When The 'Market Isn't The Market', Actions & Consequences

When The 'Market Isn't The Market'!

Listen to this commentary

 Or, 'Can It Be Sunny on a Heavily Overcast Day'?

 Can It Be Sunny on a Heavily Overcast Day'? Of course it can, but in the same physical place, extremely unlikely. How much time would you spend listening to someone who met you on the street and who, on a day when you both had umbrellas keeping the rain off, thick cloud cover, thunder and lightening in the background, says to you with great enthusiasm - man, what a great sunny day it is?

 Yet I hear and read things that I think may be analogous to that in the face of today's equity markets. For example, over the past few days, I have read, as I am sure you have, multiple articles that comment directly or indirectly on the extreme volatility that has been ongoing in the world's equity markets since the beginning of August to mixed reviews. Some of those articles include:

• The madness of Wall Street- August 19 - reading time 4 minutes;

• The Wild & Crazy Market's Silver Lining - August 18 - reading time 3 minutes;  

• Advisers Urge Investor to Take a Deep Breath - August 12 - reading time 3 minutes;  

• Why You Should Be Calmer Than Mr. Market- August 12 - reading time 4 minutes; and, 

• Are you ready for this (and perhaps you are): William Greiner: Stock Market Rally Has Just Begun - August 12 - reading time 1 minute.  

If you wonder about the dating of these articles, I purposefully chose articles for this commentary that were published at the end of the first and second trading weeks after the U.S. Federal Government agreed to increase the U.S. Debt Ceiling, and S&P announced it was downgrading the U.S. Credit Rating.

If you are going to read only one of these five articles, I suggest it be the first one. In fact, if you haven't focused in a serious way on the equity markets currently being far more 'trading markets' than they are 'investment markets', and don't know the statistics that support that thesis, I suggest 'The madness of Wall Street' is an absolute MUST READ if you are an investor in the equity markets - and that the article may prove quite valuable to you if you are a 'day trader'.

If you are going to read only two of these five articles, I suggest the second one you read ought to be the fourth in the list, 'Why You Should Be Calmer Than Mr. Market'. I think this article makes a number of good points, although I do think it has what I call the 'typically money manager bias toward stating that the equities markets are the place to be'.

With respect to the other three articles, the second focuses on the possibility that it will prove advantageous in the longer term to own 'high quality dividend paying stocks', which the author currently believes to be underpriced.   The third article of the five holds to the view that "There is nothing like a good crisis to make you re-evaluate your investment plan", and says (I think very sensibly) that: "The trick (to reading and hearing news that is said to affect the equity markets) is separating out day-to-day and hour-to-hour headlines form the underlying factors driving those headlines". I say "bingo", but one obviously has to be able to do a credibly job of that 'separation' to make sense of what is going on.

As for the fifth article, you might consider reading it and reaching your own conclusions as to its content.

Reverting, 'The madness of Wall Street' caused me to do some serious thinking, and to consider the possibility of something that had not previously occurred to me. The article reports:

• that some finance professionals are concerned that the current extreme market volatility, combined with what happened in the equity markets in the fall of 2008, "could reshape investor behaviour for months and years to come" - in circumstances where "this turmoil may not be some temporary anomaly";

• on what is broadly called 'a liquidity black hole', a term used to describe a 'trading phenomenon' where there is so much 'computer algorithm based' large-cap selling activity that "stocks plunge precipitously". The article (I think both interesting, and persuasively) says "Such selling with no regard to corporate fundamentals makes the notion of stock picking seem quaint". I don't why the authors used the word 'quaint', a word that comes from the Old French, and means (1) attractively unusual, in an old-fashioned style, and (2) odd, peculiar, or inappropriate. By either definition, I applaud the authors for their choice of word, as I think either interpretation of 'quaint' may prove to be increasingly appropriate to apply to the equity markets going forward;

• that in the 'frenetic' week ended August 8, 'high frequency' trading firms and strategies accounted for 65% of the daily U.S. trading volume;

• 'some' fear that retail investors with a long-term time horizon will be driven further from stocks as "this new hair-trigger trading dynamic becomes more common". I presume 'some' in this context means investment bankers, analysts, investment advisors, personal financial planners, and others with a strong vested personal financial interest in the viability of the equity markets as perceived by retail investors, and for that matter 'day-traders';

• by implication, that conventional 'day-traders' will have an increasingly difficult time successfully 'trading' in a trading market dominated by programmed computer trading;

• that if investors indeed are 'driven from the market' by computer trading-induced volatility, that may make it more difficult for small, interesting, niche companies to raise capital; and,

• that aside from providing a number of interesting statistics, quotes one investment manager as saying "People distrust Wall Street at one of the highest rates I can remember.

And what did I consider for the first time as I read this article? Two things, but the second is the one I find intriguing:

• as perhaps never before, both investors and conventional day-traders need to understand who is 'trading the equity markets', how it is being done, and the risks inherent in such markets; and,

• query: Is it possible that computer trading by the Investment Banks, Hedge Funds and others will result in the investment business ending up in internal strife and conflict where (1) computer trading increasingly dominates, (2) conventional investors and day-traders 'give up on the market in increasing numbers', and (3) the 'abundant fees' that have been generated over the past 25 years by those in the 'money management business' are significantly reduced?

The more I think of it, the more I think that last question is a very interesting one, and may be at the heart of why the first article said: "some fear that retail investors with a long-term time horizon will be driven further from stocks as "this new hair-trigger trading dynamic becomes more common".

Something to consider discussing with your investment advisor!

Actions & Consequences!

Listen to this commentary

An August 19 article, reporting on U.S. Vice-President Biden's visit to China, says that in a speech given in China on August 18, 'Biden assures China on its U.S. investments' - reading time 3 minutes. In the article, Vice-President Biden is quoted as saying: "U.S. Treasurys we're going to take care of very closely, not merely because China owns 8% of them, but because the Americans own 85% of them", and "And very sincerely, I want to make clear that you (the Chinese) have nothing to worry about". In response, Chinese Premier Wen Jiabao is quoted as saying (according to an English transcript of his remarks) "You've sent a very clear message to the Chinese public, that the United States will keep its word and its obligations with regard to its government debt"..."It will preserve the safety, liquidity and value of U.S. Treasury's. I'm sure that will give a boost to the investors' confidence in the U.S. economy".

My belief is that Premier Jiabao and his advisors are highly intelligent, 'street smart' and commercially adept. As I read these quotes, what Premier Jiaboa said, converted to 'commercial terms', is: 'You have now made a public promise, and we (the Chinese people) now have every entitlement to hold you to that promise'.

Vice-President Biden is a lawyer who qualified as an attorney in 1969, became a county councilor in 1970, and was elected to the U.S. Senate in 1972 at the age of 30. A career politician, I am sure Biden is well intentioned. Hopefully, he and those advising him have the 'street-smarts and business-smarts' of the Chinese leadership. That said, it strikes me that Vice-President Biden's remarks made in China last Thursday with respect to U.S. Treasuries might come back to bite America where it doesn't want to be bitten, and in a way or ways yet to be determined.

About Ian R. Campbell
Ian R. Campbell, FCA, FCBV, is a recognized Canadian business valuation authority who shares his perspective about the economy, mining and the oil & gas industry on each trading day. Ian is also the founder of Stock Research Portal, which provides stock market data, analysis and research on over 1,600 Mining, Oil and Gas Companies listed on the Toronto and Venture Exchanges. Ian can be contacted at icampbell@srddi.com