February 28, 2013

February 28, 2013

Chairman Bernanke Makes it Clear that Markets Don’t Need to Panic about an End to QE

Last week’s publishing of January’s Federal Reserve meeting minutes left many investors fearing that the Fed would stop their Quantitative Easing (QE) earlier than had been expected.  Many have felt that the Fed would not stop before the middle of 2014, and thus QE would not be carried on as long as necessary to fulfill the Federal Reserve dual mandate: lower unemployment while keeping inflation low.

In its public pronouncements, the Fed stuck to this policy and stated that it might extend QE past June 2014 if its unemployment goals and inflation targets had not been met.  Periodically, Fed members have come out and voiced their positive opinions and longer-term concerns about QE.  Some of these opinions and concerns were mentioned in the January minutes, and the markets got spooked.  These are just the board members’ individual opinions.  The focus of the Federal Reserve board as a whole has not changed.  The Federal Reserve will stick to its goals, and believes that it must continue QE in order to do so.

Chairman Bernanke testified on Tuesday and Wednesday of this week in front of both houses of the U.S. Congress and made it clear that the Fed has not changed its QE policy.  From the beginning of his Chairmanship, Ben Bernanke has tried to be more collegial and open to other opinions than his predecessors.  He has allowed Fed members to have their own press conferences and convey their personal opinions about monetary and fiscal policy.  This has brought comment from most Fed open market committee members.  Some are pro QE, while others oppose it; a third group believes in it if certain economic events are taking place.

In our opinion, the Fed, the central banks of Europe, U.K., Japan, and many other countries, have no choice but to continue QE over the long term.  Why?…

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China: The Economy is Healthy and Will Continue to Grow… Yet Caution Flags are Flying for Chinese Stocks

Although we don’t share the opinion of those who are predicting a 2008-style banking disaster in China’s unofficial banking sector, nor do we believe the economy will collapse, we are feeling less optimistic about China as a destination for equity investment.  In the short term, with property prices rising and credit extensions beginning to rise, the Chinese government may be forced to respond with a policy measures that could be interpreted as bearish for investors — which could act to move stock prices down

What‘s Causing Concern?

We would like to make two points about the feared risk of China’s economic collapse that periodically scares investors from Beijing to Timbuktu…

The Answer to the Question of Where the Money Went

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What’s Next for High-Speed Trading?

On Hard Times, HST Moves into New Markets

Smarting from the relatively slower-moving U.S. equity markets during the downturn, challenged by a playing-field saturated with competition, and looking at the possibility of consolidation, high-speed trading (HST) is looking for new territory.  One of the largest HST firms, Virtu Financial, is one of several firms who want to bring algorithmic trading into the world of bonds, currencies, and derivatives.

The main downside of HST presented in the press is the risk it creates of unpredictable “flash crashes,” such as happened in May 2010, when feedback loops of errant electronic trading algorithms drove the Dow down a thousand points in minutes.  Another example occurred last August when a glitch at Knight Capital handed it an ultimate $460 million loss.  We have written several times about the dangers of HST and HFT (high frequency trading).

Such instability is hardly desirable in an already-fragile world financial system still in recovery from the Great Recession.  High-speed traders, however, can argue that these events have been rare — HST has been around in one form or another for a generation,  and in its current hyper-fast form for a decade.  Further, they can argue that exchanges have put measures in place to detect such aberrations and shut trading down if they occur.  The prospect of HST expanding into a whole array of new asset classes does raise concerns about instability in a deeply interlocked global financial system.  But concerns about stability are not at the heart of the matter.

The heart of the matter is simply that HST gives insiders an enormously powerful set of tools with which to game the market; create and arbitrage price discrepancies; and drive out and demoralize retail, value-driven investors.

The world’s equity markets are the means by which capital is efficiently allocated.  The crucial failing of HST is that whatever liquidity it does create in the market (and analysts say that outside the handful of most-active U.S. stocks, it’s not much), it creates opportunities primarily for manipulation, undermining the purpose that financial markets are meant to serve, and harming those investors genuinely focused on long-term value.

Having spent a decade building an enormous and expensive technical infrastructure, HST firms are being faced with diminishing returns — some say as a result of slower markets after the downturn, some say as a result of much increased competition.  In any event they are eager to deploy their technics in new fields.  HST firm Getco recently opened its books and revealed that its profits peaked in 2008 — which makes sense, as HST thrives in conditions of extreme instability.  Other high-profile firms have shut down entirely, and an industry shakeout seems to be in progress.

This means that new asset classes are on the radar — bonds, foreign exchange, and derivatives.  HST’s share of global foreign exchange trading has reached 40 percent, up from 25 percent three years ago.  We find that prospect alarming, and we are not optimistic about the capacity of regulators to understand the changes afoot or to react to them with speed and intelligence.

In the face of regulatory impotence, some private actors are taking action themselves.  U.K. brokerage firm ICAP, one of the world’s largest brokers doing transactions for institutions, tweaked its currency trading to reduce HST firms’ opportunities for arbitrage.  Their CEO said bluntly in the Financial Times: “People with speed as their sole strategy for trading do not add value to the overall market of our clients.”…

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Providers Say the Affordable Care Act Will Drive Rates Up

Other Unintended Consequences Prepare to Rear Their Heads

If there is a cardinal rule of economics, it’s that people respond to incentives.  The legislative environment shapes what those incentives are, and therefore shapes how people will respond to them.  Frequently the most well-intentioned legislation turns out to do more than its architects imagined — often on the downside.  In the end, human behavior will reveal the incentive-structure of a law much more clearly than the legislative debate and discussion that accompanied its passing.

The Patient Protection and Affordable Care Act (PPACA, known as “ObamaCare”, is an example of a well-intended, large-scale reform — reform of a sector that’s considered needed and long overdue by those on both sides of the aisle.  It also has some unintended consequences that are beginning to show themselves as its 2014 implementations get closer.

The main legal challenges to ObamaCare focused on the individual mandate — the requirement to buy insurance or face a fine.  Industry data now suggest, however, that rates may be set to rise so precipitously that many consumers (especially young and healthy ones) may willingly forego coverage and face those fines rather than pay skyrocketing premiums.

Survey of Providers Shows Significant Rate Hikes in the Works

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Source: Investors’ Business Daily

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In this week’s Premium Global Market Commentary available to Gold Subscribers, we:

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  • Discuss Europe’s Response to Italy’s Elections

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