Tuesday, 11 May 2010

A New Enron in the Stock Market
By Jeff Clark

Imagine winning the lottery twice in the same week.

Imagine picking the exact finishing order of all the horses in the Kentucky Derby
... five years in a row.

Now, imagine you're Goldman Sachs.

The illustrious Wall Street firm that seems to beat all the odds did
 it again last quarter. Goldman traders were profitable in 63 out of
63 trading days. Not one losing day in the bunch. This amazing feat
 follows on the heels of the 61-out-of-63 record for the quarter ended
December 31, 2009.

Daily profits for the firm ranged anywhere from $25 million to well
over $100 million. Indeed, Goldman traders rang up over $100 million
in profits for 35 of the 63 trading days.

Now, it is entirely possible Goldman traders are THAT good.
Maybe they can have a perfect batting average and they can hit
 homeruns more than 50% of the time. It's also possible I could
be struck by lightning while being attacked by both a great white
shark and a lion at the same time.

Possible, but not likely.

What's really going on here? Allow me to speculate...

Like Michael Milken's old firm, Drexel Burnham, ruled the junk-
bond market in the 1980s, and like Enron controlled the
electricity market in 2000, Goldman has cornered the stock market
today.

Everyone follows what Goldman is doing. If Goldman's computers
are buying, you better be buying. If they're selling, you sell, too.
It's like a playground game of follow-the-leader. Everything goes
along fine as long as the kid in the front of the line doesn't do anything
that could hurt the little guy at the back.

Like your mom used to say, "It's all fun and games until somebody loses
 an eye."

Eyes were popping out everywhere last week.

The computer algorithm trading programs, which are largely responsible
 for Goldman's odds-defying profit streak, went nuts. They kicked off
sell programs that wiped out nearly 10% of the stock market's value in
10 minutes. Then they executed buy programs that pumped prices
back up to more reasonable levels.

"No harm done," the Wall Street big wigs will likely argue. After all,
as of this morning, stocks are right back where they were before
last Thursday's shenanigans.

The problem, though, is the little guy got hurt.

There was nothing wrong with junk bonds in the 1980s. The market gave
 low-quality firms access to capital, and investors received a reasonable
return for the risk. But the leader went too far and the little guy got hurt.
Drexel Burnham went bankrupt, and Michael Milken went to prison.

There was nothing wrong with trading energy contracts in 2000.
It allowed states with excess electricity to sell to other states that
were energy deficient. But the leader went too far and nearly bankrupted
several states. Enron went under and CEO Ken Lay was surely headed to
prison (he passed away before his trial).

There's nothing inherently wrong with algorithmic computer trading
 programs. They provide liquidity and increased volume on the exchanges.
But last week, the leader went too far.

There's no doubt Goldman, and many other big Wall Street firms,
made gobs of money during last week's volatile sessions. Normally,
there's nothing wrong with that.
Goldman CEO Lloyd Blankfein should be a little nervous today.
Best regards and good trading,

Jeff Clark

P.S. Last week,
I mentioned I would write about the bearish setup in
South Korea's stock market. That setup played out last week as the
KOSPI dropped 7% in two days
.


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