In a number of previous blogs I warned about the dangers of stock market investment- from market timing tricks used by big institutional investors, to the presence of unregulated derivatives, to the fact that we are in the midst of another stock bubble which bursting could have worse consequences than the last episode (tied to the credit default crisis) in 2008. This bubble is tied directly to the Fed's continued low interest rates (~ 0.25%) which creates a "cheap money" surplus that entices much more risk as well as speculative recklessness.
The good news is many investors, especially with 401ks needed for retirement, are playing it safe this time, despite incessant cajoling and pressure from the usual suspects (business cable networks, Wall Street Journal stock humpers, financial pundits at the major networks) to “get off the sidelines”. As usual, many of these cite the inflation risk to keeping money in minuscule interest earning instruments such as CDs and money market accounts. (Not money market funds, since those aren’t FDIC-insured, though they are also earning pitiful interest).
As we all know and understand, yearly inflation – even at say 2%- will quickly eat up returns averaging barely 1.3% (For example, in the money market account I am currently in.) Over time, losses pile up. Thus, a $10,000 1-yr. CD earning 1% a year interest ($100) will lose $200 to inflation, for a net loss on that account of ~ $100 per year. (If the CD is rolled over and the conditions not changed). Thus, the following year, one commences with $9,900 and the net loss is:$200 – 99 = $101 etc., and that’s assuming no increase in inflation.
For bank savings and checking accounts the losses can be much greater, mainly because they pay a pittance in interest. In one of my (joint) bank CDs the interest is about 0.0025% a year, meaning I’m getting taken to the cleaners via inflation. However, I keep the (low amount) CD because it means I have to pay no bank fees at all. Sure I could look for a credit union or such, but that would be wasteful of energy – since this bank is only a block away and one can use the “two foot express” as opposed to driving eight miles to the nearest credit union each time. (As for online banking, sorry, don’t trust their systems! Despite all their soothe-saying and assurances, too much potential to be hacked!)
Anyway, the bottom line is one takes the risks where they make most sense to him. My question is this: Which makes more sense, losing $500-$1000 a year to inflation from all one’s fixed interest accounts, or losing $50,000- $100,000 in a large and even well diversified stock account? I say the former tableaux makes much more sense, since to lose the latter will likely mean taking years to reach the break even point.
As the DOW now climbs toward 12,000 many think they’ll make back what they lost in 2008, but they’re living in a fool’s paradise. First, as PARADE resident genius Marilyn vos Savant once pointed out in answer to a question, the market volume is geared so that only 10-15% can redeem in time and make their money back. All the rest will lose. This also applies to stock mutual funds. The reason is that most of the stock inflation and pump up is due to high P/E ratios, while REAL money is poured in to purchase them. In effect, one is gambling using his real, hard earned bread that he will hit the P/E high note and get that money out without suffering losses. Think again!
Most big institutional investors from pension fund holders to corporations use some form of market timing to get the news of companies’ stocks and their “bottom lines” before the little guy can read about it in the Wall Street Journal (usually the following day).
Now, with high frequency trading(HFT), it’s much worse. Because of the nature of the trades, buyers (or sellers) can know what you’re doing and react to it almost before you can get to a telephone to call your broker. HFT allows one group of investors to see the data on other people's orders ahead of time and use their supercomputers to buy in front of them. It's called front-loading, and it goes on every day.
In an interview on CNBC, HFT-expert Joe Saluzzi was asked if the big HFT players were able to see other investors orders (and execute trades) before them. Saluzzi replied:
"Yes. The answer is absolutely yes. The exchanges supply you with the data, giving you the flash order, and if your fixed connection goes into their lines first, you are disadvantaging the retail and institutional investor."
So, with HFT even the “big guy” (institutional investor) is placed in a marginal position in terms of the capacity to say redeem the stock phantom money (usually based on a very high P/E ratio) and capture actual real money at the cash out end.
Does this even begin to paint the warp and woof of the problem? Nope! Here’s another newsflash for the ordinary, non-HFT pipsqueaks still in stocks or considering them: The deep-pocket bank/brokerages actually pay the NYSE and the NASDAQ to "colocate" their behemoth computers ON THE FLOOR OF THE EXCHANGES so they can shave off critical milliseconds after they've gotten a first-peak at incoming trades. It's like parking the company forklift in front of the local bank vault to ease the transfer of purloined cash.
How can a new buyer be affected, for example? In a recent post, ‘Zero Hedge’ blogger Market Ticker explained some fine-points of HFT, such as, how the banks/brokerages probe the exchanges with small orders in order to find out how much other investors are willing to pay for a particular stock. He asserted:
"Let's say that there is a buyer willing to buy 100,000 shares of Broadcom with a limit price of $26.40. That is, the buyer will accept any price up to $26.40. But the market at this particular moment in time is at $26.10, or thirty cents lower."
So the computers, having detected via their "flash orders" that there is a desire for Broadcom shares, start to issue tiny "immediate or cancel" orders - IOCs - to sell at $26.20. If that order is "eaten" the computer then issues an order at $26.25, then $26.30, then $26.35, then $26.40. When it tries $26.45 it gets no bite and the order is immediately canceled.
Now the flush of supply comes at $26.39, and the claim is made that the market has become "more efficient." Balderdash! In fact, there was no "real seller" at any of these prices! This pattern of offering was intended to do one and only one thing - manipulate the market by discovering what is supposed to be a hidden piece of information - the other side's limit price!
With normal order queues and flows the person with the limit order would see the offer at $26.20 and might drop his limit. But the computers are so fast that unless a buyer owns one of the same speed devices, his order is immediately "raped" at the full limit price! Losses like this can pile up, and we aren’t even looking at the “sell” end which is often more critical if little guys need to get their moola out in a hurry so junior can go to college, or to pay off medical bills or whatever.
Again, my best advice? Stay out of the stock market unless you have money you can afford to lose. Especially with all the literal gaming still going on, and the fact that unregulated derivatives still pervade stocks and we all saw what those can do!
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