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…)

First Things First

If you’re in a tree sawing off a branch, note which side of it you’re standing on.

The guy studying the branch was Brad Katsuyama, CEO at dark pool IEX, which has designs on exchange-hood. He was speaking along with others before that folksy and fashionable Washington DC club, the Senate Permanent Subcommittee on Investigations (you get a titular sense our republic is engaged in perpetual sleuthing – and how do you conclude a hunt when its sponsor is permanent?).

Katsuyama, who called markets “rigged” in Michael Lewis’s Flash Boys, said yesterday, “IEX was created within the current regulatory framework.”

Translation: “We invested big bucks finding a solution that helps investors and complies with rules and we won’t cut off our noses to spite high-speed faces.”

Wait a minute. Doesn’t IEX hate the current framework? For those who’ve not read Flash Boys yet, I won’t spoil it. Ronan Ryan, who earns his own “problem” chapter, entertained a big NIRI National breakout session last week. Karen (beloved spouse and ModernIR COO) thought it was the best one ever at NIRI. Even with the f-bombs.

I’m not knocking IEX! Love ‘em. But a point has been missed. In order to facilitate what should naturally occur – buyers finding sellers – IEX had to perform unnatural acts. Let me rephrase. There are rules governing stock orders. To comply, IEX created the Magic Shoe Box, a 38-mile fiberoptic hampster wheel to neutralize fast-trading’s version of location, location, location.

Why is some crazy Rube Goldberg contraption necessary to structure a market so it appeals to real investors? Today’s equity market defies Occam’s Razor, which at risk of offending you experts on philosophy I’ll dumb down to “simplest is best.” For proof, the outfit heralded with restoring fairness must perform technological gymnastics to achieve it.

Having committed effort to solving a problem that only exists through synthetic warping-by-market-rule, IEX now is in a quandary. It can’t call for an end to something for which it just found a solution.

We here at ModernIR have long decried how arbitrage prices stocks. The role of the consolidated tape in prices, how data revenues are shared among market centers, and what makes data and circuits at exchanges valuable cements that reality. This foundation now underpins the US stock market with its ETFs, its 44% short volume daily, and its tens of trillions of dollars annually.

It may be an SOB. But to paraphrase political leaders of past generations describing distasteful foreign dictators who were allies: it’s our SOB.

The Senate hearing spotlighted “maker-taker,” about which we’ve written much and often. It describes incentives paid to traders to bring their orders to markets. The NYSE is on the record calling for its end.

We remain uncertain if the new owners of the NYSE understand how the market works. Remove incentives at the NYSE, and why would anyone do business there? It’s a marketplace lacking any native orders. It imports 100% of its goods, with rebates.

“Quast has gone round the bend,” you say. “He’s for HFT.”

Not at all! But first things first. Before we outlaw maker-taker (happy to explain what this means – just send me a note), we had better disconnect markets from each other, and remove the requirement that trades match between the best bid and offer. If we don’t, we will have a stunning disaster. Public companies should care about that.

And if the SEC is unprepared to loosen its grip so the market may function as a free one should, where buyers and sellers match at prices within the natural limits of supply and demand, then we best get used to the SOB we’ve got.

Either way, IROs, do you measure markets the way they work now? Monitor behavioral market-shares, short-volume and dynamic fair value. If you’re tracking ownership and moving averages, you’re missing most of what’s actually occurring.

The Big News

With crowning dreams of California Chrome and the unfortunately tinny conclusion to the equine trifecta dominating news, you might have missed what counted last week.

There was Liquidnet, operator of a members-only trading market for the buyside (a “dark pool”), paying $2m to settle SEC charges it shared confidential client information through its Infrared ID program at the NYSE and a couple other applications.

There was Wedbush, clearing firm for high-frequency traders, facing SEC charges that it inadequately policed how clients used its brokerage desk to directly and anonymously trade stocks (called sponsored access or direct market access for you word collectors).

Big news, both. But not The Big One.

No, I learned the big news first from Karen (our chief operating officer and my beloved spouse), who emailed a link saying, “Read this.” Not much later, Joe Saluzzi (NIRI National was fortunate to have Joe as my fireside-chat guest yesterday afternoon on whether markets are both broken and rigged) emailed snippets and said , “From Chair White speech…”

He meant Mary Jo White, SEC chair. She’d addressed the Sandler O’Neil Global Exchange and Brokerage conference June 5. And she said, drum-roll please:

“The secondary markets exist for investors and public companies, and their interests must be paramount.” (more…)

Crossfinding

We marked May’s end aboard a boat on the trade winds from Norman to Anegada in the archipelago of the British Virgin Islands. It’s an indisputable jewel of that empire upon which the sun once never set.

Now, back to reality!

“Arnuk and Saluzzi, the principals of Themis Trading, have done more than anyone to explain and publicize the predation in the new stock market.”

So writes Michael Lewis in his No. 1 New York Times bestseller Flash Boys, which rocked the US stock-market community. If you’re coming to NIRI National next week in Las Vegas, put this on your calendar:

I’m moderating a fireside chat with Joe Saluzzi (regular CNBC and Bloomberg TV guest, two 60 Minutes appearances about high-frequency trading) on Tuesday June 10 at 4:10p in Bellagio 2. Click here for details. Expect insight and entertainment – and bring hard questions!

Speaking of markets, did you see that Credit Suisse and Goldman Sachs released details about their dark pools? These are members-only trading venues regulated as broker-dealer Alternative Trading Systems under what’s called Reg ATS.

Credit Suisse’s Crossfinder is reputedly the world’s largest such market, which is in part due to the volume of orders that other brokers are routing to Credit Suisse. We monitor routing practices. It’s apparent to us that Credit Suisse leads in routing market-share.

Now, why do they lead? And why should you care, there in the IR chair? Because how the market for your shares functions is in the IR wheelhouse. Right? You know how your company sells products and services. How about the way your shares are bought and sold?

After all, the goal of IR boiled down to quintessence is to foster fair value in your shares and a well-informed marketplace. How do you know when that’s true?

One might say “when my shares reflect a certain multiple of the discounted present value of future cash flows.” But that measure is only true for investors measuring cash-flows. Eighty-five percent of your volume comes from forces motivated by something else.

You can’t control these but you can influence them, and measure them, and differentiate between when your active investors are setting price, and when something else is. To the degree that the prices of one are similar to the other, your market is fairly valued. It’s that simple, but you have to establish a way to measure it (we have).

Which leads back to Credit Suisse Crossfinder. In its Form ATS, the broker says it segments participants in its market into four groups.

Son of a gun. We segment the entire market into four groups, both in individual shares, and broadly, so we can see variances in these groups comparatively and by duration.

Credit Suisse calls the four groups Natural, Plus, Max and Opportunistic. The broker creates what it calls an “objective formula” predicated on a “variety of metrics” to “capture the trading behavior” of these clients.

Well. That’s exactly what we do. We think Credit Suisse is successful because it observes its clients’ behaviors and clusters similarities to improve outcomes for them. Logical stuff. I’m sure they know which behavior is dominating at any given time.

So do we, in the way we measure four behaviors ranging from natural to opportunistic. Now, why does this matter to IROs? For the same reasons. To improve behavioral outcomes. And because it’s how the market works. It’s how institutions are behaving.

I’ll probably fall short of instilling profundity, but this is on a magnitude of realizing that the earth you thought was flat is in fact round. It changes everything.

The holy grail of market intelligence isn’t knowing if Fidelity bought. It’s understanding whether the behavior of your dollar-flow is natural or opportunistic. That, my friends, is where the meaning lies.

Well, The Meaning may also be just off the coast of Virgin Gorda. Meanwhile, see you next week (booth 615) in Las Vegas!

Tapering Tantrum

EDITORIAL NOTE: We’re right now plying the azure waters off Richard Branson’s Necker Island. The following edition of the Market Structure Map ran May 29, 2013, ahead of last year’s NIRI National Conference (if you’re heading to NIRI in Las Vegas this year, don’t miss my fireside chat about Flash Boys and Broken Markets with famed HFT expert and frequent CNBC guest Joe Saluzzi of Themis Trading. More on that next week!). The Fed continues to be de facto captain of risk assets and the wind beneath their wings. It behooves us all in the IR profession to realize we’re in the process of undergoing separation anxiety. It just hasn’t manifested yet.

 

“If something cannot go on forever, it will stop.”

This witty dictum by Herb Stein, father of Ben Stein (yes, from Ferris Bueller’s Day Off, The Wonder Years, Win Ben Stein’s Money and TV in general), is called Stein’s Law. It elucidates why stocks and dollars have had such a cantankerous relationship since 2008.

Last Wednesday, May 22, Ben Bernanke told Congress that the Federal Reserve might consider “tapering” its monetary intervention called quantitative easing (QE) “sometime in the next several meetings.” You’d think someone had yelled fire in a crowded theater. The Nikkei, Japan’s 225-component equity index, plunged 7%, equal to a similar drop for the Dow Jones Industrial Average at current levels. On US markets, stocks reversed large gains and swooned.

Why do stocks sometimes react violently to “monetary policy,” what the heck is “monetary policy,” and why should IROs care?

Let’s take them in reverse order. Investor-relations professionals today must care about monetary policy because it’s the single largest factor – greater than your financial results – determining the value of your shares.

By definition, “monetary policy” is the pursuit of broad economic objectives by regulating the supply of currency and its cost, and generally driven by national central banks like the Federal Reserve in the United States.

Stay with me here. We’ll get soon to why equities can throw tantrums. (more…)