The Exchange

Why investors shouldn’t worry if the market is rigged

The Exchange

If you didn’t think stock markets were rigged last year, you may have changed your mind this year. Flash Boys, the latest book by Michael Lewis, focused a spotlight on high-frequency traders and the technological tricks they use to gain an advantage over competitors. The exposé revived a long-simmering debate over whether the market is rigged in favor of slick practitioners, with ordinary investors losing out.

It just might be the other way around, with ordinary investors losing out because they’re worried about a rigged market. At the annual finance conference sponsored by the nonprofit Milken Institute in Beverly Hills, Terry Duffy, president of the CME Group, pointed out that worried investors have missed epic gains because of scary headlines about wayward bankers and a regulatory standoff between Wall Street and Washington. “It’s really a shame people look at the market and say, ‘Why would I want to participate in a market I feel is not legitimized?” Duffy tells me in the video above. “The market has incredible value to it.”

The numbers are on Duffy’s side. Since it bottomed out in early 2009, the S&P 500 stock index has risen by a whopping 180%. And since 1989, stocks have risen by 500%. Yet data show many Americans pulled their money from the stock market during the 2008 financial meltdown, and have kept it on the sidelines.

There are obvious reasons why. Despite the market run-up, a flurry of lawsuits between the government and marquis Wall Street firms such as Citigroup (C), Bank of America Merrill Lynch (BAC) and J.P. Morgan Chase (JPM) seems to suggest unsavory practices are the norm. New regulations promulgated under the Dodd-Frank reforms are so voluminous the majority haven’t even gone into effect yet, creating rampant uncertainty about Wall Street profits.

Duffy suggests everybody would benefit from tougher policies on murky Wall Street traditions such as “dark pools,” in which large institutional trades occur away from central exchanges with no public oversight. “Transparency is of the utmost importance, especially for the small investor,” he says. “You’ve got to have confidence the game is not rigged.”

Regulating dark pools, hedge funds and other elements of the so-called shadow banking system may very well be matters policymakers consider in the future. But for now, Washington is stymied by partisan bickering and fatigue over government intervention in the economy.

So what should investors do until there’s more transparency? Step back, perhaps, and take a longer-term view than they’re accustomed to. “People should feel confidence in the structure of the market,” Duffy says. “The market has gone straight up and nobody has been in it.” Past performance, of course, is no guarantee of ... well, you know the rest.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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