Biggest threat to Wall St. is the enemy within

Memo to the Occupy Wall Street movement: Should it come up in a strategy session, don’t bother with trying to destroy the financial markets as we know them.

The people now in charge are doing a fine job of that themselves.

The protests that have mushroomed nationwide in recent weeks broadly target Wall Street and corporate greed, which makes the stock market a convenient symbolic backdrop.

But for many Americans, the market since late July has become more a symbol of fear than greed: fear of more losses, fear of head-spinning volatility, fear of grave policy mistakes by governments and central banks, and fear that stock trading is mostly controlled by computer algorithms, not by any semblance of rational human thought.

If the silent majority of tens of millions of small investors were to take to the streets, they wouldn’t have a hard time agreeing on a grievance list.

Start with, “Give us back a stock market we can believe in!”

Public disaffection with equities began a long time ago, of course — with the 2000-02 crash led by the technology sector. It got worse with the 2008-09 meltdown, then with the “flash crash” of May 6, 2010, and may well be reaching another inflection point with the wild market swings of the last two months.

A common theme in any discussion about Wall Street today is that the markets are hopelessly broken, co-opted by traders whose time horizon is measured in nanoseconds rather than years.

“Nobody wants to own stocks anymore” is the refrain.

It’s a ridiculous statement. There are trillions of dollars in stock held by individuals, the majority of whom still seem to be sticking with the basic idea of long-term investing.

Though the richest 1% of people control a massive amount of the national wealth, there are a lot of investors down the food chain (i.e., among the other 99% the Occupiers say they represent). An estimated 52.3 million households, or 44% of the total, own mutual funds. Most of them own at least one stock fund, often in a retirement account.

Most small investors aren’t likely to be out wearing tricornered hats to tea party rallies or pitching a tent with the Occupiers. They’re a modern version of the old Silent Majority, just hard-working people trying to do the right thing for their financial future.

The $5.4 trillion in conventional stock fund assets shows there is an ingrained desire to believe that equities can pay off over time. And those fund assets don’t count the individual stocks held in household portfolios, or assets in exchange-traded funds.

But it’s clear that the patience of many average investors is being pushed to the limit. To register their discontent with the market, they don’t go to the town square. They just sell stocks — or stop buying.

Now, obviously it’s unrealistic to think that every stock fund investor would just sit still in a tough market. Plenty of people use funds as short-term trading vehicles. Others learned in the 2008 stock crash that they can’t bear the risk of major loss, period.

It’s the dominant trend of recent years that speaks to the frustration level with stocks: So far this year, a net $83 billion has exited U.S. stock funds. Since 2006 the net outflow comes to $417 billion. Some of that has shifted to other stock vehicles, such as exchange-traded funds. But much of the money has gone into bonds or the bank.

It could be that investors who are abandoning equities have the right idea. As measured by the blue-chip Standard & Poor’s 500 index, we’ve already had one lost decade. The S&P, at 1,224.58 on Friday, is no higher now than it was in 1999. What if that was just a prelude to more long-term misery?

There also is a growing sense that fundamental stock research means little anymore. Given the massive government and central bank interference in the economy and markets worldwide since the 2008 financial crisis, well-meaning though it might have been, stock-picking has been subverted by an obsessive focus on policymakers’ next moves.

And even if investors believe they have superior skills ferreting out stock bargains, too many times since 2007 they’ve seen everything move at once, and violently, as machine-driven trading kicks in.

Yet for veteran investors, the more negative the popular attitude toward the market, the louder the voice in their head saying this is exactly the time to look for opportunities. In its latest bounce, the Dow Jones industrial average rose 166.36 points, or 1.4%, to 11,644.49 on Friday. It has jumped 9.3% from a one-year low of 10,655 on Oct. 3.

Still, there is a legitimate fear that, in the longer run, the market will become even more dominated by short-term traders — chasing everyone else away — if something isn’t done to try to curb volatility.

European Union leaders think they have at least a partial solution: a financial transaction tax. They propose a 0.1% tax on stock and bond trades and a 0.01% tax on derivative trades.

The idea is to raise revenue, which politicians will always say is badly needed. But the EU sees the tax as serving the dual purpose of dampening market volatility by penalizing heavy traders. Key targets are the much-maligned high-frequency trading firms, which daily enter massive numbers of buy and sell orders into the markets, hoping to profit from tiny price moves in the blink of an eye.

Not surprisingly, bankers hate the tax idea. They say it would ultimately just be passed on to real investors. And if Europe applies such a tax, but the rest of the world doesn’t, traders would just migrate to other venues.

Opposition also comes from people who aren’t bank apologists. Kenneth Rogoff, the esteemed economics professor at Harvard, wrote an opinion piece this month calling the transaction tax concept “extremely misguided.” He argues that markets would become more illiquid, harming investors, while “both theoretical and simulation results suggest no obvious decline in volatility.”

On the other side is Joe Saluzzi, a principal at Themis Trading in Chatham, N.J., and one of the most vocal critics of the high-frequency traders. He prefers to call the tax idea a “fee” on hyperactive traders.

Saluzzi likens the market to an ocean ecosystem that now is badly out of balance. “When the sharks are 70% of the market, that’s not a healthy market,” he said.

A transaction tax may have unintended consequences, but the idea addresses a sad reality: Wall Street’s recent history has been one headlong rush after another into ruinous products or strategies in the pursuit of short-term gain. We’ve all paid the price for that self-destructive streak.

Sometimes, capitalists really do have to be saved from themselves.

tom.petruno@latimes.com