April 16th, 2014 — The Market Structure Map
Suppose the engine of your vehicle was on fire.
The logical response would be to shut it off. But what if you were traveling at highway speed and killing the fuel supply meant you had no power breaks or steering? What if your vehicle was a jet fighter?
There are ramifications.
Last Thursday and Friday stocks plunged. Monday and Tuesday this week, shares soared. I doubt most of us think that people were selling in a stampede last week and then woke up Monday and went, “Shazzam! What have we done? We should be buying!”
This week offers an event in similar rarified air as blood moons in the northern hemisphere. Good Friday closes markets to end the week. Between are the usual three sets of expirations: volatility derivatives, index futures, and the remaining host of options and futures set for monthly expiry (with earnings now too – another reminder for you learned IROs to avoid that mash-up if at all possible).
There are but two days for all three. Some wild concoction will brew up in the market blender. If you were a volatility trader, last week’s sharp declines presented a compelling chance to trade equities up into today’s VIX expirations. Mission accomplished.
But how does that affect risk managers calibrating hedges in markets overhung by a Putin pall and a sudden scurrying of high-speed cockroaches in the blinding Michael Lewis glare (no offense, HFTs)? Good question. Internally, we never like to see stocks jumping before expirations, as it often means investors are monetizing insurance policies and leaving equities until the cost of protection falls back to earth.
It’s no absolute. The 10-point ModernIR Behavioral Index, bouncing like a contestant on reality TV’s Wipeout, sits April 14 near 4, just shy of a market-bottom signal. When the behavioral measures seem schizophrenic, it’s not the measures but the money.
Which brings us back to the proverbial engine fire and kill-switch. Columbia University’s economics Nobel-prizing-winning professor Joseph Stiglitz (who uttered one of my top-ten favorite quotes: “dollars are depreciating assets”) yesterday said we should tax high-speed trading to stop front-running. That’s like telling everybody to stand up and fining anyone not sitting down. HFT is a product of rules. It’s hitting the kill-switch before realizing you’re flying a jet fighter (parachutes, anyone?).
The taxonomy, pun intended, of market structure today coalesces around the fighter jet of high-speed trading. Rather than killing the engine, we should contemplate first landing the aircraft. Otherwise, we don’t know where it’ll crash and who’ll be hurt.
This is not reason to ignore the problem, but a prompt for a plan of action. Were it up to me, I would propose three steps (Lynyrd Skynyrd playing in background): First, improve trading data for everybody. FINRA could provide complete broker volumes with long-short activity on a one-day delay. Brokers are the conduits, so investors, get over it.
Second, drag issuer-ownership data into the 21st century. If money managers provide clients with monthly statements, public companies should know monthly who owns shares. It’s not directly related to market structure but the bright light of day for all is a first principle.
Finally, how about permitting a couple exchanges to voluntarily disconnect from the national market system and run standalone? Let the market figure out what works. Millions of sentient beings motivated by self-interest are inherently better insurance against risk than the opinions of five regulators in a Washington DC room.
The engine may well be on fire. But we don’t want a fiery crash.
April 9th, 2014 — The Market Structure Map
It’s all in the recovery.
That’s the philosophy put forth by a friend of mine for dealing with unpleasant facts.
I think the chief reason for the recent swoon in stocks was not anemia in the job market but a sort of investor outrage. You can’t troll a trading periodical or blog or forum without wading through rants on why Michael Lewis, author of the bombshell book Flash Boys on high-speed trading, is either guilty of torpid whimsy (a clever phrase I admit to swiping from a Wall Street Journal opinion by the Hudson Institute’s Christopher DeMuth) or the market’s messiah.
What happens next? Shares of online brokerages including TD Ameritrade, E*Trade and Schwab have suffered on apparent fear that the widespread practice at these firms of selling their orders to fast intermediaries may come under regulatory scrutiny.
What about Vanguard, Blackrock and other massive passive investors? Asset managers favor a structure built around high-speed intermediation because it transforms relentless ebbs and flows of money in retirement accounts from an investing liability to a liquidity asset. Asset management is about generating yield. Liquidity is fungible today, and it’s not just Schwab selling orders to UBS, Scottrade marketing flow to KCG and Citi or E*Trade routing 70% of its brokerage to Susquehanna.
It would require more than a literary suspension of disbelief to suppose that while retail brokers are trading orders for dollars, big asset managers are folding proverbial hands in ecclesiastical innocence. The 40% of equity volume today that’s short, or borrowed, owes much to the alacrity of Vanguard and Blackrock. The US equity market is as dependent on borrowing and intermediation as the global financial system is on the Fed’s $4 trillion balance sheet.
Hoary heads of market structure may recall that we wrote years ago about a firm that exploded onto our data radar in 2007 called “Octeg.” It was trading ten times more than the biggest banks. Tracing addresses in filings, we found Octeg based in the same office as the Global Electronic Trading Co., or GETCO. Octeg. Get it? Continue reading →
April 2nd, 2014 — The Market Structure Map
I don’t skateboard. But the title of Michael Lewis’s new book on high-speed trading, Flash Boys, made me think Lewis could’ve called it DC-town & Flash Boys.
Legendary skateboarder Stacy Peralta directed the 2001 documentary Dogtown & Z-boys chronicling the meteoric rise of a craze involving slapping wheels on little boards and engaging in aerobatic feats using public infrastructure such as steps and handrails. From Dogtown, slang for south Santa Monica near Venice Beach, Peralta’s Sean-Penn-narrated film tracked the groundbreaking (and wrist-breaking) 1978 exploits of the Zephyr skateboarding team, thus the “Z-boys.”
Skateboarding has got nothing to do with trading, save that both are frantic activities with dubious social benefit. We’ve been declaiming on these pages for more than a half-decade how fast intermediaries are stock-market cholesterol. So, more attention is great if the examiner’s light shines in the right place.
If you missed it, literary gadfly Lewis, whose works as the Oscar Wilde of nonfictional exposé include Moneyball (loved the movie), Blindside, Liar’s Poker and the Big Short, last week told 60 Minutes the US stock market is rigged.
The high-frequency trading crowd was caught flat-footed. But yesterday Brad Katsuyama from IEX, a dark pool for long investors that rose out of RBC, dusted it up on CNBC with Bill O’Brien from BATS/Direct Edge, an exchange catering to fast orders.
Which brings us to why Lewis might’ve called his book DC-town & Flash Boys. The exploitation of speedy small orders goes back to 1988. In the wake of the 1987 crash, volumes dropped because people feared markets. The NASD (FINRA today) created the Small Order Execution System (SOES – pronounced “soze”) both to give small investors a chance to trade 100 shares electronically, and to stimulate volume. Banditry blossomed. Professionals with computers began trading in wee increments. Volume returned. The little guy? Hm.
Regulators have always wanted to give the little guy opportunity to execute orders like the big guys. It’s admirable. It’s also impossible. Purchasing power is king. Attempt to make $1 and $1,000 equal in how trades execute, and what will happen is the big guys will shift to doing things $1 at a time. The little guy will still lose out but now your market is mayhem confusing busy with productive.
These benighted gaffes seem eerily to originate in Washington DC. Michael Lewis says big banks, high-speed traders and exchanges have rigged markets. We agree these three set prices for everybody. But they’re following the rules.
It’s like basketball. Rules now say that every play-stoppage in the last two minutes of a game must be reviewed. So in the final 2.3 seconds of the Wisconsin-Arizona game, an epic and nearly perfect sports achievement up until that moment, play was halted for FIVE MINUTES while referees scrutinized film for who touched the ball last. Basketball depends on tempo. Alter rules, and you change the game.
Regulation National Market System similarly confuses the purpose of the enterprise. Reg NMS linked markets around a national best price, forcing competitors to share orders and to undercut each other, while perversely rewarding data revenues to exchanges setting the price most often.
What did we get? Pandemonium in pursuit of price-setting that coalesced into a game controlled by big banks, HFT firms and exchanges. But we should single out the refs. The SEC. Penalizing people for adroit rule-following is – well, as dubious as HFT.
Look, I like the folks there. They’re eminently approachable and they mean well. Give the little guy a shot. But we can all see that the entire purpose of the enterprise has been altered for an objective that is unachievable.
Maybe it’s time we pulled the plug on Reg NMS. HFT would then be a sideshow. And I bet the SEC would throw in monthly ownership and daily trading data for public companies. That would be face-saving. So now is the time to ask!
And, thank you, Michael Lewis!
PS – Come join us at the Philly NIRI chapter April 10 as we discuss this in part, and whether the case ahead for markets is bullish or bearish. Should be interesting!
March 26th, 2014 — The Market Structure Map
Last week whilst (as the Brits would say) tooling on cruiser bikes past beanie baby tycoon Ty Warner’s palace on the Santa Barbara bluffs, we sighted paradise. This week we’re in Boston where we sponsor the NIRI chapter. Hope to see you there.
What if we did nothing?
In the investor-relations chair, in the 4:39 pm lull (or whenever you catch your breath), have you thought it? Suppose you held no earnings calls, went to no sellside conferences, engaged in no outreach. Would anything change?
Cold fear-sweat pops from your pores.
Don’t worry! This is just a simulation. But it would be telling to observe the impact of stopping whatever you do, for a quarter – to see who’s paying attention. I’m reading John Steinbeck’s East of Eden on my Kindle Paperwhite. It’s another I’d meant to read but hadn’t. One character is talking and seeing a lack of attention from his companions. Without varying tone he inserts two sentences of gibberish. They don’t bat an eye.
No, you shouldn’t plop a couple dabs of gobbledygook into your next earnings call or release to see if the capital-markets bourgeoisie are tuned in. (Tempting? Sure.)
That’s not the point in fact. One of our clients announced a debt deal. We said we’d track the impact on hedging. Debt offerings don’t typically prompt selling but they’ll change the cost of portfolio insurance – hedges. Our client said it shouldn’t surprise anyone since they’d said it was coming.
I said we weren’t worried about the audience that was listening, which is 14% of volume. It’s the other 86% we’ve got eyes on.
We know companies with budgets enough for every tool, from two surveillance providers to all the neat gadgets, devices, services and subscriptions. They spend hundreds of thousands of dollars. My IR budget was never near hundreds of thousands unless you counted the annual report we once printed for our hordes of retail holders. We’d do a photo shoot of employees (a big task that cost scads), hire artists to design cover artwork, and manufacture this lustrous printed opus.
It was right, for the time. Investors liked seeing quality. We cut it to a 10-K wrap. It had no bearing on share-performance because the market had moved on from when retail money set prices to where it was rolled into algorithms priced by Blackrock orders through UBS, Barclays and Goldman Sachs.
We’ve got clients who only use our analytics. There is no appreciable difference in outcomes between these, I guess you could call them paupers, and the princes of big IR budgets. In fact, using our Action Items they often outperform. What’s more, the paupers may possess something princes don’t: They understand the demographics of their equity market.
When 86% are of a sort that won’t notice if you insert gibberish because they listen less to you and more to the metrics of your sector, your government and your central bank, you want to distinguish between what matters and what doesn’t. There’s no glory in confusing busy with productive.
What matters is knowing why your shares are down 3% even though you told investors over and over to expect a debt offering. That’s one – not the only but a biggie – key to bringing value to the IR chair. After all, who else in the company will comprehend how the equity market actually works today?
As Ben Stein’s character in Ferris Bueller would say: “Anyone? Anyone?”
What counts isn’t the amount of action, but the knowledge. Because what you’re doing daily may not be enough to matter. In today’s equity market it pays to know what’s going on. Anyone can meet investors. But the best IROs manage the equity product. That’s about what you know, not who you know.
March 19th, 2014 — The Market Structure Map
Is you is, or is you ain’t, my constituents?
If you know cinema’s Coen Brothers and the epically hilarious 2000 movie “O Brother, Where Art Thou,” you’re smiling. You remember the scene, the southern accent.
In geopolitics, a sweeping referendum last weekend reunited Crimea with Mother Russia but we heard nothing about the Latino vote or the union vote or the male vote. Demographics, we gather, weren’t crucial to Putin’s putsch. The constituents supporting secession were of a cloth.
Say you run a clothing retailer on the cutting edge of young fashion. Slicing your demographics with analytics drawn from your in-store inventory management system, you find that females aged 18-34 drive half your revenues. These are your core constituents, and you’ll concentrate on keeping them happy. But you realize too that growth takes more than one group. You craft a plan with products, advertisements and placement to expand patronage from other demographic segments.
The equity market has core constituents too. Your active holders, the ones who measure story and strategy. We divide them further with growth, value and growth-at-reasonable-price (GARP) characteristics, and often finer still.
Had we a marketplace where consumption of the product – your shares – was only about story and strategy, we’d call it a wrap and the movie would end. Yet this constituency taken together is still just one: Active investors.
Blackrock is the world’s largest investment manager. Most of its $5 trillion in assets are allocated not according to corporate story but around sector, industry and class. So what do we consider this indexed constituency? We at ModernIR call it Passive investment behavior or simply Indexes/ETFs. Continue reading →