From "dark pools" to "murky waters"...

Are "dark pools" a by-product of the singularity effect on markets?

As computing technology advances and as communication gets closer to being instantaneous, the whole landscape of investing is being impacted. This was first observed in a significant way with the so called "flash crash" of 2010, a glitch in computerized trading algorithms that, for a fraction of a second, sent the Dow tumbling down 9% before recovering.

The exponential growth in computing power and its increasing ubiquitousness in the financial markets are posing a threat to the more traditional approach to investment management. Rapid-fire traders, assisted by computing power running complex algorithms are able to second guess and place orders before your average investor can, thereby reaping the benefits of "first come, first serve". This is proving to be problematic for a whole range of investors that are ending up buying high and selling low.

Dark pools basically provide a way for investors to trade stocks away from public stock exchanges and, more importantly, away from the prying eyes of opportunist rapid-fire traders. Blackrock, for example, is in the process of setting up an "independent" fixed income trading platform for its clients. But even dark pools, it seems, are not immune from the clutches of the singularity effect, and, unfortunately, not always in a benign way.

According to a recent SEC finding, a firm called Pipeline Trading Systems LLC, that was running a so called "dark pool" for its clients, was actually using another firm it had created as the counter-party to its client trades. Even more revealing was the fact that the firm used sophisticated algorithms in its trading platform to outsmart the clients, thereby reaping nice profits from the trades. In other words, far from being shielded from the damages of high frequency traders, the "dark pool" the clients were trading in was nothing more than a mirage. This is unfortunate but could also suggest that possibly the only effective way to counter this trend would be to employ more computing power. With all the emotional bias shortcomings to investing that have become even more evident with the financial crisis, it might be time to rethink the whole approach to investing.

Is Spain the next Greece?

These are dire times for the Eurozone because, despite the positive effects of the LTRO, there doesn't seem to be any follow-up going on. The same medicine is being applied, i.e. forced austerity with no relief in sight. Even more worrying is the signs that the Greek triggered contagion seems to be spreading to the larger "peripheral" economy of Spain and this is where the real troubles begin. The country's fiscal balance and public debt were amongst the healthier ones of the zone when Greece's troubles first surfaced in 2010. Spain entered the crisis as a result of the real estate bubble that was being fuelled with cheap lending from core members. Unemployment is already rampant, at levels comparable to the "great depression" era of the 1930's and the austerity measures are only contributing to deepening the slump.
The graph above clearly shows that the LTRO effect is running out, accelerating the growth of the debt burden through higher borrowing costs. Unlike Greece, Spain's economy is significantly larger making it significantly more difficult to bail it out. If the Eurozone cannot afford having Greece fail for reasons of contagion, imagine the risk that Spain represents!