Why so few investors trust the market

By David Weidner, The Wall Street Journal

A trio of new trends is sidelining investors, who are losing faith that age-old stock strategies mean anything in an age of computerized trading.

Over the last decade, the march to democratize the markets has charged forward, with each new innovation or revamp heralded as making the playing field more even and giving smaller investors a greater sense of fairness and trust.

These efforts have yielded two tangible results: lightning-fast execution and slashed trading costs. The floor of the New York Stock Exchange is witness to this shift. The number of floor brokers has shrunk by half, to 1,500, in just five years. Actual trading on the floor is less than 10% of volume.

Taking the place of humans are those coldly efficient and incorruptible machines.

And yet despite these efficiencies, most investors find themselves questioning tried-and-true principles and strategies: value investing, technical analysis, momentum plays and even the simplest maxim, "buy low and sell high."

Poll after poll shows that investors feel the markets are tilted unfairly against them. What's worse is that investor skepticism is higher than it was before market "reforms" allegedly improved the system.

In its latest poll, released in December, the Chicago Booth/Kellogg School Financial Trust Index found that only 16% of investors said they trust the stock market. That is roughly the same level of "trust" the survey found in the months after Lehman Brothers collapsed and the Dow Jones Industrial Average (INDU) fell to below 7,000.

Market confidence has historically ebbed and flowed with market performance. People feel ripped off in a correction. They feel they are getting their fair share in bull markets. Today the Dow is in the midst of a six-month rally, flirting with the 13,000 level -- so why is confidence still in the tank?

There are multiple reasons. Regulators such as the Securities and Exchange Commission and Commodity Futures Trading Commission are forever a step behind. Alternative trading platforms, or "dark pools" are anonymous and menacing, and they have been susceptible to market manipulators, critics say.

Also, there are the high-profile examples of wreckage: the botched BATS initial public offering, for one, which came on the same day Apple (AAPL) shares went through a trading glitch that slashed value.

Those factors are enough to make investors nervous. But the bigger trends are what are really at play here, not momentary glitches. They make those of us old enough to remember long for the good old days when trades were handled by fallible, corruptible humans. In a nutshell, three new trends have turned many investors into spectators in a game they are supposed to be playing, not watching:

High-frequency trading: Now an estimated 70% of the volume pie, computerized-trading platforms seem to have their own will. Most investors, while benefiting from the liquidity these machines provide, are reasonably skeptical of high-frequency trades' influence on price, especially in periods when the markets have low volumes made up mostly of mechanized transactions. Witness shares of General Motors (GM) that traded at more than $1 even after the company filed for bankruptcy in 2009, a mystery that was blamed on high-frequency trades propping up the stock so they would continue to collect rebates for filling orders.Derivatives: Today's markets are often the tail wagging the dog. Futures and exchange-traded funds are a part of this, but a bigger menace is the credit-derivatives market -- the vast network of agreements and contracts that bet on debt. Bond prices are now set in the derivatives market, a trend that has extended to the equity market as well. A study by Greenwich Associates in 2007 concluded, "In many ways, hedge funds have become the market."Absence of the big computer: Perhaps the biggest difference between today's market and that of a decade ago is the disappearance of brain power. For as much as they were maligned, specialists and floor traders kept a measure of reason in stock trading. When a trade didn't look right, there weren't big, inexplicable flash crashes. The trades were executed by humans who used instinct and experience to avoid panic. For all the electronic advances, the big computer -- your brain -- still is the most powerful of all. That is why much of the business during the May 6, 2010, flash crash ended up in the hands of humans -- not that they were any match for the machines.

Ultimately, these factors have combined to make the best intentions of regulators and exchange companies ineffective. Investors used to worry that a specialist might front-run a trade or play favorites. And certainly, as SEC investigations of the early 2000s showed, those fears were real.

But when compared with an entire landscape so completely skewed by outside forces beyond simple supply and demand economics for a stock, the days of front-running almost seem quaint and innocent.

Buy low and sell high? What's low? What's high? Is there anybody out there?

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Water: Good as gold for investors

By Jim Jubak

The world's most critical commodity is getting harder to find, which makes it an attractive investment. Here are 10 ways to play it.

Water.

It's the global commodity that most deserves a place in your portfolio -- ahead of gold, iron ore, copper or oil, I'd argue.

And it's also the toughest to invest in. Water isn't traded -- in fact, in many countries it's not even metered. Pure-play water companies are hard to find, especially if you rule out the obvious but slow-growing water utilities. The leading companies in big swaths of the market are industrial conglomerates in which water has historically made up a relatively small share of revenues.

For example, among the top 10 companies in the Guggenheim S&P Global Water (CGW) exchange-traded fund, which is designed to track the Standard & Poor's Global Water Index, I'd call five of them water utilities and two diversified industrial companies with a presence in water. That leaves only three, or about 30% of the ETF and index, anywhere near the sweet spot in water. (More about what the sweet spots are later in this column.)

But this is changing.

As the individual parts of the water market get bigger, investors are seeing a wider array of pure plays. For example, orders for desalination equipment to convert seawater into water for drinking and industrial processing hit $5 billion in 2011, according to Global Water Intelligence. Those orders are forecast to hit a record $17 billion in 2016.

And it doesn't hurt that both companies and investors see water bucking the trend of other environmental sectors. As of Aug. 29, the Guggenheim S&P Global Water ETF was up 8.85% from last year, versus a brutal 38.53% drop for the PowerShares WilderHill Clean Energy (PBW) ETF.

You can put together the investment case for water from the headlines.

Supply is falling. Droughts devastate -- depending on the year -- the United States, Australia, India, China and Argentina. Evidence mounts that the global climate is becoming more volatile, putting historic water-carrying weather patterns such as India's monsoon season at risk. Supplies of clean water shrink as underground aquifers are mined for limited supplies of water accumulated over millions of years. Clean water supplies also dwindle as existing sources are polluted by farm chemicals, inadequately treated industrial discharge and untreated urban sewage.

Amid all this, demand is rising. According to data from the United Nations, withdrawals of fresh water have tripled in the last 50 years, with demand for fresh water increasing by 64 billion cubic meters (64 trillion liters, or 16.9 trillion gallons) a year. Some of that is from global population growth of about 80 million people a year, at current rates. Some is from changes in lifestyles and eating habits that increase per-capita water consumption. And some is from soaring demand for clean water from farmers, industry and city dwellers. Add in increases in energy production (because tapping sources such as oil sands and biofuels requires more water than extracting from traditional sources of oil and natural gas).

The math is pretty simple: Falling supply and rising demand will drive the price of the commodity higher. Want to know where to invest in water? Follow the flow. In this column, it takes me to 10 water stocks in three categories.

Rising prices for water will produce gains for global water utilities, even if those returns are capped by regulators at a specific return on invested capital. The best bet here is on water utilities that are building out infrastructure in places where water demand is rising most rapidly and new investment represents a large percentage increase over existing investment.

If that sounds like a prescription for investing in water utilities in developing economies, it is.

For example, Manila Water (trading in Manila as MWC.PM), which already supplies water for half the Philippine capital, has recently bought a 47% stake of Vietnamese water distributor Kenh Dong Water Supply and 49% of treatment-plant operator Thu Duc Water. The stock is up 43.86% in the last year.

Or Guangdong Investment (GGDVY), which supplies Hong Kong's water (and is up 33.97% in the last year). Or Companhia de Saneamento Basico do Estado de São Paulo (SBS), which collects, treats and supplies water in Brazil's São Paulo state (and is up 60.62% in the last year).

Stocks mentioned in this article include Xylem (XYL).

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