We are pleased to present ITG’s newest research paper: Liquidity and Price Discovery in Exchange-Traded Funds: One of Several Possible Lessons from the Flash Crash.

Here’s a brief summary of our findings:

• Exchange-Traded Funds (ETFs) were disproportionately affected during the May 6th “flash crash” (approximately 2:40-3:00pm ET). ETFs represented over 70% of all the equity trades cancelled by the exchanges on May 6th due to a price drop of greater than 60%.

• Price discovery failed dramatically for ETFs during the flash crash. ITG’s research shows that the immediate case of this failure was not due to market structure or to a flaw in the ETF products themselves. Rather, it was due to a dramatic evaporation of liquidity for ETFs, both in absolute terms and also relative to the baskets of individual equities which the ETFs track.

• Bid-ask spreads for the 120 ETFs ITG tracks in this study average 3 to 5 bps. During the flash crash some of these spreads blew out to hundreds of basis points as providers of liquidity made an exodus from the market. Consolidated liquidity for these ETFs saw a 14-fold plunge in a matter of minutes.

• At the height of the flash crash, the returns of some ETFs completely decoupled from the underlying baskets of stocks which the ETFs track, with some ETF returns briefly underperforming the returns of their underlying portfolios by over 60 percent.

Read the full whitepaper here

Amid falling share prices, gushing Gulf Coast oil and panicky European bondholders, ITG’s Chief Economist, Bob Barbera, maintains his above-consensus forecast for US employment and GDP growth.  Despite the lackluster May payroll numbers, Bob notes that total hours worked continue to grow strongly, and he believes that below the surface of the fear, the fundamentals of this recovery are still sound.

Over the last three months, on average, private payrolls rose by 139,000 per month. That is below our expectation of a gain of 200,000 per month. That said, over the same period the average workweek climbed at a 3.7% annualized rate, well above our expectation. The sum of growth in private payrolls and the workweek, through May, suggests that Q2:2010 will register a gain of nearly 5% for total hours worked.

U.S. trading costs stayed basically flat when comparing the first quarter of 2010 to the previous quarter, but decreased by 28 percent on a year-over-year basis, due in large part to a decrease in implementation shortfall costs. In the UK, trading costs increased in the first quarter of 2010 by 14 bps from the previous quarter, driven by an increase in commission costs offset by a decrease in implementation shortfall costs.

Read ITG’s proprietary Global Trading Cost Review for analyses of total trading costs in the US, Europe, Asia, and Canada, as well as a breakdown of these findings.

The bear case for U.S. equities claims that the rally would fizzle when the effects of the government stimulus wore off. While the recent correction in the face of European sovereign debt woes is understandable, ITG’s Chief Economist, Bob Barbera thinks the corporate profits recovery is sustainable, not just an artificial sugar high. Barring a full-blown crisis in Europe – a Lehman Part II – Bob believes that investors will refocus on the strong fundamentals underlying the U.S. recovery.

ITG’s Asia Pacific Liquidity barometer rose in April despite the turmoil in European Union equity markets. Trading costs ticked down slightly to an average of 46 basis points across developed Asia, according to ITG’s TCA database, which covers almost 30% of total Asia ex-Japan equity turnover. Japan and Australia both saw an increased move towards electronic trading, tied in to the continued popularity of Arrowhead and changes in order types at the ASX, respectively.

Read the full Liquidity Barometer here

While central banks have kept the monetary spigots open for the last couple of years, inflation has yet to rear its head. ITG’s Chief Economist, Bob Barbera, points out that both core US inflation and core services prices have risen at only a 1% clip for the last several months. This, coupled with the dramatic fall in oil prices, has kept inflation in check in both North America and Europe.

ITG’s Canadian Market Microstructure Review for Q1 2010 examines changes in Alternative Trading System (ATS) market share. Highlights include:

• Volume is higher, spreads are tighter, volatility was lower (until May) but quote depth has dropped off slightly.

• ATS market share has increased to 33% this quarter from 26% last quarter, but it has declined 33% in March from 35% in February. This is the first monthly decline Canada has seen.

• There have been several trading fee changes lately as the light ATS’s jockey for position.

• Blocks were relatively unchanged at 15% of volume. Assuming 45% of volume is High Frequency Trading (HFT), 21% of institutional volume is in blocks.

ITG is proud to present our latest trading and analytics research, Alternative Trading Systems in Europe: Trading Performance by European Venues Post-MiFID.

This whitepaper represents the first performance analysis of European trading venues since the implementation of the Markets in Financial Instruments Directive (MIFID). MiFID is credited with breaking down the market power traditionally held by national exchanges. The introduction of MiFID raises a variety of issues, not the least of which is whether the regulatory changes benefit investors overall. By analyzing a sample of trading activity in Europe, we have determined that:

• Alternative trading markets, and dark pools in particular, add value relative to primary markets by lower trading transaction costs.

• The risk of slippage is greatest in primary markets, and dark venues perform better in this respect than the displayed alternative markets.

• The benefits of higher participation rates in dark pools increase with the relative size of an order.

• There are significant differences in the performance of dark and lit MTFs.

This whitepaper, along with ITG’s research papers, Understanding and Avoiding Adverse Selection in Dark Pools, and Cul de Sacs and Highways: An Optical Tour of Dark Pool Trading Performance, provides a detailed analysis of dark pool performance against other trading venues across multiple regions.

While financial markets are focused on the plunging Euro, surging gold and the generally sorry state of government balance sheets, ITG’s Chief Economist, Bob Barbera, notes that the US economic recovery continues apace. Bob believes the EU bailout dubbed “Le TARP” will ultimately stave off a pan-European crisis. While the Euro devaluation is negative for US exports, he notes that the dollar is little changed against Asian currencies, while US interest rates and oil prices have retreated, priming the pump for further economic recovery here at home.

Friday’s above-consensus payroll report is further evidence that the US economy is on the mend, contends ITG’s Chief Economist, Bob Barbera, while the household employment figures point to more gains to come. Although the Greek crisis has spooked the markets, Bob does not think it will derail US growth prospects unless it develops into a full-blown “Aegean Contagion.”