12/23/10…liquidity fading away

yesterday was the fourth lowest NYSE volume of the year and third consecutive lower volume…can we beat that today? If it is below 700M we will have the second lowest of the year. By the way the 12 month low was set on 12/18/09 at a meager 319M shares (and also incredibly a quad witching!). If you want to match that number you have to go back to the last century. A possible explanation is the increased use of derivatives due to the lack of a ‘buy and hold’ mentality…we have no patience for anything do we?

Look at the volume on the NYSE since 12/9, the last day with 1 billion shares trading before a string of weak days,

12/10 975M

12/13 963M

12/14 953M

12/15 1.11B

12/16 990M

12/17 2.02B – Quadruple witching! Highest volume since 6/25/10

12/20 829M

12/21 811M

12/22 784M – 4th lowest of 2010, 11/26’s 428M was THE low of year

A friend brought to TB’s attention that the reason for last Friday’s volume spike was options expiry (third Friday of the last month of the quarter and the last of 2010). This ‘quadruple witching’ (stock index futures, stock index options, stock options, and single stock futures), requires rolling over of expiring options/futures and thus the spike in volume. Since then, as TB pointed out we have gone sideways with a very slight bias to the upside (two consecutive higher highs on the Dow but almost imperceptibly which can perhaps best be explained by a lack of sellers as opposed to a preponderance of buyers.

That our markets should be so dominated by derivatives is just another sign of how we have created the world’s biggest casino with no basis in future performance…isn’t that supposed to be what price-earnings ratios measure? But why so much emphasis on derivatives? Because there is money to be made in them, that’s why? If they were not profitable for Wall Street they would be meaningless.

Similarly, the very derivatives that created the financial crisis…mere speculative plays that did not work out for the vast majority and which pitted ruthless (?) dealers (dare we say Goldamn? – sic) against true investors…for what? Profit! But the majority of them blew up or seriously impaired their own capital…or worse as was the case with Lehman and Bear Stearns…because they didn’t understand the dynamics of what THEY were selling! Nor apparently, did they understand liquidity when everyone is on the same side of the trade!

TB has become a big believer in ETF’s, and in fact was one of the early ones being attracted by the ability of iShares and a few others to not only offer a low cost diversification product that is liquid but to even produce profits that reduce the impact (tracking error) of the fees. Contrast this to mutual funds with their high fees and tax inefficiency (capital gains on phantom gain often even when the value of the assets is declining). Furthermore, the better a fund performs the least likely it is to be able to repeat that performance as large volumes of new money flow in, while the worst performing funds tend to revert to the mean. Like with derivatives, the biggest benefactors are the fund managers (generalization), not the investors.

CAUTION: there are now however ETF’s that have little or no – even a negative relationship to the index…such as the volatility one as well as those that are based on unproven indices. Those often have the highest fees and like all investments if you don’t understand them – don’t buy them. TB


For another parallel, that is the same way the outsized gains for the CEO (sadly and frequently also the Chairman of the Board leaving no one to represent the shareholders…certainly not the other board members who are cronies of management and a virtual rubber stamp to he/she who is setting the agenda for meetings and of course the almighty compensation.

As our timeframe for performance grows shorter and shorter…to match the incentives offered to management not the longer term goals of investors (are there any that are still out there?), the risks increase proportionately…or is it exponentially?

Some of you would say that Apple, Google and a few others are safe investments, destined to outperform the market forever. But ask Bill Miller who runs the Legg Mason Value Trust and holds the record for consecutively outperforming the S&P 500. His concentration in financials stocks as well as holding Google, Yahoo and a few other high fliers, which due to rapid run-ups flatlined while his holdings of bank stocks which were to be his ‘anchor to windward’ plummeted, sank nearly into oblivion.

True, Apple holds a unique franchise and due to the (belated) wisdom of its founder, Steve Jobs, has developed a marketing strategy that is masterful: planned obsolescence by the quarter! But is this any different than the innovations of AOL, EBay, and others? Going back to the 60’s and 70’s (1900’s not 1800’s which were similar with railroad stocks), we had conglomerates where the whole was supposed to be greater than the sum of its parts, but sadly was less than it.

No marketing strategy works forever…didn’t we just see that with the flawed derivatives and while replication is the highest form of compliment it is also the source of reversion to the mean.

Does anyone remember Levitz Furniture which introduced warehouse style marketing of household furniture? International Industries (not the same one that exists today) which, the CFO told a group of students in the 1970’s was growing at 30% per year. When asked how long they could do that he said “indefinitely”, to snickers by those who were paying attention as they would eventually surpass the GDP of the entire U.S. What was their product? Pancakes! IHOP! Do you get the picture? These companies don’t exist for the shareholders they exist for those who run them…if this sounds cynical it does not apply to the majority of well-managed industrial companies that actually manufacture something of lasting value rather than consumption.

Weren’t Visa and Mastercard supposed to be the safest plays since they make money on every transaction with NO credit risk? Yes…until two actions by the Feds in very short order shattered their returns wiping out more than 15 months of them on both occasions.

Lastly come the ‘intellectual properties’ the dotcom’s which already managed to go bust and implode at an even faster rate than they advanced…except for the day of the IPO of course! If it is not a physical product that requires plant and equipment to manufacture it can be quickly replicated in today’s world…and perhaps better. Ask Time Warner about this who arguably made the most ill-timed purchase ever of high-flying AOL. What could go wrong? Everything TB just described!

TB hopes you will ponder the above commentary, it might save you money. But then again…timing is everything! But as Vince Lombardi said, “winning isn’t everything…it’s the only thing.” …and we must now have a record number of those out there trying to achieve that goal…at whatever cost to the rest of us is necessary…enjoy!

. . . - - - . . .    . . . - - - . . . (S.O.S.)

Daily, TB hears from friends lamenting his choice to live in snowy Minnesota…which to refresh is not just a lifestyle decision but to be near his children and grandson who is nearly five and growing rapidly.

But then TB gets a chuckle as he watches California being deluged as seen last night as the San Diego Chargers (like the Minnesota Vikings last week). Meanwhile it is exhilarating going out in the snow…especially for the holidays…and it is a nice 20 degrees here, which feels warmer than a cold rainy day in the Bay Area.

Wishing all of you a very happy holiday and health in the new year!

TB

Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries...as he sees it...and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Copyright TBD Capital LLC, December 23, 2010.

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