Coronaviruses are common throughout the world. So says the US Centers for Disease Control and Prevention.
The market didn’t treat news of spreading cases in China and the first in the USA (from a Chinese visitor) that way though. Airline and gaming stocks convulsed yesterday.
There’s as ever a lesson for investor-relations practitioners and investors about how the stock market works now. News compounds conditions but is infrequently causal. Investors, there are opportunities in divergences. IR pros, you need to know what’s real and what’s ripple-effect, because moves in stocks may not reflect rational sentiment.
Airline and leisure stocks demonstrate it. Active Investment pushed airlines up 2.4% last week, industry data we track (with proprietary analytics) show.
Shorting rose, and demand for derivatives used to protect or leverage airline investments fell 7% into last week’s options-expirations (know the calendar, folks). That’s a signal that with new options trading yesterday, counterparties would shed inventory in those stocks because demand for options was down.
Both facts – Active buying last week, weak demand for leverage – run counter to the narrative of investor-fear. The data say these stocks would have been down anyway and news is simply compounding what preceded it.
No doubt some investors knee-jerked to headlines saying investors were selling, and sold. But it’s not the cause. It’s effect.
We can’t isolate gaming in GICS data but leisure stocks shared behavioral characteristics with airlines. Investment was up last week, led by Passive money rather than Active funds (Active rose 2% too). But Risk Management, the use of leverage, declined 3%. And the pattern of demand changed.
What if the real cause for declines in these industries is the rising cost of leverage?
I’ll make my last plug for the book The Man Who Solved the Market. Near the end, one of Jim Simons’s early collaborators at Renaissance Technologies observes, “I don’t deny that earnings reports and other business news surely move markets. The problem is that so many investors focus so much on these types of news that nearly all of the results cluster very near the average.”
He added that he believed the narratives that most investors latch onto to explain price-moves were quaint, even dangerous, because they breed misplaced confidence that an investment can be adequately understood and its future divined.
I’ll give you two more examples of the hubris of using headlines to understand stocks. The S&P 500, like airline and leisure stocks, experienced a 2% decline in demand for derivatives into expirations last week. Patterns changed. Ten of eleven sectors had net selling Friday even as broad measures finished up.
If the market is down 2% this week – and I’m not saying it will fall – what’ll be blamed? Impeachment? Gloomy views from Davos? The coronavirus?
One more: Utilities. These staid stocks zoomed 4% last week, leading all sectors. They were the sole group to show five straight days of buying. We were told the market galloped on growth prospects from two big trade agreements.
So, people bought Utilities for growth?
No, not the reason. Wrapped around the growth headlines was a chorus of voices about how the market keeps going up for no apparent reason. Caution pushes investors to look for things with low volatility.
Utilities move about 1.4% daily between intraday high and low average prices. Tech stocks comprising about 24% of the S&P 500 are 2.6% volatile – 86% more!
Communication Services, the sector for Alphabet, Facebook, Twitter and Netflix, is 2.8% volatile every day, exactly 100% more volatile than Utilities.
The Healthcare sector, stuffed with biotechnology names, is 4.8% volatile, a staggering 243% greater than Utilities.
These data say low-volatility strategies from quantitative techniques, to portfolio-weightings, to Exchange-Traded Funds are disproportionately – and simultaneously – reliant on Utilities. If volatility spikes, damage will thus magnify.
IR people, you’ve got to get a handle on behaviors behind price and volume (we can show you yours!). Headlines are quaint, even dangerous, said the folks at Renaissance Technologies, who earned 39% after-fee returns every year for more than three decades.
Investors, you must, too (try our Market Structure EDGE platform). None of us will diagnose market maladies by reading headlines. The signs of pathology will be deeper and earlier. In the data.