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October 30, 2005

WIR Backgrounder, Sun., Oct. 30, 2005, 7:20 AM

When I uploaded the first version of this week's Week in Review (see previous article), I was unaware until readers pointed it out that I had at least 50 typos, including a whole summary section taken from the week earlier report. Sorry, but that's what happens when I try to do too much in too short a time frame, by myself.

Yesterday was one of those times when I never re-read a single time what I had been typing. I just start from a template that contains updated charts from the prior week plus the earlier text, which helps me recall what I wrote.

In any event I have at 6:00am Sunday corrected the initial number of typos from the report I had uploaded at 6:00pm Saturday. Later today I will actually read the full report if I have time, and I'll find and correct other typos.

For this week's original WIR, I had decided to insert a backgrounder to why I believe equity markets are becoming so volatile. It is better suited here in a separate article.

The bottom line is that over the years, the sell-side of the securities industry has lost credibility, and so their customers, who are the owners of most of the capital, have turned outside the industry for guidance.

That means there are now many unregistered persons giving advice, including myself some might say. That is the reason I feel uncomfortable with making forecasts or recommendations, even though they are done in the context of educating and informing readers, and as part of a broad personal opinion.

Some of the new advisors" the public has turned to are smarmy promoters, including newsletter writers who have been around for years, often fighting SEC staff who believe many of these persons are trading in securities" without registration.

I have seen this myself where an internationally known advisor" " i.e., newsletter editor and speaker-circuit favorite " will use the medium to sell personal holdings. One trick I saw used by a man who the mass media has often profiled as a master trader, but who has been permanently banned from entry to the U.S., was to cover his tiny Over-The-Counter oil & gas stock amidst a list of mega-cap stock names like Shell and so forth.

In that case, I thumbed down the list, identified the culprit immediately, and pulled the research " what little there was -- to find persons of record who, let's just say, travel in the same circles. So whether this man was paid $50,000 or handed a million shares of stock to sell for his own benefit, is not relevant. I know there was a benefit paid or else he would not have touted the penny stock.

So, as you know, it's always been a case of buyer beware; the point I am making today is that over time (i) some of these people have managed to build name recognition as well as avoid the net of regulators (ii) technology today has made communications cheaper and easier, so there is much more touting going on (iii) the registered sell-side has failed miserably in their professional obligations and duties, so that the public has turned elsewhere, and (iv) many of the advisors" the public is turning to are highly evolved marketing networks down to individuals ranging from (a) over-hyped charlatans who have in the past also come up against regulatory investigation, or (b) characters who wouldn't know equity from fixed income if it was sitting on the end of their nose.

I think this has become a downright scary situation in which securities regulators are in over their head. There are situations going on today that regulators are letting pass that absolutely drive me nuts, but the truth is that I respect these civil servants more than I do say people who sit on the boards of directors of the major financial institutions who have the power to ensure that the customer is well served, but seldom is.

When I first got involved in capital markets, coming out of university in the late 1960's, the marketplace was completely different than it is today. There were digital computers of course, but they were slow, and all forms of communications were slow in terms of the facilities people have today.

A megabyte of memory in the late ‘60's cost at least $1 million. Today it costs ten cents.

So there was only snail mail, and punched cards and ticker tape... and greedy broker-dealers (b-d) whose clients had to go to them to trade. And the cost was three percent going in and three percent going out.

That meant there wasn't much trading, and the b-d's had all the inside info from the corporations and the movers-and-shakers, including takeover plans and so forth. So with a round" trade costing six pct, clients went to their broker for so-called information" that was worth the cost of trading. Inside information was the currency of the day.

That was the character of trading in the 1960's and ‘70's, into the ‘80's. Then after the crash of October 1987, where many of the highest quality blue chips" lost 30 pct or more inside a week, traders on the outside made enough stink that the SEC permitted the customers to have direct access to trading markets. The b-d role then changed from know-it-all" to know-it-first".

What that did was cause the b-d's to become editors and publishers of information. But to do that they needed superstar" analysts, or story writers, to convince the client that what the b-d knew was good stuff" worthy of trading, which the client did more frequently because the direct access systems were more cost efficient, and desktop computers worth a couple thousand could do more work by the late 1990's than computers costing a thousand times more could do in the ‘60's and ‘70's.

But the sell-side game stayed the same: trade against the public. Screw the public, one client at a time. This was confirmed when at the 2000 market peak, 98.5 pct of Wall Street analysts were issuing client advisories" to buy and hold, and yet they knew the customer was not well served with that advice.

The paper garbage that was created and sold to the public by Wall Street got so bad that one of the world's best-known analysts for one of the world's biggest b-d's sent out e-mails to his personal network that he and his firm were flogging crap.

That disconnect between professional duty and self interest grew wider through the late ‘90's, and led to a terrible bear market in the Year 2000 (Y2K), where the majority of the new tech stories created and promoted by Wall Street either went off the board or lost +90 pct of their cost of acquisition by the client. So the public fell into a state of distrust of the b-d and the mutual fund managers and distributors.

After all, nothing had changed in the real story: Where are the customer's yachts?"

So the latest iteration in market communications began in the past couple years, which is the rise of the Kudlows and Cramers and Agora Publishing types. I call it the Trading in Securities Without a License Era".

That's where the public is getting their market information and recommendations from people other than their broker or fund sales person.

But to make this short, here's the point. If you watch a recent phenomenon in sports stadiums called the Wave, do you think it is a spontaneous thing, or are there cheerleaders? Does the Wave start at a particular time in the game for a reason or for no reason?

You answer that and you will see the state of communications in capital markets today.

Yes, as the economy slows, there is a slowing in the underlying reasons to participate in equity markets. At the same time there are greater risks. But there is also a massive community of interests on Wall Street still hungry for their year-end bonuses, and they have a disappointing first three quarters of '05 to base good bonus expectations on.

And so Wall Street is promoting the Kudlows and the Cramers and anybody else who wants to become a cheerleader.

These people all know where it is their bread is buttered " it is the side that influences the other side.

So in addition to promoting the television personalities, Wall Street also now facilitates the concept of in" groups " which I call influence" groups " like Business and Economic Roundtables, Money Shows, and Industry Forums.

That's because they want " they need " to push the group think" notion that has always been the source of their power, because, as you recall my premise, they (the sell-side) trade against the public (the buy-side).

Applying this discussion to events in the market at this moment, the storywriters and storytellers are trying to focus the public on the double-digit earnings of industries like banking, and the fundamental changes occurring in the telecom services markets. That's simply because, as fraud cops know, for any story to have plausibility there has to be some element of credibility to it.

So today, in the face of a disappointingly weak stock and bond market, the sell side needs two other things going for them: (i) the whole bull choir singing the same tune, and if necessary (ii) a shock treatment to get the public moving, kind of like Cramer screaming out Paddle, paddle!" to a market in cardiac arrest, or throwing chairs against the wall in his TV studio.

Yes this market could be cheerleaded higher for a couple months. And should the S&P 500 index move up a tiny bit higher from 1198 to say 1210, then I expect that to happen.

But if there is one thing I've learned from trading the capital markets over 40 years it's that the higher the high-risk buy, the bigger and faster will be the subsequent fall.

And the second thing I learned is that if, as and when everybody expects a market to move in one direction, it doesn't.

It's like trying to bring a cat to heel, which if you have ever owned a cat, you'll know who is boss. Animal owners who love that feeling of control choose dogs instead. And call them man's best friend" instead of man's best servant.

The markets are set up today, as before, to serve one master, which is Wall Street. It's just that today the way the game is played is a little different because of the circumstances leading up to the present time.

Posted by Posted by Bill Cara on October 30, 2005 07:20:15 AM | Category: Guide to Markets

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