Frontrunning Undermines Confidence

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For the past few years, long-term market professionals have been puzzled by the failure of volume to return to the U.S. stock market.  The mystery is especially noteworthy because the current cyclical bull market in stocks has now extended beyond the four-year mark.  Historically, the normal pattern calls for greater investor participation the longer a bullish trend remains in place.  Because old-timers have observed the “volume confirms price” lesson for decades, many of the most experienced professionals have looked skeptically at this rally in which prices have moved persistently higher without volume confirmation.

Numerous explanations have been offered, not least among them the unprecedented intervention of the Federal Reserve in this country and other major central banks elsewhere around the world.  Fearing the artificiality of market rallies in an era of monumental money printing is certainly understandable.  Market action this week may further explain lack of participation by large numbers of investors.

On Monday morning, many millions of dollars of exchange traded funds were traded 15 milliseconds before the scheduled 10AM release of the potentially important ISM manufacturing report.  We later learned that Reuters “inadvertently” released the report a fraction of a second early to certain high frequency trading clients, who obviously were prepared to act on it.  On Friday morning we saw a similar situation play out in a different venue.  Just 62 milliseconds prior to the scheduled release of the widely watched non-farm payroll report, gold prices plummeted, preceding an even more significant sell-off as the day wore on.  No explanation has been confirmed.

With memories of 2010’s “flash crash” still vivid in investors’ minds, apparent market disruptions at the hands of high frequency traders have to drain confidence from investors who suffered through massive market declines from 2000-03 and 2007-09.  That confidence is further undermined by the clear appearance of favoritism when select investors receive data before others and frontrun other traders and investors.

There are a great many reasons why individual investors have retreated from stocks.  Until, however, regulators see fit to level the playing field for all investors, a large segment of those investors are likely to remain permanently absent.