The Markets This Week

August 7th, 2012

A favorable employment report on Friday led the stock market to its fourth consecutive weekly gain and a three-month high on Friday. U.S. payrolls added 163,000 jobs in July, above the 95,000 expected, giving investors some hope that the economy will manage to shuffle along, instead of falling into a recession.

The Dow gained 217.29 points Friday to hit 13,096.17, reversing losses from earlier sessions. The index rose 20 points, or 0.16%, on the week. Likewise, the Standard & Poor’s 500 rose 25.99 points Friday, bringing its weekly haul to five points, and leaving the index at 1390.99—10.6% higher than it started 2012. The Nasdaq Composite wasn’t left behind. It gained 58.13 points on Friday, ending 9.81 points higher on the week at 2,967.90.

The July jobs numbers offset some of the disappointment investors had after both the Federal Reserve and the European Central Bank failed to act on recent rhetoric that they would move to help the economy. Milton Ezrati, senior economist and market strategist at Lord Abbett, believes the ECB may announce a plan to provide liquidity within the next two weeks and he’d expect the markets will continue to rally on the news.

“We think the market over the next six to 12 months will return more than 10%,” he says. That’s in addition to the gains the market has already enjoyed this year. If the economy can grow 2%, and inflation runs about 3%, he believes companies can grow revenue 6% to 7%, especially if they have international exposure. So even if there is no margin expansion, corporate earnings should improve moderately. Not bad for a sluggish economy.

THE BIG SURPRISE of the week was the $440 million loss racked up by Knight Capital Group (ticker KCG) in just 40 minutes. Thanks to a software glitch, the company
accidentally bought almost 150 stocks on Wednesday. It sold those stocks to Goldman Sachs at a loss.

Knight stock collapsed from $10.31 at the week’s start to a low of $2.27 on Thursday, then bounced more than 50% to $4.05 on Friday on reports that the company secured a line of credit.

Knight might not be well known on Main Street, but it is a vital part of the equity markets. The firm is the largest secondary trader of U.S. equities, trading 15% of the stocks listed on the New York Stock Exchange in the first half of this year and 16% of those listed on Nasdaq. You may not think you’re trading with Knight but the trade that you send to your broker may find its way to Knight to be executed.

Knight is reportedly working to raise equity, which isn’t surprising given it only had $336 million of cash on its balance sheet as of June 30. But even if it manages to raise the capital it will have to repair its reputation and convince the Street it’s safe to trade with them again. By the close on Friday, TD Ameritrade and Scottrade had resumed trading with Knight, while Vanguard Group and Fidelity Investments reportedly continued to trade elsewhere.

“Knight has a very strong reputation and was known for staffing up with smart people,” says one equity trader. Adds Larry Tabb, founder of the research firm TABB Group: “They have a great business and it’s amazing that in 40 minutes you can do that much damage to a company like Knight.”

Knight’s software nightmare is just the latest in a spate of market malfunctions. Think JPMorgan’s big trading losses, the flubbed Facebook and Batts IPOs, MF Global, and the infamous Flash Crash of 2010. One potential solution: Increase the difference between where investors can offer to buy and sell stocks, particularly on mid- and small-cap stocks. The spread is now a penny and Tabb thinks it should be wider to improve liquidity and slow down the market.

“My viewpoint over the last year and a half has really changed,” says Tabb, who previously thought narrow spreads and more technology would improve liquidity across the markets. “This market is not robust.”(Source: Barrons Online).

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