Metrics

How many of you wear a Fitbit?

I remember the last time I saw Jeff Morgan, erstwhile NIRI CEO.  I said, “Jeff, you’ve lost weight. You’re a lean machine!”

He tapped his wrist, and said, “Fitbit. You can appreciate it, Tim. It’s just measuring data, right? Burn more than you take in.”

When we were roaming Barcelona last September, Karen’s phone was a cheering section congratulating us for achieving footstep goals.  Because there’s an app for that of course.

We’ve now bought a Peloton for our home gym, a finessed stationary bike replete with interaction and data. You can measure everything. You mark progress and capability.

On Friday the 13th the Wall Street Journal ran a story about online life insurance. Companies are using algorithms that parse lifestyle data from prescription-drug, motor-vehicle and credit-card sources to meter risk in place of testing blood and urine.

Data reveal facts about conditions. That’s the starting point. The next step is comparing data gathered in one period with the same metrics from another to see what’s changed. It’s what your doctor does.

And it’s the heart of financial reporting. We can debate the flaws of the requirement, but every quarter public companies are providing metrics to investors and analysts, who in turn model the data to understand business outcomes.

In fact, it’s the beat of the market. Every week data pours forth from governments and central banks on producer-prices and purchasing managers and jobs and consumer sentiment and on and on it goes.

I think it’s too much, promoting arbitrage on expectations versus outcomes. But think of the cognitive dissonance in our profession, investor-relations.  While everyone is measuring short-term, IR is trying to manage long-term. Yes, we want long-term commitment to our shares.  But that’s not how prices are set.

Unless you measure something the way it functions, you’ll get incorrect conclusions.

Much of the IR community isn’t measuring at all. We react. Right? The stock moves, and we call people for explanations.  How can answers be accurate without comparatives?  You don’t know what’s changed. No Fitbit is delivering data supporting conclusions.

The key to good management is consistent measurement. It’s the only way to understand an ecosystem and sort what you can control from what’s systemic.

Suppose I declare that I will float across the room.  Well, gravity, the rule governing the movement of bodies in this universe, says on this planet my pronouncement is flawed.

The gravity of the stock market is Regulation National Market System.  It defines how money moves from point A to point B.  We can observe those movements.

I showed a company yesterday how shares climbed from $60 to $70 during election week last November on Asset Allocation, and from $70 to $72 on Risk Management. That means ETFs and derivatives boosted shares.  Active money didn’t buy until the stock was at $75, even though it was selling the stock at $61 right before the election. Active money didn’t know what to do.

What followed? Fast Traders sold and shorted because the last fools to the party were the Active stock-pickers unaware of how the market works now.  No wonder many lag the averages.

If investors making rational decisions set the prices of stocks more than 50% of the time, the market can be called rational. Otherwise, it’s got to be called something else.  IR professionals, it’s your job to help management see the market realistically.

All the people talking about stocks are of a breed. The sea of money using models isn’t telling others what it’s doing!  But it’s setting prices.

You must measure now. What’s your Fitbit for the IR job?  Is it calibrated to the market we have today or one that no longer exists?

Case in point: I told a healthcare company recently that the data showed they would be unable to hold any gains until short volume were no longer consistently 65%.

“But our short interest is well below sector averages,” they said.

“That measure is from 1975,” I said. “It doesn’t reflect how the market works now.”

The stock dropped 8% yesterday and remains at the same average price it’s had since short volume rose over 60% well more than a quarter ago. The data – the Fitbit for IR – will tell them when conditions have changed.  Fitness can be measured in IR as it is elsewhere.

Measurement is management.  Put key metrics in front of your management regularly. Don’t wait to be asked for information – then it’s too late and you’ve lost control and become a glorified assistant (and they’ll define the job for you).

Create anticipation with metrics. “We’ve had a nice run but Fast Traders are leading, we’re Overbought, and short volume is over 50%, so expect some pressure next week.”

That’s what you should be doing.  Stop calling people for wild guesses unsupported by data AFTER something has occurred. Start measuring and setting expectations – especially around earnings, or events like options-expirations today through Friday.

You can only set expectations if you’re first consistently measuring and comparing key data points. This is evolved IR.  You can invent your own metrics. But we’ve already done that for you.

The Death Star

Last Sunday treated us to a picture-perfect Santa Monica day.

We were there helping investor-relations folks at the NIRI Fundamentals conference understand the stock market.

Of it, you probably won’t say to your CFO, “I bet you have no idea how our stock trades.” But it’s bad news if you’re asked by the CFO and have no answer.

So let’s talk about the Death Star. That’s what the industry bemusedly calls today’s trading environment.  The stock market is not at the corner of Broad and Wall or in the heart of Times Square.  It’s in New Jersey on banks of computers at several massive colocation facilities connected by superfast telecommunications infrastructure.

DeathStar

The Death Star (courtesy IEX, T Rowe Price)

The three big exchange groups today each operate four stock markets on those giant computer arrays. Suppose Nordstrom ran four stores in the mall rather than one. We’d think: “Why don’t they put the stuff in one place so customers can easily find it?”

Good question. We’ll answer it in a moment.

BATS Global Inc. is the largest stock exchange in the US now by market-share with its four platforms. Yet it lists only its own shares and exchange-traded funds. ETF trading is good business.

At two of them, traders are paid to buy shares, and at the other two they’re paid to sell (fees differ). This paying traders to buy or sell is called Maker-Taker/Taker-Maker.  Now, the Chicago Board Options Exchange is buying BATS Global.

The Nasdaq also pays traders one place to sell and pays them another place to buy. The Nasdaq is the largest options-market operator. Now the Nasdaq and the CBOE will both run large options/equities trading complexes with fees and credits that encourage traders to do opposite things in different spots, which is arbitrage.

The NYSE is owned by Intercontinental Exchange, and equity trading and listing are fragments of a global revenue colossus in derivatives helping financial players manage risk. ICE is also a huge technology and data purveyor.

By operating multiple platforms, the exchanges can set the best bid or offer, the market’s singular entry point, more often.  Each market then has unique data to sell to brokers and other exchanges, which in turn are required by rule to prove they’re giving customers the best prices – which means they have to buy the data.

There’s your answer. Exchanges operate multiple markets because they make money by changing the prices of everything and encouraging profits on differences. By promoting the arbitrage that vexes you in the IR chair, they sell data and technology.

The only exchange solely offering equity trading and listing that’s not intertwined with derivatives and influenced by trading incentives to set the bid and ask is the newest, IEX.  For our view on IEX and much more, catch the Chicago NIRI chapter’s webcast Friday.

The starting point for understanding any business is recognizing how it makes money.  The Death Star is an inferior capital-raising mechanism (it could be good again with rule-changes issuers should push).  Today, companies like Uber and Facebook grow giant on private equity and use the public market as an exit strategy.

Microsoft and Intel were like reality TV for stocks, taking everyday investors on the long and exciting process of growing in public for all to see and own. We can quibble over causality for this divergence. Our systems monitor the Death Star. It favors trading.

When you understand the Death Star, you arrive at this sort of answer for the CFO: “Since investors and traders can only trade at the best price, our price is most times set by the fastest machines. The big exchanges pay them to set the price so they have price-setting data to sell. They also encourage customers to engage in arbitrage.

“Occasionally active investors shoulder through the arbitrage.  Waves of asset-allocation flows can dominate.  A lot of the time derivatives lead because everybody is focused on managing risk, and in that process short-term divergences develop, which can be traded for profit. And this is why you need an IR professional more than ever.  Somebody has got to understand the Death Star.”

It’s easier to say, “I’m not sure but our story is central.”  It’s just not true most times.

Every IR gal or guy faces this moment of truth: Do I mail in the pat answer, or do I assail the battlements of convention and learn about the Death Star?

You can change your stars, as the Heath Ledger movie A Knight’s Tale asserts. Consistent metrics resonate with executives. If last week Active money led and Sentiment was Neutral, 5.0/10.0, and short volume was down, driving gains, they’ll want to know how those metrics changed this week. Measure and report.

They’ll look to you for the next episode of Star Wars, so to speak. That beats watching the stock or getting sent by them on wild goose chases for answers.  Embrace the change.

Speaking of change, we plan to launch in coming weeks daily sector reports highlighting key metrics – Sentiment, Key Behavior, Short Volume, etc. – for the eleven big industry classifications so you can see what’s happening in your group and how you compare.

There’s much more, so stay tuned! And don’t fear the Death Star.

Two Pillars

I hit a nerve.

What sparked the tempest was my assertion last week that investor-relations professionals can’t be just storytellers when over 80% of trading is not Active investment.  (For you investors, it’s why stock-picking is performance-challenged.)

It’s not that respondents raged against the machines of the markets, or at me. Folks just wondered what to do instead.

A good friend and respected veteran in communications prodded me.  “You need to be specific,” he said. “You do a good job explaining the market, but don’t fade to generalities at the finish.”

I’m paraphrasing. In my mind, I’m clear. Perhaps on paper I’ve been less so. I conceded that he must be correct. So as the new year begins with the prospect of blessings, here are two firm principles for IR:

Rule No. 1: Build a diverse palette of institutional relationships strategically, then consistently match product to consumer tactically.

The market at some point will treat your shares, which are a product, in a manner that departs from the story you tell to support them. Broaden the audience.

Investors, think about this from a stock-picking perspective. You can select companies with great fundamentals but if Asset Allocation models don’t like them, expect the stocks to lag.

And yes, it’s possible to know what kind of money moves into and out of which stocks or sectors. We do it every day. We’ll come to that with some real examples.

Now match product to consumer, which is good relationship-management. Make this tactic a simple weekly action. We lay out a plan for you. It turns on metrics.

Nordstrom doesn’t randomly call people when the new Eton shirts are in, or whatever. They know which customers buy those shirts because they measure and track behavioral data. IR should too, and can.

Say you’re a growth story. But your shares are falling. The data show it’s Fast Traders shorting your shares, not investors selling. You can only affect active money, but get specific. Call the kind that likes Eton shirts. Deep-value high-turn hedge funds.

Every IR team should build (strategy) three or four such relationships. Tactically follow up only when your product matches. Help them achieve their investment objectives. They’ll help your shares recover so you’re a growth stock matching story.

Rule No. 2:  Measure the kind of money setting price, and make it part of management’s thinking (which takes persistence).

We’ve made it simple with six key metrics. The stock market is not a single monetary demographic, and it’s not long-term. Facts. Not threats to IR.

Copernicus said the earth was orbiting the sun, not the other way around. People wanted to go on doing what they always had.  Help your management team adapt to the real world. Yes, they’ll resist. Don’t let them revert to incorrect practices.

Example: A health care company has for the last five of seven weeks had Fast Trading as the leading price-setter, and short volume is consistently 65%.  Price reverts repeatedly.

The IR professional should tell management so executives won’t waste money on trying to reach more investors or blame IR for communicating ineffectually.

The data say investors are not responsible. Sure, the team might pick relationships to call that buy Eton shirts – aggressive, able to take risks in trading ranges.  But high short volume signals investors prefer renting shares out to investing more money in them.

The vital action item here is to set realistic expectations for management – perhaps flat tell them that the story and strategy need adjustment if investors are to engage again.  That’s powerful. And cost-effective.

A big client did a massive deal. For months the data showed investors hated it. No matter what they said with their lips, their money was not setting prices. The team tracked data and tweaked message and finally behavior changed. The deal closed. Powerful data.

Another client tracked investor-engagement for a year through a short attack and industry disfavor but ended with Superb investor-engagement using our measure called Gamma.  Awesome success metric.

Another had become a momentum growth stock without a momentum growth story, thanks to industry expectations. Data showed the dilemma ahead of a call that would likely recalibrate expectations. It showed big downside risk. But the transition out by growth money and the point where value investors set price were measurable, helping the IR team consistently inform management despite a painful reset to price.

The most important effort in any management discipline is understanding how the ecosystem functions. It’s impossible to make good decisions by guessing.  IR is a product manager.

There are two pillars to great IR in the 21st century. Build and manage diverse institutional relationships, matching product to consumer. Measure the data, understand the behavior setting price, and communicate it to management relentlessly.

You can’t run a truly 21st century IR program without knowing what kind of money is setting your price.  And why would you?  I didn’t say you can’t run a program. But it’s that vital, essential.

You can know what sets price. You can see how money changes over time.  You can use it to run your IR program efficiently and proactively (it’s our plan to bring behavioral analytics to investors in 2017 too). And you can look cool and feel less stressed.

That’s a darned good 2017 strategy, resting on big pillars.

The Math

“Making investment decisions by looking solely at the fundamentals of individual companies is no longer a viable investment philosophy.”

So said Steve Eisman, made famous in Michael Lewis’s book The Big Short, upon shutting down his new investment fund in 2014.  Actor Steve Carrell portrayed Eisman as Mark Baum in last year’s hit movie from the book.

Michael Burry, the quirky medical doctor running Scion Capital in the book and the movie (played by Christian Bale), first earned street credibility via posts about stocks on Silicon Investor, the online discussion forum huge before the dot-com bubble burst.

But in the ten years after Regulation National Market System transformed the stock market in 2005 from a vibrant human enterprise into a wide-area data network, 98% of all active stock-pickers failed to beat the S&P 500, proving Mr. Eisman correct.  You can’t pick stocks on merits alone now.

That’s contrary to the legacy objective of the investor-relations profession, which is to stand the company’s story apart from the rest.

As with finding the root of the mortgage-industry rot, today the market is all about data.  Everything is.  Google Analytics examines internet traffic patterns.  ZipRecruiter is analytics for hiring. Betterment is analytics for personal investing.  HomeAdvisor and Angie’s List are analytics for home-repair. Pandora is analytics for music you like.

Pick your poison. Everything is data. So why, ten years after Reg NMS, is the IR profession calling someone to ask, “How come my stock is down today?” All trades pricing the market under Reg NMS must by law be automated.

If you’re calling somebody to ask about your stock, I’m sorry but you’re doing IR like a caveman. And, paraphrasing Steve Eisman, running the IR department solely by telling the story to investors is no longer a viable industry philosophy.

Why? Because it begins with the flawed premise that the money buying and selling your shares is motivated by fundamentals alone.  For the past decade – the span of Reg NMS – trillions have departed active stock-picking portfolios and shifted to indexes and Exchange-Traded Funds, because tracking a benchmark is a better path to returns.

Take yesterday.  All you had to do was buy technology and materials stocks.  Today it might be something else. The most widely traded stock on the planet is SPY, the S&P 500 ETF.  It traded $7 billion of volume yesterday, ten times BAC, the most active stock.

Here’s another. XLU, the Utilities ETF, was among the 25 most actively traded issues yet the sector barely budged, up 0.04%. Why active then? ETFs fuel arbitrage.  Profiting on price-differences. It’s not where prices close but how they change intraday.

Best trade yesterday?  NUGT, the leveraged gold ETF, was up 7.5% even though gold has been a bust the past month.  The S&P 500 took the whole year to gain 10% and then only on the Trump Bump. Between Dec 30 and Oct 31, the S&P 500 eked out 2% appreciation. You could triple that in a day with NUGT so why invest long-term?

“Boy, Quast,” you say. “It’s the holiday season! What are you, The Grinch?”

Not at all! The opposite in fact. I’m on a quest to make IR central to public companies again. We invented Market Structure Analytics, data for the IR profession to address the demise of IR as Storyteller.  The future for our profession isn’t a command of fundamentals but knowledge of market form and function.

Let me be blunt. Anybody can tell the story. Only IR professionals dedicate themselves to knowing how the market works – and that’s job security, a transferrable skill set.

The way IR shifts back from a rotational role to vital standalone profession is through knowledge of the stock market. If you want to be a biologist, study and understand biology. If you want to be a biology reporter, you just need to know some biologists (no offense to biology reporters).

Which will the IR profession be in 2017?

Having threshed trading data for 15 years now through the regulatory and behavioral transformation of the equity market, I feel a tad like those guys in The Big Short who studied mortgage numbers and concluded it was irrefutable: It was going to blow up.

These data are irrefutable: Over 80% of your volume most days is driven by something much shorter-term than your business strategy.  Ergo, if all you tell your Board and management is how your strategy influences the stock, you’ll at some point be in trouble.

This is the lesson of 2016.  Make 2017 the year IR transforms how the people in the boardrooms of America understand the stock market. That is an invigorating challenge that will breathe value into our profession. The math doesn’t lie.

Verve and Sand

The whole market is behaving as though it’s got an Activist shareholder.

In a sense it does.  More on that in a minute.

We track the effects of Activism on trading and investment behaviors both before it’s widely known and afterward. A hallmark of these event-driven scenarios is behavioral volatility. That is, one or more of the big four reasons investors and traders buy and sell stocks routinely fluctuates day-over-day by more than 10% in target companies.

(Aside: Traders and investors buy and sell stocks for their unique characteristics, when they have characteristics shared by others, to profit on price-differences, and to leverage or protect trades and portfolios. The market at root is just these four simple purposes.)

Event-driven stocks can override normal constraints such as Overbought conditions, high short volume, or bearish fundamentals.  In fact, short volume tends to fall for catalyst stocks because the cost of borrowing shares rises as more want to own rather than rent, and unpredictability of outcomes makes borrowing shares for trading riskier.

Currently in the broad market, shorting trails the 200-day average marketwide. The market has manifested both negative and overbought sentiment and has still risen.

And behavioral volatility is off the charts.

Almost never does the broad market show double-digit fluctuations in behavior because it’s a giant index smoothing out lumps. With quad-witching and quarterly index rebalances Dec 16, Asset Allocation ballooned 16.3% marketwide, signaling that indexes and ETFs are out of step with assets (and may be substituting).

Also on Dec 16, what we call Risk Management (protecting or leveraging trades and portfolios) jumped 12%. It’s expected because leverage with derivatives has been pandemic in markets, with Active Investment and Risk Management – a combination pointing to hedge funds – currently leading.

Here’s the thing. The combined increase for the two behaviors last Friday was an astonishing 28%.  Then on Dec 19 as the new series of marketwide derivatives issued, Fast Trading – profiting on price-differences – exploded, jumping 25%.

A 25% change for a stock trading $100 million of dollar-volume daily is a big deal. The stock market is about $300 billion of daily dollar-volume.

Picture a skyscraper beginning to sway.

Looking back, Risk Management jumped 16% with July expirations, the first after searing Brexit gains. The market fell from there to September expirations when again behavioral volatility exploded. The market recovered briefly before falling all the way to the election. With expirations Nov 18, Risk Management shot up 11.2%.

Behavioral volatility precedes price-volatility. We have it now, monumentally.

What’s happened in the broad market is a honeymoon before the wedding. The incoming Trump administration has sparked an investing surge betting on a catalyst – exactly the way Activist investors affect individual stocks.  Fundamentals cease to matter.  Supply and demand constraints go out the window. A fervor takes hold.

The one thing our long bull market has lacked is fervor. It’s the most hated – and now second longest ever – bull market for US stocks because so many have loathed the monetary intervention behind ballooning asset prices.

That’s all been forgotten and a sort of irrational exuberance has set in.

Those who know me know I embrace in libertarian fashion broad individual liberty and limited government because it’s the environment that promotes prosperity best for all. I favor a future with more of it.

We should get the foundation right though. I’ll use a metaphor.  Suppose a giant storm lashes a coast, burying it in sand. Some return to the beach to rebuild homes and establishments but much lies listlessly beneath a great grainy coat.

Then a champion arrives and urges people to build. The leader’s verve lights a fire in the breasts of the people, who commence building a vast structure.

Right on the sand.  Which lies there still unmoved, a shifting layer beneath the mighty edifice rising upon it.

It’s better to remove the sand – all the central-bank buildup from artificial prices, the manufactured money, the warped credit markets.  Otherwise when the next wave comes the damage will be that much greater.

So call me wary of this surge.

Fed Up

We’re in New York hoping to run into Janet Yellen because today the Federal Reserve probably raises rates.

In December last year the Fed hiked, and markets jumped – and then imploded. Worst January start ever for the stock market.

If you’re not right now feeling a deadening of your senses, you’re an outlier. Assemble a focus group and you’ll find folks have roughly the same reaction to the words “monetary policy” that they do to “dental appointment.”  It’s all floss, scraping and blood.

With stocks at all-time highs due more to the growth of the Fed’s balance sheet than verve in the economy, one wonders if it’s held together with dental floss. The world’s leading currency manipulator by my estimation isn’t China but us. The USA.  We micromanage the supply of dollars, and all currencies turn on the value of the dollar.

So we have to talk monetary policy. If the supply of money expands faster than the economy, inflation will show up somewhere. Inflation simply means your money doesn’t go as far as it used to.  See everything from real estate to education to stocks now.

The Fed from 2009-15 increased the supply of dollars by 62% while the economy grew 24% (about 2% per year). The adult population expanded 7%. Those employed increased 10% (but only 4% if you back up to peak mid-2008 pre-crisis jobs).

The only way an economy grows faster than population is if productivity – doing more with less – increases. Our most productive year by far in recent times was…wait for it…2009.  Yes, when the economy imploded and the value of the dollar exploded, suddenly our money went farther, and the bloat came out, and productivity spiked 5.5%.

But the Fed immediately shoved the entire economy full of bucks. Productivity nose-dived because our money didn’t go as far as it used to, as prices for everything from houses to stocks climbed sharply.  Productivity since has averaged less than 1% growth per year and totals but 5% from 2010 through the third quarter this year.

So if the supply of money is the only thing growing rapidly, we have an economy built on what the sellside analysts call multiple-expansion, which is just another name for your money doesn’t go as far as it used to.  You’re paying more for the same thing.

This, while we’re at it, is how income inequality increases.  When governments expand the supply of money, people with more (the rich) spend it on houses and cars and art and stocks, increasing the prices of those things, and the rich get richer.

But for the poor who do not have assets, the money they have doesn’t go as far because stuff like toilet paper and cereal and toothpaste costs more.  So they have less (we thus have a curious confluence in which the Fed rails against income inequality while promoting it with policies).

The ideal structure is for money to have timeless value so that technology for making things boosts productivity, and prices come down some over time (prices declined by 50% from 1800-1900 and we had our most explosively productive stretch ever) and everybody’s money goes a little farther.

The Trump administration brings a message of opportunity. That unstoppable force of hope is slamming into the immovable object of economic fact. Stocks are up some 10% without underlying change. It says how much we long for the good times to roll again.

There are two questions here as we conclude. First, do we want to build the future atop a giant pile of wobbly Fed pillows stuffed full of cash, or would it be better to ground it firmly on economic output?  Hope is a powerful elixir but it’s not empirical. Empirically, there should be a massive sale – everything must go – in America before we begin again.

And question number two is will that happen?  The US dollar strengthened sharply before the Internet bubble burst in 2001, putting everything on sale. We have valuations now matched only by those then.  The dollar is at the strongest level since then.

The strong dollar will mean weaker Q4 revenue and profits for multinationals and if it continues into Q1 next year, the economy will first slow before Trump policies may put wind in the sails. When record stock markets mash into falling corporate profits and slowing economic outcomes, expect trouble.

I’m excited about the future in America. Before it comes, we should first get Fed up.  Dump these asset prices created by a vast accumulation of cash.  Start fresh. Will it happen?  That’s the unknowable part.

Bang the Close

I find myself in an uncomfortable position.  I’m siding with a high-frequency trader.

There’s a key lesson here for investor-relations professionals about how prices are set, and it dovetails with why the bulk of volume concentrates around the open and close.

The title of this piece would be a great name for a rock band but it refers to submitting securities trades during the last 15 minutes of trading to affect how average prices are calculated. That’s “banging the close,” it’s said.

Venerable Chicago high-speed firm DRW, a proprietary trader focused on derivatives markets, has been accused by commodities regulators of manipulating prices on a key interest-rate swap. The alleged malfeasance occurred in 2011.

Normally firms settle with regulators when charged with rule-breaking. Founder Donald R. Wilson, a prominent figure in Chicago, insists DRW did nothing wrong and is battling the US Commodities Futures Trading Commission in court.

The CFTC says DRW submitted a thousand orders over seven months that didn’t conform with other prices during the vital last 15 minutes when “settlement prices,” or average prices for contracts and broker margin-requirements, are calculated. A broker serving as counterparty might have to furnish more capital if the price moves.

The CFTC is miffed because it believes DRW made money even though none of its bids produced a matched trade.  DRW says it was simply profiting on differences between the futures contract and the same product traded over-the-counter (that is, by brokers). The swaps contracts pay buyers (DRW was always the buyer) a fixed fee and sellers a floating one. Floaters lost, among them the now-defunct MF Global.

Let’s summarize for those who like me need an adult beverage after sorting this matter. The CFTC claims DRW manipulated prices for gains by putting in bids that weren’t like other bids. DRW says it bids what it thinks things are worth, not whether the price conforms to others’ views, and sometimes someone loses. That’s my interpretation.

What’s this got to do with IR and stock-trading? The IR job is predicated on helping investors understand why your shares are worth more than somebody else’s.  Are you manipulating prices then?  Of course not. And sometimes stocks decline.

Secondly, one reason Blackrock and Vanguard routinely beat your active holders for investment returns is because of stupid rules forcing prices to averages at the expense of those looking for outliers. Without outliers in markets, there’s no room for stock-pickers – the lifeblood of the IR profession. The market should reflect all prices, not averages.

It’s partly why volume is big in the morning and at the close.  Those prices are used to calculate averages. Your shares often move up or down early, toward the mean between, and then up or down into the close (see yesterday’s trading).  It could be argued that many algorithms are banging the close, which means banging is no aberration – or that the whole market is a series of continuous manipulations (don’t answer that!).

If DRW is a manipulator, then so was George Soros in the British pound. So are trading algorithms pursuing volume-weighted average prices because they undermine your effort to help your stock diverge from averages.

So is the Federal Reserve. The Fed sets artificial interest rates to manipulate broader ones, which it will likely do again Dec 14 (with $460 billion of reverse-repurchases on its balance sheet, another manipulation scheme, the Fed signals hike intentions). How is that different from DRW bidding at prices it believes reflect appropriate value?

If DRW is a price-manipulator, so was my dad.  On the cattle ranch of my youth, we’d take our animals to market and bid on them to push the price up to a level we thought proper. If the buyers didn’t like it, we bought the cattle back and took them home.

This would apparently have earned CFTC accusations of manipulating cattle prices.

Pardon me for bluntness but let’s knock off the crap, shall we? Rules that force all prices to the mean – which proliferate in equities and everywhere else now – defy supply and demand, foster mediocrity and promote sudden and irrational reversions to a mean.

I don’t prefer proprietary traders committing no long-term capital to budding businesses.  But.  If we want to reduce risk in the capital market, here’s an idea:  Let any buyer or seller price as he or she wishes. Suppose brokers could do it too. Maybe that would bring aftermarket support back to IPOs, creating new IR jobs again.

That’s my suggestion for the incoming SEC chair.

Long December

Are you a Counting Crows fan?

Karen and I saw the band years ago at Red Rocks, our fabled foothills venue. Front man Adam Duritz lived, he said, in Denver as a child.  One great song goes, “It’s a long December and there’s reason to believe that this year might be better than the last.”

On this last day of November I’m thinking back.  On November 30, 2015, marketwide short volume – daily trading on borrowed shares – was about 43%, a low number versus trailing standards. By January 2016 it had risen to 52%. At Nov 28 this year its 43%, the same as last year.

The dollar then as measured by the DXY Index was the strongest in a decade, at 100.5.  It’s at 101.0 now, a fourteen-year high.

Let’s pause. What’s a strong dollar mean? Using an analogy, a football field is one hundred yards long. Suppose your team is way behind, down 30-0. So the referees shorten the field to 60 yards to give you a chance to catch up.

A strong dollar is a long field. A weak dollar is a short field. Weak dollars shorten play by making prices rise, earnings from abroad converted back to dollars appear stronger, and borrowing cheaper.

From 2009-14, the USA played on a short field, thanks to the Federal Reserve. We were down 30-0. By latter 2014 we trailed about 30-14.  I use that score because by historical measures – housing starts, GDP growth, discretionary income, retail sales (excluding autos), industrial output, productivity and more – we are half what we were.

But we’re catching up, so the Fed is getting set to stretch the field again (Aside: We should never shorten the field. If you’re used to running 60 yards in practice but the games play at 100, your training is all wrong. A steady dollar is what we need.).

DXY

Courtesy Dow Jones Marketwatch

 

Getting back to our December comparisons, in 2015 the Fed inched the cost of overnight borrowing called the Fed Funds Rate up to 0.25%-0.50% (it settles sort of in the middle), the first hike in ten years.  This December it’s widely expected the Fed will mosey the rate up another 25-50 basis points.  Simpatico again.

In December 2015, the bond market was weak, with interest rates on the 10-year US Treasury at 2.33%, up from 1.7% in January, a 39% increase (prices and rates move inversely, so when people sell bonds, rates rise and when they buy them, rates fall). As November 2016 ends, the 10-year Treasury is 2.32%, from 1.4% in July (68% rise).

And the S&P 500 is about 5% higher now. (Speaking of stocks, don’t miss our NIRI webinar tomorrow called Hide and Seek: The Incredible But True Story of How Big Institutions Buy and Sell Your Shares.)

There is one major difference between then and now. Using our long-field/short-field analogy in a different way, when the Fed’s balance sheet has big bank reserves, that’s a short field. Low bank reserves, long field. Between early December 2015 and early January 2016, the Fed took $500 billion out of bank reserves, pushing the playing field to the full hundred yards as it tightened rates.

The whole globe rocked.

Stocks imploded and money screamed into bonds, driving rates down. For awhile at the end of January it seemed downside for the market was bottomless.

By pushing the entire $500 billion back into reserves and chopping the playing field to 60 yards, the Fed got stocks to reverse and soar all the way to the Brexit (they overdid it).

This time they’re starting December where they began January, with a long field and low reserves. They believe they can hike rates December 14 and hack the playing field down to 60 yards by boosting bank reserves, and thus next year will be better than the last.

They might be right.

I’ll tell you the risk should they get it wrong and what would set it off:  If the economy lurches sharply down – despite headlines this week there’s a real chance of a recession next year looking at trends – then the Trump Rally will be a big belly well out over the Fed’s skis as winter hits. If that happens this current year will be better than the next.

I’m hoping for a short December.

Best Of: The GRAR

Editorial Note: Happy Thanksgiving!  We hope you reflect gratefully this season, as we will.  And speaking of reflecting, you might think with markets hitting new all-time highs after the election that we’ve beaten a retreat (what the military calls without irony “advancing to the rear”) from our two-year declamation about coming risk-asset revaluation. We’re by no means complaining about gains. We think prospects for the USA merit giving thanks. 

But there will be no escaping the consequences of artificial asset-price inflation. You can’t blow a balloon full of air and suppose it’ll float forever.  Runs here in November will have a profound reversal magnified by the meteoric dollar-rise. Whether it happens in days or weeks, it’s coming. The question for the new administration will be whether it possesses the fortitude to let prices find proper equilibrium so the economy can actually find “escape velocity” finally, in its aftermath.  -TQ

Originally posted Nov 9, 2016:

Power changed hands in the USA today.

I don’t know in what way yet because I’m writing before election outcomes are known, and about something for the market that will be bigger than which person sits in the oval office or what party holds congressional sway.

The GRAR is a lousy acronym, I admit. If somebody has got a better name, holler.  We started talking about it in latter 2014.  It’s the Great Risk Asset Revaluation. We had the Great Recession. Then followed the Great Intervention. What awaits the new Congress and President is the GRAR.

I’ll give you three signs of the GRAR’s presence.  Number one, the current quarter is the first since March 2015 for a rise in earnings among the S&P 500, and the first for higher revenues since October 2014. Until now, companies have been generating lower revenues and earning less money as stocks treaded water, and the uptick still leaves us well short of previous levels.

Since 1948, these recessions in corporate financials of two or more quarters have always accompanied actual recessions and stock-retreats. The GRAR has delayed both.

Second, gains off lows this year for the Dow Jones Industrial Average have come on five stocks primarily. One could use various similar examples to make this point, but it’s advances dependent on a concentrated set of stocks.  This five – which isn’t important but you can find them – include four with falling revenues and earnings. Counterintuitive.

Finally, the market is not statistically higher (adding or subtracting marketwide intraday volatility for all prices of nearly 2% daily) than it was in December 2014.

That’s remarkable data.  It says prices are not set by fundamentals but intervention.

We might think that if earnings growth resumes, markets will likewise step off this 2014 treadmill and march upward. And that’s independent of whatever may be occurring today – soaring stocks or falling ones, reflecting electoral expectations versus outcomes.

In that regard, our data showed money before the election positioned much as it was ahead of the Brexit vote:  Active buying, market sentiment bottomed, short volume down – bullish signals.

You’ve heard the term “delayed gratification?” It means exercising self-discipline until you’re able to afford desired indulgences.  Its doppelganger is delayed consequences, which is the mistaken idea that because nothing bad arises from bad decisions that one has escaped them.

The bad decision is the middle one – The Great Intervention.  The Great Recession was a consequence arising from a failure to live within our means. When we all – governments, companies, individuals – spend less than we make, nobody ever needs a bailout.

But you don’t solve a profligacy problem by providing more access to credit.  The breathtaking expansion of global central-bank balance sheets coupled with interest rates near zero is credit-expansion. To save us from our overspending, let’s spend more.

If I held in my palms a gold coin and a paper dollar and I said to you, “Pick one,” which would you take?

If you said “the dollar bill,” I can’t help you and neither can Copernicus, who first described this phenomenon that explains the GRAR 500 years ago. Nearly everybody takes the gold, right? We inherently know it’s more valuable than the paper, even if I tell you they have the exact same value.  This principle is called Gresham’s Law today.

Credit does not have the same value as cash.  But assets in the world today have been driven to heights by credit, the expansion of which diminishes the value of cash.

What happens when the people owning high-priced assets such as stocks, bonds, apartments in New York, farmland in Nebraska and so on want to sell them?  All the cash and credit has already been consumed driving prices up in the first place.

What will follow without fail is the GRAR. Depending on who got elected, it might come sooner or later.  But without respect to the winner, it’s coming.  The correct solution for those now in power is to avoid the temptation to meet it with credit again, and to let prices become valuable and attractive. Painful yes, but healthy long-term.

That’s the path out of the GRAR. I hope our winner has the discipline to delay gratification.

Selling the Future

Karen and I are in Playa del Carmen, having left the US after the Trump election.

Just kidding! We’re celebrating…Karen’s 50th birthday first here on the lovely beaches of Quintana Roo and next in New York where we go often but never for fun. This time, no work and all play.

Speaking of work, Brian Leite, head of client services, circulated a story to the team about Carl Icahn’s election-night buys. Futures were plunging as Mrs. Clinton’s path to victory narrowed. Mr. Icahn bought.

If you’ve got a billion dollars you can most times make money.  You’d buy the cheapest sector options and futures and aim your billion at a handful of, say, small-cap banks in a giant SEC tick-size study that are likely to move up rapidly. Chase them until your financial-sector futures are in the money.  Cash out.  See, easy.

(Editorial observation: It might be argued the tick study exacerbated volatility – it’s heavily concentrated in Nasdaq stocks and that market has been more volatile. It might also be argued that low spreads rob investors of returns and pay them to traders instead.)

If you’re big you can buy and sell the future anytime. The market last week roared on strength for financials, industrials, defense and other parts of the market thought to benefit from an unshackled Trump economy.

An aside: In Denver, don’t miss my good friend Rich Barry tomorrow at NIRI on the market post-election (Rich, we’ll have a margarita for you in Old Mexico).

We track the four main reasons investors and traders buy or sell, dividing market volume among these central tendencies. Folks buy or sell stocks for their unique features (stock picking), because they’re like other stocks (asset allocation), to profit on price-differences (fast trading) and to protect or leverage trades and portfolios (risk management).

Fast trading led and inversely correlated with risk-management. It was a leveraged, speculative rally. Traders profited by trafficking short-term in people’s long-term expectations (there was a Reagan boom but it followed a tough first eighteen Reagan months that were consequences of things done long before he arrived).

Traders buy the future in the form of rights and sell it long before the future arrives, so that by the time it does the future isn’t what it used to be.

They’re grabbing in days the implied profits from a rebounding future that must unfold over months or even years. Contrast with stock-pickers and public companies. Both pursue long arcs requiring time and patience.

Aside: ModernIR and NIRI will host an incredible but true expose with Joe Saluzzi of Themis Trading and Mett Kinak of T Rowe Price Dec 1 on how big investors buy and sell stocks today. 

Why does the market favor trading the future in the present? It’s “time-priority,” meaning the fastest – the least patient – must by rule set the price of stocks, the underlying assets. We could mount a Trump-size sign over the market: Arbitrage Here.

We’re told low spreads are good for investors. No, wide spreads assign value to time. Low spreads benefit anyone wanting to leave fast. Low spreads encourage profiting on price-differences – which is high-frequency trading.

Long has the Wall Street Journal’s Jason Zweig written that patience is an investing virtue.  Last weekend’s column asked if we have the stamina to be wealthy, the clear implication being that time is our friend.

Yet market structure is the enemy of patience. Options expire today through Friday. The present value of the future lapses. With the future spent, we may give back this surge long before the Trump presidency begins, even by Thanksgiving.

I like to compare markets and monetary policy. Consider interest rates. High rates require commitment. Low borrowing costs encourage leverage for short-term opportunities.  We’ve got things backward in money and the markets alike. Time is not our friend.

Upshot?  The country is in a mood to question assumptions. We could put aside differences and agree to quit selling the future to fast traders. Stop making low spreads and high speed key tenets of a market meant to promote time and patience – the future.