequency traders).  He believes they are essentially creating false liquidity by creating massive trading orders of which only a fraction are filled. 

This essentially allows them to game the market as investors run to the sidelines.

It becomes much easier for the HFT's to game the markets(especially when the SEC is essentially asleep at the wheel) when the market volume is so pathetically weak like it has been recently.  I have read recently that the HFT's may be supplying up to 80% of daily volume seen in the markets.

This would make sense given the fact that the market hasn't dropped as money flows so powerfully into treasuries.

You can blame the SEC for this mess.  The quants are so far ahead of these guys it's not even funny.

Think about it:  How in the heck can stocks be rising with such strong money flows into bonds?  This NEVER happens.  Take a look back at history.  One market's weakness is another ones gains.

There has never been a time in history where EVERYTHING went up at the same time like this.  It is absolutely ridiculous and it should not be trusted.

Another market maker friend of mine gave me his explanation of what he thought is also going on in addition to the HFT debacle.  He suggests that market liquidity has become hugely dependent on ETF's.

He believes that speculators have taken over the markets using these new investment vehicles.  Real investors have stopped owning individual stocks for the most part in his opinion and have decided to head for the hills for the most part.. 

This is a scary thought if it is true because it means the market is filled with nothing but speculators that go massively long and short investments vehicles like the SPY.

If the specs are not indulging on options you have to assume that they are buying leveraged ETF's that go long or short various sectors in the market. 

This risky behaviour has basically turned the market into a casino that has scared away the average individual investor.

I'll be honest:  It has scared me the heck away for the most part.  I want nothing to do with this market long or short because the whole thing is a SHAM. 

I see no confidence in the markets.  Investors are panicked when you look at whre bond yields are. 

It's becoming obvious that no one knows what anything is worth anymore because the laws and regulations have essentially allowed Wall St to avoid marking anything to market.

The reason there has been ZERO price discovery is because the losses are so catastrophic.  Since these losses do not have to be recognized, the market acts as if nothing is wrong with any of the assets that are related to the credit collapse.

This gives investors a flase sense of security which is a recipe for disaster!

Denial is a Powerful Emotion

The market is as unstable as I have ever seen it in my entire life.  We have securities like MBS that are trading at 100 cents on the dollar when they are essentially worth pennies on the dollar without the Fed guarantee. 

The same goes for many other credit assets:  Commercial real estate bonds/mortgages, high yield bonds, level 3 assets etc.  Everything is ridiculously overvalued and no one holding these assets has been forced to take the majority of the losses. 

The same thing goes for housing:

Families stuck in overvalued McMansions are unable to take the losses because they are underwater on their mortgage and they cannot afford to short sell the house.

This has TOTALLY distorted housing values.  I wouldn't touch a house with a 10 foot pole at this point because the real value of these assets has not been established.  

The sellers are stuck and they have no way of getting out.  This will not end well, and the real bottom in housing will not occur until the housing market is cleared.  We are far from seeing this given the fact that most markets have about 11 months of inventory plus god knows how much shadow inventory.


Let me repeat myself and explain why buying a house now at record low interest rates is the WORST time to buy a house:

There is no way for the house to appreciate in value because rates will be going against you over the term of the loan because rates will eventually start rising.

Rates might fall from here shorter term due to deflation,  but our deficits are going to eventually push rates up over the longer term.

The only way a house appreciates(other than bubble speculation) is when interest rates drop which allows buyers to borrow more. This former rising tide now goes against you as lending rates rise after dropping to about as low as they will ever get.

You need to start looking at buying a house like you do when you buy a car and realize that as soon as you buy it you are pretty much guaranteed to lose money on it as soon as you sign the papers.

Ignore the idiot Realtors who tell you rates are at record lows so now is the time to buy! It's actually the worst time to buy!

The Bottom Line

One thing is very clear here folks:  The bond market would not be trading like this if the markets were stable! 

Bill Gross just increased his treasury holdings in PTTRX from 30% to 50%.  You don't do this unless you fear deflation or some other market event.  Many other large players have been making similar trades.

The market is preparing for deflation and this isn't going to be pretty when it happens.

The recent holding pattern seen in the markets is a result of the HFT's combined with false hope that is  based on the misrepresentation of the value of credit assets.  As I have said before this is unsustainable because the losses must eventually  be taken. 

The Fed has been trying to reflate the credit bubble for 3 years now and it has done nothing to help the situation.  The economy continues to rapidly deteriorate as our deficits begin to overwhelm our revenues which leads to more job cuts and foreclosures.

If you trade long or short this market please put tight stops on your trades and stay nimble. 

Disclosure:  No new positions at the time of publication.


Anonymous said...

"You can blame the SEC for this mess. They quants are so far ahead of these guys it's not even funny."

Funny you should mention that the same day I see this story:

1 million square feet and 800 new SEC employees - wow! Hopefully that will lead to more inforcement and more transparency for us regular folk who dont want to get creamed by the HFT guys out there.

Of course, your antagonistic anon will point out this is yet another reason why DC housing prices will not fall :) Keep up the good fight!

getyourselfconnected said...

More and more money keeps leaving stocks (for good?) on the retail side and like all true geniuses they flock to the "safety" of bonds which allow bod prices to rally while the Algo games push up equity prices as well. I wish i had more to offer than to say "its all a serious mess" but what could I add to your thoughts or mine?

Good stuff as always!

Jeff said...



Missed that. That's great. The more the merrier.

Hopefully the guys are smart enough to keep up with Wall St.

I have a former Wall St vet friend that tells me that part of the problem is the Wall St boys run circles around the SEC's 100k a year average Joes.

They are out of their league when it comes to matching up with the big boys. We need some people in there that have the brains to match up.

As for the heckler it's part of the territory:)

Thanks for the support

Jeff said...


Thanks bud.

Yeah not much else to say. It's all so obvious.

One of my friends that works on the trading floor tells me about how bad it is.

He said the SEC is a total joke. HFT's are going hog wild. Total fraud etc.

It's always nice to here it from someone in trenches versus reading about it on the net.

Herb said...

If you believe a hyper/high inflationary period is coming, buying a house right now would not be a bad move.

Jeff said...


I hear that arguement all the time but I don't buy it.

You need wages in order for that to work.

If the dollar crashes and wages continue to spiral downward then housing will continue to decline because no one will be able to qualify for the Hyperinflated prices.

If we do see hyperinflation it will be followed by massive deflation as everything collapses.

Weimar Germany was brief and then turned into a deflationary spiral as people could not afford to live at inflated prices.

Let's hope history doesn't repeat itself.