High Frequency Trading, by D.R. Barton Jr.
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Are We Still in A Secular Bear Market?
by Van K. Tharp, Ph.D.
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Those of you who have been following my Tharp’s Thoughts newsletter since 2000 know that I said we entered into a secular bear market in that year. I have never said that we were out of it. My definition of a Secular Bear Market is the same as that of Ed Easterling (Crestmont Research) meaning a period of falling PE ratios. It could be inflationary (as was the 1966-1982 secular bear) or it could be deflationary (as was the 1929 -1944 secular bear).
I gave a short presentation on secular bull and bear markets in our recent Blueprint For Trading Success Workshop, and, as I saw a period of continual highs, I began to wonder if we were now in a secular bull market. After all prices were making new all-time highs since 2013, as shown in the 14 year monthly chart of SPY below.
For a larger version of this chart please Click Here.
The Case for the Secular Bear Continuing
The reason I had never concluded that the secular bear had ended was that none of the criteria for ending such a bear market had ever happened. First, this is the start of the 15th year and I was expecting this bear to last 15-20 years. So did it end at the low in 2009? Or when new highs occurred in 2013?
Second, secular bear markets end when the PE ratios of blue chip stock fall into single digit territory. Nothing like that has happened. In fact, the chart below shows what happened to the PE ratio of the S&P 500 since 2000. Notice that it had fallen to almost 10, but that it is now at 23 and that’s way above historical averages.
Third, secular bear markets end when the yield of blue chips stocks become extremely high like 5-7% and no one wants to touch stocks. I expected retirement plans to prohibit trading in stock and most mutual funds (which have to be 100% invested) to fold.
Finally, the fundamentals going on in the background are terrible and getting worse, although secular bears can have good fundamentals and vice versa. Right now, the debt of the US government is going up by a trillion dollars a year. And according to www.shadowstats.com, based upon the old CPI calculations, the US has been in a recession since 2000 with only one quarter in 2003 showing positive numbers. That chart is shown below. You can click on the chart to link to the original chart at www.shadowstats.com. Notice that when the GDP is adjusted for inflation using the CPI as it was calculated in 1980, only the 3rd quarter of 2003 is above zero. The rest are all below zero which means recession. The government, of course, only acknowledges a slight recession in 2008-9.
Based upon this data it’s difficult to suddenly say we’re now in a secular bull market.
The Case for the Secular Bear Ending
One can also make an important case for a secular bull market being in force.
First, as shown in the first figure, the S&P 500 has been making new all-time highs since 2013. Thus you could say that a secular bull started in 2013 or at the old low in 2009.
Secular bear markets typically occur during periods of high inflation or deflation. Right now it would be difficult to say what we have. First, the Federal Reserve has been pumping money into the system like crazy, but the normal stimulants have not been working because the bank’s money multiplier is less than one. Normally, this stimulation would cause high inflation. However, the CPI based upon the 1980 methods of calculating it, still shows double digit inflation and that’s why shadowstats.com argues we continue to be in a recession. In contrast, my inflation deflation predictor (given in each month’s market update) tend to show a deflationary predictor. So we can be meaning makers and give this any meaning we want.
Second, just based upon a contrarian effect, lots of people are predicting huge crashes. For example, Harry Dent is saying, based upon demographic data, that we are due for a huge deflationary crash that will start this year. Robert Prechter, who is continually wrong, says that numerous waves are aligning and that we are in for a megacrash. But, he has said that many times before and he predicted that 2007 was the end of a megalife cycle and would start the worst crash ever. Jim Rickards, who used to work for the CIA, is now saying that many US government intelligent agencies are predicting major economic problems in the near future (include the demise of the US dollar, cyberwar against the US economy, the decline of China, and many other negative factors).
In addition, on Feb 7th in a google search I found the following articles on market crashes:
Hill predicts a crash because: 1) the earnings consensus on the S&P 500 is expected to fall; 2) the PE ratio of the S&P 500 is still way too high (see the chart above); 3) the RBCCCM market sentiment index shows record optimism (see below); and lastly, 4) volatility is near historic lows.
And just to emphasize my point, here are more 2015 headlines about a market crash this year.
Another sign, despite the extreme optimism shown in the RBCCCM chart above, is the public is not participating in this market. In 2000 the book stores had rows and rows of bookcases stocked with investing/trading books. I visited a Barnes and Nobel bookstore yesterday (Feb 7th) and saw about 5 shelves of personal finance books (Kiyosaki, Orman, and the other usual suspects) and about five shelves on trading/investing books (several Jim Cramer books and Tony Robbins new bestselling being a good example of what the public is buying). People are not buying good trading books like Trade Your Way to Financial Freedom or Trading Beyond the Matrix in this market climate and they are not carried in the bookstores.
And finally, there is one sign that I expect near the bottom of a bear market. I learned last month that qualified investment plans (i.e., my major trading account included) are no longer permitted to use margin. This effectively eliminates all day-trading and swing trading strategies and shorting. That’s much of what I have done since that account was open. And now that type of trading is prohibited. In a bear market, I have to find alternative investments or just go to cash — no shorting allowed. Perhaps that’s what I was looking for in term of pension plans not being allowed to trade stocks.
So are we in a secular bull market or a secular bear market? Does it even matter?
My thoughts about Secular Bear markets came from two books that predicted the 2000 demise of the markets. They were Michael Alexander’s Stock Market Cycles and Ed Easterling’s Unexpected Returns. Ed owns Crestmont Research and calls his research “financial physics.” When I looked at his website, he still says we are clearly in a secular bear and none of his criteria for it ending are even close. He doesn’t pay attention to new market highs.
Let me summarize Ed’s conclusions published this year on his website. First, PE ratios of the S&P 500 stocks are at levels where bull markets end and bear markets begin. Dividend yields are also in the range where bull markets end and bear markets begin. The CPI is in a range where bear markets begin. And finally 20 year treasury yields are in a range where bull markets end and bear markets start. So he clearly says we’re in a secular bear market.
But does it really matter? Talking about investment cycles is a form of prediction. And while most people think this is important for investment success, I don’t. Instead, look at what the market is doing right now. When it’s going up, then buy. When it stops going up, then sell. And when it’s going down, go short or stay out. It’s that simple.
So if you want you could say that a new bull began in 2009 and that the secular bear lasted from 2000 through 2009. Or if you want, you could say that we’re still in a secular bear with expected declining PE ratios that will continue for some time. Or if you like, you could say that the public is not participating in the stock market but the market is going up because the Federal Reserve stimulus money (rather than going into the economy) is being used to invest in the stock market. These are all just beliefs. Pick the one that is most useful for you and realize the context in which it is useful.
About the Author: Trading coach and author Van K. Tharp, Ph.D. is widely recognized for his best-selling books and outstanding Peak Performance Home Study Program—a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.vantharp.com. His new book, Trading Beyond The Matrix, is available now at matrix.vantharp.com.
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High Frequency Trading
Two Charts That Tell You Everything You Need To Know
by D. R. Barton, Jr.
Several years ago, my son was playing golf for his high school team. It was early March and we still had a foot of snow on the ground here in Delaware (kind of like this year). So Josh (my son) and I decided it would be good idea to fly to Orlando and for a long weekend and get some quality rounds in to prepare for the golf season. The sacrifices that a loving father will make know no bounds!
While we were in Orlando, we wanted to visit Sea World. There were two reasons. First, we both love animals and we’d enjoy seeing the marine animals doing amazing things. Secondly, we both love roller coasters. But we didn’t know if we’d be able to see enough animal shows and ride enough roller coasters in an afternoon (we were there to play golf, after all).
Enter the wonders of the “Quick Queue Unlimited”. Sea World has an add-on pass that costs an additional $20 - $40, depending on the season, that allows you to go to the front of the line for the most popular rides (including all the roller coasters!). You know how long the lines can be for popular rides at these parks. The availability of this pass sealed the deal for Josh and me. We would spend Friday afternoon at Sea World.
And a glorious afternoon it was! Our first tipoff to how good this would be was the line for the window to buy our Quick Queue Unlimited, there was none. No one was willing to pay extra. Armed with our line-skipping passes, we hustled straight to one of the most popular roller coasters. There was a 55 minute wait, but not for us. We went to the front of the line, showed our passes and got on the next ride.
Awesome! But the scornful looks we got from those waiting in the slow line could melt icebergs. The two-tiered system was a boon for us. We rode as many roller coasters as we could stand, but was “salt in the wound” for those waiting in the normal line.
That is actually the perfect analogy for High Frequency Trading (HFT). HFT firms pay for faster access data, and use this two-tiered system to great advantage.
High Frequency Trading Firms – Earning Their Scornful Looks
High frequency trading is legal, but it’s certainly not fair. For smaller traders, the impact that HFT has is arguably minimal to modest for larger traders and institutions. The effect on a given trade can be much more impactful.
HFT strategies are quite secretive, but one of the key tools they use in many of those strategies is the ability to post (and remove) quotes (bid and offers to buy or sell contracts or shares) much faster than anyone else. This tool provides many opportunities, the ability to front-run big orders and the chance to grab easy liquidity-providing trades (for which they are paid by the exchange). The list is long. A chart provided by the folks at Nanex is very descriptive. You may remember Nanex as the data crunching firm that gave us so much insightful information about the Flash Crash back in 2010. Here’s the chart with comments below.
Over the past eight or nine years, HFT has grown by leaps and bounds. And on the CME, the effect has not been to raise the volume of trade (the orange line above), but to actually raise the volume quote activity more than ten-fold.
But because HFT firms account for 17-32% of exchange revenues, the exchanges are incentivized to support them.
An Unfair Advantage that Works
If Josh and I bought our line-skipping passes and still stood in line with everyone else, we would get no advantage. Or if we weren’t diligent enough to look for, find and use the bypass lane, our advantage would not benefit us.
But, as we shall soon see, HFT firms are using their advantage to make huge amounts of money. And not just that, so far, it seems to be almost risk free money. The chart below shows the real problem with HFT – the advantage they have is TOO BIG. No one should be able to make money 1,484 out of 1,485 trading days.
You read that right, only one losing day in a little less than six years of trading. The chart comes from the Virtu Financial S-1 filing with the SEC (and posted on zerohedge.com).
The bottom line? HFT is legal. It provides some general benefit to traders in most markets by reducing bid-ask spreads. And it is totally unfair. Since HFT arguably affects mom & pop investments less than institutional ones, regulators have been slow to act. But there is a clear need to level the playing field, at least a little bit.
Your thoughts and comments are always welcome - please send them to drbarton “at” vantharp.com – I always enjoy hearing from you!
About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured analyst on Fox Business’ Varney & Co. TV show (catch him most Thursdays between 12:30 and 12:45), on Bloomberg Radio Taking Stock and MarketWatch’s Money Life Show. He is also a frequent guest analyst on CNBC’s Closing Bell, WTOP News Radio in Washington, D.C., and has been a guest on China Central Television - America and Canada’s Business News Network. His articles have appeared on SmartMoney.com MarketWatch.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "vantharp.com".
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