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Occasional rallies to be only relief for markets unless Europe finds solutions

THE Australian sharemarket rose in chorus with global equities yesterday as punters speculated that the bear market had reached its nadir and the days of doom and gloom were over. It is a noble feeling but a tad premature.

THE Australian sharemarket rose in chorus with global equities yesterday as punters speculated that the bear market had reached its nadir and the days of doom and gloom were over. It is a noble feeling but a tad premature.

A commitment by six European central banks to join forces and pump liquidity into the system for at least a year, coupled with a reduction in interest rates in Brazil and China, weaved its magic through all equities markets, adding tens of billions of dollars to investor wealth.

But it is magic that will be short lived unless a fix is found for the fiscal and political problems that face Europe. Speculation was rife yesterday that a solution will be revealed next week, but whether it will be enough to sort out the crippling debts and social unrest that is gripping Europe as a result of austerity measures to repay debts is yet to be seen.

Until the problems are sorted out, rallies like yesterday's will be nothing more than relief rallies buoyed by opportunistic short covering.

The brutal reality is trading volumes are still relatively thin as investors have spent the past six months cashing out of equities. (In Australia, the equities market has fallen more than 15 per cent since April, wiping billions of dollars of value from investor wealth). The average value traded per day is down 23 per cent on last year.

The upshot is any above-average buying or selling has a violent impact on markets on the upside and downside.

Yesterday world markets rejoiced at the surprise announcement by six central banks that they would provide a liquidity lifeline until 2013. It then fuelled speculation that the European Community will come up with a palatable resolution next week.

If the solution is to pump more liquidity into the system it will increase the risk of an inflation bubble in 18 months.

For Australia, it will herald the peaking of the Australian dollar and a signal that the US dollar will resume its ascent, along with gold prices.

The latest bear market has caused a lot of collateral damage. Investors have lost a fortune, retirees have watched their retirement savings shrink and brokers have been decimated by reduced trades and therefore reduced brokerage.

The only real winners have been hedge funds and high frequency traders, who thrive on volatility by betting against the market using sophisticated algorithmic strategies. With ultra short-term strategies dominating short-term equity pricing it is no surprise that when momentum changes it has an extremely large influence on price.

As stockbroker Charlie Aitken recently remarked: "While the global fast money has a massive short-term influence, the simple fact is they hunt as a pack and take markets to extremes. They eventually crowd out their own positions and then when the unwinding starts, they realise they have been playing a game of pass the parcel with themselves."

Right now, an estimated 20 per cent of local trading is classified as short-term trades, including short selling, derivatives playing, dark pool trading and high frequency trading.

In the United States and Europe, with multiple exchanges, short-term trading now accounts for between 50 and 65 per cent of all trades, making a mockery of the traditional buy-and-hold investors. This type of short-termism is on the rise as faster computer technologies emerge that make it possible to buy and sell shares in milliseconds or even a picosecond, which is one trillionth of a second. The computers search for liquidity or gaps in the market or small points of leverage to buy and sell a stock.

CORPORATE regulator ASIC, the ASX and the many brokers that rely on Penson Australia to clear more than $60 billion of equities trades a year can sigh with relief after the clearer was sold to a blue ribbon rated bank in the US.

Bank of New York Mellon announced yesterday it had won approval to buy Penson Australia in a $US33 million share purchase transaction.

Penson Australia has been on a knife's edge since it emerged this year that parent Penson Worldwide was in trouble and had had its credit rating cut to junk bond status.

Not surprisingly, it drew attention to the arrangements in Australia for third-party clearing and the potential systemic risk that has been created by the decision made by the ASX during the global financial crisis to crack down on brokers, particularly those that self-clear.

Penson's local boss, Craig Mason, will take up the position of Pershing Australia boss, after earlier trying to structure a management buyout bankrolled by private equity.

Penson Australia has net assets of $20 million so any sale needed to be at a minimum of $20 million to enable it to meet its capital obligations to the ASX from January 1. Third-party clearers need liquid capital of $10 million but from next year this will double to $20 million.

Penson is the clearer for more than 20 market participants, which is the bulk of retail brokers, and more than 50 shadow brokers. In dollar terms this is equivalent to clearing $65 billion of trades a year.

While an ownership change in this instance is a good thing as Pershing is a solid operator, having one dominant third-party clearer handling so much clearing and settlement of shares on behalf of retail brokers carries a risk.

The risk is this: if the third-party clearer fails, or several of its clients fail, it could threaten the entire settlement system. It is called concentration risk.


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