Banks & Transports Still Tired. Modest Pullback Here.

Last Friday, I discussed what appeared to be tired behavior in the banks as they were selling off on good earnings news after rallying sharply into earnings season. Citigroup and JP Morgan were the examples. This morning, Goldman Sachs and Morgan Stanley beat earnings expectations, yet reaction has been muted with the former opening sharply higher and then selling off while the latter is hanging tight. I would not be surprised to see Morgan Stanley buck the trend in the short-term and finish better than its peers have.

Another one of my key sectors, transports, is following through to the downside after seeing its own “key reversal” last week, another sign of a tired sector. While I am not looking for a substantial decline in either sector, I do believe the upside is now capped and the best case is some sideways activity for a few weeks.

On the stock market index side, I continue to be of the opinion that an October pullback remains in the cards as I have discussed for the past few weeks. Nothing big or traumatic. Just a modest, single digit bout of weakness. On Monday with new highs in the Dow and S&P 500, there were more stocks declining than advancing on the NYSE. That comes off an all-time on Friday in the NYSE A/D Line. While one day does not amount to much, it does support my over theme of a slightly tired market.

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Flash Crash II – HFT and Computers Run Amok… AGAIN

Well that was certainly fun on Monday! Stocks crashed 1100 points at the open, rallied 800 points and the fell almost 300 points to close down 588 points. Given yesterday’s full Street$marts edition and the two blog posts I did here, I am sure most people were expecting a market update. After all, I did offer 3 Scenarios for Monday’s Trading and the market did end up following scenario number one the most. I will get to the market in a subsequent post. Of note, almost every single interview I saw and comment I read called for “staying the course” or not selling. I guess those were the same folks who told investors that all was well over the previous few months as the major indices peaked. Hmmm…

It’s not a topic I often mention, but from my seat, the system was clearly broken in the first half hour and the computers ran amock. It was beyond embarrassing and ridiculous, AGAIN. Just like we saw in May 2010, this was a second Flash Crash. NYSE and NASDAQ? Goldman Sachs, Citadel, Merrill Lynch and Virtu? You can hear crickets from the cats who ate the canary.

As someone who had forecast and was positioned for the correction, I was chomping at the bit to deploy some cash. Without any widespread firsthand knowledge, I believe that High Frequency Trading or HFT was responsible, not for the whole stock market decline, but for the quick acceleration and pricing dislocations or anomalies. Remember, HFT thrives when markets are volatile and liquid. Not so much in quiet and less volatile markets.

What I did see firsthand was enough small orders of less than 100 shares early in the day to make me believe that the computers were out of control as one of the footprints of HFT is odd lot trading or orders less than 100 shares. Let’s add in the outrageous pricing in the opening few minutes that went away quickly enough that I couldn’t even finish getting my orders in the que to execute. A little sour grapes perhaps? Absolutely, but there was also something very wrong with our markets.

As the day began and I was glued to my screen, I noticed that XLV, a healthcare ETF was in free fall, showing an opening loss of 6% which almost immediately became 20%. These are not high flying micro cap technology stocks that don’t trade volume. These are the most liquid stocks in the healthcare field. Johnson & Johnson and Pfizer account for almost 18% of the ETF. Memories of May 2010 and the Flash Crash immediately came to mind. I quickly checked IBB, a biotech ETF, and saw similar but not as dramatic weakness. That was clue number two as biotech is almost always more volatile than XLV and should have been down more.


You can see what I am talking about in the chart above. XLV opened down 6% and quickly collapsed to down 26% at the bottom of the green candle right after the tall red one. Minutes later, XLV was trading at $69 or 20% higher. That’s not only abnormal, but shows a system not functioning like it was supposed to. And during this brief period as you can see above, volume was enormous, another hallmark of HFT.

I started looking at random large cap individual stocks both in and outside the healthcare sector and saw some truly astounding pricing dislocations in my opinion. Again, these stocks should not have fallen 20% in a matter of a few minutes. None had company specific bad news. GE, JP Morgan, CVS, McKesson and Verizon to name a few. I have not done a lot more research since then because I don’t think it’s worth the effort at this point, but I know from speaking with colleagues and peers that it was widespread in the ETF space. Just look at VHT, also in the healthcare space, below.


I am not big crier of injustice and “demander” of government intervention to fix our problems, so you won’t find me flooding the SEC with calls and emails or creating a grassroots campaign to do so. I won’t be surprised, however, if the SEC does open a formal inquiry into Monday’s opening of trading as another Flash Crash did occur. While my clients may have lost an opportunity, there were thousands of investors who were likely stopped out of their positions when they should not have been, costing them untold amounts of money.

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STILL Targeting JP Morgan?

It’s really amazing how the media latches on to a story.  Not long ago, Apple was all the rage. Positive story after positive story.  As you know, I took the very unpopular other side of that equation publicly.  And they trashed me all over the place.  Funny how that chatter has really quieted down!

Now we have JP Morgan in the very unenviable position of being at the other end of that spectrum.  Negative story after negative story.  The media just feeds on it!  Once again, I am taking the unpopular side and saying that the JP Morgan news is totally overblown and much ado about very little. 

I will take Jamie Dimon over every single banker not only in the US but around the world.  He took control, owned up to the problem and heads rolled.  Citibank, are you listening and watching?  Bank of America, hello, anybody home?

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JP Morgan, The Next Recession and The Wave of New Jobs

I did an interview with FOX Business on Friday where I offered my comments on the overblown mess at JP Morgan, which is the story of the day/week.  I also opined that the next recession in the US will likely be seen in 2013 or 2014.  I was somewhat surpised that the anchor thought that was so outrageous.  Except for the 1990s, we typically see one or two recessions per decade with one being more severe than the other when there are two.  Given that the last one ended in 2009 according to the folks who keep the data, by 2013 or 2014, we will be due for another. 

While I certainly don’t want to see another recession or navigate through another bear market, they are a fact of capitalism.  The key is what kind of shape the consumer and corporate America are in right before it hits.  I would argue that we are in a better position to weather the storm than at any similar period during the modern investing era.  And guess what happens on the other side of the next recession???


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Is JP Morgan as Dumb as the Rest?

 As you will read below, I don’t think this is the beginning of another leg in the financial crisis, nor do I think we will see more of this from JPM or other banks.  When you trade and invest, you don’t always win and sometimes the losses can be large, especially if people make some pretty stupid decisions en masse. This is Jamie Dimon’s first real black eye since taking the helm at JPM years ago.

My takeaways are that Jamie Dimon will not let this happen again on his watch and this just gives proponents of Dodd-Frank more ammunition for regulation.

NEW YORK – Big bets gone wrong aren’t supposed to happen at best-of-breed banks like JPMorgan Chase, which is headed by Jamie Dimon, one of Wall Street‘s most respected and successful bankers with a reputation for managing risk well. But it did.

  • JPMorgan Chase's headquarters in New York City.By Spencer Platt, Getty ImagesJPMorgan Chase’s headquarters in New York City.

By Spencer Platt, Getty Images

JPMorgan Chase’s headquarters in New York City.

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The CEO, who steered the financial giant safely through the 2008-09 financial crisis, came clean in a conference call with investors after the market closed Thursday and acknowledged that the bank has suffered a $2 billion trading loss, mostly occurring in the past six weeks.

News of the unexpected loss, which will result in an estimated second-quarter loss of about $800 million for that segment of its business, resulted from what Dimon says was a “flawed” and “sloppy” derivatives trade executed by the bank’s chief investment office, whose job it is to manage or hedge the bank’s own risk. The division had been expected to show a profit of $200 million.

“This portfolio,” the bank said in a regulatory filing Thursday, “has proven to be riskier, more volatile and less effective as an economic hedge as the firm previously believed.”

In a conference call with investors, Dimon described the trade as “poorly executed and poorly monitored.”

Shares of JPMorgan (JPM), which closed up 10 cents to $40.74, fell nearly $7 in after-hours trading.

The news packed a not-so-pleasant public relations punch, causing a hit to the firm’s credibility and reputation.

“It is one of the largest, safest and best-managed banks out there,” says Michael Farr, president of money management firm Farr Miller & Washington and a JPMorgan shareholder. “Part of me now says if it can happen there it can happen anywhere. This is the kind of surprise investors don’t like.”

The admission of the huge loss, which was paritally offset by gains from sales of other securities, could put a dent in investor trust in markets and the financial sector.

“It sure does not inspire confidence,” says David Kotok, chief investment officer at Cumberland Advisors. “JPMorgan is the darling of the banks. It has jilted its lover.”

Adds Paul Schatz, president of Heritage Capital: “The story wouldn’t be so bad if it was any other bank but Jamie’s. He set the standard, post-crisis, and now an awful lot of investors are going to question his risk management and if this is the first cockroach.”

The controversial loss comes at a time when the government is trying to rein in risks at banks via more regulation and tighter controls.

Indeed, it shines a brighter spotlight on the so-called Volcker rule, which forbids banks to use their own cash to bet on the market. The rule, which was part of the Dodd-Frank legislation passed in the summer of 2010 but which has yet to go into effect, has been aggressively attacked by banks.

But the trading mishap at JPMorgan will give Volcker rule backers more ammunition in pushing for tougher sanctions on banks’ risk taking, says Farr.

“The Volcker rule will have more support as a result,” he says.

In the conference call, Dimon admitted as much, noting that the bad trading loss “plays right into the hands of a whole bunch of pundits out there.”

The latest trading mishap on Wall Street sends a message that banks are still taking too much risk, says Gary Kaltbaum, president of Kaltbaum Associates.

“It opens back up the fact that these banks are still (using their own cash) for trading and that there are still trillions of dollars in derivatives that no one knows the downside,” he says.

If there is a silver lining, it is that it is not likely the “beginning of a crisis or contagion,” says Schatz. “It’s (just) one event that involved some pretty stupid decisions.”

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