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Posted 28 October 2010 - 01:58 PM

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HOME OF "PICTURES OF A STOCK MARKET MANIA" October 27, 2010
Alan M. Newman's Stock Market CROSSCURRENTS
Alan M. Newman, Editor

Excerpts from our October 25th issue


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Rationales & Targets

Last time out, we estimated that the cash-to-assets ratio for mutual funds might have fallen to 3.3%, which would be another new record. However, in the last two weeks another $6 billion has come out of domestic funds. Since asset prices are higher, it is possible the ratio may have fallen to 3.2% as of today, by far the lowest in history. Can there be any question about the levels of optimism and complacency shown by fund managers? There is tremendous risk present, if only for the reason that funds have no cushion if prices were to suddenly head south. This is quite similar to the environment in March 2000 and October 2007. The foreclosure mess threatens to develop into another new economic crisis. The action in most financials (save for Goldman Sachs) implies risks to investors in U.S. stocks are still intolerably high. For months, we have targeted October 23rd as a very important low. Given the extent of our error, we now believe the October 21st print high was instead, a very important high. At the risk of sounding like a broken record, we expect a significant correction.


SPECIAL SHORT TERM OFFER
YOUR COST IF YOU RENEW FOR A YEAR = ZERO! Theater Of The Absurd

The Wiki's explanation of Theater of the Absurd claims authors "expressed the belief that, in a godless universe, human existence has no meaning or purpose and therefore all communication breaks down." Sounds like a perfect description of HFT and the flash crash. If there is any piece of news that highlights the absurd extent to which the absurd nature of trading has metamorphosed, it was the recent revelation that two Norwegians outwitted the automated trading platform of a U.S. broker to trade Norwegian shares and were fined and one was actually jailed. Never mind that the algorithms used by U.S. quants similarly attempt to predict prices from trading patterns, and allow them to profit thereby, but when humans do the same, they may be blamed for manipulation. Despite computer algorithms that are permitted to manipulate the market by spitting out thousands of bids or offers in mere seconds with absolutely no intention to buy or sell, at least Norwegian humans are confined to posting legitimate bids and offers. However, it is increasingly clear that in the U.S., computers are allowed to venture where humans may not. According to the Financial Times article (available via CNBC, http://tinyurl.com/248uss5), prosecutors said the pair "gave false and misleading signals about supply, demand and prices," precisely the same complaint that has been made about high frequency trading in this country.

In another absurd development, the SEC finally got around to pointing their collective fingers and laid the blame for the flash crash at the feet of Waddell & Reed, not exactly a household name. We're not certain how much W&R has under management but we have seen figures as high as $70 billion, roughly one-half of one percent of total U.S. market cap. Bear in mind W&R's assets under management presumably include other categories as well, such as bonds. Clearly, W&R have clout, but believing that they can be responsible for lopping $800 billion off total stock market cap in mere minutes is quite a stretch. The SEC's complaint details a hedge in which W&R dumped 75,000 E-Mini contracts valued at $4.1 billion at 2:32 pm on May 6th, just as things were beginning to get quite dicey. A cogent analysis of the details is provided by Tyler Durden of Zero Hedge (see http://tinyurl.com/328o6yl and http://tinyurl.com/28oz5ez). Durden logically makes the point that, if anything, the SEC's report simply underscores a continuing fiasco; "HFT's dominance in the market and its ability to pull all bids whenever desired, will lead to ever more market crashes."

HFT is believed to now comprise 70% of all transactional volume. During the tech mania, when the lemmings arrived by the millions to march over the cliff and $310 billion entered equity mutual funds, program trading was only 10% of NYSE volume and total dollar trading volume (DTV) was $32.6 trillion. Over the last 12 months, while funds have suffered net outflows, program trading is averaging over 30% of NYSE volume and DTV has doubled. Holding times of milliseconds ensure that valuations never enter the picture. We're astonished that the SEC can blame a single hedge. Manoj Narang of Tradeworx, a team of quants whose computers trade 40 million shares a day, put it best, when he recently told 60 Minutes correspondent Steve Kroft that their algorithms don't know or care whether a company is well managed (see http://tinyurl.com/2egwzbs). "It doesn't know who the CEO is or what that CEO's background is. Doesn't know the management team," Narang says. Obviously, programs and algorithms do not even give a fig what earnings or prospects will be. Truly a theater of the absurd.

Insiders See Great Value.... In Cash

Every once in a while we take a look at insider activity in an attempt to gauge the confidence corporate execs have for the future of their own companies. Typically, in the past, we have examined the top ten companies in the Nasdaq 100 in one issue, then a couple of months later, we look at the retail stocks and then another couple of months later, we examine what insiders are doing in the Semi sector. On rare occasion, we have even tallied insider activity for all 30 Dow stocks. Of course, sellers are always more prevalent than buyers because compensation is based partially on options granted, vested and then later sold. As well, dividends have pretty much gone by the wayside, so any impetus to hold onto shares has been dramatically reduced. The fact is, as more options have been granted over the years, insiders have had the ability to retain their original holdings or even increase them, all while diluting the holdings of all other shareholders, mutual funds and individuals alike by selling portions of their holding. A very strange game.

We were pondering the subject for our lead article in this issue when we realized we hadn't covered insider activity in quite awhile. Thus, our first step was to tally how insiders felt about the top Nasdaq companies. We show only nine of the top ten here simply because one of the ten largest, Teva Pharmaceutical (TEVA), is not an American company and has no insider transactions listed in our database. Of the nine remaining, the chart below represents the worst showing we have seen since we began doing this exercise at least ten years ago in the midst of the tech mania. Yahoo's stats show 238 sellers and only 2 buyers over the last six months, a ratio of 119 sellers for every buyer. Moreover, share purchases totaled a mere 9500 against a stunning total sold of 88.9 MILLION, a ratio of 9354 shares sold for every share purchased. Despite the apparent revulsion insiders have for their own shares, Wall Street's analysts are quite complacent and only a bit more than 5% of all recommendations for these stocks are on the sell side. If the future is so bright, why are insiders selling so heavily?

We always prefer to check the data as thoroughly as possible, thus we also visited Bloomberg's weekly tally online to ensure that insiders were still exiting their shares recently as well as over the entire six month timeframe of Yahoo's stats. The list at http://tinyurl.com/36s8j3b proved enlightening and instructive. While the ratios were not quite as awesomely frightening as the three sectors we illustrate today, this broad representation of frantic dumping is nevertheless indicative of where the true value lies for corporate insiders—cashing out their own shares. There were only four buys versus 72 sales. Less than 28,000 shares were purchased for $509,000 but 8.47 million shares were sold for a grand total of $332.1 million. For every dollar spent on buying shares, $652.46 was realized as a result of a sale. It would be a heck of a stretch to believe any of the proceeds were headed back into stocks. Clearly, with $76 billion exiting mutual funds since the end of April, it is clear insiders are not interested in U.S. stocks. Frankly, given the background of the economy and high frequency trading (HFT), we can certainly understand why.

EDITORS NOTE: THE REMAINDER OF THE ABOVE ARTICLE IS AVAILABLE IF YOU QUALIFY FOR OUR FREE TRIAL. SEE BANNER BELOW.

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Powerful Commentary. Unique Perspectives.



ABOUT ALAN M. NEWMAN

Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.

The newsletter is published roughly every three weeks and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.

Subscription rates are now $189 for one year and $100 for six months. A FREE 3 issue trial subscription is available by emailing us (click the "free trial" link above). Please note: trial requests must include name, address and phone number and must originate from the email address the trial is to be delivered. Trials are only available by Email (.pdf files). U.S. Mail subscriptions are available but include a nominal surcharge for postage and handling.