Archive for October, 2012

• When Will the Fed Raise Rates?
  Eddy Elfenbein, October 11th, 2012 at 11:37 am

  According to the latest pronouncements from the Fed, the central bank doesn’t have plans to raise short-term interest rates for a few more years. But going by some economic models, a rate increase may not be that far away.

  In January, I posted an interest rate model developed by Greg Mankiw. According to his model, this is where the Fed funds rate ought to be:

  Federal funds rate = 8.5 + 1.4 (Core inflation – Unemployment)

  For the last few years, the model has indicated negative rates and since the Fed can’t lower rates below 0%; that’s why we’ve had the QE policies.

  Here’s how the Mankiw model looks compared with the Fed funds rate.

  

  What’s more is that the surprising fall in the jobless rate we saw last week brings us even closer to a rate increase. We don’t yet have the September figure for core inflation but there’s a very good chance that it will finally signal positive interest rates for the Mankiw model.

  The math works like this: With an unemployment rate of 7.8%, which we had in September, a year-over-year core rate of inflation of 1.8% would cause the model to signal interest rates of exactly 0%. Any core inflation rate greater than 1.8% would cause the model to show positive interest rates. The year-over-year core rate ending in August was 1.92%. The next consumer inflation report comes out on Tuesday.

  Of course, this is just one model and it doesn’t mean that the Fed will follow it. I would think some members of the FOMC are troubled by the weak labor market participation rates, which is a fancy way of saying that lots of folks have stopped looking for a job. But still, the Mankiw model has fairly accurately shown what the Fed has done over the past several years.

  In 2010, Paul Krugman crunched the numbers and came up with different coefficients for the model:

  Federal funds rate = 9.0 + 1.8 (Core inflation – Unemployment)

  

  Krugman’s model has interest rates lower than Mankiw’s. Still, the drop in the unemployment rate will push Krugman’s model to -1.6% (assuming 1.9% y-o-y core rate for September). That’s low but the Krugman model was signaling -9% two years ago.

  I think it’s far too early to say that the Federal Reserve has “won” or that a rate increase will be coming soon. But it may be the case that a rate increase could happen before the Fed’s current timeline of 2015.

• Morning News: October 11, 2012
  Eddy Elfenbein, October 11th, 2012 at 6:04 am

  S&P Downgrade May Nudge Spain Bailout Along

  IMF Lagarde Seeks More Time for Greece Austerity

  Under Chinese, a Greek Port Thrives

  EADS-BAE Failure Shows Road to United EU Ends in Berlin

  Should a Government Official Blacklist a Foreign Company?

  Drop in Openings Signals Limited U.S. Job Growth: Economy

  Fed Says Economy Grows ‘Modestly’ on Housing, Autos

  U.S. Sets Anti-Dumping Duties on China Solar Imports

  Toyota Recall Of 7.5 Million Autos May Slow Its Rebound In U.S.

  Ebay Unveils Major Redesign And Same-Day Delivery Service

  FedEx Relies on Express Revamp to Meet $1.7 Billion Goal

  With Tapes, Authorities Build Criminal Cases Over JPMorgan Loss

  Shell Faces Lawsuit Over Niger Delta Pollution

  Edward Harrison: My Comments on Spiegel’s Post on How Monetary Policy Threatens Savings

  Howard Lindzon: Apple – A Bull and Bear Case

  Be sure to follow me on Twitter.

• Anniversary Time
  Eddy Elfenbein, October 10th, 2012 at 3:18 pm

  Gary Alexander notes that the media is highlighting that yesterday was the fifth anniversary of the top. But that’s not all. There was a major low on October 9, 2002. There were also lows on October 11, 1990 and October 8, 1998.

  It’s interesting but what’s the reason behind this? Nothing. It’s just finding patterns in noise.

• The Big Picture Investment Conference
  Eddy Elfenbein, October 10th, 2012 at 12:07 pm

  I’m at Barry Ritholtz’s Big Picture Investment Conference. I got here a little late so I missed the first speakers. I was able to hear James P. O’Shaughnessy, the author of “What Works on Wall Street.” James takes a very long approach to investing and he’s currently very bullish on stocks, especially compared with bonds. It’s hard for me to disagree. He pointed out that TIPs buyers are locking in 91 cents on the dollar by 2022. That doesn’t sound like a good plan.

  Next up is Barry Ritholtz. He’s riffing on behavioral finance which is basically the area of science that looks at the many ways our brains actively work to trick us. They make us think we’re smarter than we truly are. We have to rationalize certain ideas.

  The media is very savvy at giving us people who sound like they know what they’re talking about. Audiences rally around confidence. Speakers who convey nuance aren’t liked by audiences. Furthermore, the greater self-confidence of the expert, the worse track records are. I always find these facts disquieting because we expect our brain to be our guard against irrational beliefs. But the truth is, our brain doesn’t do a terribly good job of this. We prefer nice neat stories.

  Lunch!

  David Rosenberg is up. He defends himself against the perma-Bear charge. I like how he describes himself as the firm’s chief worrywart.

  Rosenberg called the Fed minutes as being from La-La Land. The lists of worries aren’t from a recovery, especially considering the stimulus. He’s going through the numbers and says they’re dismal. He says that going by previous cycles, real growth in this cycle should be closer to 8% instead of the 1.5% we’re getting.

  Rosenberg says that we’re still going through a deleveraging cycle and it’s not nearly done. We have to go back to long-term ratios of debt to equity and debt to income. Rosie says that we’ll eventually get to the Holy Grail of sustainable growth without massive government aid. He said we’re probably about halfway there.

  Now is the HFT panel. Josh asks the panelists how they came to be HFT critics. They said that around 2007, they noticed unusual behavior. They claim that there are unfair predatory practices and the rise of private exchanges. The glue that holds them all together is HFT.

  The other panelist said that he wanted to write about HFT and his editors were stunned to learn that HFT controls 70% of the trading volume. At first, he thought HFT was ok in that they provided liquidity. In 2010, he went to an HFT firm. Soon after was the Flash Crash. He called some HFT firms and they said they had pulled out of the market. He then realized that this was a major structural problem for the markets. The panelists also point out that spreads have not narrowed. Since 2007, they’ve actually expanded.

  I think the best anti-HFT point is about the integrity of the capital markets. No one cares about a fraction of a penny. But the key about HFT is that it has squeezed out smaller firms. There are no more second- or third-tier firms, and that has hindered new IPOs. HFT is now going into other markets like currencies.

• The Wrong 73 Years
  Eddy Elfenbein, October 10th, 2012 at 11:13 am

  I’m often called a buy-and-hold investor. That’s true but I’m not in favor of locking in on an index and forgetting about it.

  Here’s an interesting fact. Between September 20, 1929 and October 9, 2002, the Dow Utility average grew by 16% not including dividends. That’s 16% over 73 years. Ten years ago yesterday, the Utes reached the trough of an awful bear market.

  

  I’m buy-and-hold but it depends a lot on what you buy and what you hold.

• Morning News: October 10, 2012
  Eddy Elfenbein, October 10th, 2012 at 7:23 am

  Europe Still at Odds Over the Workings of Its Bailout Fund

  Greek Reform Pledge On Trial As State Sales Resume

  Japan Calls China PBOC Chief Skipping IMF Meeting ‘Regrettable’

  China Slams Congressional Charges Against Its Telecom Firms Huawei And ZTE

  India’s Embrace of Foreign Retailers

  U.S. Stocks Drop Before Alcoa Report as IMF Cuts Growth Forecast

  Fiscal Cliff May Be Felt Gradually, Analysts Say

  Government Sues Wells Fargo For Reckless Lending Practices

  Wal-Mart and AmEx in Prepaid Card Deal

  Bain Capital Buys Maker of Craftsman Tools in $1.6 Billion Deal

  GOLDMAN: A Significant Tax Hike Is Coming, And Neither Party Is Even Talking About Stopping It

  EADS, BAE In Last-Ditch Struggle To Save Merger

  Facebook Fought SEC to Keep Mobile Risks Hidden Before IPO Crash

  Joshua Brown: Fast Money: The Apple Dip Debate!

  Cullen Roche: Is The Volatility Index Really That Low?

  Be sure to follow me on Twitter.

• The Market Top Five Years On
  Eddy Elfenbein, October 9th, 2012 at 12:21 pm

  Five years ago today, the S&P 500 had its all-time high close of 1,565.15. The index closed yesterday 6.98% below its all-time high close.

  

  Here’s a look at how sector ETFs have done since the market top. These returns include dividends.

  Staples ($XLP) +47.1%
  Discretionaries ($XLY) 34.6%
  Healthcare ($XLV) 24.0%
  Technology ($XLK) 18.0%
  Utility ($XLU) 6.9%
  Energy ($XLE) 4.6%
  S&P 500 ($SPY) 3.2%
  Industrials ($XLI) -2.2%
  Materials ($XLB) -4.5%
  Financials ($XLF) -49.9%

• 4% of Trading Activity Last Week Was Due to a Mysterious Algorithm
  Eddy Elfenbein, October 9th, 2012 at 11:50 am

  From John Melloy at CNBC:

  A single mysterious computer program that placed orders — and then subsequently canceled them — made up 4 percent of all quote traffic in the U.S. stock market last week, according to the top tracker of high-frequency trading activity. The motive of the algorithm is still unclear.

  The program placed orders in 25-millisecond bursts involving about 500 stocks, according to Nanex, a market data firm. The algorithm never executed a single trade, and it abruptly ended at about 10:30 a.m. ET Friday.

  “Just goes to show you how just one person can have such an outsized impact on the market,” said Eric Hunsader, head of Nanex and the No. 1 detector of trading anomalies watching Wall Street today. “Exchanges are just not monitoring it.”

  Hunsader’s sonar picked up that this was a single high-frequency trader after seeing the program’s pattern (200 fake quotes, then 400, then 1,000) repeated over and over. Also, it was being routed from the same place, the Nasdaq.

  “My guess is that the algo was testing the market, as high-frequency frequently does,” says Jon Najarian, co-founder of TradeMonster.com. “As soon as they add bandwidth, the HFT crowd sees how quickly they can top out to create latency.” (Read More: Unclear What Caused Kraft Spike: Nanex Founder.)

  Translation: The ultimate goal of many of these programs is to gum up the system so it slows down the quote feed to others and allows the computer traders (with their co-located servers at the exchanges) to gain a money-making arbitrage opportunity.

  The scariest part of this single program was that its millions of quotes accounted for 10 percent of the bandwidth that is allowed for trading on any given day, according to Nanex. (The size of the bandwidth pipe is determined by a group made up of the exchanges called the Consolidated Quote System.) (Read More: Cuban, Cooperman: Curb High-Frequency Trading.)

  “This is pretty out there to see this affect this many stocks at the same time,” said Hunsader, adding that high-frequency traders are doing anything to “tip the odds in their favor.”

• Morning News: October 9, 2012
  Eddy Elfenbein, October 9th, 2012 at 5:54 am

  IMF Says Global Recession Risk Grows

  EADS, BAE Said to Plan Extra-Time Request to Salvage Deal

  Spain Foreclosures Spread to Once Wealthy

  China Tech Giant Under Fire

  Toyota to Nissan Sales Plunge as Chinese Shun Japanese Cars

  
  Recent India Reforms to Boost Foreign Investment

  MegaFon Files for IPO in Biggest Russian Sale Since 2007

  Oil Declines a Second Day as Europe Ministers Meet Amid Slowdown

  One In Eight Of World Population Going Hungry

  Investors’ Billion-Dollar Fraud Fighter

  Netflix Rises to Highest Since July After Stock Upgraded

  Barclays to Buy Online Assets of ING Groep

  American Airlines Is Losing Important Customers

  Wal-Mart, Amex Take On Banks With Low-Priced Debit Card

  Roger Nusbaum: Fixed Income Allocations

  Jeff Carter: Crowdfunding Summit

  Be sure to follow me on Twitter.

• Is Dell a Bargain?
  Eddy Elfenbein, October 8th, 2012 at 12:51 pm

  Here’s a quick podcast I did with Jeff Reeves of InvestorPlace.