Cans and Roads

The problem with kicking the can down the road is what happens when you reach a hill.

Speaking of hills, Taos wasn’t what we’d expected.  Galleries cluster the square, yes.  We loved our circuitous bike ride along the foothills to Arroyo Seco. El Meze boasts views, an iron-chef James Beard winner and delectable fare. The Rio Grande Gorge nearby inspires awe.  But you won’t find posh on La Placita at Paseo del Pueblo Sur. Julia Roberts bought Don Rumsfeld’s 40-acre ranch here to escape Rodeo Drive, not to replace it. Taos is backwoods, weedy, agrarian, a bit Baja. Signature dish? Fry bread at Ben and Debbie’s Tiwa Kitchen down the dusty street from Taos Pueblo, a Native monument.

Do you know what a whole life insurance policy is? It’s money for death that first builds cash value.  You might suppose there’s little connection to either Taos or investor relations. Conventional wisdom taught folks to “buy term and invest the difference.” Why blend your hedge with your investment? Insurance by definition is the price you pay for the unexpected, and investing used to be the opposite.

At Taos Pueblo, for a thousand years the people bested marauders with adobe walls and wooden ladders. The apartment-like construction permitted entry through holes in ceilings doubling as doors. If enemies breached walls, occupants pulled ladders and the complex transformed into an impenetrable fortress.

Today Taos Pueblo is a reservation with a casino down the road. Doors and stairs have replaced holes and ladders and the wall once 10-15 feet high is now a short decorative reminder re-plastered annually for the tourists. Residents count today on the federal government.

Whole life insurance is effectively what’s gotten the planet into trouble. A policy is an agreement to exchange value. Say $1 million. It’s a contract costing you a sum and guaranteeing you a million dollars if you die, which also lets you leverage the amount you’re spending but with immediate impact on the contract’s value. It’s a complex derivative. AIG offered them. The contract guarantees a return, so AIG got insurance on the insurance from a reinsurer and transferred the remaining risk to brokers like Lehman Brothers, which bought mortgage-backed securities to offset promises to backstop AIG’s commitments to pay life-insurance contracts a guaranteed return.

This all works fine until you come to a hill. Take Greece. So long as the value of assets – homes, stocks, bonds, art, commodities, on it goes – rose, everybody got a guaranteed return and one out of three people could work for the government and still expect to retire at 50 with a pension. That concept came to a chaotic halt when stuff stopped rising in value. Now we wait for a conclusion or a shoe smacked into the can rolling up the rising road.

For most of a thousand years Taos Pueblo ruled its domain and relied on nobody.  Today you take Camino del Pueblo north from Taos Plaza until it dead-ends into a dirt parking lot, where you pay a fee to visit.

What were they doing for a millennium that worked so much better? One could say, “No, Europeans showed up. That’s what stopped it.” Sure. The lesson that you’re better off relying on nobody stands, even if that means you don’t have doors and instead have holes in ceilings, and ladders. Is anybody paying attention?

Back to IR. Your shares today are a whole-life insurance policy.  They’re an asset with associated costs and capacity for leverage via indexes and ETFs, options and futures. All of it is interconnected.  Your story becomes secondary to liabilities and yield.  I’m sorry to tell you so but it’s a fact.  It must be part of what you explain to management or you’ll be leaving out the linchpin of contemporary capital markets.

History is predictive analytics.  The fundamental flaw in our global model is simple. You cannot guarantee a future without hills and if your model depends on kicking cans down roads, sooner or later the can will roll back to you.

The solution?  Simplicity.  Occasional inconvenience. Something a bit Baja. You may have to crawl through a hole in the ceiling. Cutting a door in the wall makes life easier but supposes risk is gone permanently.

We’d warned in May that June might be the roughest month since last autumn in what is our ongoing Great Risk Asset Revaluation. It was, though it took longer than we thought.  We’re not through this turbulence. We’ve reached a hill, of some sort.

Taos Pueblo still stands and its people are delightful and resilient as are humans generally regardless of whole-life insurance policies and risk-transfer. But tomorrow comes, and convenience costs. That’s today’s capital-markets lesson.

Being Novak

What moves you?

I gave it thought during ModernIR’s tenth NIRI National (I think 18 of them total for me now) at the Hyatt Regency in Chicago, here looking north across the river from the 33rd floor. It’s easy to fall into habits and skirt that unique brand of satisfaction bred in a job done well. We humans are given to routine.

Worn out after, Karen and I repaired last weekend to a resort on Arizona’s Carefree Highway, inspiration for an iconic Gordon Lightfoot tune, and were moved to tranquility despite the anvil heat. The desert offers a rich diversity of flora and fauna (extra points for spotting the cottontail) easy to miss in the confrontational brutishness of its mid-June exterior.  We embraced it and reflected.

To give our best we must be motivated.  A week ago in Chicago, we were clustered at evening with others in the Purple Pig, dining on that gastropub’s moving cuisine. We’ve done it twice now and relished both occasions. This one offered something special.

Space is a premium and so we were seated by another couple, kind and engaged youngsters by Karen’s and my estimation, a few years in age behind us (how time flies). We struck up a conversation.

I didn’t ask them if could share it so I’ll change names to protect privacy. I’ll call him Novak, her Andrea.  He was born in Serbia, then Yugoslavia, the son of wealthy parents who lost most everything when war erupted there in the 1990s. They came to the US.

Novak found real estate. What he lacked in language and knowledge he offset with motivation.  In realty then, the fax machine was dominating communication and Novak found a man to modify a PC circuit board so it could continuously dispense listings. He’d collect them all in the office and cut and paste and copy and fax, the PC dialing nonstop.

Of course faxing drove people crazy, both recipients and colleagues. But “every morning I had an offer,” Novak said.  He was a machine himself.  With indomitable motivation to be the best he became it, selling a billion dollars of real estate.

A buyer for a building he was selling was Andrea, and they married and now ten years later they have two children and a real estate development firm with a hundred people and millions in assets and they support a charity theater they created to perpetuate their own sense of what it means to be inspired and moved.

One of my favorite IROs talks about the line between what she calls “mailing it in” and setting oneself apart in our profession. If you’re not careful, investor-relations becomes repetitious. Quarterly reporting, annual reports, road shows, conferences, it runs together. You start dismissing new thinking as an affront to convention (this is true in politics too).

What’s the secret to fresh and new every day?  Being Novak. Finding inspiration that moves you to set yourself apart.

What thrills about market structure still after ten years is its never-ending novelty.  Today’s investor-relations officer must know Story, sure. But that’s just half the job.  The rest today is Structure – the way the market works. The knowledge of it is powerful and it breathes added vigor into the patterns of our profession.

Motivation. I remember when Tim Tebow tweeted that one-word anthem. We don’t all have to be Novak, conquering heights.  But learning market structure today is motivation – and since Structure is as important to price now as Story (yup, true), you’ll be enhancing your career.

And that’s uniquely satisfying.

The Escalator

As the US investor-relations profession’s annual confabulation concludes in the Windy City, we wonder how the week will end.

The problem is risk. Or rather, the cost of transferring it to somebody else. Today the Federal Reserve’s Open Market Committee Meeting adjourns with Janet Yellen at the microphone offering views on what’s ahead. The Fed routinely misses the economic mark by 50%, meaning our central bank’s legions of number crunchers, colossal budget and balance sheet and twelve regional outposts supporting the globe’s reserve currency offer no more certainty about the future than a coin flip.  That adds risk.

The Fed sets interest rates – not by ordering banks to charge a certain amount for borrowing but through setting the cost at which the Fed itself lends to banks. Higher rates paradoxically present lower risk because money can generate a return by doing nothing.  Idle money now wastes away so it’s getting deployed in ways it wouldn’t otherwise.

If you’re about to heave this edition of the Market Structure Map in the digital dump, thinking, “There goes Quast again, yammering about monetary policy,” you need to know what happens to your stock when this behavior stops. And it will stop.

When the dollar increases in value, it buys more stuff. Things heretofore made larger in price by smaller dollars can reverse course, like earnings and stock-prices.  As the dollar puts downward pressure on share-prices, derivatives like options into which risk has been transferred become valuable. Options are then converted into shares, reversing pressure for a period. This becomes a pattern as investors profit on range-bound equities by trading in and out of derivatives.

Since Sept 2014 when we first warned of the Great Revaluation, the apex of a currency driven thunderhead in things like stocks and bonds, major US equity measures have not moved materially outside a range. Despite periodic bouts of extreme volatility around options-expirations, we’re locked in historic stasis, unmatched in modern times.

The reason is that investors have profited without actually buying or selling real assets. This week all the instruments underpinning leverage and risk-transfer expire, with VIX volatility expirations Wednesday as the Fed speaks. The lack of volatility itself has been an asset class to own like an insurance policy.

Thursday, index futures preferred by Europeans lapse. There’s been colossal volatility in continental stock and bond markets and counterparties will charge more to absorb that risk now, especially with a sharpening Greek crisis that edges nearer default at the end of June. Higher insurance costs put downward pressure on assets like stock-prices.

Then quad-witching arrives Friday when index and stock futures and options lapse along with swap contracts predicated on these derivatives, and the latter is hundreds of trillions of notional-value dollars. On top of all that, there are rebalances for S&P and Nasdaq indices, and the continued gradual rebalancing of the Russell indexes.

Expirations like these revisit us monthly, quad-witching quarterly. That’s not new. But investors have grown wary of trading in and out of derivatives. Falling volumes in equities and options point to rising attention on swaps – the way money transfers risk. We see it in a trend-reversal in the share of volume driven by active investment and risk-management. The latter has been leading the former by market-share for 200 days. Now it’s not. Money is trying to sell but struggling to find an exit.

Here at the Chicago Hyatt Regency on Wacker Drive, when a NIRI General Session ends, the escalators clog with masses of IROs and vendors exiting. Index-investing, a uniform behavior, dominates markets and there is clogged-escalator risk in equities.

It may be nothing.  Money changes directions today with staccato variability. But our job as ever is to watch the data and tell you what we see.  We’ve long been skeptics of the structure wrought by uniform rules, and this is why.  It’s fine so long as the escalator is going up.  When the ride ends, it won’t impact all stocks the same way, however, because leverage through indexes, ETFs and derivatives – the power of the crowd – has not been applied evenly.

This year’s annual lesson then is no new one but a big one nonetheless. Investor-relations professionals must beware more than at any other time of the monumental uniformity-risk in markets now, wrought not by story but macroeconomics and structure.

So, we’re watching the escalator.

It Aint So

The equity market is like Mark Twain said. The trouble ain’t what people don’t know, it’s what they know that ain’t so.

Thus did Sam Clemens articulate the difference between the price of ignorance and the consequence of arrogance. I thought about this distinction a number of times after reading a late-April article on proposed SEC policies for pay-versus-performance.

Now, don’t worry. I’d rather have a hole drilled in a molar than ruminate on SEC regulatory recipes. We’re a data-analytics firm tracking equity-market behaviors. No, what happened was that stories ran in press outlets, a number of which said these rules affected 6,000 public companies.

I was curious where the number came from and asked reporters. They referred me to the SEC.  I reached out to the Division of Trading and Markets, which after a couple weeks sent me to Corporation Finance, who in turn routed me to the Division of Economic Research and Analysis.

It’s June. I’m still waiting for an answer. It’s curious that a body responsible for articulating compliance to a swath of businesses would have difficulty determining how it tabulated the swath.

Which leads me to something you may not know.  The German equity market corrected. On April 10 the DAX hit 12,374 and yesterday closed at 11,001, a 12% drop. Retrenchment of 10% is a correction.

Over the weekend, Deutsche Bank, one of the world’s largest derivatives counterparties, fired its co-CEOs.  HSBC, the erstwhile Hong Kong and Shanghai Banking Corp., another global derivatives backer, Monday declared a shakeup that axes 50,000 and rebrands its UK outlets.

Whenever there’s an earthquake now somewhere in the world, I’m wondering about consequences.  Invariably if a temblor rocks Indonesia there’s a volcano soon erupting on some island, a quake in another region. The planet is interconnected – and so are markets.

Your smart phone today knows you, and the providers of the apps you use can triangulate your contacts, your patterns, your calls, texts, schedule, your travel. It’s at once startlingly efficient and disturbing that Something knows Everything.

Do you get alerts on stocks? Maybe you have Google or Yahoo or somebody else ping you when shares move a certain amount or volume is up some percentage. If you surf the web, whatever you search from Cadillacs to underpants will be served up in advertisements. Yet stocks are still bland price and volume as though what’s behind both is homogenous and disconnected – the exact opposite of all else around us from nature to finance to web apps.

Today we launched the first-ever Market Structure Alerts for public companies that reveal not price and volume but what kind of behavior is driving them and whether it’s buying or selling and when it changes meaningfully for just you. Nobody has ever done it.

I see Bloomberg is offering companies technical analysis, something 30 years old. We agree that you should consider it a fundamental fact and duty of IR to know your equity market. What we know that ain’t so, however, is that technicals are not setting prices. What sets price is what money is doing, and it’s following models today.

Tuesday, we publicly unveiled Gamma™, our proprietary measure for knowing if your marketplace is well-informed, your investors engaged, not through what they say but how they spend money competing to buy shares.

The SEC is still trying to figure out how it counts companies. Here’s another fact: There are fewer than 3,850 public companies in the National Market System, with massive money concentration in them through a decade-long explosion of indexes and ETFs.

ETFs are derivatives, part of a big cast of them now. There’s more than $700 trillion of notional-value in currency and interest-rate swaps, which are impacted by asset-class volatility.

German bunds in the past two months have risen from 0.05% to 0.99%, a gain of 1,880%.  Institutions use big firms like Deutsche Bank and HSBC for risk-transfer – assigning the consequences of the unknown to someone else through derivatives.

When global risk-asset revaluation got underway in Sept 2014 – a process that continues now with intensifying risk – we theorized that one or more major global derivatives counterparties would run into financial trouble.

Everything is connected today.  Your shares are connected to derivatives and counterparties, indexes and ETFs, currencies, and all manner of options, futures and swaps. Quad-witching looms next week, with Russell rebalances.

We can do something for you that not even Goldman Sachs can manage:  We know what behavior sets your price, and how it connects to the big picture. What investor-relations professionals have to confront in this environment is both what you don’t know and what you know that ain’t so. We can help on both counts.

Challenge your assumptions – and all the tools that haven’t changed in 30 years. The informed IR professional is a powerful expert to whom management will turn.

Quiet Midday

The midday equity-market silence is deafening.

Writing for the Wall Street Journal last week, Dan Strumpf roiled capital-markets constituents describing how stock-trading is now focused around the opening bell and the last half-hour, with volume dribbling otherwise.  NYSE strategists are now contemplating a midday auction.

Successful solutions spring from correct diagnoses. The issue isn’t that Everyone Goes Away at Midday. What’s occurring is symptomatic of structure in both the equity market and institutional investment. This is the giant elephant in the stock-market room. Concentration early and late in volumes reflects the explosive growth in passive investment.

The investor-relations profession predicates its existence on differentiating the corporate story.  You target investors appropriate for your stock. You get out there and set meetings to see investors.  You tell the story unflaggingly. You run a good business, delivering the results you’ve helped investors to expect.

Fine, good. There’s just one problem. This strategy obviates the bedrock principle of public speaking: Know your audience.  In the 1980s when stock-pickers dominated market volumes that weren’t coalesced at the open and close, rational investment behavior led and corporate competitive differentiation mattered most.

Today, the elephant is the core audience. For ten straight years investors have been shifting from picking stocks to allocating assets.  Over that time, the once-fringe notion of using statistical models to invest in stocks has become the predominant approach. Blackrock, Vanguard and their dollars by the trillions today see equities as products.

We flew to the Bay Area yesterday and after our first plane experienced mechanically related delays, we switched flights and I found myself crammed into a rear row next to a Schwab employee from the sprawling Denver office. She’s in the Registered Investment Advisor group, supporting independent planners. Schwab has now launched “robo advisor” services for both retail and advisory markets in response to growth at firms like Betterment, Wealthfront, Personal Capital, Motif Investing and others.

These automated investing services identify your preferences and goals and then construct a model to match them. In Schwab’s case the models are entirely ETF-driven and rebalance daily to match allocation targets.

Advisors could have ignored the elephant trampling the traditional model. The smart ones are embracing them. There’s a lesson for public companies: The elephant of passive, model-driven indexes and ETFs isn’t obscuring your audience. It IS your audience. This is what institutions are doing now.

That doesn’t mean you stop telling the story. It does mean that what you measure, how you gather investor feedback, what you tell management about stock-valuation and how you target investors – in fact, how you see the job – must change. We can’t ignore the giant passive-investment elephant in the room, and go on doing the same things.

Which gets back to silence at midday. Indexes and ETFs are paid to track benchmarks. Tracking is best served by orders near the close. As passive investment has exploded, volume has concentrated in the closing half-hour to mark broad measures.

The opening frenzy is also a consequence. Traders hoping to move index components for arbitrage opportunities act early in the day, leading to frenetic sprints at the bell.  And buttressing this proliferation in model-driven money is mushrooming derivatives-use, from over-the-counter options to fixed-for-floating equity swaps, all of it about the elephant in the room and arbitrage. And 44% of market volume is rented – short, borrowed – to boot.

It’s all related.  A midday auction won’t help the elephant in the room or anyone else because it hasn’t diagnosed the problem. What might help is 24-hour trading. Indexes would be relieved of the need to be near a close.  But investment would then devolve into relentless and repeating arbitrage even more than now, the continuous plucking of profits on slight separations between securities.

We could disconnect markets and disabuse ourselves of the false premise that all need the same price regardless of size – which would bring the Passive Investment juggernaut to a halt and level the playing field again for stock pickers.

That’s not going to happen. Anytime soon, at least. In the meantime, IR professionals, embrace the elephant and make measuring its movement a core part of the job because it’s your core price-setter. It’s concentrating volumes.

And that’s the quiet truth.

Trading Through

Memorial Day is a time for reflection.

We marked it by viewing American Sniper, introspective cinema on prolonged war.  There comes a point along that continuum where people begin to feel helpless, caught by something they can neither fix nor change.

That of course got me thinking about the first Equity Market Structure Advisory Committee meeting, convened May 13 without anyone from the issuer community on hand.  Chair Mary Jo White tasked the team with weighing Rule 611.

Fight the eye-glaze urge that overwhelms at mere sight of the name. If you’re a participant in the equity market as all public companies are, you need to know how the market for traded shares works.

Rule 611 is one of four key tenets of Regulation National Market System, the regime behind our current terrific marketplace, and says trades cannot occur at prices worse than those displayed at another market in the national system. We say Order Protection Rule or Trade Through Rule because it prohibits “trading through” a better price.

The thinking was if brokers were jobbing clients with inferior prices, how do you stop it? The old-fashioned way of doing that is how you buy a car. You do some comparison-shopping, and enterprising folks create apps like TrueCar (which is what ECNs were!).

Perhaps concluding that humans buying and selling stocks are just too busy to take responsibility for getting a good deal themselves, the SEC decreed that all orders capable of setting market prices must be automated and displayed by exchanges. As the memo’s authors write, “If a broker-dealer routes an order to a trading venue that cannot execute the order at the best price, the venue cannot simply execute the order at an inferior price.”

This is why algorithmic and high-frequency trading exploded. But the SEC deserves credit here. In an unusually blunt and rather readable treatise prepared for Committee members, the SEC admits its rules “significantly affect equity market structure.”

What the SEC really wanted through Rule 611 was more limit orders, or stock-trades at defined prices instead of whatever one is best at the moment. “The SEC believed,” the memo says, “that greater use of displayed limit orders would improve the price discovery process and contribute to increased liquidity and depth.”

The opposite happened, and the SEC is again forthright, saying “limit orders interact with a much smaller percentage of volume today than they did prior to Rule 611. This development may suggest that Rule 611 has not achieved the objective…”

Supporting that conclusion, earlier this year Fidelity and fellow investing giants said they will launch a marketplace for stocks called Luminex Trading & Analytics. Other members are Blackrock, Bank of New York Mellon, Capital Group, Invesco Ltd., JPMorgan Asset Management, MFS Investment Management, State Street Global Advisors and T. Rowe Price Group Inc. The cadre manages assets topping $15 trillion.

These are your owners. The stock market isn’t working for them. The SEC is talking about it – even admitting errors. All the major exchanges in the past year – NYSE, Nasdaq, BATS Global Markets – have proposed big changes.  IEX, famed from Flash Boys, is working to create a radically different exchange model.

Yet 90% of CEOs and CFOs at great American public companies don’t know investors are unsatisfied or that everyone else in the equity market is talking about fixes. That’s not because they can’t grasp it. They don’t know because IR isn’t explaining it.  You can’t expect exchanges to do it. They serve multiple constituencies and we’re the least economically meaningful, to be frank.

This can be the Golden Age of IR if we seize the opportunity to command a role in market-evolution. IR sells products – shares of your stock. If they were widgets, we’d know every intimate detail about the widget market (executives would expect nothing less).

So why not the stock market? (Hint: We can help you drive this organizational change!)

The Cube

Investor-relations is an itinerant profession. We’re on the road a lot.

If you’ve had one of those three-hour flights, say from Denver to Atlanta, in a cramped regional jet (we’ve vowed to avoid them but United interdicts our solemn ecclesiastical commitments), you may utter profanities.

You might also ponder the supply chain. It takes work to match plane to demand so well that a body is wedged into every seat, leaving no logistical slack. Give airlines credit (or the finger) for it.

Like seats on planes, there’s a finite supply of your shares. If long-term holders never sell, who supplies them to new buyers, and how can your owners drive trading volume? The Investment Company Institute (ICI) in 2013 measured median portfolio turnover at 29%, meaning most big investors sold just a third of holdings over the year. Supposing a seller must exist for every buyer, you should see roughly a 7% change in ownership on a net basis in a typical quarter.

Go to Whalewisdom.com and look up your own ticker (or pick one of your choosing).  At the top of ownership data you’ll see net increase or decrease between the two most recent periods (December 2014 to Mar 2015).

There’s a company in Basic Materials, market-cap over $30 billion. The IRO and I have talked about Market Structure Analytics (our proprietary software and algorithms for measuring the composition and price-setting activity behind daily volume).  I checked: Net institutional change period-over-period was 40,000 shares.

Even I, an inveterate student of market mechanics, raised an eyebrow. I went to Google and pulled data for Oct 1, 2014-Mar 31, 2015. The stock traded over a million shares daily and in the period had composite volume topping 163 million shares.

Holy cow. Hidden inside 163 million shares of volume was real ownership-change of a few thousand shares over 130 trading days. They’ve only got 214 million shares out.

“Wait a minute, Quast,” you say.  “You’re looking at this wrong. There’s a lot of musical chairs, people jumping up and sitting down again across those quarters.”

No, that would contradict the ICI data indicating many investors sit on positions. Picture a Rubik’s Cube. (Am I dating myself again?) The multi-colored tiles comprising the puzzle never change.  They just trade places, like your institutional owners. What determines the outcome isn’t fluctuation in tile-count but how tiles are manipulated.

Without Market Structure Analytics, you’re measuring tiles, not what moves them.  Suppose your CEO said, “You’re telling me we traded 163 million shares over two quarters, and the net result of all that movement was 40,000 shares?”

Telling your executives the truth carries a measure of risk, sure. They may challenge you. They’ll ask you questions. The facts about market-function demand a corresponding change in perception and measurement, and you, IR, keep that gate. The alternative is perpetuating a myth. Choose wisely.

Back before we were vacuum-packed like camping rations into aircraft – “we hope you have a pleasant flight” – a lot of airlines went broke.  You leave too much space free and it takes a toll on finance when you’re in the business of moving people around.

Today in the brokerage business, about 30 firms control 90% of volume and half of those are the biggest banks the world has ever seen. The truth is your share-price is set by them.  The supply chain. In the past week 45% of all market volume came from borrowed shares. Indexes trade back and forth with the ETFs tracking them. How that movement nets out at quarter-end is often a random act with no connection to fundamentals.

You’d think the suppliers and the consumers would get together and change the distribution model.  But that’ll never happen so long as the C-suite believes owners set prices. There’s only one constituency capable of changing that: You. The IR profession. It begins with redefining what you tell Management and Boards, so they know the difference between 40,000 and 163 million.

The math doesn’t lie.  But it raises questions deserving answers (which we have—and for which you can get credit!). Ask yourself:  Is an executive team that never asks IR questions better or worse for you – and your value – than one with lots of questions?  Ponder it.

Smart Beta

“Management wants answers when we don’t trade with our peers.” This is a lyric from a song by the rock band Smart Beta.

Just kidding. But Smart Beta is as good a rock-band name as One Direction and each begets the other in the stock market. Because capital-markets globally have become variations on a barcode theme – call it one direction – investors are experimenting with ways to break away.

Just yesterday you could see a currency patina painting worldwide equities, with some Asian markets up equal to declines in European stocks. Then when US shares began trading, ours were both up and down, a sort of global convergence.  As currencies fluctuate, divergences spill into assets denominated by them, feeding short-term arbitrage. It’s still a pattern.

Back to the opening salvo, it’s a routine refrain: “My CEO wants to know why we’re down and our peers are up.”  Patterns vex not only IR folks trying to answer management but the scads of money entrusted to fund managers promising as they all do to “outperform the market.”

Enter Smart Beta.  Some call it “factor-driven investment,” others “strategic beta.” Beta in investment-speak defines comparative performance so smart beta implies better comparative performance. Beta 1.0 defines behavior for the whole market. Figures above or below 1.0 signal a security’s historical tendency to be more or less volatile than broad measures.

We get all that, right? It’s outdated. Beta no longer captures volatility well since any widely traded stock will have thousands of daily prices, the final one the closing price. We prefer to measure intraday volatility.

And our hunt for better metrics is like quantitative effort to break from the Blackrock/Vanguard pack. That’s smart beta. Vanguard itself is toying with the concept through funds like the Vanguard Dividend Appreciation ETF.  Founder Jack Bogle nonetheless scoffs, telling CNBC’s Tom Anderson in a March 2015 story, “Active managers are just trying to come back and say there is a better way to index, when they know damn well there isn’t a better way.” (more…)

25 Basis Points

Whether public companies are winning in the stock market comes down to basis points.

The Buttonwood Agreement formulating the US public equity market in 1792 affirmed in two terse sentences that its parties would charge a quarter-point commission.

Last weekend Jason Zweig wrote about “May Day” for the Wall Street Journal. On May 1, 1975, under pressure from the SEC and Justice Department antitrust lawyers, and seeing a path to reducing market-fragmentation and competition from low-cost platforms like Instinet, the NYSE ended fixed commissions. Many brokers saw doomsday looming and called it “Mayday.”

As Mr. Zweig says, assertions of industry demise proved both exaggerated and misplaced. Volumes boomed, advertising about stock-trading exploded, Charles Schwab created the greatest Everyman brokerage in the history of the profession and here in 2015 the notion that set costs for trading was ever a good one are scorned.

It was called “deregulation” since the rule inked by quill pen May 17, 1792 stating “We the Subscribers, Brokers for the Purchase and Sale of the Public Stock, do hereby solemnly promise and pledge ourselves to each other, that we will not buy or sell from this day for any person whatsoever, any kind of Public Stock, at a less rate than one quarter percent Commission on the Specie value of and that we will give preference to each other in our Negotiations” was rescinded.

Under deregulation has come tens of thousands of pages of rules ranging from exchange order-types that hide shares even though exchanges are markets where shares are displayed, to the structural opus magnum Regulation National Market System decreeing trading at the best national price and dividing consequent data revenue.

When you dine out, what’s a fair tip?  If somebody handles bags for you at the hotel, what do you give them?  In 1792, brokers thought 25 basis points an acceptable fee for finding a buyer for a seller, and vice versa. (more…)

New Answers

What’s the purpose of life?

We want simple answers to complex questions.  Such as when management asks why the stock price is up or down. Since elementary explanations are often incorrect, there’s been a loss of confidence.  “We broke through our moving averages” wears thin with the CEO.

I’ll give you a couple examples. Yesterday an energy master limited partnership trading on the NYSE announced an unchanged cash distribution for the first time in years. This company is known for steadily ratcheting up quarterly outlays to holders.

The stock tanked. Right?  Nope, it doubled the modest sector gains in energy yesterday. Maybe investors thought the company would trim the distribution?  Now we’re speculating because the opposite of what was expected occurred.

We’re also assuming price depends on rational thought, which if the feds now contending a trader spoofing the futures market with placed and canceled trades caused the Flash Crash, is the exact opposite of reality.  Do you know the SEC’s own trading data show at least 25 cancels for every completed trade in stocks of all market-caps (250 per trade in high dollar-volume issues), and over 1,000 cancels-per-trade in big ETFs?

Another company last week dropped sharply amid block volumes, prompting conventional stock soothsayers to conclude big holders were selling. Seems logical, right? If your stock trades 8,342 times daily on average your closing price is the 8,342nd trade.  It’s where the day’s music stopped and useless as a central tendency – and yet closing price is the de facto measure of action (we prefer midpoint price, by the way).

In the 1961 science fiction novel Solaris by Polish writer Stanislaw Lem – made into a 2002 movie starring George Clooney – Kelvin the protagonist questions his sanity. Seeing things that appear real but seem impossibly so, he begins to believe his entire journey may be occurring in his own mind.  To establish a reality baseline he performs some calculations. He reverts to the math.

Back to the stock above, the math showed the opposite of what reality appeared to say. Active value investors had been buyers. When buying stopped, traders abruptly quit lifting prices, prompting a brief plunge. Short volumes, which had jumped 40% in two days, sharply retreated at once, implying block prints reflected short-covering – by the very brokers who’d just filled buys for Value money.  The stock is now trading higher, which would be unlikely if big holders were sellers.

Ah for simple answers – but we don’t live in that world. Which brings us to today. Two vital macro events collide like matter in a particle accelerator: In the morning, we’ll get a first read on US GDP this quarter.  Then later the Federal Reserve via the non-apparitional personage of Janet Yellen will pronounce something about monetary policy.

Beneath the surface the market is on pins and needles. The Fed represents the supply of money, economic growth its cost.  The US dollar has been coming off decade-highs for days now, indicating some see growth drearier than hoped.  In the ModernIR 10-point Behavioral Index, sentiment is still weakly over neutral, meaning investors think whatever happens will be accommodative and therefore helpful to stocks.

But hedging is breathtaking – radically greater in the past five days than any other behavior. Investors are in fact in sharp retreat as price-setters. Effectively, everyone but the Fed has transferred the risk of being wrong to somebody else. Where that hot potato lands will determine the fate of equities. Moves either direction could be large.

Data suggest the economy will offer a limp pulse, perhaps wheezing in below 1% despite expectations from the Fed itself last December of 3%. If the Fed is off by 70% nobody there will get fired, which is good news for the jobless rate.

What’s it all mean? We pine for Easy, Simple. We’re sure as IR officers our shares stand out, and I hear all the time, “My stock is different.”  Like doctors studying angiograms we see the data and say, “You look like the typical patient to us. The good news is that means we’ve got answers.”

The great modern opportunity for the IR profession is the same presented to any generation, scientist, philosopher or explorer challenging convention.  We first face complex reality and then translate it into refreshing value for those we serve.

It’s not simple – but it’s exhilarating. So today, whatever your stock does in response to Janet Yellen’s invigorating oratory and the probable whiff from the economy, ask the question – why? – and if you’re still laboring along the flat earth of old-fashioned perspectives, stop.  Seek new answers. They exist!

Then the CEO will again ask you for them – a measure of value from those you serve.