Our Capital Markets are Broken

61 | By Shah Gilani

The markets are broken.

And what has to be done to fix them likely won’t get done. That’s because the folks capable of fixing them are actually captives of the folks who like them the way they are.

That’s the bad news.

The good news is, if you understand what’s wrong and who’s responsible, you can actually make a lot of money playing the game the way it’s been set up.

Let me explain.

First of all, what’s happened isn’t by some grand design. There is no great conspiracy to screw the public. (Not this time.) Rather, incremental changes in various corners of the capital markets manifested innumerable unintended consequences.

The net result is this: Our capital markets aren’t functioning for the greater good of the economy and the nation. And the public is getting screwed. But you knew that.

The markets have become a kind of stacked deck in a rigged card game. A game being played by a bunch of whispering pros against mostly deaf, dumb, and blind amateurs (yeah, I’m taking about too many people you know) in a shady casino overseen by pit bosses who work for the house – which is owned by the pros who set up the game in the first place.

I’m not going to break down what the incremental changes were that got us here. I’ve done that over innumerable articles I’ve written for Money Morning, Forbes, Wall Street Journal’s MarketWatch, and right here.

This isn’t about how we got here. This is about proving where we are now by means of a kind of grand supposition that hopefully is going to open your eyes. And probably is going to scare the you-know-what out of you.

Earlier I said the public is getting screwed, but you knew that. How do I know that you know the public is getting screwed? Most people are out of the market. They are either on the sidelines or out of the game for good. They know the markets are a casino, and most people have come to realize that they have no idea what the game is, let alone how to play it.

And that, children, is the unhappy ending. Precisely because the public is so leery of losing their shirts and knickers in the strip poker club, investing is a thing of the past.

Long-term investing is dead. Long live short-term trading.

Volatility has undermined the kingdom of “buy and hold,” of building wealth by accumulating shares of solid companies, and of a future of promises of an easy retirement with a nest egg of safe investments yielding something, anything we’re capable of living off of.

Want proof the public has exited stage left? I’ll give it to you in the simplest of terms. You need this proof to understand that a huge part of the volatility that is now on the back of every card in the decks we’re playing this crazy game with isn’t going away.

Look at volume. Keep looking. It’s there; it’s just that you can’t see it because there’s so little of it. There’s no volume because the public has left the casino.

The ICI (Investment Company Institute) recently reported that since the great rally (yeah, that one that’s gone missing lately) began last October (we were up some 25%), some $42 billion has exited equity mutual funds.

Since the 2008 credit crisis and market crash, some $400 billion has exited the markets.

I’m not talking about what was lost. I’m talking about money that came out of the market because people had had enough – enough losses and enough of their shirts being ripped off of them in the strip game.

According to Credit Suisse Trading Strategy, average daily volume is now half of what it was at its peak in 2008. We’ve gone from an average of some 12.1 billion shares being traded on a daily basis to an average of just over 6.5 billion shares being traded daily now.

New York Stock Exchange daily volume (and the NYSE is still one of the principal exchanges in this country, although there are too many others now) is down 23% year-over-year.

Oh, and that’s the good news.

You see, inherent in the low daily volume today is a too-often-ignored little piece of extraordinarily frightening news…

Are you ready?

About half of the volume today, on any given day, is the result of high-frequency traders plying their game. And their game ain’t investing, folks.

So, if you want the truth (“You can’t handle the truth”… I love that line!), any rally we see is based on traders trading and not investors investing. In other words, there is no backstop. There are no investors waiting with wads of cash to pick up shares when they slip a little.

There is only the great unknown under wherever we go, under whatever heights we get to.

And that’s what scares the hell out of me.

Oh, I forgot, it’s Sunday morning and I’m supposed to throw in some hopeful news in these sermons (am I preaching?).

Here it is: Call the lack of volume, which is the result of a lack of long-term investors, the “fundamentals” of what’s scary in the market. The “technicals” are worse.

Remember the “flash crash?” We still don’t know what caused it.

You probably don’t remember that BATS itself (another fairly large exchange venue where tons of shares are traded, well maybe not tons, there aren’t tons traded anywhere anymore) decided it was time to do the first IPO on its own exchange. And guess who their first IPO was for? It was an IPO of BATS shares; how cool is that?

Only tragedy struck when they had to pull the IPO on its IPO debut because the exchange blew up. Not that that is likely to happen at any other exchange, so don’t worry.

Oh, wait. Didn’t that just happen at the NASDAQ with another small inconsequential IPO that you may recall goes by the name of Facebook Inc. NasdaqGS:FB)? Oh, yeah, that fiasco.

Bad technicals, folks.

The markets are broken. The fundamentals are bad, and the technicals are bad.

But keep on investing. You’ll do just fine.

Or, you can join the traders at the insider’s card game. And guess what, I have seats at my table. I’ll teach you how to play the game.

And the message (sermon) to take home today is: “Rules are alright, if there’s someone left to play the game.”


61 Responses to Our Capital Markets are Broken

  1. Eric Brown says:

    I have basically exited the market except for two companies in which I’m an insider. I know where these companies are now and am reasonably confident as to where they are going. I sold all of my other holdings about 8 months ago at prices much higher than where they are now.

    • Robert Ferguson says:

      Gave up on the buy-and-hold concept many years ago. It is disturbing to see the financial casino players run our markets with no regard for the need to continue to finance and encourage businesses in our country. Investment and commericial bankers want to take derivative risks with other people’s money and let others pick up the pieces when they drop the ball, as in the sub-prime mortgage bubble that so many fostered for so long. Housing has suffered drastically and millions of our citizens have been left holding the bag for the schemes permitted after Glass-Steagall was repealed when Phil Graham was in the senate cheerleading for its demise. Just a reminder of the most recent royal screwing that so many endured. When we hit the cliff that so many are predicting, I know who is going to be there to push us over the side, but the casino boys are going to go over that cliff, too! It has happened before in the 20s and early 30s, but a great many people who don’t learn from history are definitely doomed to repeat it.

  2. VoiceInTheWind says:

    It would be good if you would write (another?) one of these articles (soon?) about dividend investing and the “Dividend Champions.” In some other forums, dividend investing is the Holy Grail. It is often difficult to see through the spray of sparks flying off those grinding wheels. What do you see from your perspective?

    The Facebook IPO was and continues to be a fascinating spectacle. Most of what I read from you and from the other analysts to whom I subscribe, all the way back to last October, was to avoid that IPO for a lot of reasons. Everything from all IPO’s are too dicey for retail investors to the Facebook Business Model not having much in the way of a business. Cannot imagine why anyone would have put money into that. Just watching and wondering how it will develop. If I got the early advisories right, no way of knowing how it will all come down for six months or much more, and that will be in plenty of time to invest if investing still looks like the thing to do.

  3. Dr. Robert Dean says:

    Shah, you have hit the nail on the head. . .however, how do you figure out precisely what these high speed trading gurus are thinking so you can ride their up swings (or short their down swings) in a timely manner to profit from their greed and insanity? Further, the consequences of the crazy game they are playing (turning the market into a casino) is causing consequences that are rather apparent (a massive world wide collapse of the banking, sovereign and financial markets that will lead to riots, destruction, hunger, destruction of governments and ultimately major war. What will the dollar or Euro, Yen or British Pound be worth then. Indeed, will gold and silver even matter when people need food, shelter, medical care and related security? The gravity of what I see coming from now into 2014 does not, at my age of 69, make me glad I’m living on this planet at this time. There will be hell to pay and karma will collect its dues from those who created this disaster.

    I suppose the best we can hope for is to ‘make it while we can” via your uncanny “inside” info and unique ability to see the “wave forming and rolling in from the conditions in the market and surf with them into a temporary form of wealth that allows for the purchase of shelter, food, supplies and everything it will take to survive in relative comfort until national leaders rise up to save our constitution (which will hang from a thread) and begin the enormous task of putting America, and ultimately the world back on a footing that leads to civility and prosperity.

  4. scout says:

    you hit the nail on the head. I’m on the sidelines and inflation and devaluation are eating me up. What do I do?

    • sandy says:

      What do u do? Take Shah’s advise! I’m up over 60% on 3 investments in 4 days. I have to admit, I did “tweak” his recomendations a little. That is, waited until the puts were cheaper, bought them at a market high. They are fairly long dated so since the makt is down today i will wait to take my profits, then probably do the whole thing again. I said in Seeking Alpha that buy & hold was dead 5 months ago & u should have heard the howl from the naysayers. Oh well-

  5. Malcolm Rawlingson says:

    Shah, Great insight into the stock markets of the world and generally I don’t disagree with what you say. The trading volume on many days is so thin it is bound to result in volatile prices. But I know many of those who have fled the stock market casino (it always was a casino so nothing changed – just the technology) and the money has just gone somewhere else – to the bond casino down the road because people think that is a secure casino. But as you yourself have pointed out it is a bigger casino than the stock market. Just as people got fed up with the stock market manipulations of the investment banks so people will get fed up with net negative rates of returns of the bond market. The simple fact is that inflation (the REAL inflation that is) wipes out any bond returns and puts you in negative territory. Losing your wealth by steady attrition is the same as losing your money when you sell out low in stocks.
    So once people realize they cannot retire on bond returns they will move their money somewhere else. But where? Real estate – possibly a good place ti invest right now but most investors have no stomach for that risk given events of recent years. Which leaves under the mattress gold or back to the stock market.
    While I am sure this will not happen overnight you will see a steady return to investing in companies that pay good dividends and are going to be around for a while. And anybody who invested in Facebook is a complete idiot and really deserves to lose their shirt. There was and is no justification for that share price. It’s really worth about $5 a share and that is being generous.

    I follow Warren Buffets’ two rules for investing:

    Rule 1: Never lose money.
    Rule 2: Never forget Rule 1.

    They work.

    Regards and thanks for your great insights.


  6. Joe Hughes says:

    Very interesting comments on the market. We look forward to hearing more about where we ought be focused before it all goes to hell.

  7. David E Poole says:

    I seem to get 100’s of emails, but I always read yours. So many “services” as structured to pass you to a more expensive “service”, which is better but leaves you guessing, unless you move to the “more expensive” service. I am getting sick of the BS, and want an affordable endgame that will provide me with understanding, and executionable/profitable – I know “risk” – but something I can work with, without having to enjoy your training, experience and insight personally.

    I’m not a “big” investor – about $100k to work with, so let me know what a seat at your table cost me and the benefits I can expect.

    By the way, many of the articles I see coming down the pipe are written from “hindsight is 20/20”, which is supposed to tell me what I have missed, but could have enjoyed (maybe) if I had ponied up for the “more expensive service”

    Sorry for the rant, but I have over a thousand email open on my computer (minimal number from friends), which I have found little benefit from, and feel that I should just cull them from my computer, cancel any/all subscription, and just deal with friends email.

    Ultimately, as I’m sure all your reader’s would agree – let’s make a LITTLE consistently , and not get RIPPED OFF constantly.

    Thanks for listening to me


  8. Gus Basurto says:

    Excellent study on the subject
    but it remains to be seen if share holding
    is not the very best very long term investment

  9. Stephen Blank says:

    I have been forced to accept this new reality. Though I must admit I still have far to much invested hoping for a miracle. The rules have changed, maybe the whole game has changed. Our leaders don’t have the will or the ability to fix any of this. It’s no wonder so many people have left the markets or have run out of money to invest. Thanks for the insight; keep up the good Shah

  10. Jim Reese says:

    Yes, Shah, I left the casino several months ago….although I was a stockbroker for 25 years. Those were the days when a broker had the latitude to study, pick a stock and recommend it to his friends and customer….before the lawyers took over the research departments. The Compliance Departments at the brokerage houses now protect their companies from lawsuits by other lawyers….but, in the process, they prevent good stockbrokers from doing their job.
    Perhaps a part of the solution would be to tax expenses and not productivity…implement H. R. #25 and S. #13….eliminate the IRS and fund the federal government with a national retail sales tax. With no income tax, jobs would come flooding back into this country. There would be no “deductions” and, thereby there would be no reason for companies to fund the re-election of their lackeys in Washington……

  11. Steven says:

    Your prognosis certainly explains current conditions very well. But you know, the present is always changing. I can’t believe that investing is dead in an election year where the Obama juggernaut is ready to set things right for his re-election. Do you not foresee the appearance of a “Recovery” perhaps by the Fall buoyed by a Fed Q.E? Of course, after the election the house of cards may collapse. What do we do then?

  12. jack says:

    In order to make any money, in your case, are we suppose to invest in all your recommendations in order to come out ahead? I have been pick and choose, and have not done well.

  13. captain B says:

    What you say and describe sounds like the truth, I do not disagree. But I would like to retire someday (I am 62) and it appears I will be working until I am no longer able to. What can I do if the markets are nothing but a roulette wheel in the casino waiting to empty my accounts? Savings accounts and CD’s do not provide nearly enough growth. Is it bonds, and bonds are not always safe and certain in these days.
    Is it possible to learn this new trading game instead of the old out of date investing model of buy and hold? I am not an expert or one with learned knowledge of equities and markets.
    Thanks for any reply that may help or give some hope.

  14. Robert in Canada says:

    There is a proven way for average scared investors (like me) to invest in blue chip stocks and make good monthly income by buying and holding Covered Call ETF’s.

    Covered Call ETF’s hold the biggest 30 or 50 stocks (depending on which ETF). The ETF manager sells covered call options on these stocks to Wall Street/Bay Street traders who are trying to leverage or hedge their portfolios.

    The covered call premium paid to the ETF manager is paid out to the ETF investors along with the stock dividends every month, resulting in an annual dividend rate of 8% to 15%, depending on which ETF you buy.

    There are covered call ETF’s on the Toronto and New York stock exchanges such as HEX, HEJ, and HEE. Do some research and make money the old fashioned way – buy and hold.

  15. Benton H Marder says:

    Like many of us, I’m not smart enough to pick stocks. Like many of us, I’m not sharp enough to keep up withe sheer velocity of trading. I can’t keep up with computers. So, I stick with something I can understand and something I can deal with: physical possession of precious metals. This is probably the only way one can buy and hold without having to be too smart or sharp. We all know that the governments and the central banks are going to screw up the money. We know that, one fine day, we’re going to wake up and find out that our paper assets are nothing but bumfodder and ‘magnetism’. Some of us are going to find out that we’ve been ‘corzined’ or ‘celentised’. So we lay low and watch and wait. Maybe there’ll be something worth investing in after the dust has settled. Right now, the scene is very hazardous to our health.

  16. maria says:

    how much is the price of your subscription and do I have to have a US account to invest in your trades?
    PS I wrote you quite a few times but I imagine it is impossible to get an answer
    thanks anyway to answer to this one! Maria de’ Bianchi

  17. Jeff Pluim says:

    I don’t want to sound mushy, but you’re my hero Shah. I have been beating the same drum for anyone around me to hear. You have the podium to make the drum beating mean something. If only the government would make fast trading illegal, it would open the field for investors to return to the markets. Fast trading can easily cause your/my stop-loss to engage. And then when the institutional fast traders have forced the stocks down, they start to scoop them up. The only way that I was able to counter that was to widen my stop-losses, which of course increases my potential for greater loss. Unless I sit at my computer all day to watch my stocks, my exposure to loss is greater with these thieves (fast traders) in the market place. I know there has been some discussion about these guys, but it is not enough. Only the media, by focussing on this fast trading rip off of the market, can there be enough pressure on the poiticians to change the rules. It HAS to happen. Otherwise the markets will never be anything close to a level playing field. And as long as it is not at least close to being a level playing field, all of the investors’ money will remain on the sidelines. After watching the classic movie “The Sting” with Paul Newman and Robert Redford, I can’t help but see an amazing resemblence of fast trading, to the movie.

  18. Ben says:

    What you are saying serves more to warn me off investing than anything else.The investing world you are describing is less like a poker game and more like a crap shoot-it is technically impossible to predict the results of craps unless you were the ones loding the dice.

  19. Richard Valenta says:

    You say some $400 billion has exited the market. Where has it gone? Do banks have that much more in savings and checking accounts? Do bond funds and bond sales show tremendous increases? Where is it?

  20. Lyman Phillips says:

    What in the world did your message mean to folks who do invest. Run from the Markets as fast as you can? Get out now; the Markets are broken? Your article is very disturbing and leaves the reader with quite a canundrum! Are you proposing that trading is now the only game in all financial markets? What about retirees who have to in some way live off of their accumulated financial assets?

  21. C. E. Eastburn says:

    This is an outstanding, informative, tell it like it is, appraisal about what is facing us in this market – from now on forward – as well as how we arrived at this point of time. I am 78 years old, retired army officer, consulting engineering corporate officer and finally owner and licensed consulting engineer and land surveyor of my own company – trying to retire one-more-time. My primary hobby is the stock market and has been for 0ver 40 years, frankly, nice returns, versus this current fiasco which is proving dangerous for our financial well being for the foreseeable future. History does repeat itself – for me it appears to be heading in that direction – born in a depression – deceased in a depression.

  22. mark chipperfield says:

    should we forget about stock trading altogether & just concentrate on soft commodities ?

  23. Peter Weldon says:

    People are not investing for several reasons, including those you mentioned, but no one in their right mind is going to put most of investment funds into, not only a rigged market, but a totally unstable World.

    Instead their thinking is about Financial Survival, my focus has changed, even my Banks attitude has changed. I think a trend in the market will develop, but will be short lived. – 120 days = done.

    Once that trend develops and plays itself out, it will every Man, Woman and Child for themselves.

    If it were not for my age (71) I would move out of Canada, to a Country that sits on the sideline.


  24. Kevin Donnelly says:

    There was a time it wasn’t hard to make a living
    Working was the given thing to do
    Married and working for the company
    That was the gig for me and you.
    Then the company closed and moved the plant to China
    for labor that was cheaper far than mine.
    It got tax relief, paid no Social Security
    Did’nt deal with Regulators or with Unions all the time

    All in All, it thought that that was fine

  25. John Schumacher says:

    What do we do now,shah? dump and run,with half of what we once had?. And feel lucky they did’nt get it all. or hold for the long run? Or jump the bridge?.

  26. lois Poster says:

    I read everything you send me, and enjoy it. My question: in exactly what venue will you best tell me how to profit from this mess?

  27. eric taylor says:

    I do not believe that long term investing is dead, but all boats do not rise
    so easily in this rolling-recession, where our domestic content is not helping
    us, but instead many developing foreigners, while we fall deeper into turmoil
    and confusion, and the long term investing prospects narrow down. It used
    to be, remember if you can, that we would sneeze and the rest of the world
    would become really sick, but the tables have turned around for the many
    political economic players. Multinational with good income reinvestment
    may still be good over the long term, but resources (things of commodity value) are still worthwhile, and often pay good dividends for reinvestment
    long term, but selectively sourced, and held long term enough to knock out
    the short term risk! You are better than half right that short term investing
    is suspect, for various reasons. I hope we will wake up and begin true
    progressive reform change soon.

  28. stowitts says:

    You’ve got to be kidding! You DON’T KNOW what caused the flash crash? Perhaps you’re close to the trees to see the forest! Poor metaphor to be sure; but its inconceivable YOU haven’t figured it out yet

  29. Ed says:

    O.K. Shah,
    Maybe what you’re saying has an element of truth. Be more specific about the existing Casino Royale and about your gameplan for gaming it.

  30. hcc says:

    I love all your insights and commentaries. Does this recent “sermon” suggest we little people who believed in long term investing for retirement should sell all and get out of the fixed game? Noone in their right mind would sit down at a table knowing the game was fixed and there was no way to win.

  31. mike says:

    I suppose that’s why volatility is so low, even when markets do very poorly; the only ones left in the game already know where the markets are going, cause they are driving. On whose orders is another bit to chew on.

  32. Richard K says:

    This you may find insulting – it’s not intended to be. But you remind me of Obama a long while ago – he sounded like he knew the answers, he sounded capable of leading us out of the political mess. But he didn’t. Will you deliver?

    I’d love to believe in your approach because you sound like you have answers to what’s happening in the remarkably corrupt systems we have today. How is your trading history using your knowledge of ‘the matrix?’ How will you stay out of the way of the traders who watch what you’re doing?

  33. beatriz bensinger says:

    dear shah, if i may call you by your first name. i feel like i know you because of reading your articles so often.

    i believe you and am sure you are giving us straight talk . it is too bad i cannot subscribe to your good offer of the matrix because i simply do not know how to place the orders.

    any suggestions? im writing from brasil and have a scottrade acct.

    many thanks, beatriz benetti bensinger

  34. Redman Live says:

    I couldn’t agree more. Just trying to be on the right side of the fix more than not. The pain of losing 20% far exceeds the joy of making 20%.

  35. Jerry says:

    This type of market does make it tough for the mutual fund investor who is penalized for frequent trading.

  36. Dominick Sciola says:

    Another sad but enlightening story.

    Where did you get your figures for trading volume? Specifically, ‘About half of the volume today, on any given day, is the result of high-frequency traders plying their game?’ Would love to hear more about this and how these stats are tabulated.


  37. Claude Moffat says:

    Thanks for your article. It confirms for me exactly why I should buy shares in good companies, far from the US markets, that are still doing well in this unhealthy climate. There are good yields in these as investors desert but the production figures are still profitable for those companies.
    Or have I missed something far more dire?
    The worst case is a flight to zero as everyone loses in the trading pit.
    Where nobody wants anything anymore= exit western society as we knew it.
    A grim picture, but possible, I am hopingit doesn’t get that bad.
    regards, Claude

  38. mike mackay says:

    Shah, excuse the pun with the email addy. But it really is Anyhow. keep up the good work and I what I would like to see is a list of say, the top ten people who are screwing the rest of us. The politicians and mainstream media dont have the jam to do it. I think you do. It would be fun. People need to know who is responsible. I understand the legal ramifications but that hasnt seemed to stop you so far. I live near Vancouver BC and would love to see your opine on who YOU think are the top 10 jackasses. Lets do a Letterman top 10. Hope you come through……….Mike Mackay

  39. JT says:

    I pulled out of the markets. BEST THING I EVER DID! Now, my new investments are making 12%-15% guaranteed with no risk. I am way ahead and have no fear of losing a dime, no fear of being in the markets as i watch them sink lower and lower, and am making way more than any average investor on his good day. At 12%-15% ROI and no risk…what more could I want?? AND…BTW….when I have stated these facts I have talked to so many doubters. They can believe or disbelieve..but the proof is in writing. Good riddance to the con jobs on wall street..and the con jobs that want to sell me stocks (they make money when I buy them)—also (they make money when I sell them…even if I lost my butt)…screw them all.

  40. toshi nobe says:

    I don’t want to pay for more high end services. I rather pay you a commission on your matrix system based on your delivery. This system I like.

  41. PN says:

    Intriguing article, Shaw, but there will always be a market because human nature requires gambling, whether in old bones and skins, or modern currency and ownership rights to corporations which earn that currency. Things are looking grim right now, but there are lots of reasons for optimism, too. Alternative energy, for example. We’re not doing that much yet in the US, but countries like China and Germany are deadly serious about alternative energy, and I think this will spawn new industries and growth.

  42. James Eberhardt says:

    Shah, thanks for the “trading manual” you sent out to your subscribers. I am reading it now. Fortunately, I exited the market at the recent highs, temporarily moved into T-bills and am moving those funds into a dynamic set of high dividend stocks, Real Estate and Commodities.

  43. Bob says:

    And yet, in his latest press conference Bernanke is urging the people to take on more risk, at exactly the wrong time when the global economy is teetering. That is one of the stated purposes of “operation twist.” To what end, Mr. Chairman? So that more citizens can be wiped out financially! This hokum of “the wealth effect” has been going on ever since Greenspan was Chairman and under Bernanke and Yellen shows no signs of abating.

  44. Tony says:

    Am I missing something here???

    1. If folks are “investing” or “buying and holding”, then certainly volume is going to go down as fewer shares are traded. Such is a totally consistent explanation in contrast to “folks leaving the market”.

    2. In terms of “billions being pulled out of the market”, how does such happen except by the price of stocks going down. However, if the price of stocks goes down, folks that are merely “sitting on” stocks will have lost the money and it will appear to have been “pulled out of” the market.

    I think we need some more relavent metrics.


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