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Are we at the start of a tightening cycle, or not? That seems to be the question.
The answer: We seem to be in that shadowy period leading up to a tightening cycle.
That's an important distinction for stocks, because equities tend to gain in the period leading into those cycles, then reverse when the tightening begins.
MKM Partners, for example, noted that in the six months leading up to the three prior tightening cycles—February 1994, June 1999 and June 2004—the S&P 500 gained an average of 6.3 percent, led by financials, which were up 12.2 percent. That makes sense, since interest rates invariably rise, helping banks.
But three months after tightening began, the S&P 500 was lower in all three periods by an average of 4.2 percent. Defensive stocks such as telecoms outperformed cyclicals, including industrials and consumer discretionary.
The Fed does it again. The markets were terrified at the prospects that the Fed would remove the "patient" phrase. The Fed did exactly that, and yet stocks have traded in their widest range since January (roughly 41 points on the S&P 500,) 10-year bond yields have had one of the biggest declines since January, and the dollar has had one of its biggest declines in months.
The Fed accomplished this in two parts:
1) Slightly downgraded the economic outlook saying "growth has moderated somewhat" instead of saying "activity has been expanding at a solid pace."
2) Declared that an increase in the Fed fund rates "remains unlikely" for the April FOMC meeting, but in the next sentence declared that the Fed would not be raising rates until there is a "further improvement in the labor market" and they are "confident" that inflation will move back to toward their 2 percent objective.
In other words: the barrier to raising rates is still pretty high.
Here's the key sentence: "This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range."
At the press conference, she put this in even simpler terms, for those of us too stupid to understand the subtleties of the Fed's phrasing:
1) "Just because we have removed the phrase 'patient' it doesn't me we are going to be impatient."
2) There will be no rate hike in April, but "such an increase could be warranted at any later meeting depending on how the economy evolves."
3) We don't expect any sudden jump in inflation: "Inflation has declined below our long-term objective, and in light of the continuing appreciation of the dollar, we likely continue to do so in the months ahead."
What would Yellen look for in inflation? Seems wage growth pickup is the highest on her list, as well as the usual inflation indicators.
As for the slightly downgraded outlook on the economy, she hedged that statement as well in the presser, insisting "this is not a weak forecast" and that she continues to project above-trend growth and an improvement in the labor market.
You can have all the ideological debates you want about whether the Fed is behind the curve, but even the most advanced cynic has to admire the deft handling of a very tricky moment in the Fed's history.
As for Yellen, she just seems to be getting better and better in tamping down fear and anxiety. She is, as I said yesterday, the anti-drama Queen.
And she accomplished this with no dissent from any of her colleagues.
The downside to this is that the Fed has downgraded their expectations for the economy. GDP is lower. But the market is hardly howling its disapproval.
Its been one year since Michael Lewis' 'Flash Boys' hit the shelves. What has been the impact of the book?
It certainly sold books. Four consecutive weeks at Number 1 on the New York Times nonfiction list is quite a feat.
And it generated a lot of debate. Remember, at heart, it's a book about market structure. A book about market structure that makes the bestseller list? Wow.
It was the marketing that really made the book, and the timing. Lewis' main allegation—that the market is "rigged" in favor of high-frequency traders—fits in perfectly with the broader societal condemnation of the financial crisis and with the even broader folk mythology that the markets—and other human affairs—have always been manipulated by a small elite.
To a certain extent, the book reflects what Richard Hofstadter famously called "the paranoid style in American politics," the vague fear that there are dark, evil forces controlling us (and our money), that our fates are not our own.
Regardless, the book had a substantial impact, of that there is no doubt.
Let's try to keep this to a couple issues:
HOW HAVE REGULATORS RESPONDED TO THE ALLEGATIONS?
SEC Chair Mary Jo White emphatically stated that "the markets are not rigged" and, in Congressional testimony, said the retail investor was "well served, very well served, by the current market structure."
As for high-frequency trading (HFT), she said it "is not unlawful insider-trading."
That doesn't mean the SEC is delighted with all aspects of market structure. In January, White created a Equity Market Structure Advisory Committee to advise the SEC on what, if any, changes need to be made.
There is certainly a range of opinions on how much needs to be done to improve the markets at the SEC, but the lack of an emphatic response from them clearly indicates they do not believe the U.S. markets are in dire straits.
On the enforcement front, the book generated some smoke, though it's debatable how much fire has been generated.
The FBI, the U.S. attorney general, New York state prosecutors and the SEC have confirmed they are investigating the practices of high-speed firms.
New York state Attorney General Eric Schneiderman has been particularly active, even announcing that subpoenas were sent to exchanges to examine their relationships with HFTs.
Yet, there have been remarkably few "gotcha" moments. In one small case, the NYSE did pay a $4.5 million fine over violations regarding "co-location," or allowing HFTs to site their computers right next to the exchange's "matching engine" so that information can be accessed more rapidly.
In another case, the exchange Direct Edge (now part of BATS) was fined $14 million in December 2014 for failing to follow rules regarding disclosure of how it handled order types. That investigation was underway long before the Lewis book came out, but the publicity likely accelerated the investigation.
In perhaps the most high-profile case, the New York attorney general is currently embroiled in a dispute with Barclays over the way it has managed its dark pool, alleging that the bank did not tell traders about the presence of high-frequency traders in the pool.
But these are actions against exchanges and a bank. There are few actions against HFTs themselves that are engaging in "abusive" or "manipulative" behavior.
This is surprising, because I do believe that there are bad actors. I think it's highly likely that some HFT somewhere has tried to game the system, to engage in practices that could be considered "abusive" and "manipulative" under the law.
Why do I believe this? Because the entire history of trading—for hundreds of years, long before HFT—are filled with examples of individuals who have tried to abuse the system. Why should high-frequency trading be different?
That doesn't mean the whole system is rotten, it just means enforcement should be rigorous.
In the case of HFT, much of the problem is that it is extraordinarily difficult to catch blatant abuse. It's hard because intent can be difficult to prove, and it's hard because in many cases the data isn't sufficiently robust to demonstrate abuse.
The SEC is trying to remedy that. There are proposals out now for a Consolidated Audit Trail (CAT) that would allow regulators to efficiently and accurately track all activity throughout the U.S. markets. Let's hope the plan can be executed at a reasonable cost. Unfortunately, it appears to be years away from implementation.
And FINRA has proposed the creation of the Comprehensive Automated Risk Data System, which will gather trading data from some 4,000 brokerages in over 110 million investor accounts. That, too, is some years away.
Both of these proposals were well underway before Lewis' book.
One rule that needs to be implemented immediately: the SEC is trying to require high frequency traders to register with the SEC. It's about time: if HFTs are such a big part of the trading process, why doesn't the SEC even know anything about them? This is a first step and hopefully this will be done by the end of this year.
WHAT HAS BEEN THE RESPONSE OF THE FINANCIAL INDUSTRY?
For the most part, the industry—big banks, exchanges, and the mutual fund industry (with a few exceptions) has rejected the claims.
It may not be surprising that the sell-side defends the status quo, but what about the buy-side? They, presumably, are getting the short end of the stick. Why, for example, haven't the big mutual funds issued denunciations? Even Jack Bogle, founder of Vanguard and no friend of high-frequency trading, has rejected the claim that the markets are rigged.
And what about the companies whose stocks are supposedly being manipulated. Why aren't there more complaints? Why, for example, haven't we heard issuers and companies themselves complain more? Maybe there is a company that has made an issue of this on a quarterly conference call, but I don't know of one.
Again, you can argue they are all corrupt, but do you really believe that? Isn't a more likely answer that: 1) this issue, if it is even a little true, is not among the highest priorities for funds, and 2) investors care a lot more about the long term returns of what they are buying, and those results have been excellent.
Still, there have been some moves to change things, though they are not related to Lewis' book. In one significant move, mutual fund giant Fidelity, in conjunction with several other firms (including T. Rowe Price, Blackrock, and JPMorgan) are getting ready to launch a dark pool of their own, called Luminex, designed to only trade large blocks between institutional firms. That, when it launches, will be a significant development.
HAS THE BOOK RESULTED IN ANY CHANGE IN MARKET STRUCTURE OR THE WAY STOCKS TRADE?
The short answer is no, nor does it appear that any regulator has dramatically changed their course of action. You could say this is because: 1) the dark forces have totally corrupted all the enforcement agencies, or 2) the enforcement agencies are alert to the prospect of bad actors, but most do not believe the overall market structure needs to be completely overhauled.
If you believe that 1) is the right choice, nothing I'm going to say is going to change your mind.
But I've spent years with enforcement officials, and the NYSE, and the Nasdaq, and everyone else who built the current system. Most have told me that the current system is not being torn down because it is a vast improvement over the old system, and by "old" I mean the system controlled by the NYSE (specialists) and Nasdaq (screen-based traders) that was the dominant paradigm until about 20 years ago.
Remember, 30 years ago if you wanted to buy 1,000 shares of IBM it would have: 1) cost you hundreds, and possibly thousands, of dollars, and 2) taken anywhere from 20 minutes to the following day to get a confirmation of execution. This was a time when the spread between the bid and ask was $0.125, then $0.0625, and then finally a penny in the year 2000.
Today, you can buy 1,000 shares of IBM and the cost could be as low as $7.99, with a confirmation that will occur in a sub-second interval.
This advance has nothing to do with HFT, it has to do with technological progress, but regardless, it is an improvement over the old system for retail investors.
Still, I am not a complete apologist for the current system. I think it is way too complicated (40 dark pools, 3 exchanges) which leaves the system open to technological failure. I also am no fan of the idea that exchanges should be paying customers to trade on their exchanges.
To the extent that Lewis' book shed light on a rather obscure part of the market, it has been a valuable contribution to the debate.
But I also recognize that there's always been intermediaries, and that throughout history, people have bitterly complained any time someone steps between a buyer and a seller and tries to make a profit, big or small, justified or not. Check out my "Brief history of high speed trading in the 1800s" for a small sample.
Programming note: Michael Lewis will be on Squawk Box Monday on CNBC.
My colleague Michelle Caruso-Cabrera made some very good points on air today concerning investing overseas: because of enormous moves in currency, buying stocks overseas—including ETFs—can be perilous.
As an example, she notes the German DAX index is up 22 percent this year, but the iShares Germany ETF, which measures the performance of the German equity market, is up only 8 percent in U.S. dollars, thanks to the tremendous drop in the euro (down almost 13 percent against the dollar).
This brings up a very interesting question: why doesn't everyone buy hedged international ETFs when they want international exposure, rather than unhedged ETFs?
There are several reasons:
1) Until recently, it was almost impossible for the average investor to do so. There simply were no ETFs that enabled an investor to hedge out currency. A professional could hedge, of course, but at considerable cost.
Now that more hedged ETF products are becoming available, investors are taking note. In fact, the biggest European ETF is now a hedged product, the WisdomTree International Hedged, which recently surpassed its biggest unhedged rival, the Vanguard European ETF.
2) There was not a huge demand for such a product because currency moves like we have seen in euro this year (down 5 percent against the dollar) are very rare. Oh sure, maybe if you were investing in Argentina, but not the euro, not the yen. Most years did not involve anywhere near such dramatic moves.
This year, for example, the yen has barely moved against the dollar, so the difference between a hedged Japan ETF and an unhedged Japan ETF is very small:
That was not the case last year, when there was an enormous move in the yen versus the dollar, and investors made the DXJ the hottest ETF in years.
As for the cost for international ETFs, it's true they are a little more expensive than plain-vanilla U.S. ETFs. Typically, you'll pay roughly 0.5 percent for a hedged ETF, and even for many unhedged. One exception is the Vanguard European ETF which charges a low 0.12 percent, but that is Vanguard's specialty.
Still, when you are dealing with moves of 21 percent, as you are with Germany this year, an 0.5 percent fee is not unreasonable. It does take work to keep these hedges accurate.
One final point: because interest rates are relatively flat worldwide, it is not that difficult or costly to hedge. The cost is the overnight interest rate. This would be very difficult to do with, say, Brazil, where interest rates are around 8 percent.
As these products get more assets, it's possible the costs will come down.
Wow, what a miss on February housing starts. At just 897,000, the read was 14 percent below expectations of 1.04 million units on a seasonally adjusted annual basis. That is an enormous miss, and because this is the housing data that is directly plugged into GDP, it is cause to sit up and take notice.
The only good news is that there is clear evidence that poor weather was the major factor.
While all regions saw a decline, the areas hit the most by weather (Northeast, Midwest) declined much more.
February new home starts vs. January 2015 (source: Census Bureau)
Permits, which do not require any construction, were up three percent, to 1.09 million, the second highest level since the end of the recession. I would be more comfortable saying this suggests a spring rebound, except the gain was driven entirely by multifamily permits, which were up 19 percent. Single-family permits were down 6 percent month-over-month.
Regardless, we now have a long string of disappointing releases for February: industrial production, capacity utilization, NAHB Housing Market Index, retail sales, regional Fed surveys. Only ISM Services and nonfarm payrolls (arguably the most important report) have been above expectations.
All of this suggests that while the FOMC may indeed remove the "patient" phrase from its forward guidance on interest rates, the members will still act with patience.
Read MoreSee CNBC's economy coverage here
If you doubt the effect that stimulus has on stocks, look no farther than the headlines over this weekend.
The Shanghai market rallied more than two percent to its highest levels since 2009 after Premier Li Keqiang said China was prepared to take action to stimulate the economy and the government had a "host of policy instruments" it could use.
This is as close as you can get to Mario Draghi's "whatever it takes" statement, and this is from the leader of China!
Europe is also rallying on the weakness in the euro and the stimulus being provided by the European Central Bank. Germany's DAX is up 1.5 percent at another historic high, while France's CAC hit a seven-year high and Italian stocks touched a four-year high.
If you have any doubt this is stimulating interest in European equities, just take a look at the fund flows for far this year for Europe and the United States.
Q1 fund flows (source: EPFR/Financial Times):
The inflows into Europe are mirroring the outflows from the United States. The previous record for European inflows was $32 billion in the first quarter of 2014.
Dead money. I said stocks would have trouble until we saw the dollar stabilize, or at least stopped the parabolic move it has gone through this month (up almost 6 percent in March).
Today, we not only had the dollar, we had oil moving down, close to the lows in January. Throw in the Fed next week, which will probably drop the language indicating they will be "patient" on when they may raise rates, and it's little wonder stocks are having trouble.
The risk remains on the downside. But even if we went to 2,000 on the S&P 500, which is likely, it's still just another garden variety 5 percent pullback.
The dollar strength/euro weakness is playing havoc in the stock market. First, it is forcing foreign money out of U.S. stocks and into Europe in general.... European markets like Germany, Italy, and France were all up this week, with Germany at historic highs.
Intel, which warned of lower revenues for the first quarter, partly due to currency issues, is down roughly 7 percent this week.
Oil reared its ugly ahead again toward the end of the week as it approached the lows we saw in January....oil has been quiet recently, but the combination of increasing supply and the dollar strength is again pressuring prices...the Energy sector overall was far and away the worst performer on the week, down about 3.2 percent.
As for the dollar, I'm amazed we haven't seen more profit taking. I noted yesterday that the Dollar Index was more than three standard deviations away from its 50 day moving average. That is extraordinarily rare: it's happened only 0.3 percent of all trading days since 1986. Almost invariably, the dollar index has been down in the following days, but that is not happening yet.
This week saw much choppier trading: Monday, down big; Tuesday, down small; Wednesday, up big; Thursday, modestly down. At the open on Friday, it all adds up to a practically flat week so far.
Still, the S&P 500 is less than three percent from an all-time high.
One bit of good news for U.S. stocks. Oil has been weaker on still-high U.S. stockpiles and a firmer dollar, but it's not taking down the markets. West Texas Intermediate, for example, is down 7.1 percent this week, including another two percent this morning, but the S&P 500 is down only 0.3 percent, though the energy sector is down 2.4 percent.
Still, I remain troubled by the earnings outlook.
Intel lowered its first quarter 2015 revenue guidance from $13.7 billion to $12.8 billion. The announcement rippled through the markets yesterday, and did cause some to lower earnings guidance. As I have noted, weak oil revenues and now the strong dollar is really weighing on earnings expectations for the markets.
S&P 500 earnings estimates (Source: Factset)
Why the rally? Traders were surprised by the strength of the rally Thursday morning, which mostly occurred in the first 20 minutes of trading.
There are several factors:
1) A modest reversal in the dollar's strength, which caused traders to buy the U.S. market and sell Europe.
2) Weak February retail sales were plausibly blamed on weak weather, and traders took cheer in the fact that Internet sales were up 2.2 percent month-over-month and 8.6 percent year-over-year.
But all this was known well before the markets opened. The strong rally right at the bell ringing—almost all our gains were accomplished in the first 20 minutes—suggest there were other factors.
The most obvious explanation is that we were simply oversold and traders needed to cover short positions or felt the need to buy.
Indeed, one of the reports most widely passed around on trading desks this morning was from Evercore ISI, which noted that their Hedge Fund Survey showed that net exposure to the market was at its lowest reading since last October. This is historically a good contrary indicator for the market. In other words, when hedge funds have unusually low exposure, the market often rallies.
On Wednesday, Morgan Stanley noted that Global funds had added to short positions for 15 straight days.
Another healthy sign for stocks: West Texas Intermediate (WTI) is down 2.2 percent, at its lowest level in six weeks, and while the energy sector is down, it is not taking the market down with it.
Are stocks dead in the water thanks to the dollar rise?
Talk about an anemic rally. First, it was the decline in energy prices that hurt earnings.
Now, the dollar surge is adding another dimension to the decline in earnings.
I noted Tuesday that earnings growth for the first and second quarter have already gone negative, and that full year earnings growth sits at a measly 1.1 percent:
S&P 500 earnings estimates:
Q1: Down 2.6%
Q2: Down 1.8%
2015: Up 1.1%
Source: S&P Capital IQ
The concern is that if the dollar keeps rallying, we are not going to see any earnings growth at all this year.
And yes, while many companies do not break out currency impact, or even the contribution to revenues and earnings by geographic region, enough do to indicate that a significant dollar rise could knock several percentage points off earnings and revenues.
Here are a few examples:
1) Campbell Soup recently gave 2015 sales guidance to -1 to +1 percent gain in sales, which included an estimated 2-point negative impact from currency translation;
2) TJX said that negative currency impact would reduce 2015 earnings by four percent.
3) Home Depot said 2105 earnings estimates of $5.11 to $5.17 a share was reduced by 6 cents a share due to currency impact.
4) Deere said 2015 sales would be decreased about 3 percent due to currency impact.
I could go on, but you get the point: there is a fairly consistent narrative that currency impact is reducing 2015 earnings and/or revenues by anywhere from one to four percent.
And this guidance was given several weeks ago: the Dollar Index is up almost 5 percent just this month!
Those numbers I cite above are going to get much worse if that sticks, or the dollar keeps rising!
That may make the market dead money in the short term.
Bottom line: the more confident you have that the dollar will keep going up, the less confident you will be on earnings growth.
Despite earnings, investors cannot help but notice the continuing impact of the strong dollar on tech revenues.
In a first for a U.S. stock exchange, Nasdaq OMX Group on Thursday agreed to pay $26.5 million to settle a lawsuit involving its bungling of Facebook's IPO.
Many pros scoffed at the notion that Navinder Sarao was the sole culprit of the spectacular plunge on May 6, 2010.