Our NY presenter still likes IFSIA and ASCMA as long-term holds, but is not recommending either name at current levels. In his view, both stocks have run up too much too fast.

Flash Trading and Private Property Rights

The investment management industry has a lot at stake in the flash order controversy. The freedom to acquire and dispose of one's property is a fundamental right, and property owners must be allowed to determine the methodology by which they will acquire or dispose of their assets. Have you ever been called by a real estate broker who tells you a home you are interested in will be coming on the market soon? That's a form of flash trading. Long before we had electronic trading, we had block desks. These desks often called customers they believed might have the other side of an order before sending the order to the floor. That's a form of flash trading. On the NYSE floor, a floor broker might decide to leave a small bid on the public order book, but whisper to the specialist that he has an interest in size. The specialist might discreetly shop that interest, or discreetly begin to acquire shares in "stabilizing transactions" in order to accumulate enough shares to make an offer in size. Sounds like flash trading, doesn't it?

After the PC was developed, portfolio managers were able to use optimizers to generate hundreds of orders at a time. The original electronic dark pools, POSIT and The Crossing Network, sprang up to help traders defray the cost of executing these orders. Typically, the order list was shown to the dark pool, and the residual was taken to the floor for execution. Dick Grasso at NYSE argued this created fragmentation (the "F" word) and was bad for markets. We electronic traders argued it was the "S" word--segmentation, or "different strokes for different folks." Investment managers, with a fiduciary obligation to obtain best execution, began to have an increasing number of alternative venues on which to place their orders, and the ability to decide which one was best for each of their orders.

Senator Schumer's "little guy" benefited from this enormously. Years ago the little guy called a broker, who took his order over the phone, then walked it down to the wire operator, who sent it to the exchange. Eventually a report came back to the branch, and hopefully the broker called his client to provide the report. Today's little guy sends the order in on his PC and gets a report as fast as browser can switch to the order status page. And instead of quarter-point spreads, the little guy is paying a penny or two in large-cap stocks. A more robust system for handling institutional orders might mean that a 200,000 share order creates less market impact, which protects the little guy, who apparently can't stand the volatility these orders create. In any case, the little guy's feedback loop on an order today is at worst a few seconds longer than an institution's, rather rather than several minutes.

Thirty years ago, most of the trading happened at the NYSE post or in the upstairs market. The upstairs market was fragmented and tricky, as traders had to figure out who really might have the other side of the trade: Goldman, Morgan, Jefferies, or Cantor, etc. If you guessed wrong you could be embarrassed as someone else found a seller first and sopped up the liquidity you were looking for. That's no less an issue today--which dark pool or ATS has the other side? Flash orders are a legitimate technique for finding the liquidity you need. Any trader knows they aren't for all situations, just as any homebuilder knows some jobs take a hammer, while others take a screwdriver.

I'm dismayed by the knee-jerk reaction by the SEC to all of this. Mary Shapiro must have spent too much time at CFTC, where futures exchanges was monoploy contracts could change the rules at will and the customers were stuck with them. Stocks can trade anywhere, and if the SEC is disregards economic necessity and prohibits what are essentially long-standing, sensible trading techniques, that trading could easily move offshore. It's all a matter of where the servers are. And Shapiro was an SEC commissioner from 1988 to 1994, when the electronic markets were first developing. She should understand that traders are for the most part evolving electronic trading structures that replicate techniques developed in the old Analog" days.

Bottom line--I think it's important that the industry stand up for the fundamental freedom of having the right to acquire or dispose of property as you see fit. If you agree, write your Congressman and the SEC, and maybe let Senator Schumer know you're thinking of moving your firm to New Jersey or Connecticut, or at least moving your executions out of state. If you disagree, let me know why. Maybe you're right and I'm not.

Many worries about China this week. Jeremy Grantham, always a force to be reckoned with, says his analyst worries that China is "dangerously
unbalanced and very likely to come unhinged in the next few quarters." http://www.gmo.com/websitecontent/JGLetter_ALL_2Q09.pdf
Additionally, investors such as Marc Faber and Jim Rogers are also concerned. There is clearly a liquidity bubble in China. Bank loans this year are up dramatically, despite indications the economy isn't that hot. As money will do when the real economy can't absorb it, it seems to be finding its way into stock and real estate markets. The central bank is warning banks not to make speculative loans. There is a great deal of discussion about toxic assets in state-owned enterprises, new buildings with only 20-30% occupancy, etc.

This makes perfect sense in the short term. It isn't easy running a growth company, or a growth country, in a big recession. Traditionally, you have to build facilities ahead of your need, anticipating the increased worker base you'll need with business up 10-20% every year. When the music stops, you have a lot of empty offices. You'd better be well financed. From an external standpoint, China is well financed. But I can think of another country, across the Pacific from China, that also has toxic assets in state-owned auto companies and banks, plenty of empty office buildings and warehouses, and tons of debt both internal and external. This country has a political system that can't say no to any special interest that can round up some voters, and its provincial governments are in a heap of trouble trying to pay for all the pork. Soon the national government will need to rethink its agenda--the central bank is now buying its bonds, not truly as instruments of monetary policy, but seemingly as a buyer of last resort. While the Chinese still have some racial unrest, especially in provinces that are now part of China but whose native tribes don't really feel like full-fledged members of society, that other nation still arrests minority constitutional law professors on their front porches for dubious reasons.

The point is, nobody's perfect. Not companies, and certainly not governments. If you can get reasonable execution, and you have competitive advantages, you can do well long-term. When you look at China, you see plenty of cheap labor, and plenty of international credit to buy the capital equipment to make it more productive. You also see the massive investment in infrastructure to facilitate commerce. Meanwhile, the developed world seems to be very interested in raising the cost of labor even more. This has always been a prelude to the export of jobs. And the Chinese have the workers and the capital to take those jobs.

I''m not sure I want to invest heavily right into the teeth of this liquidity bubble. But I think there are too many reasons not to ignore China over the next decade. What do you think?

CIT exposure

Word is that some of the big retailers are already notifying vendors that they will assist in financing the holiday buys. This is a BIG issue. CIT needs more cash to finance lines and players like Urban Outfitters have major exposure from smaller suppliers like CIT type customers.

Cant help but weigh in. I thought I had a clunker but it got to many MPG. But just heard junkman tell me he crushed a 2002 Hummer in perfectly good shape with 34,000 miles. The guy traded it in for a 2009 Hummer and says he is trying to sell it $2000 below sticker for a $1500 profit. Only in America.

Our New York presenter likes infoGROUP's (IUSA) strategy adjustments and cost cutting initiatives that are running ahead of schedule. New management is making all the right steps to put this provider of marketing solutions in a great position to capitalize on the ongoing transition to digital and interactive marketing. IUSA has lowered its debt to the level where tripping of covenants is no longer a threat. A takeover by a larger rival is a possibility that has to be taken into account.

As an avowed capitalist, and democratist, I find myself wondering if China's hybrid econo-political system might be better than the current American system at efficiently allocating capital and pushing the special interests aside in favor of making the nation richer. Sure, there are hitches in the process, but in China there was evidence that some people would have to wait for economic gratification, while in the U.S. we seem to be dedicated to the principle that almost every special interest group has the right to gratification of the instant variety, unless it's the current handful of hateful groups (currently healthcare administrators and financiers). It would appear to me that China has about 250 million farmworkers who can ultimately be moved right into the industrial/service economy. The plan seems to be to move them off the farm as opportunities present themselves. The current global slowdown is only a minor hitch in the secular move. Some of these 250 million workers will absorb real world growth, but many will be replacing makers of physical goods in Europe and America. With PPP GDP per capita at about 1/8th of ours, we better figure out how to educate our workforce into more high-value jobs, or we won't be able to afford our health care dreams.
Despite its high savings rate, it seemed to me that China wouldn't be like Japan, and that consumer spending could grow faster than GDP as a whole as consumers upgraded from Mao-era privations to modern excess. Ads are appealing to consumerism, with bigger houses, even with golf courses, more BMWs, Audis, and Lexuses. The Chinese seem quite status-conscious. With their country making all the things that we consume in America, from stuff sold at Wal-Mart to designer apparel, the Chinese can buy the unexported goods at unexported prices, stoking the flames of a consumer inferno. It's popular in the US to blame a cheap Chinese currency for our troubles. At first glance one might think there's room for the yuan to run, with a Big Mac at less than $2 and $80 shirts for $15-20, but if the yuan rises, China will just be buying all those raw materials around the globe at cheaper prices, as well as incurring cheaper transportation costs. The increased value of the yuan would only affect local value-added.Getting back to that national asset allocation scheme, the Chinese stimulus seems better than ours in that it really seems to support industrial infrastructure. China does have it's SOEs, the state-owned enterprises that reduce the supply of capital available to real businesses, but that sector seems to be geting smaller there, while it seems to be increasing here. One could look at the Chinese SOE situation and view it as the wind-down of a system that resulted only a short time ago in the state owning all the capital. It's funny that they seem to be moving away from that while we seem to be moving toward it. And they are the ones with experience in that system.

Bankers and Real Estate Agents and Health Care

Business is tough. Over the last week talked to numerous bankers. Its always credit committee against sales folks. Sales are being told go out and find loans. The credit committees say no except to the very cream of the crop. The cream is not getting lower and the sales people are still searching for more quality cows. There is just very little activity. Looking for commercial real estate and prices are off 20-30%. They also say it is better. It just doesnt seem to be any better. Shaker Boulevard where Obama visited today I counted 14 houses for sale in a one mile route. I wonder if they kept the signs up as he was arriving. I just cant get over the comment from last night. If my child has a sore throat Obama said the current system incentivizes taking a take the tonsil out approach rather than long range treatment. What doctor thinks that way.