Are You One of the Market Elites?

Before we get to the wonderful world of investing, it’s important to set the scene. Make yourself a cup of hot chocolate, sit down and get ready for your blood to boil. You’re about to find out how financial markets really work…

In the funniest TV exchange of the decade, a bundle of CNBC hosts and guests discussed the latest dodgy goings on in the markets. No, it’s not the news that currency quotes are rigged. That’s yesterday’s news. Instead, a reporter discovered that the University of Michigan and Reuters provide early access to their consumer confidence information to a select few.

The public gets the data at 10am. The so called ‘elite clients’ at 9:55am and the ‘ultra elite clients’ get it 2 seconds before the elite. Sure enough, if you take a look at the trading data, markets move at 9:54:58 on days when consumer confidence is due.

Putting this into perspective, we also know that the following financial markets are rigged:

  • Libor — interest rates manipulated for traders
  • ISDAfix — swap quotes fixed
  • Platts — oil prices jigged
  • WM/Reuters — Foreign Exchange quotes front run
  • High-Frequency Trading — equity trades front run
  • Fed minutes — leaked

Throw in the effects of public policies like QE, and nothing is honest anymore. Of course, never forget that the gold and silver price isn’t manipulated — that would be a conspiracy.

Back to the consumer confidence data. The CNBC crowd in the video was outraged that this early release happens at all. They reckon it’s illegal and can’t believe it’s happening.

But Reuters says that because it mentions it sells the data early on its website, this is legal. You just have to pay top dollar to get 5 minutes on everyone else, and even more to get two seconds on those who think they’re ‘elite’.

If you have a big enough trading account, and a machine to analyse the data in a split second and send out the corresponding trade, you can make a killing. According to the journalist who broke the story, Eamon Javers, Reuters even implies this in its marketing material for subscribing to the early release.

After the pundits on CNBC finished expressing their levels of outrage, CNBC’s man on the trading floor, Rick Santelli, dropped the real bombshells. Keep in mind this fellow triggered America’s tax day tea party protests a few years ago with a rant on CNBC that went viral.

First of all, Rick claims the early data release for elite and ultra elite clients has been going on for years. Better still, everyone on the trading floor knows it happens, but nobody in the media would listen to their claims in the past.

CNBC’s anchors were doubtful of Santelli’s statements to say the least. So, in the midst of an argument on the matter, he pulled over a random guy from the trading floor live on air:

Santelli: ‘Jerry, Jerry, you’re a currency trader. Get over here, hurry up. Get over here… Jerry, you’ve been trading for years and years and years. Is it any surprise that subscription guys have gotten University of Michigan [data] early? You talk about it every month, right?’

Jerry: ‘every month’

The anchor promptly changed the subject.

The video is a must watch to realise how clueless the media is, how clued in the guys on the floor are to the bizarre goings on in financial markets, and how dodgy those markets really are.

But even without front running, rigging and early releases, investing is difficult enough in times like these. The thing is, what if things ever get back to normal?

When Market Normality Became Dangerous

Central bankers and politicians wish the world would just return to normal. You probably wish for rising stock markets, rising house prices and abundant mining jobs luring your neighbourhood delinquents into the desert too.

But be careful what you wish for. Normal has become dangerous.

That’s because normal financial markets and economic conditions mean higher interest rates. Yet the so called recovery we’ve seen in the global economy is dependent on low interest rates. To be specific, the so called recovery we’ve seen represents the increase in debt the world is willing to take on at lower rates.

If the economy and financial markets improve, those rates will rise. If rates rise, debt costs rise with them. Suddenly the recovery becomes very expensive to finance. And it’s exposed as a sham. Then, rates will have to be lowered again to encourage more debt.

It’s a Catch 22. In fact, it’s practically the definition of a Catch 22, if you consult Wikipedia’s ‘Catch 22’ article:

‘Often these situations are such that solving one part of a problem only creates another problem, which ultimately leads back to the original problem’

The first problem we have is a floundering economy. Solving that problem leads to higher interest rates, leading us back to a floundering economy. As the philosopher Homer would say, ‘doh’.

We thought Catch 22 was a baseball term for when a runner is stuck in between two bases. The basemen have to tag him with the ball in their mitt to get him out. Every time he breaks for the safety of one of the two bases, the basemen throw the ball back and forth, blocking off his route. The result is a bizarre amount of running back and forth as the base men close in. Here’s a video if you’re confused.

(Ed note: We told Nick he’s the confused one and suggested he read Joseph Heller’s classic novel, which gave the world the phrase)

It turns out, that’s got nothing to do with a Catch 22. It’s actually refers to a ‘pickle’, a damned if you do, dammed if you don’t situation. Markets are also in a pickle, so that works out well.

ASX200 in a 5 Year Pickle — Going Back and Forth

Source: Yahoo Finance

Anyway, the Catch 22 scenario just got very interesting. In case you’ve forgotten, there are three variables at play — interest rates, the stock market and the economy.

The following chart uses an American proxy to represent each of the three. The stock market is in green, the interest rate in orange and the economy in purple.

By the way, the orange line actually measures the US 10 year government bond yield, which mortgage rates are commonly tied to. And the purple line actually measures the outperformance or underperformance of US economic data.

But just think of them as the stock market, the economy and interest rates.

Before October of 2012, all three indicators were highly correlated. Stock markets and interest rates rose as the economy did. That makes sense. As the economy does well, people leave the safety of bonds, increasing interest rates, and go into stocks, increasing stock prices. So a rising purple line should make the green and orange line rise. And that’s what happened.

A falling purple line should lead to a falling orange and green line. In October 2012, when US economic data stopped surprising to the upside by increasing amounts, stocks and interest rates suddenly fell. People piled back into the safety of bonds, knowing things couldn’t get much better in the economy.

The thing is, since the beginning of 2013, things have gone haywire. We’ve had every possible combination of rising and falling lines that do not make sense.

Impossible Combinations

Source: Bloomberg, ZeroHedge

To be specific, there are eight combinations of rising and falling lines possible. And you can find all eight in the chart above.

For example in January, US economic data started deteriorating. But stock markets and interest rates soared. Then, in February, US economic data began outperforming expectations and stock markets continued to soar but interest rates fell.

Since May, the relationship has changed to a third possible but illogical combination. US economic data disappoints, interest rates rise and stock markets fall.

If you’re confused, well done. None of this makes much sense. Markets have gone haywire.

One of the reasons is that bad economic news can now be interpreted as good news. It increases the chances of intervention by central banks, which also move stock markets and interest rates.

But that doesn’t explain why the relationship between economic news, stocks and bonds keeps changing. Nothing is consistent. And that’s dangerous for investors. Even a neutral asset allocation portfolio can’t protect you if markets aren’t moving in ways that make sense.

The point is that trying to understand this market is very difficult. That’s true on every level, not just the technical (chart based) one above. Remember, the Catch 22 and pickle we started with? It showed that fundamental, or economic, analysis is just as much of a muddle.

So what do you do if you can’t make sense of what’s going on?

In the Money for Life Letter, we’ve been looking into ‘non-financial investments’. When the financial world is going bonkers, you should look to invest money elsewhere.

This month’s issue is all about predicting your health in retirement. And trying to avoid any bad conditions that may be waiting for you there.

But the truth is, that’s just one way you can opt out of financial market shenanigans. Another way is to focus on stocks that aren’t affected by bizarre policies like Abenomics, QE and the European Union’s bailout funds. And that’s why you need to take a look at Kris’ technology presentations, starting tomorrow.


Nickolai Hubble.
Markets and Money Weekend Edition

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From the Archives…

A Disguised Depression in the US Economy
7-06-13 – Bill Bonner

A Genuine Economic Recovery Requires a Genuine Bust
6-06-13 – Greg Canavan

Why it’s Going to Get Ugly When Interest Rates Rise Again
5-06-13 ­– Greg Canavan

Big Trouble in the Australian Economy… Everybody Relax
4-06-13 – Greg Canavan

Why Growth Stocks Could be the New Target of the Big Money Hunt
3-06-13 – Dan Denning

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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