JP Morgan and Market Structure

Karen and I will join the ghost of Billy the Kid and about 3,000 cyclists in New Mexico next weekend for the Santa Fe Century. Weather looks good, winds below gale force. Should be fun!

Speaking of gales, JP Morgan blew one through markets. So many have opined that I balk at compounding the cacophony. My own mother is throwing around the acronym “JPM” in emails.

But there’s something you should understand about JPM and market structure, IR folks. First, put this on your calendar at NIRI National next month: EMC’s global head of IR, Tony Takazawa, is moderating a panel Monday June 4, at 4:15p, on IR Targeting and Investor Trading Behaviors (scroll down to it). The aim: Understand how markets have changed, how institutions have adapted, and what that means to gaining buyside interest today. I’ll be there, and we hope you will be.

Back to JP Morgan. You could define “market structure” in many ways. We prefer “the behavior of money behind price and volume.” What’s JPM got to do with that?

A lot. We observed in the days before word broke about trading woes at the big custodian for Fannie and Freddie that its program-trading volumes in equities were down by wide margins across the market-cap spectrum. It disappeared entirely from some small-cap clients that it typically trades algorithmically with great consistency (indexes, models, ETFs).

These facts raised no particular red flag because we saw widespread discordance in program-trading last week. Then word of JPM’s whale of a London loss broke. Maybe it was coincidental that its program-trading volumes fell. Regardless, it demonstrates the interconnected nature of markets today. Missteps in the risk-management arm of a bank can blight program-trading in health care, technology and other equities.

Also before the news hit, we saw a singular risk event marketwide May 8-9. Re-risking – balancing equity-risk exposure with derivative hedges – was measurable and visible in nearly every issue. The euro, we surmised. Market risk over currencies is grave now.

But it may have been a chain reaction. Declines across a set of algorithms could have triggered responses by risk-monitoring software for other banks and institutional investors. Picture one car braking on a crowded and whizzing freeway. Some stocks spiked, some plunged, some gyrated, some were dead calm.

And it wasn’t investment behavior.

Market structure matters to IR today. If you don’t have metrics for monitoring it, your management team isn’t as well-informed as it should be – and may be flying blind. Be sure to catch the panel at NIRI. We’ll talk about why these things occur.

Soberly, it requires no genius to grasp that a structure in which one party hedging a bet might disrupt the entire ecosystem is what the Brits would call suboptimal. Just remember: The market didn’t choose this structure. Structure was forced upon it through three little words: “national market system.”