Friday, September 21, 2012

Wall Street doesn’t know what business it is in. Regulators don’t know what the business of Wall Street is. Investor/shareholders don’t know what business Wall Street is in.

Only one word needed: Absolutely. Mark Cuban hits the nail on the head with  this article on what does Wall Street do. Aivars Lode

The only people who know what business Wall Street is in are the high frequency and automated traders. They know what business Wall Street is in better than everyone else.  To traders, whether day traders or high frequency or somewhere in between, Wall Street has nothing to do with creating capital for businesses, its original goal. Wall Street is a platform. It’s a platform to be exploited by every technological and intellectual means possible.
The best analogy for traders  ? They are hackers. Just as hackers search for and exploit operating system and application shortcomings, high frequency  traders do the same thing.  A hacker wants to jump in front of your shopping cart and grab your credit card and then sell it.  A high frequency trader wants to jump in front of your trade and then sell that stock to you. A hacker will tell you that they are serving a purpose by identifying the weak links in your system. A trader will tell you they deserve the pennies they are making on the trade  or the rebate they are getting from the exchange because they provide liquidity to the market.
I recognize that one is illegal, the other is not. That isn’t the important issue.
The important issue is recognizing that Wall Street is no longer serving the purpose  what it was designed to .  Wall Street was designed to be a market to which companies provide securities (stocks/bonds), from which they received capital that would help them start/grow/sell businesses. Investors made their money by recognizing value where others did not, or by simply committing to a company and growing with it as a shareholder, receiving dividends or appreciation in their holdings.  What percentage of the market is driven by investors these days ?
I started actively trading stocks in 1992. I traded a lot. Over the years I’ve written quite a bit about the market. I have always thought I had a good handle on the market. Until recently.
Over just the past 5 years, the market has changed. It is getting increasingly difficult to just invest in companies you believe in. Discussion in the market place is not about the performance of specific companies and their returns. Discussion is about macro issues that impact all stocks. And those macro issues impact automated trading decisions, which impact any and every stock that is part of any and every index or ETF.  Combine that with the leverage of derivatives tracking companies,  indexes and other packages or the leveraged ETFs, and individual stocks become pawns in a much bigger game than I feel increasingly less  comfortable playing. It is a game fraught with ever increasing risk.
So back to the original question. What business is Wall Street in ?
Its primary business is no longer creating capital for business. Creating capital for business has to be less than 1pct of the volume on Wall Street in any given period. (I would be curious if anyone out there knows what percentage of transactions actually return money to a company for any reason). It wouldn’t shock me that even in this environment that more money flows from companies to the market in the form of buybacks (which i think are always a mistake), than flows into companies in the form of equity.
My 2 cents is that it is important for this country to push Wall Street back to the business of creating capital for business.  Whether its through a use of taxes on trades(hit every trade on a stock held less than 1 hour with a 10c tax and all these problems go away), or changing the capital gains tax structure so that there is no capital gains tax on any shares of stock (private or public company) held for 1 year or more, and no tax on dividends paid to shareholders who have held stock in the company for more than 5 years.  However we need to do it, we need to get the smart money on Wall Street back to thinking about ways to use their capital to help start and grow companies. That is what will create jobs. That is where we will find the next big thing that will accelerate the world economy.  It won’t come from traders trying to hack the financial system for a few pennies per trade.
And solutions won’t come from bureaucrats trying to prevent the traders from hacking the system. The only certainty when bureaucrats step in is that the law of unintended consequences will smack us all in the head and the trader/hackers will find new ways to exploit the system that makes them big money and even more money for the big institutions that develop products for the other institutions that are desperate to play the game.
Regulators have got to start to recognize that traders are not investors and vice versa and treat them differently. Different regulations. Different tax structure.  Different oversight. Individual investors and the funds that just invest in stocks and bonds are not going to crash the market.  Big traders who are always leveraging up and maximizing the number of trades/hacks they make will always put the system at risk.  We need to recognize that they do not serve much of a purpose other than to add substantial risk to the global economy.  That their stated value add of liquidity does not compensate the US and World Economy nearly enough for the risk of collapse they introduce into the system.
Wall Street as a whole needs to be in the business of creating capital for companies and selling shares to investors who believe they are shareholders.  The Government needs to create simple and obvious incentives for this business and extract compensation from the traders/hackers for the systemic failure risk they introduce.
There will be another flash crash, and probably a crash far worse than the May 2010 flash crash simply because there are too many players looking for the trillion dollar score. They can’t all win, yet how many do you think wouldn’t risk everything, even what is not theirs, for that remote chance to score big ? Put another way, there is zero moral hazard attached to any trade. So why wouldn’t traders take the biggest risk possible ? 
There is value to trading automation. It is here to stay. There is absolutely NO VALUE to High Frequency Trading. None. We need to bring our markets back to their original goals of creating capital for business.  It's impossible to guess how many small to medium size companies have been held back from growing and creating jobs and wealth because of lack of access to capital from the stock market. It's not impossible to know that our economy has suffered because Wall Street equity markets are no longer a source of equity for helping companies grow, it is not a platform for hackers and that needs to change. Quickly.

Sunday, September 16, 2012

As Goes Steel, So Goes China

This does not bode well for Australia or Canada. Aivars Lode. Avantce
“We reckon traders and mills have accumulated steel inventory of almost 100 million tons,” said Citigroup analyst Scarlett Chen to theWall Street Journal this month.  Steelmakers are the core of Chinese manufacturing, and manufacturing is the core of the Chinese economy.  The gross overproduction of steel tells us China will not recover this year.

CISA thinks the trend will continue for the remainder of the year.  A report on its website, written by Xue Heping of Steelinfo Consultancy, says steel production could fall 10% in the second half of this year.  As he writes, “A significant decline in China’s second half steel output is a foregone conclusion.”
In the middle of August, inventories were 26% higher than a year earlier, according to the China Iron & Steel Association, CISA.  It’s no surprise, therefore, that last month steel production fell.  Output, according to official statistics, was off 1.7% from the same month last year and 4.8% from July.
How significant?  Steel output, he projects, will reach 678.7 million metric tons this year.  That represents a 0.7% decline from 2011’s record 683.3 million tons.  Mr. Xue, in short, is projecting the first fall in 31 years.
Is CISA trying to exaggerate the woes of the mills to get even more government help?  Actually, the situation is probably worse than the trade group represents.  CISA surveys only large producers, which are doing better than their smaller counterparts.  Moreover, there is suspicion that mills are inflating their production figures.  “There are a lot of incentives to not report what is happening,” said J Capital’s Tim Murray to theAustralian Financial Review.
So how bad is the situation?  According to Murray, production may have fallen 10% over the first half of August.  “There are some seasonal factors at play, but the volume coming off is unusual,” he said.
In any event, CISA said producers were selling products below cost and that prices had more room to fall.  A four-month price decline looks set to continue.  The association also says steelmakers’ profits were down a stunning 95.8% in the first half of this year compared to the same period in 2011.  Stanley Li of Mirae Asset Securities, speaking to theSouth China Morning Postsaid most steel mills lost money in August.
So mills are cutting production, losing money, and trying to dump inventory.  Why is Beijing authorizing the building of even more of them?  At a time when as much as a quarter of the nation’s steelmaking capacity is going unused and many mills will not restart production after the summer repairs, the National Development and Reform Commission approved the building of two more plants with a total construction cost of $20.5 billion.
One of the projects became famous in China in May when a photo of Wang Zhongbing was splashed across the country.  The celebrated pic showed Wang, the mayor of Zhanjiang in Guangdong province, kissing a document just outside the offices of the National Development and Reform Commission in Beijing.  The NDRC, worried about overcapacity, sat on his city’s request for a steel mill for more than a decade—the plant was first conceived in the 1970s—but Beijing’s new desperation meant that the happy mayor got his approval pronto.
Wang, however, won’t be so ecstatic when the plant faces difficulties because it doesn’t have enough customers.  As financial columnist Yu Fenghui said to theWant China Times, “Mayor Wang kissed the approval today, but the next mayor might cry over it.”  It’s no secret that the industry’s current troubles are the result of wild expansion—China makes just about half the world’s steel—and the new approvals can only make matters worse.
Unless Beijing starts shuttering mills soon, profitability of Chinese steel producers will be poor for far longer than the next two years that analysts predict.  “Globally steel companies are all hurting, but the Chinese industry could be the worst off,” said S&P’s Suzanne Smith, chief of Asia-Pacific commodities ratings, in a conference call early this month.  “In Europe, a number of blast furnaces have been closed down, but we have not seen much of that in China.”
China has been plagued by overcapacity since 2005, but the country is now building even more mills.  Beijing is scrambling for things to spend money on, and local officials need the tax revenue and employment that the plants provide.  So it was perhaps inevitable that the NDRC approved Mayor Wang’s dream.  It may have made sense 34 years ago when his city first conceived of the project, but it makes no sense now, except in the very short term.

In the longer run, Wang can expect troubles at the new mill to ripple through his city.  As CISA points out, problems at steel plants affect suppliers.  Suppliers’ problems, in turn, burden the banks, put people out of work, depress property markets, and ultimately decrease consumption in affected communities.
The NDRC does not seem to mind, however.  Beijing technocrats are pushing China’s steel industry off a cliff—and the rest of the economy with it.