Beyond Curiosity

Let’s talk about houses.

Let me explain. Twice yesterday I encountered an issue, not a new one though. We were discussing it on a conference call too, preparing for a market-structure session Sept 9 at the NIRI Southwest Regional Conference here in Denver – which if you care about market structure is not to be missed. A highlight, Rajeev Ranjan, central banker with the Chicago Federal Reserve and former algo trader, will explain why the Fed cares whether high-speed traders are gaming equities and derivatives.

Anyway, what issue am I talking about?  I continue to hear executives and investor-relations officers say, “I don’t see why short-term trading matters when we’re focused on long-term investors.”

I hear some of you groaning.  “Quast,” you moan. “We don’t want to keep hearing the same stuff.”  I get that. If you already know the answer, you can cut out of the Market Structure Map early today.  Catch you next week.

The rest of you, if you’ve got a tickling there in the back of your head like a sneeze forming in the nose that you really don’t want the CFO to ask you why market structure matters, then let’s talk about houses.

Big money tracks residential real estate – houses. Just this week we had or will have reports on new home sales, the Federal Home Financing Administration’s housing index, the Case-Shiller Home Price Index, mortgage applications, and pending home sales. Decisions about construction, banking, credit-extension and more depend on these data.  They’re part of certain GDP components.

Now suppose it was unclear who was buying and selling houses, whether the sales were cash or financed, how much of the volume of new and existing home-sales were simply transactions between brokers trying to pump up volumes (suppose it were half!), whether mortgage applications were real or indications of interest that wouldn’t materialize, and 35% of all home-sales were in the dark with nothing more known about them save the net number.

We’d be outraged.  This condition could imperil not only the economy but the global payments system backed by government policies and the Federal Reserve. Nobody would know the actual supply or demand of houses, or whether prices were real or a figment of intermediary imaginations. The real money would leave. The sector would be a casino.

You see where I’m going. We depend on the equity market to provide some proxy on the economy and the movement of investment capital.  Yet 85% of it isn’t fundamental. It’s intermediation, asset-allocation, risk-hedging, things that can change in a heartbeat.  It’s such a big deal that The Fed and Congress are concerned.  And public companies aren’t?

Suppose you sold widgets through dealers. What if you had no idea who consumed the widgets or how they were used?  How would you market to customers? What metrics would you use to form future investment and hiring plans? How would you tell your widget story to investors, if you were a publicly traded widget-maker?  “We have no idea who buys them, but we’re really happy with volumes.”

That would be crazy.  So why isn’t it in the equity market?

The average public company’s net ownership change in a given quarter is about 3/63 of the volume for the quarter. Or if you prefer, a central tendency of 1/21, which is not statistically significant. Which consumers are driving the 20/21 of volume you’re not seeing in ownership data?

We’d never stand for this condition in any other market, period. So why is it okay in the $23 trillion stock market, upon which hinges almost everything of importance in the USA, from our individual net worth to the stability of the financial system?

That’s more than a curiosity. Knowing (and we do and can know, actually) should be of paramount importance and spearheaded by IROs and public companies. We don’t want to be the shrugging observers here.

Tray Dat

We’ll be listening in the car to a song on satellite radio’s The Pulse, trying to keep current, and I’ll say to Karen, “Do you understand what he’s saying?”

You may feel the same way about equity-market rules. Take for instance the Trade-At Rule.  No it’s not Tray Dat, but I think I heard that in a song on The Pulse.  We didn’t hear something sounding like Tray Dat during the Little River Band concert Sunday at Denver’s Hudson Gardens, the band touring 39 years with a revolving cast still delivering goose-bump harmonies on Lady, Take It Easy on Me, Cool Change and Reminiscing.

Anyway, the Trade-At Rule matters to IR because it sharply impacts the buyside and sellide – your two core constituencies. And if the CFO stops you in the hallway and says, “What do you think of this Tray Dat thing the SEC is considering?” you don’t want to stammer.

So here’s what’s happening.  The SEC in June directed exchanges and Finra, the regulatory body for brokerages, to develop a plan for testing wider spreads in stocks. The SEC wants three test groups for a year-long pilot program.  All three will include stocks with market caps under $5 billion, volume below one million daily shares, and prices over $2.

One group, the control, will trade as it does now.  The second will have greater tick sizes, or spreads between prices for buying and selling shares, called the best Bid (to buy) and Offer (to sell). The plan is still conceptual – the SEC in June gave market participants 60 days to craft their proposal – but it’s probable we’d see five-cent spreads.

The third group will incorporate along with bigger ticks another idea: The Trade-At Rule. Best way to describe it? If you’ve read the book Flash Boys, there’s a story Brad Katsuyama tells about seeing 25,000 shares for sale on his screen, and readying his own order to buy those 25,000 shares. His finger is poised over the keyboard, counting down, 5-4-3-2-1…click. He presses the button to buy – and the orders disappear and he gets but a small portion of what he could clearly see was available.

The Trade-At Rule would ostensibly remedy this problem by prohibiting somebody from front-running the displayed price. It would seem to force trades out of dark pools where prices can’t be seen, onto exchanges, where they can. There are exemptions for big block dark pools like Liquidnet and Aqua, and for exchanges with the best price right before the new “marketable” order arrives. (more…)

Buy the Rights

Know the song by OMC?  Jumped into the Chevy. Headed for big lights. Wanna know the rest? Hey, buy the rights.  How bizarre, how bizarre…

The market-structure mashup recently took a somewhat bizarre turn. InterContinental Exchange, owner of the NYSE, bought the rights to high-speed trading patents.

Said David Goone, ICE’s Chief Strategy Officer: “ICE acquired these patents with the goal of preventing third parties from using these intellectual property rights against our customers. ICE intends to make these patents available broadly for license to customers that provide beneficial liquidity in ICE’s and NYSE’s markets.”

ICE says the patents are for an automated trading system that makes pricing and trading decisions based on market-price information, and the associated intellectual property covers electronic trading in both derivatives and stocks.

What makes it odd at first blush – but certainly clever – is ICE’s opposition to high-speed trading. “You shouldn’t pay people to trade,” ICE CEO Jeff Sprecher said in October 2013, voicing dislike for the system where exchanges pay brokers for trades that create liquidity attractive to orders from others. To oppose high-speed trading and then buy patents customers can use to bring high-speed liquidity-producing trades to the NYSE seems smart but contradictory. (more…)

Big ModernIR News

Some would argue I should’ve hit him.

Only kidding! But let me tell you a story.  I was driving yesterday and saw approaching from the left at a good clip on a skateboard some lout on the sidewalk in backward cap and shorts, head down over his phone and ear buds in. There was a stop sign on his side not on mine but he never looked up and didn’t see me until he clattered into the street, where I’d stopped despite an opposite urge.  He didn’t say thanks or whew or anything, just skittered off, nose in phone. He wasn’t a kid either, probably in his 20s.

This to me is a metaphor for the markets. It’s easy to get discouraged about the future.  More on that in a bit. And that’s not the big news.  This is:

New website.  We’ve been testing our contemporary new internet home, gathering feedback, and have gotten high marks in the soft rollout. So voila! Visit modernir.com, mobile-ready and refreshed by our good advertising friends at Brand Iron here in Denver, who handle lots of things for us. Tell us what you think.

Updated logo. Brand Iron also persuaded us to touch up our image. We think it’s good work, though one observer said, “I hope the market doesn’t move inversely with your squiggle.”

New offices. Third is our new headquarters location on fashionable South Pearl Street in Denver, across from our town’s world-renowned Sushi Den and adjacent to diverse dining opportunities in both directions. Perfect for your next visit!  Stop in and see us at 1490 South Pearl Street, Ste 100, here in Denver.

New Director, Client Services. Finally, we’re proud to announce that Greg Yates has joined our client services team. Greg started with us in June and we haven’t driven him away, thankfully.  A University of Arizona graduate with a CFA, Greg began his capital markets career as a trader in fixed income for PIMCO in 1997, and moved on to trading equities at Banc of America, then to the buyside as an asset manager for a variety of firms including Mellon. Clients, you’ll find Greg a knowledgeable and apt supporter in your efforts to run the coolest and most effective IR programs in our profession. He’ll work under our Vice President of Client Services, Brian Leite. (more…)

Missing Volume

I’ve made South Dakota jokes – “fly-over state,” “waste of dirt that could have been used making Colorado larger,” etc.  Not again.

It’s but six hours by car from Denver and we love road trips, so we put a junket to Mount Rushmore on the calendar. Turns out there’s more to the “under God people rule” state than chiseled presidents. In Custer State Park (where never is heard a discouraging Ranger word) this fella ambled by while his brethren were at home on the range below Harney Peak and picturesque Sylvan Lake. Loved it. We’ll go back.

Speaking of gone, wither volumes? And should you worry?

A client yesterday asked about splitting the stock. Share volume is tepid, off nearly 75% since 2009, though dollar-volume (more important to us) is down less, about 40%. Should they do something to stimulate it, they wondered?

Weak volumes would seem cause for concern. It suggests a lack of consuming. It’s happening more on the NYSE than the NASDAQ.   In 2009, the NYSE averaged 2.6 billion shares daily, about $82 billion of dollar-flow. In 2014 so far, it’s 1.02 billion shares, about $40 billion daily.  The NASDAQ in 2009 saw about 2.5 billion shares and $60 billion daily compared to 2.0 billion shares and about $73 billion in 2014.

The big companies are concentrated on the NYSE, which has about 70% of total market cap.  Money is trading smaller companies, but not owning them, evidenced this year at least by sustained volumes for small-caps but weakness in the Russell 2000, down almost 2% this year with the S&P 500 up 7.5%.  Plus, shorting – renting – is rampant, with 44% of daily market volume the past 20 days, nearly half of trades, from borrowed shares.

Check the Pink Sheets and it’s stark. Volume is averaging about 14 billion shares daily in penny stocks in 2014, compared to about 2.3 billion shares daily in 2009.  Dollar volumes are small but have doubled in that time to $1 billion daily. KCG Holdings as a market-maker does over a 1.2 billion shares a day by itself in penny stocks.

And derivatives volumes have jumped since 2009. Global futures and options trading according to the Futures Industry Association totaled 21.6 billion contracts in 2013, up from 17.7 billion in 2009. More telling is where. In 2009, equity and equity-index derivatives volume was 12 billion contracts, identical to 2013. But energy, currency and metals derivatives trading has exploded, jumping 125% to 5.3 billion contracts in 2013.

The answer to where equity volumes have gone is into trading small caps and penny stocks and derivatives tied to energy, currencies and metals. Investors are searching for short-term differentiation and safety from uncertain asset values affected by massive currency infusions from central banks.

What’s it mean to you in the IR chair? Volume doesn’t define value. Witness Berkshire Hathaway Class A units trading 250 shares daily (about $47m). What matters is who drives it. Don’t give in to arguments for “more liquidity.” You’ll help short-term money, not long-term holders. We don’t think splitting your stock today improves liquidity or appeal to the money that matters.

Speaking of rational money, it averaged 14.5% of total equity volume the past 20 days. Tepid.  Where are active investors? Watching warily, apparently. What drives equity values right now is asset-allocation – the “have to” money that buys the equity class because the model says to.

And meanwhile that money is offsetting risk with derivatives in currencies, energies and metals. Take care not to draw the wrong conclusion about the value of your shares. It’s tied to things way beyond fundamentals at the moment.

Take and Make

What if exchanges stopped paying fast traders to set prices? Oh, you didn’t know? Read on.

Off Salt Island in the British Virgins is the wreck of the HMS Rhone, a steamer that sank in an 1867 hurricane.  Even if you’re a snorkeler like me rather than a diver, in the clear BVI water you can see the ribs, the giant drive shaft, the shadowy hulk of a first-rate vessel for its day, 70 feet below the surface.  A storm surprised the Rhone, and after losing an anchor in the channel trying to ride out the squall, the captain ran for open water, unwittingly slamming into the teeth of the tempest.

What’s a 19th century Caribbean wreck got to do with high-frequency trading?  What seems the right thing to do can bring on what you’re trying to avoid by doing it in the first place.

On July 15, Senator Carl Levin called on the Securities and Exchange Commission to end the “maker-taker” fee structure under which exchanges pay traders to sell shares.  I’ve long opposed maker-taker, high-frequency trading and Regulation National Market System.

We have Reg NMS thanks to Congress.  In 1975, that body set in motion today’s HFT flap by inserting Section 11A, the National Market System amendments, into the Securities Act of 1934, and instead of a “free market system,” we had a “national market system.” What a difference one word made.

The legislation mandated a unified electronic tape for stock prices. The NYSE claimed the law took its private property – the data – without due process.  Regulators responded with concessions on how exchanges would set prices for trading. The result: The Consolidated Tape Association (CTA).

Today, the CTA is comprised of the registered US stock exchanges.  Its rules governing quoting and trading determine how exchanges divide roughly $500 million in revenue generated through data that powers stock tickers from Yahoo! Finance to  E*Trade.  If an exchange quotes stocks at the best national bid or offer 50% of the time, and matches 25% of the trades, it gets the lion’s share of data revenue for those stocks. And the more price-setting activity at an exchange, the more valuable their proprietary data products and technology services become. Data has value if it helps traders make pricing decisions.

Here’s where history meets HFT. Reg NMS requires trades to meet at the best price. Exchanges have no shares because they’re not owned by brokers with books of business as in the past. They pay traders to bring shares and trades that create the best prices.  In 2013, NASDAQ OMX paid $1 billion in rebates to generate $385 million of net income.  Subtract revenue from information services and technology solutions ($890 million in 2013, built on pricing data) and NASDAQ OMX loses money.  Prices matter.  NYSE owner Intercontinental Exchange (ICE) opposes maker-taker presumably because it made $550 million in profit without the NYSE in 2012, and half that adding the NYSE in 2013. For a derivatives firm, equities are a tail to wag the dog. (more…)

CYNK Me

Movie tip:  Karen and I took our visiting teenaged nephew to see Edge of Tomorrow, starring Tom Cruise. Hysterically entertaining. Appropriate for teens (scary monsters but no gore), and gripping for adults!

There was a 1982 movie called The Scarlet Pimpernel (from the 1905 novel by Baroness Emma Orczy) in which the dashing protagonist Percival Blakeney (played by Anthony Andrews in the film) goes around saying, “Sink me!” with a lilting accent. Great movie.

I thought of it when this week’s theme came to us through alert reader Emily Walt at Carbonite, who first gave us a salacious peek at a firm burning up the pink sheets:  CYNK Technology (OTCMKTS:CYNK).

Most of you may now know that CYNK rose from nothing to $6 billion between June 17 and July 10, a return of 20,000%. Last Friday the SEC abruptly halted trading, with market cap still at $4 billion.

The pink sheets or the grey market, or what used to be called the OTC market, should not be confused with “over the counter,” which often refers to shares on the Nasdaq or securities trading between brokers. This is the market where standards are loose and risk is high.

CYNK Technology is run by a guy in Belize. This one fellow is listed as CEO, President, CFO, Board Secretary and the only director. SEC documents suggest the company has no revenues and no real business plan and few if any assets.

But something got folks going and it seems the germinating seed was the suggestion that the company’s website offers introductions to celebrities for a fee.  It aims, we gather, to be the social networking site where common everyday dweebs and goofballs can meet Johnny Depp and Angelina Jolie. (more…)

The Empty Chair

There’s the old joke about camels. They’re horses designed by a committee.

Speaking of committees, for the second time in a month, that august federal legislative chamber the US Senate yesterday convened a hearing on markets. Replacing the Senate Permanent Subcomittee on Investigations was the Senate Banking, Housing and Urban Affairs (none of these items appear in the Constitution under delegated congressional responsibilities, I observe) Committee calling a confab of big hitters from markets to explain why Michael Lewis has the bestselling investing tome in the USA (Flash Boys).

One weighty weigher-in was ICE CEO Jeffrey Sprecher, who testified: “The costs associated with maintaining access to each venue, retaining technologists and regulatory staff, and developing increasingly sophisticated risk controls are passed on to investors and result in unnecessary systemic risk.”

Quoted in a story by Bloomberg’s Sam Mamudi, another congregant before Congress, Dave Lauer of KOR Group LLC, said, “Regulation has created this monstrosity of a market, and it is only by peeling back some regulations and refining others that we can hope to simplify market structure and increase market efficiency.”

I must note: we’ve decried similarly for about the past seven years, before it was cool to do so and the subject of a New York Times bestseller.

Not everybody wants to rend the fabric. Said CEO Joe Ratterman of BATS Global Markets: “Whether it is banning the current maker-taker fee structure, limiting payment for order flow generally, or other attempts to alter the fundamental economics of trading, price controls are a blunt instrument likely to cause disruptions and consequences that are unforeseeable and potentially detrimental to all types of investors.”

There were witnesses from the Nasdaq, Invesco, Georgetown University and Citadel Derivatives. The empty chair? Somebody representing public companies. Not a one. We might as well hold hearings on beef prices and leave out cattle ranchers. (more…)

Setting Prices

Do you remember that movie, The Island?  The people who every day hope they’re selected to go to a tropical paradise are unwitting machinery for others.

I won’t give it away in case you’ve not seen Scarlett Johansson and Ewan McGregor tearing through the sky on some futuristic motorcycle. Things are not what they at first seem. That’s the point.

Which leads us to Nasdaq OMX PSX.  On August 1, the PSX becomes what it calls “a Price Setter Pro Rata algorithm for all symbols, pending SEC approval.” The PSX once was the Pacific Stock Exchange. Now it’s one of the Nasdaq’s three stock markets.

If it’s an exchange, why do they call it an algorithm? Because it’s less a marketplace than a mathematical calculation designed to do something: Set prices. It guarantees traders 40% of an order so long as size meets requisites.

In its marketing materials, the Nasdaq says the PSX is “a Reg NMS protected quote and runs on proven INET technology.” A quote? A price. Under Reg NMS, protected quotes must be automated and cannot be ignored by the market. So the PSX is a price.

INET was a trading system created by the dark-pool Instinet that merged in 2002 with Island, another electronic communications network, or “ECN.” ECNs slaughtered exchanges in the 90s, taking perhaps 65% of all trading at the peak before exchanges bought them and in effect became ECNs. Nasdaq acquired INET in 2005.

Now stay with me here. This story relates directly to you, in the IR chair. There’s a trading firm called Chimera Securities. We see it in about 75% of our Nasdaq client base. It’s a proprietary trader – no customer accounts. It trades equities and options. It provides a platform for hundreds of professional day-traders to execute diverse speculative tactics, and it runs automated strategies to utilize liquidity its traders hold. It’s a member of the Nasdaq OMX PSX, and the Nasdaq OMX PHLX, the latter the Nasdaq’s options platform. Chimera belongs only to these two markets. (more…)

The Risk

On a hot Sunday 138 years ago today, Lieutenant Colonel George Armstrong Custer rode into the valley Native Americans called the Greasy Grass. The rest is history.

Speaking of unexpected defeat, wonder what ambush caused yesterday’s sharp market reversal? Here’s a ModernIR Rule: The day after a new marketwide series of options and futures begins trading is a leading indicator of institutional asset-allocation plans.

Options and futures expired June 18-20. The new series took effect June 23. Yesterday was Rule Day.  Counterparties including major broker-dealers hold inventory through expirations and these resets. If stocks then decline, they had too much inventory for demand-levels.

Now, one can blame bearish Dubai stocks or sudden weakness in the UK Sterling or something else. But this rule is consistently true: If there’s more money in equities, stocks rise because counterparties undershot estimates. The reverse? Counterparties dump inventory and stocks drop.

Is this dip the tip of the long-anticipated bear turn?  Right now, total sentiment by our measures doesn’t show that risk. But. Sentiment has consistently faded before offering investors a market-top for profit-taking, in itself a bearish signal.

Speaking of risk, Cliff Asness’s high-speed trading piece at Bloomberg is humorous and compelling. I admire the AQR founder for his smarts, success and libertarian leanings.

But I disagree on HFT.  Mr. Asness defends it, saying: “The current competitive market-based solution is delivering the product, meaning liquidity for investors, better and cheaper than ever. Moving away from this competitive landscape would be an invitation for incompetent central planning or rapacious monopolistic practices.” (more…)