Controllers on Wall Street

by | May 28, 2003 | Archives

A reader whom I know well and deeply respect sent me a memo. I am forwarding excerpts to you because he has been a very successful equity trader for decades and follows the market in a multitude of ways. This means he is in a position to spot something funny that 99% of investors would miss.

I have no way of knowing (nor does he) if the theory he outlines in this memo is correct. Whether there is a conspiracy or not, I have forwarded this information so we can see that there is a strange phenomenon taking place on Wall Street of which investors should be aware and to beware.

 "Gary – it recently struck me that one of the unstated means the Fed could use to 'fight deflation' might be the quiet purchase of SPX and other stock index futures' contracts. That WOULD be, to say the least, QUITE unorthodox!"And something strange -- maybe bizarre -- has surely been happening in the stock index futures' markets. Stock indices have been running the show. This is particularly true for the SPX e-mini contracts, which have soared in open interest over the past month and a half."Last week, the CFTC's 'Commitment of Traders' -- shown in Barron's Market Laboratory section each week -- revealed that a staggering, nearly 375,000 net long positions in the SPX e-minis were held by 'Small Traders' (down just slightly from the week before)!"This is significant: That number is many times the 'normal' average of such contracts' open interest. Yet it doesn't appear to be the public, as such who's running the show?"It would be MOST unusual for individual investors to be SO enthusiastic for SO long, especially in the face of what to most long-time professionals appears to be less-than glowing news."So could it be the Fed? And if so, why 'Small Traders' using the e-minis and not the more expected 'Large Speculators' or 'Commercial Hedgers' using full-sized contracts (if the Fed were actually using this ploy?)"Small Trader figures are only determined by subtracting the 'Large Speculator' holdings from the 'Commercial Hedgers'. The result – an UNREPORTED result -- is assumed to be the current 'Small Trader' holdings. The CFTC requires holdings of both other categories be reported on a weekly basis."And why might the Fed actually do this (if in fact they legally could?) Quite simply, to give the appearance of a new bull market in stocks ... one that was being fueled by the public (read that to mean 'Small Traders') who had finally become bullish. The Fed probably hopes bullishness is contagious."E-minis, though cumbersome, would probably be used (instead of full-sized contracts, which are used mostly by professionals) to further support the appearance of public participation. And with the ongoing net outflow of money from stock mutual funds, SOMEthing is needed to give the impression that the public is finally changing its mind!"The Fed is hoping to stave off deflation -- we all know that. It is widely assumed their 'unorthodox means' to expand this fight would be to ease short term rates even further, to purchase long-dated U.S. Treasuries, and maybe even to purchase foreign bonds."But as has also been reported on CNBC, one indicator that the Fed watches to see if its efforts are bearing fruit is the stock market --- especially the return of a bullish stock market ... and particularly the return of small investors into stocks from their hiding away in money market funds."It's expensive for the Fed (or anyone) to buy bonds – especially low-yielding bonds (which would either have to be sold later at a loss or held, say, as a low-yielding Social Security investment) -- at what seems to be close to a yield-market bottom."A much cheaper and easier way would be to prime the pump by manipulating the stock index market -- there are a number of ways to do it ... assuming one has enough 'juice' to play the hand. After all, in the futures' markets, no money actually changes hands until final settlement."So it could be VERY cheap -- and possibly PROFITABLE, no less! – for the Fed to act in this way ... assuming it can convince John Q Public a new bull is at hand (and then quietly close Its long positions, just like the trading cartels of old)!"It seems reasonable to assume that only the Fed has enough horsepower to perform the "magic" that's happened in the stock index markets over the past month, at least to these battle-weary eyes (which have been focused on the financial markets for the last 40+ years)."Most hedge funds of size would be using the standard SPX contracts ... and these have remained relatively stable, in terms of open interest. So it seems quite possible somebody is hiding something with the e-minis."I suppose it would be fine for the Fed to be doing this for The Public Good ... except it completely destroys the notion of a 'free market.' And this is especially true if you happen to be a trader -- small OR large -- who assumes (a risky process, admittedly) that the playing field is at least modestly level and bases his or her trading decisions on these observations and beliefs."After all, that's what the Security Acts of 1933 and 1934 (wasn't it?) were designed to prevent: The manipulation of the stock market by trading cartels."What do you think about this hopefully far-fetched "conspiracy theory" that's been nagging at me?"

Well readers, what do you think? Let me know. Let's share what you all have to say.

Until next message, may your mind have clarity.