We certainly do not expect a mass Chinese exit from US Treasuries at any point in the near future, but the recent comments of Yu Yongding, a former central bank adviser (see http://tinyurl.com/2fflmql) seem to be widely shared by high ranking officials in China and raise the prospect that for the foreseeable future, demand for treasuries from China will wane considerably.  In the same article, Zhang Ming, deputy chief of the International Finance Research Office at the Chinese Academy of Social Sciences, is quoted “The U.S. government has strong incentives to reduce its real burden of debt through inflation and dollar devaluation.”  As we see it, there is no choice.  The U.S. must attempt to inflate the debt monster away.  

If the economy were to improve dramatically, we would expect the income side of the Fed’s ledger to expand.  The prospect of greater tax collections might ease China’s fears.  But that is not likely to occur.  The expiration of the Bush tax cuts on December 31st may very temporarily increase the income side of the ledger but will also likely act as a strong impediment to growth, and in the end, reduce tax receipts substantially as the economy continues to founder.  At least, there may be some hope now that the administration will recognize what is at stake and allow the cuts at least another year of life.
 

Isn’t it curious that as hedging and hedge funds have become a huge source of revenue for Wall Street and a boon for private investors, the public is suffering through the second worst decade in stock market history?  The sad truth is that the financial industry and the SEC have clearly shown with their actions and demeanor that the investing public no longer matters.  The deck is stacked and the game is rigged.  Moreover, as more private funds venture into the same strategies, the odds for success decrease and more losers must eventually appear.  Our markets have become arenas where the rationales for participation have nothing to do with traditional investment.  Each trade exists in a vacuum and success is determined solely by profit, regardless of what the impact on the economy might be.  In the case of the SWAPs market as shown by the NY Time’s Floyd Norris back in May (see http://tinyurl.com/2blgtbx), it has been all too easy to insure against a negative outcome and then to ENSURE the negative outcome occurs for profit.  The analogy of buying fire insurance and then burning down the house is correct.  The process worked exceptionally well for those so inclined during the housing bust of 2007-2008. 

Vis-à-vis high frequency trading (HFT), Karl Denniger’s piece at http://tinyurl.com/n8u2v7 clearly illustrates how easily the market can be manipulated.  Any claims that HFT offers increased liquidity and aids the markets by making prices more efficient are patently wrong.  The claims are put forth expressly and deliberately to mislead, exactly as the bid/offer quotes are designed to do.  The empirical evidence provided by the flash crash of May 6th should be sufficient; before HFT there never was a flash crash.  If the previous article jogs you to worry, read Alexis Madrigal’s article for The Atlantic at http://tinyurl.com/3y5bgrb in which the author correctly claims, “Unknown entities for unknown reasons are sending thousands of orders a second through the electronic stock exchanges with no intent to actually trade.”  The charts created by data services firm Nanex are fascinating and bizarre, one of which shows 15,000 quote requests made in 11 seconds in a repeating pattern; conclusive evidence of a manipulation.  Another chart represents 56,000 quotes in one second, all at the same price but with the size of the order increasing by one (i.e. 100 shares) all the way up to 40,000 shares.  It is simply impossible that any of these were legitimate bids or offers.  The redoubtable Tyler Durden of Zero Hedge takes on this subject as well at http://tinyurl.com/2g9o6e3, also worth reading.  Simply put, the quote stuffing illustrated in these charts is illegal, ploys to game the system and ultimately at a cost to investors.  No wonder the public’s demand for stocks has evaporated.  In the end, Wall Street will regret this folly.  HFT is another accident waiting to happen and it will.  Again. 

We last covered our views on the seasonal effects of the stock market in the April 26th and May 17th issues (see http://www.cross-currents.net/k042610u.pdf and http://www.cross-currents.net/n051710g.pdf for our detailed analysis).  The Dow Industrials peaked only four days before the end of April and collapsed as May commenced.  The recovery into July and early August was what most observers refer to as a typical “summer rally” but we suspect a return to reality is already in progress.  The Dead Zone is clearly in control.  Lower prices should be expected well into October.    

As illustrated below, the three month average of mutual fund inflows begins to slow dramatically in July and finally bottoms in October.  Although the Investment Company Institute (ICI) has only released stats through June, it appears that July was a horrible month.  We estimate funds likely suffered over $10 billion in outflows and August may wind up in the red as well.  By far, the worst month for stocks is September.  From 1928, September is the only month that is a downer on average (even on a total return basis)  and for more than a century, the Dow has declined in more than 60% of all Septembers.  Of course, on an individual monthly basis, September is also the worst for inflows and receives less than 2.5% on the annual total.  Given the economic background and the preeminence of HFT, there is zero reason to be in stocks right now.  September should go as expected.  Down. 

ABOUT ALAN M. NEWMAN

Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.

The newsletter is published roughly every three weeks and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation.  Broad samples of our work can be viewed at http://www.cross-currents.net/. 

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