Persuasion Time

Well, what I can say?  These are strange times we live in.

The market falls 7.6% in one week (at one point over 9% in one day), and the best the heads of the stock exchanges can say is “we are working on finding a cause for this.”  Last Monday, the market’s actions felt technical – a concerted move by hedge funds and other active traders reacting to a spike in volatility due to concerns in Europe.  I say “technical” because the market went down early in the day and basically stayed at that level to the close.

Thursday’s action was something else entirely.  What exactly, the authorities are still working to discover.  It seems unlikely it was a “fat finger” – someone pushing the “sell a billion” button instead of “sell a million.” The real culprit appears to be the automatic trading systems active traders now use.  High Frequency Traders (HFT) are also being looked at closely to determine what role, if any, this portion of the trading community may have had.

What is HFT?  At the most basic level, it is very short-term trading (measured in milliseconds) driven by sophisticated computer programs which can measure and trade on the slightest inefficiencies in the market.  A few years ago, HFT represented about less than a quarter of the daily trading volume; now that figure is as high as 75%, according to some estimates.  Despite this high volume, HFT traders only represent 2% of the number of traders out there.  HFT proponents argue that their activities make the market more efficient and lower the cost of trading (by narrowing bid/ask spreads).  Critics suggest that they have some kind of “unfair” advantage over other traders.  If last Thursday’s market action was either caused by or exacerbated by HFT, perhaps more scrutiny of this kind of trading may be warranted.

But, all of this is a distraction from what I think is really important now.  Before I comment on the important stuff, let me touch on three important groups of people germane to the discussion of the day:

1)      Journalists.  These folks love to tell stories.  When the market moves up or down, they are supposed to figure out the reasons and the cause and come up with a coherent story which explains the move.  One of my responsibilities at my first job on Wall Street was to write daily market commentary for my colleagues in Tokyo.  Every day I would search the news wires trying to put together the story of the day.  Sometimes “narrowly mixed in light trading” was the best I could do.  Journalists today have tremendous resources available to put together the story of the day, and yet some days, there just may not be a really good reason for why the market does what it does.  However, they still want and need to create and report the story.  My point: the “story” given in the media for any given day’s trading action may not be the whole picture.

2)      Traders. These folks love to make money in the short run.  They measure market trends and will buy and sell in order to capitalize on these trends.  They work for hedge funds, mutual funds, broker-dealers or for themselves.  They use complex computer programs or their “gut feelings.”  The best ones can make money regardless of the direction of the market.  My point: trading is a fine way to make money in the market, but it’s not what I do.  Traders’ opinions about the market are likely to be colored by their time horizon, which can be very short.

3)      Investors. These folks love to make money in the long run.  They measure value and try to buy cheap and sell dear.  Although there are many types of investors, they all share a number of characteristics – they hold investments for a longer time than traders, they usually stay fully invested (as opposed to holding mostly cash), they understand the markets, but may be focused on other things – individual stocks, sectors or countries, and they may care much less about the daily ebb and flow in the markets as do the previous groups. My point: I tend to value the opinions of investors, those folks do what I do and think as I do, over the opinions of other groups.  Part of the challenge of investing these days is sorting through the massive amount of information out there to find the things which really matter.

So, what’s important now?  Fundamentals, that is, those things which ultimately matter to the stock market, do not change quickly.  In my view, Greece is really a digression or distraction from the really important things.  The same goes for the technical glitches from last Thursday.  Corporate earnings, the economy, interest rates and cash on the sidelines are the most important drivers for the market right now and they are all positive.  Amid all the excitement last week, many failed to notice that the US economy added 290,000 jobs in April – something I thought would be a reason to cheer.

Bottom line – I still think that the bull market persists and last week was nothing more than a technical correction and a buying opportunity.  Many smart investors I spoke with last week agree with me and used the weakness to buy stocks.

This entry was posted on Monday, May 10th, 2010 at 8:40 am and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.