April 21, 2014

Felix Salmon writes a good piece on Michael Lewis’s flawed new book (Flash Boys) [emphasis added]:

And he also mentions that while you used to be able to drive a truck through the bid-offer prices on stocks, pre-decimalization, nowadays prices are much, much tighter — with the result that trading is much, much less expensive than it used to be. Given all that, it stands to reason that even if the HFT shops are making good money, they’re still making less than the big broker-dealers used to make back in the day. But that’s not a calculation Lewis seems to have any interest in.

In his introduction to the book, Lewis writes this:

The average investor has no hope of knowing, of course, even the little he needs to know. He logs onto his TD Ameritrade or E*Trade or Schwab account, enters a ticker symbol of some stock, and clicks an icon that says “Buy”: Then what? He may think he knows what happens after he presses the key on his computer keyboard, but, trust me, he does not. If he did, he’d think twice before he pressed it.

This is silly. I’ll tell you what happens when the little guy presses that key: his order doesn’t go anywhere near any stock exchange, and no HFT shop is going to front-run it. Instead, he will receive exactly the number of shares he ordered, at exactly the best price in the market at the second he pressed the button, and he will do so in less time than it takes his web browser to refresh. Buying a small number of shares through an online brokerage account is the best guarantee of not getting front-run by HFT types. And there’s no reason whatsoever for the little guy to think twice before pressing the button.

And that emphasis, boys and girls, is the reason why there’s such a big fuss about High Frequency Trading. But don’t forget the lawsuits!

The stuff the complaint complains about, by the way, is mostly just what’s in “Flash Boys.” Basically it’s that high-speed traders trade faster than low-speed traders, via latency arbitrage or moving in reaction to orders in the market or co-location or direct data feeds or … there’s some weird stuff here, like an accusation that high-frequency traders trade in advance of index-fund rebalancing, which is just intelligently making use of public information but which these lawyers find objectionable.[Footnote]

[Footnote reads]:Like:

Most retirement savings, such as public and private pension funds or 401(k) and individual retirement accounts in the United States, are invested in mutual funds, the most popular of which are index funds which periodically “rebalance” or adjust their portfolio to account for current prices and market capitalization of the underlying securities in the stock or other index that they track. This allows trading algorithms to anticipate and trade ahead of stock price movements caused by mutual fund rebalancing, making a profit on advance knowledge of the large institutional block orders. This results in profits being transferred from investors to algorithmic traders, estimated to be at least 21 to 28 basis points annually for S&P 500 index funds, and at least 38 to 77 basis points per year for Russell 2000 funds.

I do not get it. Index rebalancing is public information. If you have a computer that does the math and calculates that people will be buying a lot of stock on an index add, and you buy some of that stock to profit from that calculation — what is illegal or fraudulent or whatever about that? This is not in the book, by the way; they came up with this on their own.

The old guard’s next line of attack might be best execution in a rebate environment:

Brokers entrusted with orders in the U.S. stock market can choose from dozens of exchanges and private venues. Some money managers such as T. Rowe Price Group Inc. (TROW) have told regulators that incentives offered by exchanges for attracting orders can put a broker’s financial interest at odds with the customer’s.

Brokers can face a conflict of interest as they select where to send customer orders. Brokers can either capture a rebate or pay a fee to an exchange depending on the type of order used, while private venues known as dark pools charge lower fees but don’t have to disclose how they treat customers.

While improved disclosure is helpful, the SEC should experiment with altering the economic incentives that affect how orders are handled, [T. Rowe Price head of equity trading Andy] Brooks said. T. Rowe has joined the New York Stock Exchange, Royal Bank of Canada and IEX Group Inc. in lobbying regulators to ban the “maker-taker” system, which pays rebates to large brokers to attract trades.

Brokerages often put their own self-interest in front of their clients’ under maker-taker, according to a study by Robert Battalio and Shane Corwin of the University of Notre Dame and Robert Jennings of Indiana University.

The linked study is titled Can Brokers Have It All? On the Relation between Make Take Fees & Limit Order Execution Quality:

We identify retail brokers that seemingly route orders to maximize order flow payments: selling market orders and routing limit orders to venues paying large liquidity rebates. Because venues offering high rebates also charge liquidity demanding investors high fees, fee structure may affect the arrival rate of marketable orders. If limit orders on low-fee venues fill when similarly priced orders on high-fee venues do not, routing orders to maximize rebates might not always be in customers’ best interests. Using proprietary limit order data, we document a negative relation between several measures of limit order execution quality and the relative fee level. Specifically, we show that when ‘identical’ limit orders are concurrently displayed on two venues, orders routed to the low-fee venue execute more frequently and suffer lower adverse selection. Using the NYSE’s TAQ data, we show that the negative relation between take fees and execution quality extends beyond our proprietary dataset.

The big problem in Europe is deflation:

Inflation in Europe has been in decline since late 2011, thanks to gruesome unemployment, excess manufacturing capacity, the weak recovery, falling energy prices and the rising euro. At last count, it was running at 0.5 per cent, well below the ECB’s [European Central Bank’s] target rate of slightly under 2 per cent. The question is whether 0.5 per cent is the bottom or close to it. The International Monetary Fund says that Greece alone will post a slightly negative inflation rate in 2014 and most economists forecast inflation at 0.9 per cent to 1.5 per cent for the euro zone his year, rising marginally next year.

The figures don’t suggest deflation is coming. Yet the ECB in its last governing council meeting signalled it was ready to haul out the heavy artillery. Besides another interest rate cut, the options include quantitative easing, in which the ECB would make large-scale purchase of government and private debt (more likely the former) to boost money supply, or charge banks a fee to park their funds at the ECB.

As soon as [ECB honcho] Mr. Draghi said the ECB was ready to launch son of “whatever it takes,” bond yields fell in the expectation that the ECB is about to buy every bond in sight. In the past month, the yields of Portugal’s 10-year dropped 0.7 of a percentage point, to 3.7 per cent, which is only one point higher than U.S. Treasury yields. Remember, this was a country on the verge of bankruptcy not long ago. Italy’s yields have slumped to 3.1 per cent. They were double that level, or higher, two or three years ago. Greece’s yields fell so far so fast – they’re now below 6 per cent – that the country considered the prime candidate to bolt from the euro zone in 2012 is back in the debt markets. Last week, it couldn’t keep up with demand for its new five-year bonds.

It’s always interesting to read how the competition is doing:

Merrill Lynch & Co. Inc. is dangling a new incentive in front of its brokers by creating a “recognition club” for those who bring in $8-million (U.S.) or more a year from clients, more than doubling the top goals set by its securities industry rivals.

The new “Pinnacle Club” will pay its members $10,000 in cash and additional benefits if they produce $8-million of revenue or build up five million of production credits.

Club membership also gives members bragging rights as elite brokers, the ability to advertise their status on their websites, and priority when accounts of departing brokers are redistributed or when customers are referred to the broker-dealer from other parts of Bank of America, according to a description of the recognition clubs in Merrill’s 2014 compensation booklet.

Brokers who qualify for Pinnacle as well as for Merrill’s seven lower-tier recognition clubs also can participate with their significant others in “Top Advisor Summits” that are usually held over several days in resort areas.

In reporting first-quarter earnings last week, Merrill said its 13,725 brokers were on target to produce an average of $1.06-million each this year, one of the highest averages in the brokerage industry. The average is skewed, however, by heavy hitters who could qualify for the new club. Fewer than 5,200 of its advisers had $1-million or more of production in 2013.

Treasuries are, on the whole, doing better than the Street expected:

One reason yields have fallen is the U.S. labor market, which has yet to show consistent improvement.

The world’s largest economy added fewer jobs on average in the first three months of the year than in the same period in the prior two years, data compiled by Bloomberg show. At the same time, a slowdown in China and tensions between Russia and Ukraine boosted demand for the safest assets.

Wall Street firms known as primary dealers are getting caught short betting against Treasuries.

They collectively amassed $5.2 billion of wagers in March that would profit if Treasuries fell, the first time they had net short positions on government debt since September 2011, data compiled by the Fed show.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts and FixedResets both gaining 9bp, while DeemedRetractibles were off 2bp. Volatility was not even technically existent. Volume was very low.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 -0.3455 % 2,399.0
FixedFloater 4.69 % 4.24 % 33,145 17.96 1 0.0989 % 3,660.0
Floater 3.03 % 3.17 % 50,576 19.31 4 -0.3455 % 2,590.3
OpRet 4.36 % -4.48 % 39,066 0.11 2 -0.0194 % 2,692.6
SplitShare 4.81 % 4.33 % 62,120 4.23 5 0.1352 % 3,087.8
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0194 % 2,462.1
Perpetual-Premium 5.54 % -6.95 % 108,684 0.09 13 0.0786 % 2,386.8
Perpetual-Discount 5.41 % 5.35 % 111,987 14.67 23 0.0934 % 2,491.0
FixedReset 4.68 % 3.69 % 194,754 4.33 79 0.0857 % 2,532.9
Deemed-Retractible 5.02 % -0.57 % 144,681 0.15 42 -0.0239 % 2,494.6
FloatingReset 2.66 % 2.44 % 180,893 4.25 5 -0.0080 % 2,481.6
Performance Highlights
Issue Index Change Notes
No individual gains or losses exceeding 1%!
Volume Highlights
Issue Index Shares
BNS.PR.X FixedReset 181,639 TD crossed 75,000 at 25.00; Scotia crossed 104,600 at 24.99.
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 24.99
Bid-YTW : 5.08 %
BAM.PF.E FixedReset 65,025 RBC crossed 49,800 at 25.05.
Maturity Type : Limit Maturity
Maturity Date : 2044-04-21
Maturity Price : 23.11
Evaluated at bid price : 25.01
Bid-YTW : 4.22 %
ENB.PR.Y FixedReset 57,412 Scotia crossed blocks of 35,000 and 15,000, both at 23.99.
Maturity Type : Limit Maturity
Maturity Date : 2044-04-21
Maturity Price : 22.70
Evaluated at bid price : 23.87
Bid-YTW : 4.23 %
BNS.PR.R FixedReset 45,751 Nesbitt crossed 40,000 at 25.68.
Maturity Type : Call
Maturity Date : 2019-01-26
Maturity Price : 25.00
Evaluated at bid price : 25.63
Bid-YTW : 3.25 %
FTS.PR.E OpRet 41,530 TD crossed 41,500 at 25.95.
Maturity Type : Call
Maturity Date : 2014-06-01
Maturity Price : 25.50
Evaluated at bid price : 25.94
Bid-YTW : -4.48 %
TRP.PR.E FixedReset 33,950 Nesbitt crossed 25,000 at 25.40.
Maturity Type : Limit Maturity
Maturity Date : 2044-04-21
Maturity Price : 23.24
Evaluated at bid price : 25.34
Bid-YTW : 3.92 %
There were 19 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
FTS.PR.F Perpetual-Discount Quote: 24.39 – 24.86
Spot Rate : 0.4700
Average : 0.2698

Maturity Type : Limit Maturity
Maturity Date : 2044-04-21
Maturity Price : 24.09
Evaluated at bid price : 24.39
Bid-YTW : 5.08 %

POW.PR.A Perpetual-Discount Quote: 25.11 – 25.48
Spot Rate : 0.3700
Average : 0.2584

Maturity Type : Call
Maturity Date : 2014-05-21
Maturity Price : 25.00
Evaluated at bid price : 25.11
Bid-YTW : 1.36 %

PWF.PR.H Perpetual-Premium Quote: 25.30 – 25.50
Spot Rate : 0.2000
Average : 0.1327

Maturity Type : Call
Maturity Date : 2014-05-21
Maturity Price : 25.00
Evaluated at bid price : 25.30
Bid-YTW : -10.24 %

ENB.PR.A Perpetual-Premium Quote: 25.40 – 25.64
Spot Rate : 0.2400
Average : 0.1758

Maturity Type : Call
Maturity Date : 2014-05-21
Maturity Price : 25.00
Evaluated at bid price : 25.40
Bid-YTW : -4.52 %

ENB.PF.A FixedReset Quote: 25.23 – 25.39
Spot Rate : 0.1600
Average : 0.1047

Maturity Type : Limit Maturity
Maturity Date : 2044-04-21
Maturity Price : 23.20
Evaluated at bid price : 25.23
Bid-YTW : 4.25 %

BNS.PR.R FixedReset Quote: 25.63 – 25.84
Spot Rate : 0.2100
Average : 0.1575

Maturity Type : Call
Maturity Date : 2019-01-26
Maturity Price : 25.00
Evaluated at bid price : 25.63
Bid-YTW : 3.25 %

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