HFT Purge Begins: SEC Prepares To "Remove" Some High Frequency Trading Firms
Submitted by Tyler Durden on 04/13/2014 09:47 -0400
Ever since Goldman's anti-HFT Op-Ed less than a month ago, and since the even more recent full-hearted support by Goldman of Michael Lewis' most recent entry into the anti-HFT crusade (one promoting the Goldman-supported IEX exchange), one thing has been clear: the days of market structure in its current format are numbered. This was further confirmed after Goldman exited both its legacy Spear Leeds & Kellogg designated market making post at the NYSE, and is said to be winding down its market-dominating dark pool, Sigma X.
It also means that our 5 year crusade against HFT - not because we want it replaced with a different, Goldman-backed exchange but because HFTs inherently destabilize the market (see May 2010 and the now daily flash crash in individual stocks and/or exchanges) - and specifically those most profitable but also most parasitic and predatory HFT strategies...
... is coming to an end, with both the DOJ, FBI and SEC finally paying attention.
Sure enough, Post reports that just three weeks after the Gary Cohn Op-Ed, the SEC is "preparing to remove some high-frequency trading firms."
The crackdown begins:
In a purge of computerized markets, prompted by public outrage unleashed by Michael Lewis’ “Flash Boys,” the SEC’s campaign will see numerous enforcement actions, new rules and new business practices — a sweeping overhaul that could benefit the beleaguered New York Stock Exchange, The Post has learned.“You’ll probably see the commission coalesce around those enforcement cases and then bring new rules on high-frequency trading,” a source with knowledge of the SEC’s thinking told The Post. “There’s a lot of pressure on the SEC to act.”
More importantly, the broken maker/taker model, i.e., in which HFTs are paid rebates for "liquidity providing" limit orders, even if these are merely frontrunning of large block orders, is about to be overhauled:
Intense lobbying by the NYSE’s owners, IntercontinentalExchange Group (ICE), for reform of the controversial “maker-taker” rebate rule for buying or selling shares is likely to get more sympathy. The rule’s abolition or amendment, seen as increasingly likely, would help reverse NYSE’s losses to rivals who have taken volume with their better pricing.“Back in the day, we used to call it pay to play (now it is called maker-taker), and we used to vigorously fight against it,” said NYSE floor trading vet Doreen Mogavero. “You know, the practice was originally devised by Bernard Madoff — need I say more?”The source familiar with SEC thinking says the NYSE could get a boost as regulators force out dodgy players among the market’s 45 secretive dark pools, 200 “internalizers” and 13 public exchanges. But it might also be a mixed blessing.“Yes, some high-frequency guys are going to be taken out of the game, but the NYSE might get rules they don’t care for,” the source said. “The ability of exchanges to develop and [profit] from special-order types is going to be stopped — and this exchange business of selling direct data feeds is going by the wayside.”
It's not just HFTs, bur dark pools are about to fall under the spotlight:
The SEC is also mulling a trial run for a so-called trade-at rule, requiring brokerages and dark pools to send their orders to the NYSE, Nasdaq and other public exchanges unless better stock prices occur elsewhere, sources say.
The confirms what Reuters reported several days ago when it said that "U.S. securities regulators are considering testing a proposed reform that could drive business to major stock exchanges and away from alternative trading venues such as "dark pools" that critics say may be hurting investors by reducing the quality of pricing."
The proposal, which has so far only been discussed among staff involved in policymaking at the U.S. Securities and Exchange Commission, could limit how much trading occurs inside brokerages and in dark pools, according to people familiar with the matter.The measure aims to address a concern among some regulators and academics about the increasing level of trading that happens outside of exchanges.They say that the amount of trading being done in the "dark" means that publicly quoted prices for stocks on exchanges may no longer properly reflect where the market is, meaning that investors may not be getting the best prices for their trades.
One can keep reading here, or merely glance the graphic below to see how much trading has moved from lit exchanges ever since Reg NMS to dark venues. In short: unlit has lost a stunning 40% of volume as increasingly more traders seek to avoid being frontrun by the HFT parasites.
Why is all this happening? Because as everyone should know by now, what Goldman wants, Goldman gets. And Goldman wants a complete overhaul of a market that is systematically broken. Our only question is can this overhaul take place without an epic market rout as the HFTs suddenly all go into "Off" mode as their 25 year old math PhD operators look for greener pastures (and to get the hell out of Dodge before the subpoenas come flying in).
"Shadows Of March 2000" - Goldman On The Great Momo Crash Of 2014
Submitted by Tyler Durden on 04/12/2014 17:47 -0400
Behold the great momo basket which after being the source of so much joy for momentum chasers over the past year, has mutated into the source of so much sorrow over the past two weeks.
We have bad news for hedge funds who, like Hugh Hendry in December of last year,threw fundamentals and caution to the wind and, with great reservations, jumped into this momo bandwagon in which mere buying beget more buying until nobody knew why anyone bought in the first place... and then everything crashed, leading to the worst day for hedge funds in a decade: according to Goldman's David Kostin, whose job is to be a cheerleader for the intangible "wealth effect" leading to all too tangible Goldman bonuses: "The stock market will likely recover during the next few months... but not momentum stocks."
Behold the (not so) great Momo crash of 2014:
First the bad news: according to Goldman not only will the momo stocks not rebound to previous highs and resume their leadership role, but clients increasingly are wondering if this is the second coming of the dot com bubble burst.
Conversations we are having with clients: Momentum reversal and the shadow of 2000Our client discussions this week focused on two topics: Momentum reversal and comparisons between today and March 2000. Two questions dominated: “When will the reversal end?” and “Will the sell-off in momentum stocks drive a market-wide price decline as occurred in 2000?”During the past month, momentum has plunged by 7%, a 10th percentile ranking of all monthly momentum returns since 1980. We define “momentum” as the relative performance of the best vs. worst performing S&P 500 stocks during the prior 12 months. We identified 46 similar distinct 10th percentile “drawdowns” with an average one-month return of -8% and a cumulative -10% return during six months.Historical experience suggests the S&P 500, but not momentum, will likely recover during the next few months. Following the drawdowns, S&P 500 posted a 6-month return averaging +5% and delivered a positive return 70% of the time. Momentum declined by a further 4% on average, and 60% of the time the stocks posted a negative return.Analysis of historical trading patterns around momentum drawdowns shows: (a) roughly 70% of the reversal is behind us following a 7% unwind during the last month; (b) an additional 3% downside exists to the momentum reversal during the next three months if the current episode follows the average historical experience; (c) if the pattern followed the path of a 25th percentile event a further 7% momentum downside would occur, or about double the reversal that has taken place so far; and (d) whenever the drawdown ends, momentum typically does NOT resume leadership. The best performing stocks during the 12 months leading up to the start of the drawdown do not subsequently outperform (see Exhibit 2).
So what are the good news? Well, Goldman is bullish on the non-MOMO stocks, which it sees as rising during the next 6 months by, if history is any precedent, 5%. Of course, the market merely regaining its all time highs by October will hardly please the investor community which is used to 20%+ return year after year. After all someone must benefit from the Fed's ludicrous actions.
S&P 500 Index performance during 46 momentum reversals since 1980 suggests the broad market will likely rise steadily during the next six months by an average of 5%. Based on a current S&P 500 index level of 1815, a 5% rise would lift the index to just above 1900 which is our year-end 2014 forecast. A 25th percentile trajectory implies a flat equity market during the next six months while tracking at the 75th percentile would see S&P 500 climb by 15% to 2090 by the end of 3Q (see Exhibit 3).
But most interesting is Goldman's attempt to deny that this is the second coming of March 2000:
One historical momentum drawdown has come up repeatedly in recent conversations with clients: March 2000. The current sell-off in high growth and high valuation stocks, with a concentration in technology subsectors, has some similarities to the popping of the tech bubble in 2000.Veteran investors will recall S&P 500 and tech-heavy Nasdaq peaked in March 2000. The indices eventually fell by 50% and 75%, respectively. It took the S&P 500 seven years to recover and establish a new high but Nasdaq still remains 25% below its all-time peak reached 14 years ago.We believe the differences between 2000 and today are more important than the similarities and the recent momentum drawdown is unlikely to
precipitate a more extensive fall in share prices:
- Recent returns are less dramatic. Although the trailing 12-month returns are similar (22% today versus 18% in 2000), the trailing 3-year and 5-year returns are much lower (51% vs. 107% and 161% vs. 227%, respectively).
- Valuation is not nearly as stretched. S&P 500 currently trades at a forward P/E of 16x compared with 25x at the peak in 2000. The price/book ratio is 2.7x versus 6.Xx. The EV/sales is currently 1.8x compared with 2.7x in 2000.
- More balanced market.The reason it is called the “Tech Bubble” is that 14% of the earnings of the S&P 500 came from Tech in 2000 but it accounted for 33% of the equity cap of the index. Today Tech contributes 19% of both earnings and market cap. Top five stocks in 2000 were 18% vs. 11% today.
- Earnings growth expectations are far less aggressive.Bottom-up 2014 consensus EPS growth currently equals 9%, close to our top-down forecast of 8%. In 2000, consensus expected EPS growth equaled 17%.
- Interest rates are dramatically lower. 3-month Treasury yields were 5.9% in 2000 vs. 0.05% today while ten-year yields were 6.0% vs. 2.7% today. The yield curve was inverted by 47 bp. Today the slope equals +229 bp.
- Less new issuance.During 1Q 2000, 115 IPOs were completed for proceeds of $18 billion. In 1Q 2014, 63 completed deals raised $11 billion.
All great points, yet one thing is conspicuously missing and perhaps Goldman can clarify:
- how much debt as a percentage of global GDP was held by the world's major central banks then and now, and
- how much consolidated global leverage, including shadow banking in both the US and China, as well as how many hundreds of trillions of derivatives notional outstanding existed then... and now
Because one can just as easily make the case that as the global financial house of cards, teetering since the great financial crisis of 2008, and upright only thanks to the explicit "wealth effect" support of the final backstop - the world's money printers - any protracted downward move which implicitly crushes the faith in the monetary religion, and crushes the uber-leveraged smart money community, will make the "drawdown" in both momo and S&P500 stocks in March 2000 seem like a pleasant walk in the part compared to what may be coming.