I decided to dedicate some resources into the reason stock prices have diverged so far, and so fast from the underlying fundamentals. The preliminary results of my findings will be released over the next day or two, hopefully. In the meantime, enjoy this precursor.

Market volumes

Volumes in the markets are tapering down and are undermining the strength and sustainability of the recent rally. The average volume of both Dow Jones and S&P 500 in June were below the average volumes (since Jan 2008)

As a matter of fact, you can easily and visually discern from the charts above that there is a clear inverse correlation between volume and index price. The higher the volume, the lower the index goes, the lower the volume the higher the index goes. I attribute this to the observation that most REAL investors realize that there are too many headwinds in the market to truly commit significant long capital. Well, if that is the case, what is causing the stock prices to rise on light volume????

Growth in program trading

There has been a phenomenal surge in program trading over the past one year with program trading accounting for 40.4% of total trading volumes on NYSE for week ended June 19, 2009 against 35.1% in January 2009 and 27.8% for the previous 52 weeks. The growth has been exceptional particularly since the last week of May 2009. This smells quite fishy, after all the last week in May also saw a significant jump in both the S&P and DJIA on diminished volume.

Influence on market

Since April 6, 2009 when S&P 500 index was at 857 points program trading accounted for 30.9% of total NYSE volumes. Over the past two months when S&P 500 increased to 921 points program trading has increased to 40.4%. Similarly, the relation between program trading and the S&P index was also witnessed during December, 2008 - February, 2009. Increase in program trading historically has been a major contributor of increased volatility due to abrupt price changes due caused by automated rule based trading. Widespread use of program trading has been one of the causes for the stock market collapse on October 19, 1987, also referred as Black Monday. However, there are numerous other factors that could explain the increased volatility and it would be difficult to discern the sole impact of program trading on volatility.

Major Players

Goldman Sachs is the largest player in the program trading market space with nearly 20.6% of program trading volumes as of June 19, 2009. Overall, Goldman Sachs program trading volumes alone form a substantial 8.3% of NYSE total volumes, up from 7.0% since 2009 beginning. Although, Goldman Sachs trading volumes still dominate the program trading there has been significant surge in program trading volumes of Deutsche Bank, Morgan Stanley, Barclays and Credit Sussie with 158%, 89%, 152% and 118% increase in program trading volumes. Deutsche Bank, Morgan Stanley's share have increased to 12.3% and 11.6%, respectively for the week ended June 19, 2009 compared with 8.3% and 4.0%, respectively for the week ended January 2, 2009 suggesting that some of the recent rally could be driven by increased trading by these institutions.

Now, I have warned about Goldman's increased VaR and exposure to trading activities over a year ago (see "Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street"). For those that believe Goldman is invincible in the trading markets, I strongly suggest you query their December 2008 trading performance, which resulted in a big loss. These results somehow became "orphaned", not being included in Q4-08 or Q1-09 results. This was a convenient exercise of hide the sausage, since the December result would have skewed either quarter significantly to the negative. Goldman is now basically a big hedge fund, and would (and should) be valued as such if not for the premium, "mystique" brand name that has been attached to it by those who do not adequate vet the financial statements. I will bring more on this topic tomorrow. In the mean time, I suggest all re-read my missive from April of this year - "Who is the Newest Riskiest Bank on the Street?". I saw this coming a while back.

Maybe readers should send their local elected official a copy of "Newest Riskiest Bank" as well as this article to their fellow taxpayers and elected officials in Congress so all can see what our tax monies have been bailing out and supporting over the last year - the continued and blatant risk taking that was the root cause of this mess to begin with. I pray thee tell me, what happens if Goldman crashes in a programmed trading meltdown??? More taxpayer TARP, bank bailouts, supports and guarantees. Now, what do you think happens if things go well for their trading program? The biggest bonuses in the history of the company, in order to "incentivize" stars to stay. This is absolute nonsense, and the takers of the risk need to be the ones to bear the consequences of said risk, not simply be the sole persons and entities to benefit from the rewards of said risk. I say the taxpayer should share in the Q1 Goldman bonuses, since it was the taxpayers support that kept Goldman alive through Q1 (remember the Decemember loss, the expedited federal bank charter, the debt guarantees, the TARP, the ZIRP, the taking of junk assets as collateral, the TALF, the PPIP, the AIG bailout funds forwarded to GS, and the whole enchilada???). Does anyone really think that Goldman earned those bonuses without government assistance. Now, I feel I should keep my bonus, if I were to get one, because no one gave me $55 billion to keep me in business while I waded through risky mistakes until I found some that paid off! Can Goldman say the same???

Do not simply follow accounting earnings without taking into consideration the risk involved in generating said earnings. Consider yourself warned!