Everything good or bad about global finance becomes more intelligible when you understand that trades are the unit of production

Everything good or bad about global finance becomes more intelligible when you understand that trades are the unit of production. Investment banks make money on every transaction, from the tiny fractions of pennies per share for HFT to the 7% of $700 million the bankers made from the Groupon IPO.  Investment advice, which many companies will tell you is their product, is in truth just a form of marketing – better advice generates more units, trades.

The current market environment is the worst type for trade generation. The huge number of moving pieces in Europe and the irrationality of political policy making is creating investor paralysis and the trade production line has all but ground to a halt. The mass firings at UBS and Citi are in this regard no different than shift cancellations at GM or Ford. It is in environments like this that investors should pay closest attention to the advice from the industry. The smell of desperation is in the air, Christmas is coming, bonus pools are dwindling to non-existence and the nice guy at the other end of the phone may be forced with the option of either lying to you or having his Aston Martin repossessed. Or worse yet, fired.

There are hundreds of phrases constantly bandied about any trading floor, some providing useful reminders for pros like “market’s never wrong” and other reserved exclusively for suckers. One of the latter, “market always looks forward” is only trotted out when things are really bad, asking clients to ignore potential disaster and look to the amazing opportunities over the long term – Chinese consumer! Solar power! Lithium! Never mind that most traders on the floor have their fingers over the sell button waiting to hammer away at your bids. As I said, not good times.

I’m writing this post today because of charts like THIS from professor Cowen and THIS from the FT.  And tweets like this morning’s “USD funding stress just went to 11” from @credittrader.  All of them remind me directly of the day in mid 2007 when I typed GCDR into Bloomberg, saw the terrifying spike in AIG CDS prices and knew we were all well and truly screwed. (I don’t, for the record, believe markets are heading all the way back down the rabbit hole. May of the factors that caused the GFC are better understood and bank stocks are already cheap.  But still).

History will likely remember Citi CEO Charles Prince’s statement “as long as the music’s playing, you’ve got to get up and dance” as the most telling of the GFC. Outside of the industry, people were horrified, but inside it only generated grim nods, then and now.  The walls may be closing in but we have to generate trades today and besides, “who knows?”, maybe its not as bad as everyone thinks.

This all sounds pretty grim and might sound Chicken Little-ish if the ECB steps in fully backs European sovereign debt, as it seems they’ll have to at some point. That event will doubtless engender a massive rally, but we’ll still be left with economically crippling austerity in the Eurozone and a mounting number of nasty- looking cockroaches crawling out the China story.

I have been out of the serious money/info flow for a few months, so don’t construe my current pessimism as anything other than the jaundiced view of, for the time being, an outsider.  On the other hand, I would emphatically suggest investors big and small pay very close attention to advice they’re getting and, more importantly, verify them against the global credit markets where the banks themselves are forced to play with their own money (you see why Credit Trader scared the bejeebers out of me with that tweet).  In the end, they need to generate trades, its what they do, but you in all likelihood can afford to wait.

5 thoughts on “Everything good or bad about global finance becomes more intelligible when you understand that trades are the unit of production

  1. Mario says:

    great post man.

    is there a site or information source to get info on stress tests and credit markets and CDS for free? Or is that stuff payment only?

  2. Octavio Richetta says:

    As posted at pragcap yesterday:

    A few things to keep in mind.

    It is really puzzling to see the sell side talking heads defending a bullish case for stocks based mainly on rearview mirror arguments. On the other hand, I am glad there is still PLENTY Of stupid bulls out there as I would be very wary of being a bear at this point if everyone was bearish. So let me get to the point with a list of some obvious stuff people playing with OPM easily dismiss.

    1. It is now clear that the ESDC is much bigger than the sub-prime initiated crisis in 2008. Asset losses are in the multitrillion Euro level. Make no mistake, at least two trillion Euros have already been destroyed. The matter is when the losses will be recognized. The denial we are seeing now is very similar to the denial even Benny embraced in the early stages of the subprime crisis.

    2. European banks are broke; and, yes,the large US banks are broke again, only a few years after subprime. However, this time around THERE WILL BE NO BAILOUT. THERE WILL BE NO TARP. THERE IS NO POLITICAL WILL FOR THAT.

    3. And there isn’t political will for the INCREASE In deficit spending we saw in 2008. And forget also about monetary policy; we have already unZIRPed our pants, and lower them to our knees even with a twist.

    4. Remember the EM decoupling argument in 2008? Now we hear the same argument the other way around: the US will decouple from a financial crisis in Europe, it’s largest trading partner with the world strongest currency at this point (ignore yen). Moreover, banking ties with Europe are the strongest, and European Sovereign and corporate debt investment by US institutions VERY VERY VERY Large. So you truly have to have faith to believe in decoupling:-)

    5. Leading indicators are pointing to a recession and earnings are at a peak, even before the European crisis has hit full blast.

    Given 1-5 above, you tell me what business does the S&P500 have being 0.16% ABOVE the level at which it started the year?

    Why do you feel you are disconnected from the flow of info?i am a little guy fighting the fight without any insider information and have done pretty well. Could you please elaborate why you feel handicapped not wearing power attire everyday?

    • Mario says:

      “And forget also about monetary policy; we have already unZIRPed our pants, and lower them to our knees even with a twist.”

      I freaking LOVE this line!!! Humor for econo-metric dorks!!! LOL

      and great analysis Oct.

  3. kris says:

    MASSIVE STUPIDITY is a good way to put it, or better COCAINATED CROWD.

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