What Business Is Wall Street In?...Or Bay Street?

Wall Street doesn't know what business it is in. Regulators don't know what the business of Wall Street is. Investor/shareholders don't know what business Wall Street is in.

The only people who know what business Wall Street is in are the high frequency and automated traders. They know what business Wall Street is in better than everyone else. To traders, whether day traders or high frequency or somewhere in between, Wall Street has nothing to do with creating capital for businesses, its original goal. Wall Street is a platform. It's a platform to be exploited by every technological and intellectual means possible.

The best analogy for traders? They are hackers. Just as hackers search for and exploit operating system and application shortcomings, high frequency traders do the same thing. A hacker wants to jump in front of your shopping cart and grab your credit card and then sell it. A high frequency trader wants to jump in front of your trade and then sell that stock to you. A hacker will tell you that they are serving a purpose by identifying the weak links in your system. A trader will tell you they deserve the pennies they are making on the trade or the rebate they are getting from the exchange because they provide liquidity to the market.

I recognize that one is illegal, the other is not. That isn't the important issue.

The important issue is recognizing that Wall Street is no longer serving the purpose that it was designed to. Wall Street was designed to be a market to which companies provide securities (stocks/bonds), from which they received capital that would help them start/grow/sell businesses. Investors made their money by recognizing value where others did not, or by simply committing to a company and growing with it as a shareholder, receiving dividends or appreciation in their holdings. What percentage of the market is driven by investors these days?

I started actively trading stocks in 1992. I traded a lot. Over the years I've written quite a bit about the market. I have always thought I had a good handle on the market. Until recently.

Over just the past five years, the market has changed. It is getting increasingly difficult to just invest in companies you believe in. Discussion in the market place is not about the performance of specific companies and their returns. Discussion is about macro issues that impact all stocks. And those macro issues impact automated trading decisions, which impact any and every stock that is part of any and every index or ETF. Combine that with the leverage of derivatives tracking companies, indexes and other packages or the leveraged ETFs, and individual stocks become pawns in a much bigger game that I feel increasingly less comfortable playing. It is a game fraught with ever increasing risk.

So back to the original question. What business is Wall Street in?

Its primary business is no longer creating capital for business. Creating capital for business has to be less than one percent of the volume on Wall Street in any given period. (I would be curious if anyone out there knows what percentage of transactions actually return money to a company for any reason). It wouldn't shock me that even in this environment that more money flows from companies to the market in the form of buybacks (which I think are always a mistake), than flows into companies in the form of equity.

My two cents is that it is important for this country to push Wall Street back to the business of creating capital for business. Whether it's through a use of taxes on trades (hit every trade on a stock held less than one hour with a 10 cent tax and all these problems go away), or changing the capital gains tax structure so that there is no capital gains tax on any shares of stock (private or public company) held for one year or more, and no tax on dividends paid to shareholders who have held stock in the company for more than five years. However we need to do it, we need to get the smart money on Wall Street back to thinking about ways to use their capital to help start and grow companies. That is what will create jobs. That is where we will find the next big thing that will accelerate the world economy. It won't come from traders trying to hack the financial system for a few pennies per trade.

And solutions won't come from bureaucrats trying to prevent the traders from hacking the system. The only certainty when bureaucrats step in is that the law of unintended consequences will smack us all in the head and the trader/hackers will find new ways to exploit the system that makes them big money and even more money for the big institutions that develop products for the other institutions that are desperate to play the game.

Regulators have got to start to recognize that traders are not investors and vice versa and treat them differently. Different regulations. Different tax structure. Different oversight. Individual investors and the funds that just invest in stocks and bonds are not going to crash the market. Big traders who are always leveraging up and maximizing the number of trades/hacks they make will always put the system at risk. We need to recognize that they do not serve much of a purpose other than to add substantial risk to the global economy. That their stated value add of liquidity does not compensate the U.S. and world economy nearly enough for the risk of collapse they introduce into the system.

Wall Street as a whole needs to be in the business of creating capital for companies and selling shares to investors who believe they are shareholders. The government needs to create simple and obvious incentives for this business and extract compensation from the traders/hackers for the systemic failure risk they introduce.

There will be another flash crash, and probably a crash far worse than the May 2010 flash crash simply because there are too many players looking for the trillion dollar score. They can't all win, yet how many do you think wouldn't risk everything, even what is not theirs, for that remote chance to score big? Put another way, there is zero moral hazard attached to any trade. So why wouldn't traders take the biggest risk possible?

There is value to trading automation. It is here to stay. There is absolutely NO VALUE to high frequency trading. None. We need to bring our markets back to their original goals of creating capital for business. It's impossible to guess how many small to medium size companies have been held back from growing and creating jobs and wealth because of lack of access to capital from the stock market. It's not impossible to know that our economy has suffered because Wall Street equity markets are no longer a source of equity for helping companies grow, it is not a platform for hackers and that needs to change. Quickly.

Cross-posted from Blog Maverick.

Mining deals drop as commodity prices fall

• BY:SARAH-JANE TASKER 
• From:The Australian 
• September 22, 2012 12:00AM

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MINING deals have been hit by the fall in commodity prices and negative market sentiment and the lower trend is tipped to continue for the remainder of the year.

In the first half of 2012, global merger and acquisition activity fell more than 30 per cent and, excluding the Glencore and Xstrata merger, the value of transactions dropped to $25 billion, one-third of the 2011 first half-year total, according to a report from PricewaterhouseCoopers.

Jock O'Callaghan, PwC's Australian energy, utilities and mining leader, said domestic activity mirrored the global themes, but it was likely to be felt more acutely here given the importance of the sector to the nation's economy.

"We are still an attractive destination for investment, but there are fewer enthusiastic and well equipped buyers," he said.

"When you add in all the other factors, deals are getting harder to do and we don't think there is much on the horizon that is going to shift that sentiment to make deals easier to do."

He said while there were a lot of "bargain hunters" in the market looking for a cheap deal, he did not think there were a lot of keen sellers locally.

"The short-term outlook will have a big impact on sentiment and equity values, but that doesn't equate to long-term views on value," he said.

"The bargain hunters can often be disappointed."

Mr O'Callaghan said that two to five years ago, companies were focused on getting bigger and better, but now they were "battening down the hatches". The focus was on operating expenditure and productivity.

"It would take a lot of courage for buyers to go out with a company-defining transaction given the uncertain sentiment around prices and costs," he said.

"No matter how compelling strategically a transaction may be, it is very hard to convince the board and the market the merits of doing a deal right now."

The report found there were 940 transactions recorded in the first half of 2012, compared to 1371 for the same period in 2011, which was the busiest half year for deals in the mining sector's history.

"Volatile capital markets and global economic uncertainty are to blame for this significant drop in activity," the report concluded.

Mr O'Callaghan said that, from a buyer's perspective, there were very few companies who were well equipped with the financial horsepower to do deals quickly.

"As we have seen, when deals are done with a long gestation period many things can shift dramatically and the value equation can shift," he said.

"Very few can go out and cut a cheque and make a deal happen."

The report found that all signs point to a slow second half of 2012 for M&A in the global mining sector and another mega deal is unlikely given market fears.

Mr O'Callaghan said the most important indicator of transaction sentiment was the middle-sized deals. The mid-sized deals were a sign of a very confident market.

He said the market was void of such deals and that, while there were likely to be some potential sellers under pressure to perform, it would not drive deal activity in the second half of this year.

"If you are sitting as a seller under some pressure, you'd rather try and ride out this part of the cycle than give away the crown jewels," he said. "Those that are under some pressure to do something in Australia are a small number and that adds to our feeling that there is not going to be any deals of any real magnitude done."