The Stock market: a platform for gambling, trading or investing ? How to restore sanity !

[Thomas Beyer]

Have you noted that the stock market is quite volatile lately .. say the last year or 2 ?



Have you also invested in stocks and seen unusual price movement for no good reason ?



Have you owned stocks, that after a surge fell sharply, sold by you in disgust to prevent further loss, just to see it rise again days or minutes later to prices higher than your entry price ?



Have you also wondered, perhaps quite frequently recently: is this how I fund my retirement or my kids' education ?



The stock marked used to be a source for funding of new firms or their continued growth, with a platform that allowed investors to co-own firms and to get in and out with relative easy, at fair prices set by buyers and sellers !



Lately it has evolved into a casino mentality almost uncorrelated to real economic activity of the market or the specific company.



In my (humble) opinion, the
main reason for extreme stock market volatility of late is a) the many internet
and trading enabled devices like PCs, laptops and cell phones, b) the ability to make a quick buck ahead of others as a "high frequency trader"c) the
lack of transaction taxes and d) the lack of massive (close to 100%)
capital gain taxes to reduce incentives for short term trading! And the
main reason for c) and d) is the "tithing" of these profits with US
politicians, i.e. the dependence of the US electoral system on large donations.



Wall Street is the US politician's main street !



Some solutions though are at least started to be discussed:



Europe is now at least starting a discussion to
introduce a transaction tax. http://www.cnbc.com/id/44163841/Financial_Transaction_Tax_for_Europe



High frequency code is being looked at by the SEC, see article here: http://business.financialpost.com/2011/09/02/sec-takes-aim-at-high-frequency-traders/



Normally I am not a big fan of add'l government interference and add'l taxation, yet Canada should take a lead here in my opinion, and
introduce a 2% trading tax - like real estate in ON or BC - and a "greed" or "day trading" tax as follows: 90% tax on trades held
less than 1h, 80% tax on trades held less than a day and 75% for trades held less than one month - DEDUCTED AT
SOURCE!



This high frequency or day-trading benefits no one except a few
trading houses and is essentially theft from medium to long term
investors. The stock market needs to return to an investment vehicle..
and not a trading vehicle benefiting few at the expense of many!



Related post, by Texas Maverick billionaire owner Mark Cuban, comparing high frequency traders to hackers or thieves: http://blogmaverick.com/2011/08/08/what-business-is-wall-street-in-2/



What these two changes (transaction tax, high greed tax on short term profits) will do is re-establish is a foundation for stock market investing .. as opposed to merely trading ! It will allow people to get in and out of the market, it will allow companies access to funds for IPO's or growth, it will reduce intra-day or very short term stock market manipulation, it will create valuable government revenue and it will restore trust in the stock market as an investment platform that has been lost by me and millions of others !!



Will politicians go there ? We'll see ! I hope so !



Your thoughts on this ?

 

[gwasser]

A trading tax may indeed reduce high frequency trading, but a 2% tax is way too much. Buying stocks and bonds is not done once every 5 to 10 years like real estate; most people invest once every month or six. Guys like me do a transaction once every week or two.



As such a 2% tax would be a disaster. High frequency trading is based on high volumes but tiny profit margins. So a transaction tax of a few tenths of a percent per transaction would keep most retail investors unaffected but it may kill off a large portion of the high frequency trades.



It also should be understood that during this summer when most people were on vacation, high frequency trading constituted close to 65% of the trading volumes on some days. Thus a few institutions and hedge funds basically made up the bulk of the market distorting the market fundamentals entirely.



This combined with the shrill shouts of the media who are literrally living of your and mine anxiety may make you believe that the world is coming to an end; that this time is different. Nothing is further from the truth. Did you know that over the last hundred years or so there have been over 300 government debt defaults reported? That is one every 3 years - not to mention the defaults that have been lost in the fogs of history or political spin. The U.S. has defaulted before. So have many S. American countries and so have Greece, Spain and yes Germany too!



Yes debt is a serious issue as we all know from personal experience, but we should not think that what is going on now is that far from the norm.



The real issue is whether the distortions of high frequency trading is making the markets more or less efficient. Here it seems that the only ones benefitting are the few high frequency traders at the expense of everyone else. Some may claim that it makes market more liquid but do we really need such an extreme liquidity? My thoughts are that we don't, certainly not when it obscures the market outlook even more than 'normal'.



We have fought so long and hard to make paper securities and access to information more affordable and transparent to all of us who save for retirement. A 2% transaction tax would destroy that. The stockbroker would once again become an arcane profession and we would once again become dependant on mutual funds and GICs. Heaven forbid!

 

[rforgiel]

I agree, the stock market has become little more then a casino.



The high frequency traders have also caused damage in the bond markets and currency markets. In 1992 George Soros broke the Bank of England.



Yes there has been government debt default in the past. What is different now is the degree our markets are connected. In the past a government would default and the damage would be limited to that country. If we look back to 1997 when the Thai Baht was devalued it forced all the Asian economies pain needing to bow down to the IMF for help.



In 2008 the whole financial system almost collapsed. People blame it all on US sub prime mortgages when in fact Europe and the other regions were playing the same game causing fragility in their systems. The interconnectivity of todays markets not seen since the early 1900's and ended by the First World War, ripples through the entire system effecting us all.



Now we have a lot of hot money chasing distressed governments looking to make a quick profit. The traders argue they serve a useful purpose in the market. During the Asian crisis, Malysia froze all speculation on their currency. The traders decried this as creating inefficient markets, the markets know best, Malyasai will be ostracized from the world economy, blah, blah blah. In fact Malyasai was the only Asian country that found stability and did not need to adopt the draconian IMF measures and they still remain a free market economy.



The Hot Money is able to pound on the weak and exploit the stock market as Thomas has noted. Thomas also eludes to the models used to execute trades. These models are quite complex.



I say complex models not sophisticated. These traders do not know how to evaluate risk properly. Even the ones like Black Shoals who won a Noble prize for their equation, use a gaussian distribution to model the market, badly underestimating the probability of extreme events . When the hedge fund they set up (LTCM) inevitably exploded the Fed needed to bail out the system. Nothing has been learned from this crisis. The crisis of 2008 was also caused by incompetence and the same models.



Back to Thomas' question; How to restore sanity!

Here are a few suggestions from my favourite authors:

Regulate all the shadow institutions such as AIG as if they are regular banks.

Not allow any institution to become too big to fail. Just let them fail and not rely on moral hazard.

Fed has a great responsibility to burst bubbles when they see them forming. No more Greenspan puts = moral hazard.

Eliminate bonuses to traders. It also encourages moral hazard.



From Nassim Nicholas Teleb of Black Swan fame (no not the movie):

People who were driving a school bus blindfold (and crashed it) should never be given a new bus.

Do not give children dynamite sticks, even if they come with a warning label.

Citizens should not depend on financial assets as a repository of value and should not rely on fallible "expert" advice for their retirement.



All the above sounds like a lot of work. Maybe Thomas' suggestion of a 2% tax (worldwide) would cut this Gordian knot.

 

[bizaro86]

[quote user=rforgiel]In 1992 George Soros broke the Bank of England.





Which was necessary. The Bank of England couldn't have afforded to keep the pound at unsustainably high levels. Instead of it taking years of malaise to straighten out, it happened right away, which reduced the distortion in the economy from the incorrect exchange rate persisting.



After all, when rates are wrong, people make business decisions on those rates, which are then bad decisions once rates change. If the Bank of England let those bad decisions continue for years (which seemed to be its plan) the damage to the economy of the UK would have been significant. George Soros protected them from their own mistake.



Regards,



Michael

 

[rforgiel]

Michael,



You bring up a valid point on this one.

Raising interest rates in the Exchange Rate Mechanism from German Unification would cause the British economy to tank. I was also unfair to put Soros in the same class as these other high frequency traders who do not have the same subjective understanding of the market but only rely on their flawed formulas.



However, I will stick to my premise these high frequency traders are causing unnecessary volatility and fragility in the markets. It doesn't help when they are given new exotic products like CDOs ,CLOs,CMOs and ABCPs to play with.

 

[Rickson9]

Volatility is desirable for me to obtain a good purchase price. I prefer extreme volatility over price stability. Novices who prefer stability should stick to buying GICs. The stock market is a platform for raising capital. The rest is just noise.

 

[Thomas Beyer]

[quote user=Rickson9]I prefer extreme volatility
fair enough .. hope you don't get caught on the wrong side .. but yes, trading stocks makes sense for some and certainly most stock exchanges or trading houses as they take a fee on each transaction ! Why not the government to fill their empty coffers ?



[quote user=Rickson9]The stock market is a platform for raising capital.


was .. not is !



Most transactions are for TRADING ..



did you know that 3x as much capital was raised in teh "exempt market" space i.e. issuers without a prospectus / stock market IPO ?

 

[bizaro86]

[quote user=ThomasBeyer]Most transactions are for TRADING ..





The vast majority of people wouldn't be willing to buy stocks in IPOs (provide capital to firms) if they didn't have a way to sell them effectively. If you closed down the stock market, it would start back up again in a different form (probably over the net somehow) as people wanted to buy or sell securities.



[quote user=ThomasBeyer]did you know that 3x as much capital was raised in teh "exempt market" space i.e. issuers without a prospectus / stock market IPO ?


Not surprising, but the solution to that problem isn't more regulation. I believe your firm raises money through the exempt market, so you know the amount of paper, legal and regulatory work required to do so. It is significant. It is also much less than the amount of paper, legal and regulatory work required to raise capital in the public markets. The public markets are deeper and more liquid than the private markets, so they are more effective at raising capital, but the current regulatory regime means that only the largest players can participate. The solution to the problem of new capital formation isn't increased regulation.



Also, volatility isn't a problem in and of itself. What's required isn't more regulation, it's more investor education. If you've purchased the common stock of a sound company with good prospects and a good balance sheet, why should the price someone is offering you for it today make any difference? The problem is soley psychological.



If someone (say a friend named "Mr Market") offered you much less than you felt a property was worth, would you become worried and depressed, or would you tell him to take a hike? Just because other people have offered a price doesn't mean that's what a security is worth. Price and value are not the same thing, and it's important for all investors (in both the stock and RE markets) to remember that.



Warmest regards,



Michael

 

[RedlineBrett]

Some good posts in this thread. Some perspective on the stock market is nice, especially from those with a real estate background.

 

[Thomas Beyer]

oops .. UBS loses $2B on a rogue trade: http://business.financialpost.com/2011/09/15/ubs-hit-by-us2-billion-rogue-trade/

 

[Rickson9]

The stock market, from my pov, is a platform for raising capital. The rest is just noise.

Generally speaking, those who have been unsuccessful at investing in an asset class tend to be the most negative and uninformed about that asset class, but I think that makes sense. Since I've personally made a lot in both RE and stocks, I have a unique perspective. Most people are only unidextrous.

I have no problem with the system as it is. It is impossible to regulate human emotions. It is amusing that they try, but ultimately futile. Better for me.

 

[bizaro86]

[quote user=RedlineBrett]especially from those with a real estate background.



This comment is interesting, and rather apt, in my opinion.



Real estate investing is a hybrid between an operating business and a passive investment. Someone who has been successful at that has an advantage in stock market investing, if they can read and understand financial statements. Too many stock market types don't investigate the operating business they're buying, but buy on tips, hunches or technical "analysis" (quotes due to incredulity). Real estate investors understand (or should) that their investment is an operating business too, and have one leg up on stock market investing if they apply that philosophy in that market as well.



Regards,



Michael

 

[bizaro86]

[quote user=ThomasBeyer]Have you noted that the stock market is quite volatile lately .. say the last year or 2 ?


This thread is mainly about volatility. Whenever someone asks a question like that, I like to ask myself, does that seem true. Then I like to ask myself, is that factually, quantitatively true. For stock market volatility, it happens to have a definition and a measurement. The easiest way to see this is to get a chart of the S&P VIX index, which measures US market volatility. (I understand Canadian data only goes back a year, making it not ideal for historical comparisons)



http://ca.finance.yahoo.com/echarts?s=%5EVIX#symbol=^vix;range=my;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=;



Volatility has historically averaged just over 20 on the VIX scale, and has spiked in the last month or so to it's current reading of approximately 33. However, in the spring it was as low as 14.27. (By comparison, it peaked in Oct 2008 around 60) So the current market is much less volatile than it was in 2008, but slightly more volatile than it's historical average.



You might say the volatility of volatility is increasing. That's an excellent example of second order effect, which would be something interesting for those with a math/capital markets inclination to look into further. That requires calculus, so I'll leave it alone.



Regards,



Michael

 

[gwasser]

Volatility is relative. Some Calgary 2 bedroom condos sold for $250K in 2008 now they go for $175K.



In Edmonton, Queen Mary Park, 2 bedrooms went as high as $140K in 2008 now they go on average for $90k.



The TSX was Peaked around 14,000 and is now 12,000.



Just because one asset has prices reported on a daily basis and the other on a monthly (average single family home or whatever, in Canada or by neighborhood) does not mean one class is more volatile than the other.



That said, if you follow the stock market on a daily basis, especially when you read the media headlines, you may believe that things are as bad as in 2008-2009. But that is perception. In Mar 2009 the market bottommed at just below 8000 that is a lot lower than today.



Yes the stock market is volatile and there is a lot of speculation in it. There is also a lot of speculation in oil prices which you can easily deduce when the oil price swings from 79$ to $87 in less than a week - do you really think the fundamental supply and demand equation fluctuates that much? Yet we also know that over time, Alberta housing values are influenced by two factors: inflation and oil prices (maybe include gas). So maybe, if we really kept track of daily or hourly housing prices (don't ask me how) it may prove to be just as volatile.



I am not a fan of high frequency trading, but I think both asset classes - real estate and paper securities have there place in everyone's portfolio. Maybe add a dash of gold. This is not a hockey game, where one puts down the opposition. This is about diversification and assett allocation not about which one is better.



Yes some people have a preference for real estate compared to stocks and vise versa; but that is not to say that one class is right and the other is wrong. Just ask real estate owners in the U.S. Of course, Canadian Real Estate investors are so much smarter! Are they?

 

[2ndstory]

[quote user=gwasser]This is not a hockey game, where one puts down the opposition. This is about diversification and assett allocation not about which one is better.



Yes some people have a preference for real estate compared to stocks and vise versa; but that is not to say that one class is right and the other is wrong. Just ask real estate owners in the U.S. Of course, Canadian Real Estate investors are so much smarter! Are they?








That's a good point. The most common angle for real estate investors trying to raise capital is to show how much less risk and volatility there is in real estate as compared to stocks. Hence this argument. From a personal portfolio point of view, there is room for both investments. Personally, I believe that this is a great time to buy stocks, and I have begun to purchase them. Why? Because everyone is lamenting the stock market these days and there are some good deals to be had.



"We simply attempt to be fearful when others are greedy, and greedy only when others are fearful."

- Warren Buffett