December 4th, 2013 — The Market Structure Map
I’m reminded of a joke (groans).
A man is sent to prison. As he settles into his captive routine he’s struck by a midafternoon affair among his jailed fellows. One would shout out, “Number 4!” The others would laugh.
His cellmate, seeing the newbie’s consternation, explained: “We’ve been here so long we’ve numbered the jokes instead of saying the whole thing. Here, you try. Number 7 is a really funny one.”
“What, just shout it?”
The cellmate shook his head. He said, “Some people just can’t tell a joke.”
Speaking of numbered jokes, the NYSE filed with regulators to offer new order types – regulated ways to trade stocks – designed to attract large institutional orders now flowing to “dark pools,” or marketplaces operated by brokers where prices aren’t displayed. The exchange has long battled rules in markets that promote trading in dark pools, arguing that these shadowy elements of the national market system inhibit price-discovery.
Let’s translate to English. The NYSE is a big stock supermarket with aisles carrying the products your equity shopper needs, where prices and amounts for sale are clearly displayed. Across the parking lot there’s an unmarked warehouse, pitch black inside, with doors at both ends.
You can duck into the supermarket and check prices and supplies for particular products, and then hurry over to the warehouse and run through it holding out your hands. You might emerge with the products you wanted at prices matching those in the supermarket.
The advantage? You don’t attract a crowd wanting the same products you’re trying to buy the moment you reach up to take one off the shelf in the supermarket.
The NYSE says it plays Best Buy to internet shoppers, in effect, and that these unmarked warehouses, dark pools, make it hard for buyers to understand the real supply available in the market. That’s got merit, no question. If you’re led to believe that this item is the last one, you’ll pay a higher price – but what if there are scads more in the warehouse and because you just bought the one on display, a run on the warehouse ensues? This happens every day in stocks.
What’s jocular is that the NYSE, like every store, has got a back room with more supply in waiting. Exchanges even pay their suppliers, fast traders ferrying goods around the marketplace, re-stocking fees called rebates. Traders earn the best rebates for taking shares straight to the shelf. But lesser ones are paid for stocking the backroom too.
These new order types creating what the NYSE calls the Institutional Liquidity Program offer big buyers access to the backroom. It’s a dark pool. A giant warehouse at the rear of the supermarket.
So how does that foster price-discovery? By “price discovery” we mean the capacity to assess supply and demand for a particular set of equities so as to offer a fair price for them. If there’s a bit on the shelf and bunch in storage and you have to buy at the best displayed price, well, you got jobbed as an investor by confusing scarcity and choice. The same happens to companies running buybacks, evaluating “fair value,” or calculating equity cost of capital.
To be fair: Investors need protection from shelf-hoppers. The NYSE is trying hard to address a real problem and we credit them for competitive pluck. What would be better is for any marketplace selling stocks to compete standalone. The best markets would thrive, and the poor ones would fail. As it is, stock-trading in the US, unlike all other markets save health care and education, forces everybody to offer the exact same thing. That’s a sure recipe for mediocrity. The lowest common denominator will define the standard.
We might as well all shout zero! And then laugh.
November 27th, 2013 — The Market Structure Map
Happy Thanksgiving! Here’s a phrase Karen’s grandmother coined that you may find useful this time of year: “We ate to dullness.”
Since many of you are appropriately absent this week from the IR chair (or whichever office you occupy), we’ll revisit past turf. Among the most widely read Market Structure Maps of 2013 was this below from July 3. The images from our Provence cycling trip exercised influence, but sort through to the lesson.
I was reminded of it the last few days with three public companies you’d recognize. Each had the same scenario: Declines in price of magnitude unjustified by news or facts – which had shareholders as flummoxed as the IROs.
What happens between buyers and sellers, before they ever meet each other, can have as consequential an impact as the act of changing ownership. Sometimes more. Witness the so-called Flash Crash of May 6, 2010. Shill bidders disappeared, leaving a vacuum that filled with nothing until a thousand DJIA points evaporated. That’s not selling; that’s the conveyor belt connecting our fragmented market just – poof! – vanishing.
Another major structural fact today is that investors are obsessed with risk. Read on. Best, -TQ
July 3, 2013
We’re back from touring Provence aboard cycling saddles, weighing heavier on the pedals after warmly embracing regional food and drink. Lavender air, stone-walled villages perched over vineyards, crisp mornings and warm days, endless twilight, chilled Viogniers from small-lot Luberon wineries. If these things appeal, go.
In Avignon we feasted at Moutardier in the shadow of the Palais du Papes, the palace of the Roman Catholic popes in the 14th century. From tiny hilltop Oppede-le-Vieux with roots to earliest AD written in moldering stone and worn cobble we surveyed the region’s agricultural riches. After a long climb up, we saw why Gordes is where the rich and famous from Paris and Monte Carlo go to relax. And on Day 5 I scratched off the master life list riding fabled Mont Ventoux, which will host the Tour de France on Bastille Day, July 14. What a trip.
Meanwhile back at the equity-market ranch, things got wobbly. We warned before departing that options-expirations June 19-21 held high risk because markets had consumed arbitrage upside and new swaps rules would make the process of re-risking unusually testy. Markets tumbled.
The Fed? Sure, Ben Bernanke’s comments unnerved markets. But if we could see it in the data before the downdraft occurred, then there’s something else besides the reactions of traders and investors at work. Continue reading →
November 20th, 2013 — The Market Structure Map
In the timeless 1987 movie The Princess Bride, Vizzini the Sicilian, played riotously with a lisp by Wallace Shawn, keeps declaring things “inconceivable!”
Swordsman Inigo Montoya, portrayed then by Homeland’s Mandy Patinkin, finally says, “You keep using that word. I do not think it means what you think it means.”
You could say the same for short interest. It’s not what you think it means. Stay with me to the end, and you’ll see.
On August 2, 2012, Knight Capital Group’s algorithms failed. Monday at TABB Forum, Anthony Masso, CEO at trading risk-analytics provider Succession Systems, described how the SEC’s recent settlement with Knight successor KCG Holdings clarified a risk standard called the Market Access Rule. It requires brokers to have systems that forestall actions that may imperil themselves or others in the market. I’d paraphrase the law this way: “We order you to take whatever actions are necessary to prevent bad stuff. Thank you.”
That’s not what got my attention. The settlement reveals details about Knight’s errant trades. The broker bought, or went long, $3.5 billion of stocks; and shorted, or sold, about $3.2 billion. In less than an hour, its systems executed four million trades in 174 different stocks to create these positions.
This one tidbit is a tumbler unlocking vast secrets about market behavior. Knight’s algorithms were observably designed to build long and short positions of similar size principally to supply the storefronts of the stock market. When these positions failed to modulate, markets rushed into the vacuum, crushing Knight’s balance sheet.
Here’s the delicate balance in proprietary high-speed trading. Get it wrong by less than 10% and you’re done. Knight got it wrong. This same fragile trestle trains markets over the chasm each day. We’re all riding the rail.
ModernIR tracks short volume using algorithms. The daily average the past 50 days marketwide is 41%, not far off long/short equilibrium. Combined volumes on exchanges and dark pools total about 6.3 billion shares daily, meaning 2.5 billion shares each day are short.
Short interest in the S&P 500 is nearer 5% on average, though components can reach levels that roughly match daily short volume. The difference between interest and volume is that volume is just borrowed, while interest remains sold and outstanding.
Our data show that 11% of public companies have short volume above 50% of total volume. The highest in our client base the last five days was 61%. We’ve seen levels reach 85%, meaning nearly nine of every ten trades involved short shares – rented trading inventory. The lowest we saw was in a series of Class B shares trading just a few thousand per day where still 15% were short.
Elevated short interest can mean speculators are betting on a downturn. But it could as well be searing daytime demand for trading “inventory” – bowling shoes to put on for the day, for the game, traders and intermediaries finding renting cheaper than owning.
What concerns me is that short volume by definition in Regulation T is credit. So the market is heavily dependent on borrowing, just like the entire global financial system.
You have to see volume differently. Half of it is borrowed. Rented. Bowling shoes. High short interest is a product of frenetic demand on short horizons – not a certificate guaranteeing imminent pressure.
But realize that a hiccup in long/short balances can move your shares sharply – and it’s got nothing to do with ownership, or even shorting in the conventional sense. Inconceivable? No. And you know now what I mean.
November 13th, 2013 — The Market Structure Map
Today a new era begins.
One day in May 1792, 24 brokers gathered beneath a buttonwood tree in lower New York City and agreed to confederate in conducting their stock-in-trade. Thus began the New York Stock Exchange.
Today, the NYSE is slated to cease trading publicly. The InterContinental Exchange – The ICE – cleared final regulatory hurdles and closed the transaction.
It’s a study, an archetype, of the monumental change these last 15 upending years in equities, that The ICE is a derivatives market that didn’t exist when the Order Handling Rules in 1997 fundamentally shifted market orientation from investing to intermediation.
You’ve heard the cliché about the tail wagging the dog? Derivatives depend for existence on some underlying thing, an asset. Where derivatives have exploded in securities markets everywhere, equity assets have shrunk, not in value but in number. Keep this thought in mind. We’ll come to its significance.
According to SIFMA, the trade association for US capital markets, interest-rate derivatives alone reflect about $600 trillion of notional value. Compare to assets from US investment companies directed at US equities, according to consultancy Towers Watson and the Investment Company Institute: Roughly $11.4 trillion from a total $34.2 trillion under management. Dwarfed.
Sure, other assets in US equities originate internationally. But there’s been a colossal shift since 1972 (an ironic numerical anagram), when derivatives began to percolate globally as first the dollar and then the raft of global currencies departed from mooring gold, creating value uncertainty that had to be hedged in securities markets.
The pace gained steam in the 1990s and in equities it coincided with a reversal in the number of public companies in the National Market System. That figure peaked near 8,000 in 1998, data from Wilshire Associates shows. Continue reading →
November 6th, 2013 — The Market Structure Map
We were in Kansas again.
We set a personal record, visiting the state twice last week. Even Wichita is nice this time of year, as this photo shows Saturday from our downtown Hyatt Regency room on the Arkansas River – don’t ask me why that river’s in Kansas.
IR pros, you’re not in Kansas anymore. The phrase popularized by Wizard of Oz author Frank Baum in 1900 remains metaphorically relevant. It means: “Things are not what they used to be,” or even better, “Rather than complaining, recognize reality and deal with it.”
It’s apropos to your stock. A vital but overlooked fact about stock prices is what actually sets them. It’s rarely investors alone. Ever heard a stock recap on the news that said stocks were up because intermediaries bid up short-term prices to trick investors? It happens all the time.
Growing up on a cattle ranch in eastern Oregon, we raised 300 hundred tons of hay. That’s a lot. But feeding 50 pounds of it per animal every day for five months to a herd of a thousand head, it’s a fraction of what’s needed.
So you buy. You may use a hay broker or you might go direct to growers, and it could take more than one. You want the right quality. Not grass, but alfalfa with its higher protein content, better for the hard winters in the Snake River Breaks.
Then you have to move it from Nevada or Georgia where you bought it. You might get a package deal, with the hay shipped and stacked for an all-in per-ton price. You might truck it separately if the deal’s better. But you’ll need truckers.
Costs are complicated. The weather during growing season, the supply of cattle in the market carrying over the winter, competition in the hay-growing industry, the price of fuel, government deals with foreign countries impacting the expected price for beef in the spring – all these determine what you pay for hay. My dad used to crunch numbers in his model for carrying costs to the target sale date. Expenses for feeding cattle could fluctuate wildly, sometimes doubling from one season to the next, requiring careful management. Continue reading →