Our last message covered the SEC’s suit against Goldman Sachs and the general divide we see Wall Street has with Main Street. In a perfect world, at least our perfect world, Wall Street would be of service to Main Street and for that service Wall Street would receive commensurate fees and access to the resources of Main Street. We may have had that in the past. Now the model looks more like Wall Street benefits from Main Street’s lack of knowledge of the playing field. That certainly appears to be the case with the charges against Goldman Sachs. We have to admit that it does not appear what GS did may be a breach of law, but a breach of fair-mindedness and ethical behavior seems a forgone conclusion.
We had also mentioned in that letter the coincidence of starting to write about Wall Street’s conflicts of Interest the night before the SEC suit was announced. Another coincidence unfolded since that last letter. A week ago Thursday, as an example, the stock chart of Google was flashing a Buy signal according to some of the indicators we use in our work. Friday came along and every major index was up that day, all making 52 week highs, but Google was struggling all day and closed down two points. It had disappointed with its earnings report earlier that week, but we thought with the stock down over $50 the last few days, the bad news was already priced in.
Monday morning the market opened upward as it often has of late on Mondays. Google began dropping quickly. By the end of the day the overall market was flat to down a smidge, but Google was down over $13 to $531.64 on 30% higher volume than the last three month average. It was acting poorly for the prior two days on no significant news. About a half hour after the market closed we was talking with a colleague and noticed Google was trading below $525 in after hours trading. We asked if he knew why it was down so much and he said Goldman Sachs had taken it off its Conviction Buy List. We said “Do you think that is a coincidence?” and we both laughed.
The next day the market was hit hard with all the major indices, down 2-3%. Google was down less than ½%. Some people might hypothesize that some investors knew that the downgrade was coming and they shorted the stock on Friday and Monday (shorting involves selling a stock first and then hoping to buy it back at a lower price) driving the price down. They then covered their shorts on Tuesday, which might explain the stock’s relative strength in a hard hit market. Others might say it’s just a coincidence. By the way Goldman Sachs says that 80% of their recent record earnings come from their trading desk.
We have absolutely no evidence that anything illegal - or even unseemly - took place here and nothing was reported, but it does seem awfully coincidental to me. One area where there is no coincidence and we cannot fathom why the large Wall Street firms are given such a distinct advantage over you is in the High Frequency Trading arena. HFT is the process of super fast computers being able to see orders coming in, determining the direction those orders might move the market before they are executed, then profiting from that info.
We can hear you muttering to yourself, “Are you kidding me, they don’t have enough of an advantage as it is?” In an article from the website ALLGOV - “Goldman’s use of high frequency trading (HFT) reportedly helped the firm earn $100 million a day on an average of three out of five days during one stretch in 2009.” Good thing we bailed them out! For a more complete understanding on HFT, here is a link to a NY Times article. The SEC has been reviewing HFT for several months and is considering banning it. The big firms claim it improves liquidity, but it seems we were fine without it before. Some estimates are that although HFT firms represent 2% of trading firms they handle over 70% of the volume in the market.
In 2000, the first full year after Goldman Sachs went public, it earned 40 percent of its net revenue from its trading operation, 32 percent from investment banking, and 28 percent from managing assets for clients. In its latest earnings report, Goldman said it earned 80 percent of its revenue from trading, about 11 percent from asset management, and 9 percent from investment banking. So Goldman's trading desk accounts for twice the portion of revenue that it did 10 years ago. Proprietary trading has much less impact on the economy than investment banking does, but we guess you do what you got to do to get by.
For the last twenty-five years the main investment philosophy that financial advisors representing mostly Wall Street firms have sold to clients is the “Buy and Hold” strategy. Yet in their trading rooms they are making literally billions of dollars from trades that are often held for fractions of minutes. They have access to info that you do not and we would not be surprised if we learned they were using that info to trade against you. And now you find out they have computers that allow them to profit from seeing your orders before anyone else and policymakers can’t decide if that is fair?
Seems like a stacked deck to us. Hopefully the SEC’s actions against Goldman are an attempt to level the playing field so that those on Main Street continue to want to play on Wall Street. Without a doubt those on Wall Street think they are smarter than those on Main Street. We find the arrogance overwhelming, but at some point they will figure out that is a different game if Main Street does not engage. The number of clients leaving Wall Street firms and moving to smaller investment advisory firms is growing rapidly and we don’t think that it is a coincidence.
Chart Spotlight
Last time here we showed how constructive the rally of the last couple of months had been. We did also share our thoughts on how we might be nearing a top and we think the action last week supports that view. Last week was a roller coaster containing two triple digit down days for the Dow Industrials sandwiching an up one. Often increased volatility is a prelude to a direction change. Several of the indicators we follow are not confirming the recent new highs setting up what are known as negative divergences which can be a sign of exhaustion.
The chart above is that of the Dow Industrials with the MACD (Moving Average Convergent Divergent) in the top box. As you can see even though we were near the highs late in the week the MACD is pointing down rather decidedly and much lower than the week before. Looking back to January we can see a lower MACD when the index was making new highs, then a correction followed. With the broad, strong, and constructive action of late, We imagine if a correction does occur it will be in the 5-7% range. If the debt situation in Europe worsens considerably and dominates the headlines over the next few weeks, it could push it to double digits.
Did You Know
Bull Market Data Points - The S&P 500 has gained at least +25% (total return) 8 times in the last 25 calendar years (i.e., 1985-2009), including last year (the stock index gained +26.5% in 2009). In the calendar year following the 7 previous “25% and up” years, the S&P 500 was up 6 out of 7 years, gaining an average of +14.8% annually. The bottom of the bear market (and thus the start of a bull market) for the S&P 500 occurred 13 ½ months ago on 3/09/09. In the last 50 years (i.e., since 1960), the average bull market for the S&P 500 has lasted 55 months. The shortest bull market in the last half century stretched over a 26-month period during 1966-68 (source: BTN Research).
Final Thought
“Ever noticed how the stock market seems to take the stairs up and the elevator down?”
– Anonymous
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