Another week of striking volatility closed on a high note today. The Dow was up 102 points after relatively benign news came out about European banks following their “stress test.” Only seven of 91 tested banks were said to have “failed”. Some cynics suggest that not much stress was applied. Details of the testing procedure are coming out gradually, and there will undoubtedly be a great deal of commentary and speculation in the weeks ahead. It does seem curious that the banks holding the majority of the bonds of countries seen to be in danger of default are given a clean bill of health. I’m sure that decision will be widely discussed and analyzed.
Back to volatility. The five days of this week saw the Dow Jones Industrial Average make seven rallies or declines of more than 100 points. Obviously this is not investors changing their opinions from hour to hour. Well more than half the market’s daily volume now comes from computerized trading, much of it of the “high frequency” variety that depends on physical proximity to the trading posts. Physical proximity shaves nanoseconds off order transmission time and provides a slight, but measurable advantage. An IBM executive recently explained that it takes about half a second to click a mouse. The new exchanges are being designed to execute a million trades in the amount of time it will take to click a mouse. That’s not investing, folks. I suspect that inadequately controlled high frequency trading was largely responsible for the 700 Dow point drop-then-recovery within about 30 minutes on May 6. These operations, which have no long-term orientation, can severely exacerbate normal market fluctuations.
Another major force in today’s markets is the big investment bank trading for its own account. Some of the biggest banks can move markets on their own for a while. They know what they want to promote for their own profitability, and they are capable of influencing markets to a measurable degree. The Volcker rule is designed to eliminate banks’ trading for their own accounts. Eventually authorities are going to have to do something about high frequency trading as well.
I am certainly not an advocate of unnecessary regulation. On the other hand, Wall Street has proved over the decades that its primary focus is profit – its own. Customers come a distant second. Wall Street firms will argue long and hard about how their great new systems provide tremendous liquidity. Don’t believe it. Where was the liquidity on May 6? These are tools solely for Wall Street profit. Their functions need to be better understood and controlled before they do serious harm.
Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.