Liquidity

Want a big ranch out west?

Apparently you don’t. The Wall Street Journal last month ran a feature (subscription required) on the mushrooming supply of leviathan cattle operations from Colorado to Idaho, legacy assets of the rich left to heirs from the era of Ted Turner and John Malone.

A dearth of demand is saddling inheritors with big operating expenses and falling prices.  Cross Mountain Ranch near Steamboat Springs, CO is 220,000 acres with an 11,000 square-foot house that costs a million dollars annually to run. It can be yours for a paltry $70 million, $320 an acre (I wonder if that price holds for a thousand?).

What have cattle ranches got to do with the stock market?  Look at your holders, public companies.  What’s the concentration among the largest?

The same thing that happened to ranches is occurring in stocks.  The vast wealth reflected in share-ownership came considerably from generations now passing on inheritance or taking required minimum distributions. The youngsters, at least so far, aren’t stockowners. They’re buying coffee, cannabis and café food.

Juxtapose that with what we’ve been saying about liquidity in stocks, and as the WSJ wrote today.

Liquidity to us is how much of something can be bought or sold before the price changes.  Those landed dynasties of western dirt are discovering people eschew large land masses and monolithic homesteads.

In stocks, the same is true.  Back up five years to Sep 4, 2014. The 200-day (all measures 200-day averages) trade size was 248 shares and dollars/trade was $17,140. Short volume was about 42%, the average Russell 1000 stock traded about $230 million of stock daily. And intraday volatility, the difference between highest and lowest daily prices, was about 2.2%.

Five years later? Average trade-size is 167 shares, down 33%.  Dollars/trade is down 26% to $12,760. Shorting is nearly 47% daily. Dollars/day is down 17% to $170 million. Volatility is up 32% to 2.9% daily.

But market-capitalization has increased by some 40%.  It’s as though the stock market has become a giant ranch in Colorado teetering over millennials loitering in a coffee shop. No offense, millennials.

Every investor and public company should understand these liquidity characteristics because they increase risk for raising capital or making stock investments.

Why is liquidity evaporating like perspiration out of an Under Armor shirt?

Rules and behaviors. Rules force brokers – every dollar in and out of stocks passes through at least one – into uniform behavior, which decreases the number capable of complying. Picture a grocery store near dinnertime with just three checkout lanes open.

In turn, concentration means more machination by brokers to hide orders. They break them into smaller pieces to hide footsteps – and machines become more sophisticated at interrupting trades in ever smaller increments to reveal what’s behind them.

And all the liquidity measures shrink. We see it in the data. A blue bar of Active Investment rarely manifests without an array of orange bars swarming to change prices, Fast Traders who have detected the difference in the data where human influence drives machine behavior.

What can you do, public companies and investors?  Prepare for bigger and unexpected gyrations (volatility erodes investment returns and increases equity cost of capital).

Examples: HRB reported results before Labor Day. The quarter is fundamentally inconsequential for a company in the tax-preparation business. Yet the stock plunged. Drivers?  Shares were 71% short and dominated by machines setting prices and over 21% of trading tied to short derivatives bets.

Those structural facts cost holders 10% of market cap.

Same with ULTA. While business conditions might warrant caution, they didn’t promote a 30% reduction in equity value.  Market structure did it – 58% short, 55% of total volume from machines knowing nothing about ULTA and paying no heed to the call.

We have the data. Market structure is our sole focus. No public company or investor should be unaware of liquidity factors in stocks and what they predict.

Put another way, all of us on the acreage of equities better understand now that vast tracts of value are tied up by large holders who don’t determine the price of your stocks anymore than your grandfather’s capacity to buy 100,000 acres will price your big Wyoming ranch now.

What does is supply and demand. And liquidity is thin all over.  Data can guard against missteps.