We’ve had questions about the “quote stuffing,” article last week in the Wall Street Journal. In essence, gobs of immediate-or-cancel (IOC) trades gumming up markets might have contributed to the Flash Crash. It’s equity whack-a-mole, where trades pop up to draw fire, then disappear.

No form of equity order randomly appears in the markets, crafted by conniving traders. All must be submitted via rule filing to the SEC, and approved. So the orders being questioned by regulators now were earlier approved by the same regulators.

IOCs are not the choice of committed, rational money. These orders suit intermediaries, whose aggressive bids and offers keep spreads tight and markets liquid – which is what regulators and market centers seek. But there is an unintended consequence to managing, manipulating, and incentivizing behaviors – which is what crafting orders that fit certain participants best does. The markets may not do with the incentives what was hoped and expected. And notice, too, that issuers, whose shares are the blood of markets, rendered no opinion on IOCs. We should.

Remember, our market system is a “maker/taker” model that relies on manufactured volume. Buying and selling is incentivized – induced with payments and types of orders that encourage middle men with no interest in owning shares to be aggressive. Why? People fighting to outbid each other should mean low spreads and competitive prices for consumers, regulators reason.

The problem? Consumers aren’t setting prices. The forces being incentivized are. We have no real idea what value buyers and sellers place on stocks, because the entire model is unwittingly obfuscating prices. Every time someone has an interest in buying shares, a fast intermediary may run ahead and re-price the market. This is couched as “price improvement.”

So, it should be no surprise that there were clouds of IOCs around the Flash Crash. This is exactly how the system is designed to function. It’s sort of like looking at the vortex in your bath tub after you pull the plug and wondering if the vortex is responsible for water leaving, or vice versa.

Think about it. Rather than the causal link between IOCs and the Flash Crash, we might ask instead why these IOCs drew out zero, zilch, nada “natural” liquidity. That’s market lingo for “real buyers and sellers.”

A mad scramble by intermediary systems failed to induce buying and selling. So those systems pulled out. So the answer to our question is that real buyers and sellers were uncertain of prices and unwilling to commit. Real money did not, and still does not, know the price or value of stocks. That should be a huge red flag fluttering in the market breeze like Old Glory on Labor Day.

Which brings us to trading today, the first after Labor Day. Why was the market down? Because the dollar strengthened. The DXY rose $0.85, or 1%, the reverse of the market. Last week it dropped sharply and markets climbed 250 points in one day.

This is precisely the same thing that is wrong with trading markets. Governments around the globe are manipulating, managing and incentivizing behaviors. The result is not a recuperated economy but instead that manipulation becomes an end unto itself. I hope we stop before we’ve been incentivized right back down to warring city-states.

Speaking of warring city-states, it’s that season when the sellside tries to out-schedule each other with industry conferences. Do you know how host firms of conferences trade your stock? What’s their order flow like? What do they do around expirations? Do they list the derivatives trader at the top (don’t laugh, many do) of research notes?

The nature of a firm’s order flow can tell you about the money consuming your liquidity (on those occasions when it’s real). If you need more growth-style money but don’t have lots of market cap, you might attend conferences hosted by major structured products purveyors.

Committed buy-and-hold money? Focus on firms differentiating with soft-dollar programs built around research, rather than ones with multi-asset-class trading capabilities. Sometimes small conferences are better. One committed investor can change the speculative and risk-management behaviors in your trading – because someone runs ahead and re-prices.

These ideas must now be in the modern IRO’s arsenal. And with that, have a blast out there on the road. We will – spandex, spokes, sunglasses and all!

While you ponder, a confession: We’re guilty of a bait and switch. If I’d written “implementation shortfall,” which is what I mean, rather than “missing the mark” above, which is what I said, I might be responsible for a chain-reaction narcoleptic catastrophe, people randomly falling asleep mid-word and banging heads on laptops, iPads, desks, afternoon pub beverages.

“Implementation Shortfall” is some software engineer’s term for not meeting your target in a trading scheme. By analogy, say you want to sell your house for $500,000 and you get $480,000. That’s implementation shortfall. In trading, it’s the difference between what the client wants and what you deliver. Say you’re tasked with selling 200,000 shares within a price range of $0.25, and with set trading costs. The degree to which you don’t meet that target is implementation shortfall.

In the IR chair, you don’t need to know all that stuff. But you should understand how implementation shortfall can impact how your stock trades. Maybe you can’t target the institutions you thought you could because at the trading desk, the implementation shortfall risk keeps trades from occurring. Plus, it’ll show up in your stock price. I’ve got a story to tell to illustrate it.

But before that, a word on trading since options expirations 8/18-20. The Dow Jones Industrial Average is off 440 points since. Data for clients show the chief cause not to be a rout from equities by informed money, but a shifting of the balance of resources. An institution at expirations decides to swap $500 million of tech stocks for a basket of bonds and Treasuries. The transaction does not hit the open market, but because the investor had been trading around his position before expirations and now has ceased, the effect is a gradual decline in the whole sector, because each algorithmic trade causes a ripple into the behaviors of other algorithms, many of which are there to match up trades now occurring at a lower level. The sector slides 10%.

It relates to algorithmic (mathematically managed) execution. If the placing of trades is less than random, machines identify an absence of randomness and game the order flow. What we have at the moment instead is a widespread effort to randomize so others cannot front-run orders and cause implementation shortfall. The result is chaos, combined with small shifts that produce big changes in price.

In markets where investment behavior, or rational thought, is principal price setter, value money would be at work, seeking value. We don’t have that. Instead, money seeks alpha or reacts to change. That’s why you see randomness everyday in trading.

Which brings us to our story. A particular basic materials small cap stock showed miniscule nudges in algorithmic trading on but two of ten program desks. Yet this smallest lack of randomness between overall buying and overall selling caused slippage of nearly 20% in the price. No value money tried to buy shares until the whole implementation shortfall had run its course by August 26. Perhaps because it too had been randomized. Unless you see these features in your own trading, you can’t truly say if your stock trades well or not (it varies, by the way, which is why IR must learn to be tactically nimble).

One answer to this problem is for IR professionals to color a broader palette of institutional relationships, not just buy-and-hold sorts, who have largely gone random. I was speaking with Jim MacGregor at IR/PR consultancy MacGregor Abernathy, and I agree with Jim that market structure almost demands that IROs court a coterie of aggressive hedge funds.

In a sense, hedge funds are the last institutional investors standing whose actions haven’t been randomized and ionized into a form of managed, program-driven behavior incapable of responding to value opportunities. I’m talking of course about active hedge fund portfolios, and not, say, DE Shaw’s Oculus portfolio. DE Shaw runs active money too. Their ability to act can alter the randomness in your market structure with one small hedgy step.

And now if you’ll excuse me, my schedule is experiencing an implementation shortfall.

Recently Kate Welling at Weeden & Co. interviewed Prudential’s vice-chairman, Mark Grier about being public in 2010. I read it and asked if we could highlight it here. It’s critical knowledge for IROs and public-company execs now.

Prudential (NYSE:PRU) has market capitalization of $26 billion, 38,000 employees, some $700 billion of assets under management. Before the May 6 Flash Crash, Vice-Chairman Grier had lamented to the SEC about the lack of fundamental content in stock prices.

In the interview, Grier said: “What happens when the market’s fundamentals are algorithms and signals and pings and all the stuff that goes on between the machines? What happens when the machine doesn’t know whether it’s buying Prudential or McDonald’s or Continental Airlines? What happens when that is really the way in which stock prices are being determined?”

Grier said, “I believe that this disconnect between company fundamentals and stock prices is a much more serious source of systemic risks than anybody is giving it credit for. The systemic risk – if the markets are materially wrong, if they are broken down, if they are not reflecting fundamentals, and if, as a result, real investors are hunkering down and not participating – could be devastating.”

“Stock prices,” Grier said, “are reflected in corporate accounting statements, in the financials, in earnings, in capital, in mark-to-market valuations, in regulatory capital. Then we have the rating agencies that use them. We have all the headline risks that go along with the market volatility as they affect employees and as they affect clients.”

And what if the whole underpinning construct isn’t fundamentally priced? Grier said, “There’s a basic conflict between using the stock price as our report card and the way in which that price gets set.”

Grier talks about the financial crisis of the past two years. “Instead of reflecting fundamentals,” Grier says, “the market itself became the fundamental. And that’s not the way it’s supposed to work…everybody is scratching their heads trying to figure out what’s going on, and that gets translated into expectations and plans and spending and pretty soon into real behavior. So pretty soon the economy was going through a cycle that was driven by the market itself.”

These are but a few nuggets from Kate Welling’s treasure-trove interview. Read it. Pass it on to your CFOs and CEOs.

We can’t solve the problem until we first understand it. The problem is that the market only marginally reflects what we do every day. Changing it starts with IR professionals getting a grasp on how markets work.

Second, companies need to be involved in setting rules for stock markets. Public companies are the life blood. Yet rules are made by traders, for traders, and companies are silent. Imagine if supply and demand were irrelevant in the grocery store and price-setting power belonged to a cartel selling groceries. And then suppose that economists considered prices to have been set by supply and demand. Could you trust their predictions?

Here’s a challenge, IR professionals: Educate yourself about markets. This interview is a great starting point. Write a letter for your CEO to submit to the SEC, a position statement on our capital markets.

The first step toward change is forming an opinion and expressing it. These are our capital markets, after all.

It’s about time for a Sazerac.

We’d warned that markets showed excessive arbitrage. Arbs capture net spreads between opposing trades and care little about price appreciation. When it’s high in the broad markets (and in specific issues, too), it often points to impending switches in the direction of money, say from one mix of assets to another. Why? Traders apparently detect algorithmic activity and move to profit from it.

We’d seen the same thing in June and thought it might occur again. It didn’t, and the market removed all doubt that we were the fools we appeared to be.

Or so it seems. Are investors responsible for this nice recent run back to positive turf on the major market measures? We can only share general observations from data. The data are what they are. We observed two developments on 7/22. First, Nomura traded more than half our client base that day, a rarity. Nomura had become a primary dealer to the Spanish Treasury a few days earlier, and it’s also a primary dealer for the US Treasury. It owns the trading platform Instinet and Lehman’s Asian and European operations.

How do those facts bear on equity trading when treasuries are a credit market? We can only speculate. But we believe banks can effect carry trades – borrowing and paying interest to earn higher interest on something else.

At the same time Nomura rippled through equity markets, we saw a surge in conventional program trading. Our measures differ from what the exchanges use. Different kinds mean different things. In this case, it was the biggest firms helping global institutions manage transitions from one asset class to another. While market volumes have been relatively light, this increase in market share by big program traders attracted a surge in mathematical trading, which identifies disparities in market structure and capitalizes on them.

Together these could represent a bait-and-switch, not fundamental investment. Banks with trading technologies and commitments to governments to help them fund operations could get money from overnight treasury or central-bank facilities at low cost and use it to trade in equity markets and attract demand. Profits from these operations provide funds for use in required bidding at government primary-dealer auctions. It also gives the bond market a head feint by pulling demand to equities to improve bond-market rates and prices.

We’re not saying this happened. But trading data show that confusion reigns in equity trading markets. That’s not a mark of rational investment. Money may respond sporadically to earnings, and we do certainly see that. But the broad behavior is a mix of discordant sentiments and reactions. We see that, too. Somebody buys in a dark pool, and programs react to it, and algorithms follow, and speculative traders and all the auto-quote systems (translation: “high frequency trading”) tag along, and none of it knows the worth or driver.

Following rules of deductive reasoning, we conclude that if it’s not rational, it’s something else. What else would it be? Well, what dominates the global financial agenda now? Government debt.

So be ye not lulled into a false sense of security, IR pros. Trouble lurks below the rapids. But for now, we’re rafting on big programs, which seem, right or wrong, to know more than you and me.

Passing through last weekend, we had to concede that Iowa was in fact a place of surpassing and bucolic beauty, with its rolling corn-planted hills and manicured farms. The heartland at Independence Day reminded us that this land of ours and yours is jeweled.

Anyway, we’re a day late this week because it’s a long way from Bratenahl on Erie to the banks of the Platte.

Speaking of eerie, your management teams must be wondering what caused stocks to cross chasms today to the upside. Do you think investors suddenly decided stocks were cheap? To paraphrase Saturday Night Live…really?

No, today is why every corporate IR professional should develop a rudimentary grasp of market structure. The way of the world now in trading markets is more like the movement of tides than the patient fashioning of edifices. To do your job with purpose and ease of mind, it’s helpful to know when the tide turns. We said last week that stocks should benefit from a return of capital after the 4th of July. We saw surging proprietary trading by liquidity providers July 1-2, indicating that software systems expected money to arrive this week.

How do software systems find bargains where investors don’t? They look at different data. To explain, let me tell you a story. Yesterday, we traversed the plains in Kansas from Fort Riley to the Colorado border and west to Denver. Once, that area belonged to the southern Cheyenne tribe. For history buffs like me, it’s living history, crossing that grassy canvas. The Sand Creek massacre site is southward. Battles were fought with the legends of the Cheyenne people at Beecher’s Island and Summit Springs just north of I-70.

The plains people had a narrow, rational worldview. Life revolved by seasons on a finite patch of earth. It worked in predictable fashion. It wasn’t possible for most of them to study different data and reach new conclusions. Now suppose you could sweep up and away in Google Earth fashion from the trace remains of Fort Sedgwick, west of Julesburg township (which the Cheyenne twice looted and burned), and observe continents and hemispheres. What’s happening on the Smoky Hill River isn’t quite so important now.

Trading software sees continents and hemispheres. If it’s summer in Patagonia, it’s time to ski Aspen. By the same token, the movement of money and trading liquidity isn’t limited by individual financial performance, but by where the sun shines and where the skiing’s good – so to speak.

How long will it last? No one knows these days, but the tides move fast. We suspect we could hang ten till July 21. The cool, contemporary IRO won’t try to control the seasons or tides. But it’s good to know about them so you can prepare, enjoy the autumn colors, and abide with a sense of purpose and ease. It beats the agitated uncertainty that can linger when you don’t know what’s over the next knoll. And it certainly beats becoming an archaeological curiosity.

All analogies break down. So let’s finish with a more mechanical explanation. Trading systems can incorporate multi-dimensional data, including the supply and demand of currency, derivatives and stocks. That data is often quicker to imbalances than are rational bottom-up investors looking for intrinsic disconnects between market valuations and financial metrics.

We are not in Iowa, or Kansas, or Fort Sedgwick, anymore.

That’s the essence of conversations I had yesterday with two investor-relations officers. It’s tempting to suggest asking Al Gore about why things that should be up are instead down. But that’s an old joke. And it won’t make you more valuable in the IR chair.

What will enhance your value is knowing what to tell the CFO and how best to do it. Whether you provide a daily, weekly or quarterly update to management about factors behind your stock price, you should incorporate comments on your market structure. Not just the old conventional stuff.

Think of market structure this way. If you operated a retail store, and each week you summarized the state of things in your store for headquarters, you’d talk about financial performance, products moving off shelves, the traffic driving sales, and trends. Something like that, anyway.

Same with your stock’s “market structure.” There’s only one product, your shares. But otherwise, you’re assessing behaviors and measuring them to understand how your store serves its market. If you measure only one behavior or one group of customers, that’s not an accurate picture of what’s happening, and it’s bound to lead to head-scratching and questions like, “How come our stock is down when it should be up?”

What do you tell your management team about market structure? Well, say you’re providing a weekly brief on trading activity. First define your metrics – the things you’ll track. For a weekly report, you don’t want to bury them in mind-numbing data. You want a small set of consistent measures. Begin with things like the percentage premium or discount in your closing price for the week versus the trailing 20-day average price. Volume versus 20-day average. Daily average trades and shares per trade, and daily dollar flow – that is, average daily price multiplied by average daily volume.

In time, you can provide a forward-looking expectation from data – but you must accumulate metrics first. As your management team becomes accustomed to market structure information, move to simpler but more compelling information, derived from your data: What’s setting our price? What do investors think? What are traders and risk managers doing, as opposed to what investors think? What’s likely to happen to our price next? These conclusions are extrapolated from data.

Before you know it, you’ll own your market structure. You’ll be the expert on matters related to your trading. This is the first step in a larger process of making a home for market structure in the IR department just like corporate governance has become an IR bailiwick.

Why must you own your market structure? Because roughly 90% of volume today BEHAVES either according to market risk or in response to speculative opportunity, and only a small amount is rational, or seeking long-term returns. If IR spends 90% of its effort on 10% of the market, well, at least something should be known about the rest. Or else, how can you draw accurate conclusions about stock performance, or even investor sentiment?

It’s up to IR to set that agenda and drag management kicking and screaming into the 21st century of how trading markets work.

To conclude, a challenge for you IR readers: Look up the DXY – the dollar index futures contract – and compare it to the Dow Jones Industrial Average, over, say, the past year, or the three months around the May 6 Flash Crash. What does it show you?

Speaking of waking up, did you read Sebastian Mallaby’s article in the weekend Wall Street Journal called “Learning to Love Hedge Funds?” Going back to the first hedge fund in 1949, run by Alfred Jones, Mallaby contends that hedge funds represent the optimal risk-management model.  Government tries to prevent bad things from happening. Hedge funds, where owners put their money at risk and earn returns when profits are produced, view risk as a pathway to opportunity, but one marked by prudent insurance, or hedges, against downside.  Jones produced cumulative returns of 5,000% from 1949-1968, Mallaby notes.

We’ve long contended that the contemporary IR relationship palette should reflect a variety of hedge funds and turnover timeframes. In markets predicated on the making and taking of liquidity and the constant re-allocation of risk and capital, focusing only on buy-and-hold investors is like offering a Monet to a Jackson Pollock collector.  You’ve got a nice product for the wrong buyer.

That leads to current markets.  Let’s talk again about “high frequency trading.” During a panel on trading at NIRI last week, Liquidnet’s John Adam, always an outstanding panelist, mused that “the only thing everybody agrees on about the definition of high frequency trading is that it’s trading at high frequency.”

Great assessment! There’s a bewildering variety of means and methods today by which parties large and small using networks both discrete and diffuse engage in the rapid putting and taking of shares for profit. We shouldn’t mistake it for investing. 

Here’s an analogy.  There are trillions of dollars moving through global markets.  Consider it a barge on land that must be scooted across the ground. If you’re moving a barge overland, you’ll roll it on logs, pulling the last one in the line and putting it in front and continuing to motivate the barge along.

In trading markets, everybody is moving logs now, from hedge funds, to exchanges, to institutions, to broker-dealers. The barge isn’t the best source of profit anymore; moving logs is.   Some high-frequency traders make money by collecting a fee for pulling the logs from behind and others for putting them into place at the front. Some profit by taking the logs from each other and moving them, and some by moving the logs faster than other log movers.  But it’s all intermediary service, for a fee.

While the mix of this activity varies widely from issuer to issuer, in general some 70% of volume is high-speed log-moving, and over 90% of volume is either speculatively driven – a form of intermediation or trading on gaps – or program-driven, which is managing the allocation of risk and capital.

People blame hedge funds for this.  Hedge funds would do the exact opposite, were they in charge of managing risk. These conditions we have now are what you get when you put government in charge of managing risk. What happens is that the best log movers become the most profitable enterprises. 

And you’ve got problems if the log movers decide not to move logs anymore. 

Speaking of which, we reiterate what we said last week. Despite strong market moves this week, we remain concerned that quantitative order flow might take sudden leave. Programs are responsible for positive performance since June 8. We can see it in the data. We cannot possibly predict what that means. But the allocation of risk and capital is transient today. That makes us wary.

Attendance jumped from last year. A few new firms joined the lineup on the boulevards in the exhibit hall. One first-time attendee working in corporate governance said as we sat by the fire pit Monday night and watched the party crowd and the live band and the oddity of the evening, a young woman rolling around on the pool in a giant see-through inflated ball, “You NIRI folks are the nicest conference goers I’ve ever met.”

Investor-relations types are people people. Who like to party.

There’s not a lot of partying in the equity markets yet. While the IR tribe whooped it up in San Diego, the markets didn’t. We’d expected better. We wrote two weeks ago that hedge resets on May 21 (think of them like climbing cams keeping you anchored to the rock face on Switzerland’s Eiger), signaled better things for a brief spell. But days later on May 26, something rippled portfolio trading schemes. Alert reader Eric Boni at Ashland Inc. said to us, “Could it be the MSCI rebalance?”

These rebalances and other forms of risk-management are often why markets seem schizophrenic. Last week on a similar jobs report to the one we got today the market kamikazes 300 points. Today, it’s up 2% so far. What gives?

There’s arbitrage, as we described last week. Compare big ETFs like QQQ, SPY and EEM, which track the Nasdaq 100, the S&P 500 and global emerging markets. You’d think they’d diverge more since they aren’t the same things. But with most trading behind them arbitrage, they look like each other instead of the segments they approximate. Or so it seems.

There’s also leverage. Back to MSCI. EEM, the ETF noted above, is an MSCI product in the iShares family bought by BlackRock from Barclays. It’s a $35 billion ETF that mirrors the MSCI Emerging Markets Index. MSCI was Morgan Stanley Capital International, a Morgan Stanley subsidiary that first created index investment products in 1969. In 2004, MSCI acquired Barra, Inc., a risk-analysis software firm, which combined to form publicly traded MSCI Inc. (NYSE:MXB), no longer affiliated with Morgan Stanley. In March this year, MSCI said it would acquire RiskMetrics, the risk-management and corporate governance giant.

Why are indices, ETFs, software, pieces of giant investment banks, and corporate governance rolled into one? Risk management is the biggest deal today. Yet investment managers must produce returns for clients. A white paper called The Perils of Parity from MSCI stuffed with terms like “empirical plausibility” and “derived conditions” explains that institutions have moved from allocating capital to allocating risk, and in so doing, leverage has become “necessary to achieve the expected return required by institutional investors.”

Suppose you met with investors and told them your growth story. But as you talked, the investors were thinking about how to allocate risk to you, not how to get a return from investing in your stock. That’s what software is doing today, and what these indices and ETFs are designed to do. So a bad jobs report last week in context of allocated risk was ugly for equities because the risk was allocated to stocks. This week, the risk is allocated somewhere else, and the capital gets allocated to equities. And the outcome is reversed.

Bottom line, you must pay attention to rebalances, IR folks, if only so you can talk briefly to the CFO about the difference between allocated risk and allocated capital. Next up on June 18, smack in the middle of options expirations, are the quarterly rebalances for the S&P 500, the Midcap 400, and the Smallcap 600. All of which have mirrored ETFs. And who knows where the risk and capital are allocated.

Maybe we need more swimming pools filled with inflated see-through beach balls ferrying flexible young females through happy partiers. It would make at least as much sense.

What’s happened today is straightforward: Investors and counterparties – think of it like vacationers and providers of trip insurance – sorted out imbalances. The debits and credits were entered on ledgers last week with monthly options expirations. Yesterday, true-ups hit Asian and European markets. Today they rippled through ours.

We’ve got more to say about it, but let’s get there by way of DRW Trading Group and the Eurodollar. DRW is a finite example of prevailing trading realities. On May 21, DRW suddenly appeared in many equity trades. DRW trades in various asset classes around the globe at high speeds. Ever played Guitar Hero? Imagine following the blinking lights, putting your fingers in different spots and removing them. Your speed and accuracy in placing and removing your fingers determines your success at the game.

Same principle applies. DRW’s founder Don Wilson earned his stripes long ago trading Eurodollar futures. Eurodollars are dollars — not Euros at all – on deposit in European banks, and futures contracts on them have to do with interest rates and currency values at future points.

If your eyes are glazing over, stay with me here! This cuts to the IR quick. How do shares of biotech stocks in US markets relate to Eurodollar futures traded by high-frequency quantitative proprietary firms like DRW? It’s an example and we’re both simplifying and postulating to explain what occurs.

But it’s like this: the supply of currency in central banks in one part of the world acts directly on the price of things in another part. If you can trade instruments denominated in those currencies fast while betting on where the supply will land and how it will affect interest rates three months from now, you have an interesting trading scheme that drives some poor IRO at a Nasdaq-traded biotech company over the edge because the trading makes no sense.

Yet in complex algorithms, the math fits, well, like fingers on a fret board. These global inequities are normal and huge in trading activity now. And they’re brought to you by your friendly neighborhood sovereign central bank.

Which brings us back to trading today. It’s a rule of thumb in trading markets that what happens tomorrow reflects what occurred yesterday. This is also true with weather, human relationships, your cholesterol count, and sovereign balance sheets. Remember back in April when we said there were serious risk-management issues for equities? By April 27 they were a big deal, and on May 3 they bumped up to dire. Risk managers and their counterparties were sorting out discrepancies.

Thus, on May 6 we all saw the divide between actual values and the synthetic coating on the markets. The real value of the markets was a thousand points – at least – below where markets stood on May 6. Regulators responded with beatings in the hopes that morale would improve.

So today, we’re about where we were midday May 6. It happened this way. Options expired May 19-21. We saw hedge resets hitting some equities May 18. By May 21, market structure looked very similar to what we saw on May 3. Now two trading days later, the shoe drops in the markets as true-ups occur.

There’s good news: Hedge resets stabilize markets. Data suggest that despite governments shifting massive monies by swaps to and from central banks, which serves up a slow pitch for global arbitragers, market forces faced the hurricane winds and winnowed risks. For now. While it’s impossible to know what synthetic thread will come undone tomorrow, taken at face value, resets mean we can expect better performance in markets for a brief spell.

And further good news: These problems can be solved with the diametric opposite of what we’re doing. We’re at logical loggerheads. Regulators want to achieve stasis. All physics reflect constant change. The more things are subjected to controls, the less things function naturally and the more markets become defined by arbitrage. Solving a price-discovery problem will not happen through controls (Germans, are you listening?). 

What to do meantime, IR professionals? Adapt to conditions. Don’t expend effort on value investors when markets are teeming with arbitragers. They’ll find no liquidity.  You’ve got to factor market structure into your thinking, or you’ll spin your wheels.

Be nimble, be quick! When the wind stops, get on that bike and start couriering some good news to value buyers. Life in the IR chair for now must be speedier than before.

Snot Mark is also a tempting description for what’s happening behind share prices and volume, at least at times. But Global Statistical Arbitrage is more accurate, and widespread.

It’s a term that can induce instant narcolepsy too, so we’ll make it interesting. The Nasdaq can be up, the Dow down. Your stock is up, your nearest peer, down. Overnight the Asian markets are up on “renewed enthusiasm,” while by mid-afternoon the following day Europe is down on “rising pessimism.”

It’s statistical arbitrage on a global scale. It can be confused for other things, such as investing, which it is not. Suppose you were buying and selling Robert Graham shirts and doing the same with off-the-rack Macy’s brand clearance shirts. Most times, the price difference between the two asset classes is constant, but slight differences in shirts, fabrics, times of day, and customer interest produce little gaps. It’s on those that you make your money.

To the observer, it would appear that a brisk business is being done. The Robert Graham shirts are really moving and that discount rack keeps clearing out. Ah, but little actual buying and selling is occurring since most times you’re procuring and dispensing the same shirts over and over, with little risk. I’m reminded of what a sharp Israeli client once said, no doubt borrowing it from a time-tested lexicon of smart observations: “We don’t confuse busy with productive.”

Arbitrage often gets people to mistake busy for productive. Arbitrage is the former. Traders weave currencies, futures and options, and global equities into an arbitrage model to capture small, quick price gaps. European banks are doing it. Classic institutional money managers are doing it. Broker portfolio trading schemes are doing it. The catalyst for the explosion of the high-frequency version is monetary intervention over the past two years. It distorts prices – creating a “Trader’s Paradise,” to borrow and twist that old rap song sung by Coolio and penned by Stevie Wonder.

By contrast, arbitrage is risky in markets without price controls or monetary intervention. If there’s no best bid or offer, no mandated one-penny spread between price points, how do you assess your arbitrage risk? You can’t. Yet the Synthetic Market Rip on May 6 is likely leading to more controls, more intervention. Arbitrage opportunity, and therefore risk of another synthetic rupture – if your market is dominated by intermediaries you don’t know its real value – increases. It’s going to happen again.

Solutions are simple. Remove price controls. Expand the supply of currency only when saved capital increases significantly, if at all. That way, the medium of exchange isn’t being used to correct gross failure but instead to match investment capital with opportunity.

And wait! There’s immediate good news beyond simple solutions. One upshot to arbitrage markets is that they winnow some wheat from chaff. We see stark market-structure differences between companies with tight messages and IR outreach adapted to market structure, and those doing the same old things the same old way.

Price is not the measure of solid IR. Sometimes great stories have extended gaps between the rational price and the noise from intermediaries. But real value returns as fulcrum. Knowing what’s productive in your trading and what’s just busy makes you cool in crowds of intermediaries. Alas, there’s a lot of busy right now, and not much productivity. Forewarned is forearmed.