On the Skids

If electoral processes lack the drama to satisfy you, check the stock market.

Intraday volatility has been averaging 4%. The pandemic has so desensitized us to gyrations that what once was appalling (volatility over 2%) is now a Sunday T-shirt.

Who cares?

Public companies, your market-cap can change 4% any given day. And a lot more, as we saw this week.  And traders, how or when you buy or sell can be the difference between gains and losses.

So why are prices unstable?

For one, trade-size is tiny.  In 1995, data show orders averaged 1,600 shares. Today it’s 130 shares, a 92% drop.

The exchanges shout, “There’s more to market quality!”

Shoulder past that obfuscating rhetoric. Tiny trades foster volatility because the price changes more often.

You follow?  If the price was $50 per share for 1,600 shares 25 years ago, and today it’s $50 for 130 shares, then $50.02 for 130 shares, then $49.98 for 130 shares, then $50.10 for 130 shares – and so on – the point isn’t whether the prices are pennies apart.

The point is those chasing pennies love this market and so become vast in it. But they’re not investors.  About 54% of current volume comes from that group (really, they want hundredths of pennies now).

Anything wrong with that?

Public companies, it demolishes the link between your story and your stock. You look to the market for what investors think. Instead it’s an arbitrage gauge. I cannot imagine a more impactful fact.

Traders, you can’t trust prices – the very thing you trade. (You should trade Sentiment.)

But wait, there’s more.

How often do you use a credit or debit card?  Parts of the world are going cashless, economies shifting to invisible reliance on a “middle man,” somebody always between the buying or selling.

I’m not knocking the merits of digital exchange. I’m reading Modern Monetary Theory economist Stephanie Kelton’s book, The Deficit Myth.  We can talk about credit and currency-creation another time when we have less stuff stewing our collective insides.

We’re talking about volatility. Why stocks like ETSY and BYND were halted on wild swings this week despite trading hundreds of millions of dollars of stock daily.

Sure, there were headlines. But why massive moves instead of, say, 2%?

The stock market shares characteristics with the global payments system.  Remember the 2008 financial crisis? What worried Ben Bernanke, Tim Geithner and Hank Paulson to grayness was a possibility the plumbing behind electronic transactions might run dry.

Well, about 45% of US stock volume is borrowed. It’s a payments system. A cashless society. Parties chasing pennies don’t want to own things, and avoid that by borrowing. Covering borrowing by day’s end makes you Flat, it’s called.

And there are derivatives. Think of these as shares on a layaway plan.  Stuff people plan to buy on time but might not.

Step forward to Monday, Nov 9. Dow up 1700 points to start. It’s a massive “rotation trade,” we’re told, from stay-at-home stocks to the open-up trade.

No, it was a temporary failure of the market’s payments system. Shorting plunged, dropping about 4% in a day, a staggering move across more than $30 trillion of market-cap. Derivatives trades declined 5% as “layaways” vanished.  That’s implied money.

Bernanke, Geithner and Paulson would have quailed.

Think of it this way. Traders after pennies want prices to change rapidly, but they don’t want to own anything. They borrow stock and buy and sell on layaway.  They’re more than 50% of volume, and borrowing is 45%, derivatives about 13%.

There’s crossover – but suppose that’s 108% of volume – everything, plus more.

That’s the grease under the skids of the world’s greatest equity market.

Lower it by 10% – the drop in short volume and derivatives trades. The market can’t function properly. Metal meets metal, screeching. Tumult ensues.

These payment seizures are routine, and behind the caroming behavior of markets. It’s not rational – but it’s measurable.  And what IS rational can be sorted out, your success measures amid the screaming skids of a tenuous market structure.

Your board and exec team need to know the success measures and the facts of market function, both. They count on you, investor-relations professionals. You can’t just talk story and ESG. It’s utterly inaccurate. We can help.

Traders, without market structure analytics, you’re trading like cavemen. Let us help.

By the way, the data do NOT show a repudiation of Tech. It’s not possible. Tech sprinkled through three sectors is 50% of market-cap. Passive money must have it.

No need for all of us to be on the skids.  Use data.  We have it.

-Tim Quast

Serenity

Moab, UT — photo courtesy Tim and Karen Quast, Oct 2020

On Nov 4, 2020, words commonly associated with a 12-step program come to mind.

Protestant theologian Reinhold Niebuhr, who received the Presidential Medal of Freedom in 1964, sometime in the 1930s during the Great Depression is said to have coined the words we today call the Serenity Prayer.

Ostensibly it might at the earliest have emphasized courage: Give us courage to change what must be altered, serenity to accept what cannot be helped, and the insight to know the one from the other.

It’s a good life rule, a thoughtful notion after elections. And a way to see the stock market.

For public companies, there are things one can change, influence, based on how the market works.  And things you have to accept.  You cannot control the fact that 85% of volume is motivated by something other than your skill at running a business.

You CAN control what, investor-relations professionals, your board and executives understand about the way the market works.  You can know when to accentuate and accelerate your contact with holders because the data indicate conditions are favorable for them. You can avoid wasting time when conditions signal trouble for your stock and the whole market.

I’ve written about it for years, so I ask that you serenely indulge my penchant for repetition.

The stock market ebbs and flows.  It will add to and remove from your shareholder value, and it will do that no matter how much time and money you spend on telling your story and propagating data on your environmental, social and governance achievements.

Why?  Because that’s the gravity of the stock market. It has immutable forces, like this planet, that remain in place and in effect no matter who’s in charge.

Serenity comes from recognizing what you can and cannot change. And being proactive in response to both.

These principles apply to investors and traders too.

Here’s an example.  If you followed simple principles of market structure to buy and sell MSFT between Feb 1, 2020, before the Pandemic slammed us, and Nov 2, 2020, you could have made 46%.

Buying and holding MSFT has produced a 17% return – a redoubtable outcome under any circumstances.  SPY, proxy for the S&P 500, was up 2% over that span.  It covers 191 trading days.

But our 46% return in MSFT came in just 107 trading days. The other 84 days we could have owned something else to add to our returns.

How and why? The market ebbs and flows.  MSFT spent 134 days at or above 5.0 on a supply/demand scale, and 57 days below it.  Owning MSFT when it was over 5.0 produced the gains. Selling it when it dipped back below 5.0 avoided the losses.

That had nothing to do, really, with MSFT’s success as a business. It’s supply and demand.  The product is stock.

Since Sep 1, MSFT is down 11% because it’s spent about as much time below 5.0 as above it.

For you ModernIR clients, that over 5.0/under 5.0 scale we’re talking about is Market Structure Sentiment™, your gauge of the balance of supply and demand for your stock (and we go further and show you the kind of money that’s responsible).

Is the story MSFT tells any different now?  No.  It’s market structure. It’s the gravity of the stock market – the ebb and flow of supply and demand.

I’m not suggesting you stop doing the things you do to drive shareholder value.  I am suggesting that without an understanding of market structure, those dollars and efforts can be Sisyphean.

Same for you, traders and investors. I can prove six ways to Sunday, as the saying goes, that buying and holding is inferior to using market structure to help you keep gains and avoid losses.

It’s just intelligent use of technology.

Sometimes the beginning point for better ways of doing things is the Serenity Prayer. You first must recognize what you can and cannot change – and you have to accept what that realization means.  Then you find the courage to change what you can.

With the election behind us now, Market Structure Sentiment™ is about 4.0. It was on the same trajectory we measured in Nov 2016, and with the Brexit vote in June 2016.  The pressure on stocks was machines, and the surge ahead of it was short-covering.

Now we begin the next chapter.  See you next week.

-Tim Quast

Placid

The data are more placid than the people.

When next we write, elections will be over. We may still be waiting for the data but we’ll have had an election. Good data is everything.  Story for another time.

The story now is how’s money behaving before The Big Vote? Depends what’s meant by “behave.” The Wall Street Journal wrote for weeks that traders saw election turmoil:

-Aug 16:  “Traders Brace for Haywire Markets Around Presidential Election.” 

-Sep 27: “Investors Ramp Up Bets on Market Turmoil Around Election.”

-Oct 3: “Investors Can Take Refuge from Election Volatility.”

Then the WSJ’s Gunjan Banerji wrote yesterday (subscription required) that volatility bets have turned bearish – now “low vol” rather than higher volatility. Markets see a big Biden stimulus coming.

It’s a probable political outcome.

However.

The shift in bets may be about prices, not outcomes.  When there is a probability somebody will pay you more for a volatility bet than you paid somebody else for it, bets on volatility soar.  It hits a nexus and reverses. Bets are ends unto themselves.

On Oct 26, S&P Global Market Intelligence offered a view titled, “Hedging costs surge as investors brace for uncertain election outcome.”

It says costs for hedges have soared. And further, bets on dour markets are far more pronounced in 2021, implying to the authors that the market fears Covid19 resurgence more than election outcomes.

Two days, two diametric opposites.

There’s the trouble. Behaviors are often beheld, not beatified.

One of our favorite targets here in the Market Structure Map, as you longtime readers know, is the propensity among observers to treat all options action as rational. The truth is 90% of options expire unused because they are placeholders, bets on how prices change, substitutes. They don’t mean what people think.

S&P Global says the cost of S&P 500 puts has risen by 50% ahead of the election. Yet it also notes the open interest ratio – difference between the amount contracts people want to create versus the number they want to close out – is much higher in 2021 than it is around the election.

The put/call ratio can be nothing more than profiting on imbalances. And what behavior is responsible for an imbalance, valid or not? Enter Market Structure Analytics, our forte.  You can’t look at things like volume, prices, open interest, cost, etc., in a vacuum.

Let me explain. Suppose we say, “There is a serious national security threat from a foreign nation.”

Well, if the foreign nation is Switzerland, we laugh. It’s neutral. Has been for eons.  If it’s China or Iran, hair stands up.

Context matters. I said the behaviors were more placid than the people. I mean the voters are more agitated than the money in US equities.

Standard deviation – call it degree of change – is much higher in the long-run data for all behaviors, by 20% to more than 130%, than in October or the trailing 30 trading days back before September options-expirations.

Meaning? Eye of the beholder. Could be nothing. Could mean money sees no change.

Remember, there are four reasons, not one, for why money buys or sells. Investment, asset-allocation, speculation, taking or managing risk. None of these shares an endpoint.

Active money is the most agitated and even it is subdued. But it’s sold more than bought since Sep 2.  I think it means people read the stuff other people write and become fearful. It’s not predictive.

The other three behaviors show diminished responsiveness.  Yes, even risk management.

I could read that to mean the machines that do things don’t see anything changing.  The machines may be right in more ways than one! The more things change, the more they stay the same.

One thing I know for sure. I’ve illustrated how headlines don’t know what’s coming.  It’s why investor-relations and investment alike should not depend on them.

The data, however, do know.  And every investor, every public company, should be metering behavior, be it volatile or placid. We have that data.  I just told you what it showed.

Now, we’ll see what it says.

Oh, and this is placid to me, the Yampa River in CO, anytime of the year, and this is Oct 27, 2020.

What’s In It

We rode the Colorado National Monument this week with our good friends from Sun Valley. There’s a lesson in it about life and stocks both.

We would’ve been riding bikes in Puglia with them now, if not for this pandemic.  Oh, and part of the lesson learned is in Telluride.

Stay with me.  I’ll explain.

So we learned Sun Valley is comprised of four towns.  Sun Valley, Ketchum, Hailey and Bellevue. Each has its own mayor, own government.  It could be one united town, but no.

There’s a point.  While you ponder that, let me give you some background.

Karen and I wandered from Denver to Glenwood Springs (rode bikes, ate great food, soaked in hot springs, at this energetic little burg favored by Wyatt Earp and Doc Holliday), and on to Grand Junction (pedaled the Monument and bunked at the lovely Hotel Maverick on the campus of Colorado Mesa University).

We then migrated to Moab and hiked Canyonlands and cycled the Potash Highway where evidence remains of a civilization once living in paradise on the Colorado River (if your etched recreations of yourselves in sandstone reflect jewelry and wildly stylish hair, you’re well up the actualization hierarchy from basic sustenance).

We next traversed the remote stretch from there to Telluride, a dramatic geological shift. The little city in a box canyon lighted by Nikola Tesla and robbed by Butch Cassidy is a swanky spot at the end of the road.  Wow.  I get it.  Oprah. Tom Cruise. Ralph Lauren. It looks like their town.

Or towns, rather.  Because here too as in Idaho there are cities a couple miles apart with two mayors, two governments. There’s Telluride, CO, in the valley. There’s Mountain Village, CO, up above (where no expense has been spared – you cannot find a tool shed that’s a shack).

And that’s the lesson. People talk about coming together.  Sun Valley can’t.  Telluride can’t.  Could it be humans are motivated by their own interests?

And how about money behind stocks?

More on that in a moment.

NIRI, the association for investor-relations professionals, has a 50-year history.  I’m on the national board representing service providers.  We were blindsided by the SEC this summer, which abruptly proposed changing the threshold for so-called 13Fs, named for the section of the Securities Act creating them.

Our profession depends on those filings to understand shareholdings.

The SEC said funds with less than $5 billion of assets would no longer have to file.  There goes insight into 90% of funds. The SEC never asked us.

You’re thinking, “There’s a hammer here, and a nail. Perhaps I’ll just pound it through my hand rather than continue reading.”

Don’t quit! You’re getting close.

Tip O’Neill and Ronald Reagan made deals. You youngsters, look it up.  There were “pork barrel politics,” a pejorative way to describe a quid pro quo.  Wait, is that a double negative?

Let me rephrase. Politicians used to do deals.  Give me something, I’ll give you something.  You can decry it but it’s human nature.  We don’t “come together” without a reason.

Sun Valley. Telluride. They haven’t yet found a reason to unite.

NIRI could learn. We can talk for ten years about why we deserve better data. There’s nothing in it for the other side. I bet if we said to the bulge bracket, the Goldman Sachses, the Morgan Stanleys, “You lose your corporate access until you help us get better data.”

Now both have skin in the game. Stuff gets done.

Most of us outside Jesus Christ, Mother Theresa, Martin Luther King, Jr and Mahatma Gandhi are motivated by what benefits us.

Shift to stocks.  Money with different purposes and time-horizons drives them.  The motivation for each is self-interest, not headlines or negotiations between Nancy Pelosi and Steven Mnuchin.

Let’s call it, “What’s In It for Me?” All the money is motivated by that.  Humans are similarly animated.  For most of the money in the market, what’s in it is a short-term return.

If you want to understand what motivates the money, you must understand self-interest.  You can learn it in Sun Valley or Telluride.  You can learn it watching politics. And it applies to stocks. Money wants returns. When that opportunity wanes, it leaves.

That’s it. No more complex. And ModernIR measures that motivation.  Ask us, and we’ll show you what’s in it for the money behind your shares.  Too bad we can’t figure it out in politics. It’s not that hard.

Political Sentiment

There’s one left.

This week brings the last pre-election monthly options-expirations cycle. It’s the final time to take or manage risk with options that expire after votes are cast. It might be instructive about trading bets. Options expire Thu-Fri this week, and through Oct 21.

In Oct 2016, Market Structure Sentiment peaked the 3rd at 6.6/10.0.  The market was over 49% short. Sentiment leaked down to 4.0 (you longtime readers know the market trades between 4.0 on the low end and 6.0 on the high end most times, and coloring outside those lines often signals temporary bottoms and tops) by Oct 21.

But demand was weak. Sentiment is a supply/demand gauge. It must stay above 5.0 to rise, more demand than supply (above 5.0, stocks rise, and below 5.0, they fall, a mathematically consistent truth, subject to periodic variance). In 2016, Halloween was the top, a tepid 5.0, a bare mean reversion.

It’s the market equivalent of trying to jump the bridge in a Yugo (a humorous blast from the past for all you too young to know it).

Stocks began Nov 2016 with a feeble wheeze and rolled over into the election.  We thought the bull market might end.  Stocks were trading lower than in June 2015.  Sentiment double-dipped down to 3.6 Nov 9, the day after the election.

And then, boom!  Sentiment hit 7.7 Nov 25, the best read since July 2016 after Brexit shocked stocks and juiced them like a pro-cycling blood-doper. Short volume dropped below 45%.

Brexit is an apt comparative too, an unexpected outcome. Market Structure Sentiment bottomed June 23, 2016, the date of the vote, at 4.2 (it rose to 8.2 by July 20).

So, what’s it mean?  Market bottoms signal gains ahead.  Did investors secretly think Brexit would happen and Trump would win?  Both events brought party times for equities, undeniably.

Or is it the opposite?  Investors were so dour about Brexit and the 2016 election – purely in terms of market outcomes – that the nadir for quantitative reads on supply and demand fell exactly in step with both events.

I don’t know.

But I’d argue from vast seas of data spanning 15 years that enthusiasm leaks.  It’s like an ambush (admittedly a dubious analogy but follow me here) where those lying in wait are so gleeful about holding what they call in poker the nuts – the winning hand – that somebody amped on adrenaline accidentally squeezes off a round and spoils the surprise.

Frankly we see it all the time in deal situations and Activism.  Somebody just can’t help herself and takes out a long swap or something. It’s not illegal to bet on information others don’t have.  It’s only illegal to sell it.  The point is, we often catch clues about ebullience in the unmistakable humanity of front-running.

With that yardstick, the absence of any giddy bursts of early gunfire, you’d conclude investors thought Brexit would catch a toe and plunge into the pond. And a Clinton administration would land with a thud on The Street.

So.

What do the data say now?  We’ve written repeatedly – especially in our private Market Desk notes (if you want those, subscribe to our analytics and become part of the Market Structure club) – that there’s another Big One coming.  A sprawling splat for stocks. The data say so.

There was one coming in Oct 2016 too, that the apparent benighted election of Donald Trump cast in glorious light – extending the bull market all the way to Covid.

And right now, the signals say the Big One most don’t see coming is after the election. On that loose read, you could say the market is betting on a Biden regime (because it would arguably be less business-friendly than the current one, regardless of one’s sociological persuasions around candidacy).

However, shorting is very low – below 43% marketwide.  The stumbling, bumbling, weaving pattern predicting a splat for stocks into Tue Nov 8, 2016 already happened.  Between Sep 9-Oct 1, 2020, Market Structure Sentiment peaked, then fell near 4.0, crawled back to 4.9, rolled back down the hill, Sisyphean, to 3.4 about Oct 1.

And then delivered the best gains for stocks since the week ended June 5, 2020.

Right now, it’s 7.3, steamy, nearing a top.  That kind of verve tends not to precede demolition to shareholder value. I’d bet stocks will decline to a bottom by roughly Oct 22 and rebound into Election Day.

I’m not saying that’ll happen.  And humans were wrong about Brexit, wrong about 2016.  And they could as well be wrong again here.  But that data would suggest an expectation the election won’t be bad news for stocks.

That might be bad news in other ways. And the data haven’t come in yet. We’re speculating. And we’ll keep you posted in Market Desk notes, clients (send us a note and become a client and you too can read the quantitative tea leaves!).

Now, back to the political-ad beatings.

Vahlcue

You’re wondering what the heck “vahlcue” is. It was up almost 4% in the last hour yesterday as stocks tipped off the diving board.

Meanwhile, cue fall.  The photo at right reminds us that today is a consequence of yesterday. Autumn follows summer. In the Flat Tops near Steamboat, fall flames as summer smolders out.

In the stock market, cue volatility.  Pursuing “vol,” as the traders call it, is big business. It’s everything that depends on an implied price, such as the VIX index tracking implied volatility over the next 30 days in the S&P 500.  It’s priced from options on the index, which in turn is comprised of futures.

Got that?  Volatility is the implied price of an implied price, gleaned from other implied prices.  All instruments derived from implied prices are ways to trade volatility – gaps between rising and falling prices.

Cue intro music.

The Nasdaq, in concert with the Chicago Mercantile Exchange (CME), launched the VOLQ this past Monday, Oct 5, another way to play volatility.

I assume it’s pronounced “vahlcue.”

VOLQ is a futures contract reflecting the implied volatility of the Nasdaq-100, the NDX. It employs a methodology developed by Nations Indexes, innovator in volatility products that isolates the implied volatility of at-the-money options.

Ready to run a power drill through the palm of your hand to stay awake?  If you want intricate details about how it works and how it’s calculated, you can read more.

I’ve got a specific purpose.

VOLQ, like the VIX, is a futures contract derived from options on underlying stocks – three steps from the asset.  It’s a particular set of both put and call options designed to get to the volatility of instruments priced the same as the futures contract, called at-the-money options.

Have you moved on from drilling a hole in your hand to braining yourself on a brick wall?

Here’s the point. Derivatives have proliferated in the stock market. All derivatives are a right but not an obligation.  As such, the propensity to quit them is much higher than one finds in the actual asset.

Famed hedge-fund manager Lee Cooperman, whom I interviewed in the plenary session of the 2019 NIRI Annual Conference, back when humans gathered innocently, lamented in a CNN interview that stock indexes shouldn’t gap 50 points in a matter of minutes.

He blamed trading machines, the rapid-fire intermediaries setting prices. And he’s right.  But the more trading chases products that are rights but not obligations, ways to pursue changing prices, the more heightened the risk of sudden lurches.

Why? All layers of options and futures are forms of implied supply or demand.  But the moment prices move, those layers become ethereal, dissolving in an instant like those animated transitions you can put in you Powerpoint slide deck.

And the more people pursue the gaps rather than the assets, the greater the assets can be blighted by sudden lurches.  Realize VOLQ is just another clip for the automatic weapons in the Nasdaq’s volatility arsenal that already includes e-Minis and micro e-Minis on the Nasdaq 100.

The first e-Mini S&P 500 futures contract began trading in 1997 and was 20% the size of the standard contract.  Micro e-Minis are a tenth of the e-Mini, 2% of the original contract.  And you can trade options on Micro e-Mini futures too.  We wrote about them in August.

Markets keep migrating away from size, away from the core asset, toward tiny, uncommitted bets and hedges comprised of multi-layered derivatives.

It’s great for the firms selling the products.  But it makes volatility accessible to the masses.  And the masses don’t understand it. And the more the masses are exposed to things that vanish, the more given to wild swings become the underlying assets.

Sure, derivatives can work well.  VOLQ was the right play today.  Traders can hedge exposure to sudden market moves, play the probability of profits in snap swings.

But the consequence is a market that cannot be trusted.

Market Structure Analytics help one survive it. Everybody should have baseline market-structure metrics.

The market is likely to rebound, data say. But this lurch manifested a week ago – much of implied volatility is predicated on weekly options – when the sector data looked ragged to us.  Sure enough it was.  Blame volatility and its instruments. Cue the exit music.

Gaffes and Spoofs

You all remember the Fat Finger?

It’s a gaffe, trading-style.  In one 2014 instance, if the record can be believed, somebody in Japan accidentally tried to buy $700 billion of stocks including more than half the total outstanding shares of Toyota.

The trades occurred outside hours and were cancelled but the embarrassment lingers.

Do you know of Harouna Traoré?  A French day trader learning the ropes, Mr. Traoré plunked down twenty thousand euros at online platform Valbury Capital and, thinking he was in simulation mode, began trading futures contracts.

Racking up a billion euros of exposure and about a million euros of losses before he realized his error, the horrified trader said, according to CNBC, “I could only think of my family.”  But the intrepid gaffer – so to speak – soldiered on, turning one billion and losses into five billion and profits of about twelve million euros.

I don’t know how it turned out but not well, it appears. The Chicago Mercantile Exchange sanctioned Mr. Traoré in June 2020 for exceeding credit thresholds, and banned him from trading for two years.

The Fat Finger has become reliably rare in US markets, thanks to security protocols.  It’s improbable we’ll again see a Knight Securities buy $4 billion of stock in 45 minutes and be forced to liquidate to Getco as happened in 2012 (Getco is now Virtu).

That’s the good news. The bad news is bizarre moves in equities such as we’ve seen in 2020 are therefore not due to gaffes.

But they could be spoofs, legal or otherwise.  JP Morgan yesterday agreed to a $920 million fine related to spoofing in futures contracts for metals and US Treasurys.  I can’t recall a larger trading fine.

Spoofing is the deliberate act of entering orders to trade securities and then cancelling them, creating, at least momentarily, the artificial appearance of supply or demand.  Dodd-Frank outlawed spoofing after tumult in the 2008 crisis, and regulations for commodities and stocks have subsequently articulated guidelines.

Investors and public companies alike don’t want fake liquidity in markets. As gaffes do, it’s what causes unexpected lurches in prices – but on purpose.

We can all sleep well, then?

Nope.

Turns out there is illegal spoofing, and legal spoofing.  The SEC’s Midas data platform shows trade-to-cancel ratios for stocks in various volume and market-cap tranches.  Generally, there are about 15 cancellations for every executed trade in stocks.

In Exchange Traded Funds (ETFs), the ratio explodes. The gaps or so severe between quartiles and deciles that an average is difficult to find. But the rate ranges from about 100 to nearly 2,000 cancellations for every completed trade.

Well, how is that not spoofing?

Answer: If you use order types it’s legal. It means – broad definitions here – that Fill or Kill (do it at once or don’t do it at all), Limit/Stop-Loss, All or None (no partial fills, the whole thing or nothing), Iceberg (just a little showing and more as the order fills) or Passive (sitting outside the best prices) orders are sanctioned by the government.

Tons are cancelled. Layer your trades with a machine instead, and it’s illegal.  Spoofing.

Wait a minute.

Order types through a broker are trades in the pipeline. Systems know they’re there. Risk-management protocols require it.  If the orders are at retail firms that sell their trades, then the high-speed buyer sees every layer before it reaches the market.

See the issue?

The market is stuffed with legal cancelled orders – that somebody else can see before the trades execute and who will therefore clearly know what the supply/demand balance is, and what gets cancelled.

I’m not sure which is worse, a fat finger, or this.  The one is just an accident.

Now, why should you care?  Because stocks are awash in compliant spoofs.  Regulators are trying to sort, one from the other, the same kind of activity, except one lets somebody else know ahead of time that it’s there. And that’s fine.  Sanctioned.

If you trade on inside information, data you obtained that others don’t know, in exchange for value, it’s illegal. Well, trades sold to high-speed firms are exactly that, if only for a fraction of a second.

If ETFs are peppered with cancellations at rates dwarfing trades, and money is piling into ETFs, would it be good for the public to know? And why mass cancellations?

Because ETFs are legally sanctioned arbitrage vehicles. That’s another story.

The good news is we track the behavior driving arbitrage.  Fast Trading.  We know when it’s waxing and waning. It imploded into today’s futures expirations – where much spoofing occurs, legally – and just as Market Sentiment turned dour.

I hope there are no gaffes.  Spoofs will abound.  Authorities will pat themselves on the back.  It’s a weird market.

***

By – Tim Quast, President and Founder, ModernIR

In Control

What can you control?

Courtesy IEX

It’s a question largely abandoned in the modern era under the assumption humans can control everything.  Arrogance often precedes experience-induced humility.

But we’re talking specifically about the stock market.  Public companies. Share-performance.  Investor relations. What’s within your sphere of influence?

There’s a big difference between your capacity to drive shareholder value rationally in a quantitative market – and the value you provide internally to your board and executive team about what depends on story, and what turns on the product, your shares.

I’ll talk in practical terms about it Thursday at the NIRI Chicago 2020 IR Workshop, the first virtual edition. Join us for the event! I’m on about 1:30pm ET Thursday the 24th.

Market structure plays a key role.  Supply and demand affect stocks the same way they do products in any market. Yet the supply of product – shares – is almost never a consideration for public companies and investor-relations professionals, who suppose that telling the story to more investors will create volume and drive the price up.

Our friends at IEX here explain the difference between volume and liquidity (and we described liquidity and volatility last week). The more parties between the sources of supply and demand, the more volume compounds (especially with derivatives, leverage via borrowing, Exchange Traded Funds).

But volume doesn’t create more supply of the product.  This by the way is how stocks soar and lurch today (we touched on it last week).

SHOP, the big Canadian e-commerce company, saw shares plummet about 30% in a week on a share-offering. The stock then skyrocketed yesterday.  Shares were trading near $1,140 to start September, fell to $850 after the news, and were near $960 yesterday.

Rational thought?

No, supply and demand. SHOP is the 7th most liquid stock in the US market (a reason why we cluster it with close cousins the FAANGs). In fact, supply is so tight in SHOP that it depends on borrowed stock.

Most times stocks with high short volume – borrowed shares – underperform the market.  Shorting adds supply to the market.  If demand falls, short volume weighs on price.

Short volume is at a basic level rented inventory. Traders who deal shares in fractions of seconds rent stocks to sell to others, profiting on the differences in price.  At some point before the close they buy it back and return it, aiming to make more getting between buyers and sellers – see the IEX video – than they spend renting stocks and covering that borrowing.

In SHOP, the demand has been so great that even high shorting isn’t dragging the price down. They’re an outlier, and edge case (and that data clearly indicate they can afford to continue issuing stock, by the way). There’s more to be made trading SHOP every day than the cost of constantly covering borrowed shares.

Disrupt that supply chain with a stock offering and the whole SHOP market for shares shudders.

That’s why it’s essential for investor-relations professionals to help executives and boards understand what’s controllable.  If your market capitalization is less than roughly $4 billion, you’re outside where 95% of the money plays, which is in the Russell 1000.

You can either get bigger and get into the top thousand, come up with something that makes you a screaming growth play that’ll compound your trading and limited liquidity into $4 billion of market cap – or set realistic internal expectations for your team.

Data can help you make a difference with your liquidity. Use it to time your outreach to investors. Aiming to attract buyers when it’s 62% short – unless you’re SHOP – is wasting time. Wait till liquidity improves.

I’ll use a great example to kick off the Chicago discussion tomorrow. And if you’re on hand live and we have the data, I’ll tell you your liquidity ranking.

Bottom line, IR should be captaining liquidity. You’re the chief intelligence officer. Supply and demand determine your price. Know your liquidity.  Ask us, and we’ll help.

Volatile Liquid

There’s a beer in this for you.  A glass of rosé from Provence if you prefer.

What’s the most liquid stock in the US market?

I’m writing this after the virtual happy hour for the NIRI Big I Conference (it’s a strong event, and you can catch Day Two and our wrap-up today that I’ll take part in), which of course makes one think of beverages. Liquid. Virtual drinks are no match for the real thing, nor is false liquidity in stocks.

Let’s lay the groundwork.  Stock exchanges describe market quality as low spreads.  Spreads have never been tighter, they say, and costs for trading were never lower.

Heck, you can trade for free. That’s about as inexpensive as it gets. So, is a low-cost, low-spread stock market a quality and liquid place?

Depends what you mean.  The market doesn’t fail often. Yes, we’ve recorded nearly 13,000 volatility halts since Mar 9.  Remember all the marketwide pauses that month? Still, it didn’t quit operating.

The Nasdaq just corrected – dropped 10% – in three days. And rebounded as fast. It highlights the importance of the definition of “quality.”

Which leads back to liquidity, and by extension, volatility. All three words ending in “y” are related.

Let’s begin with what liquidity is not.  Volume. Liquidity, bluntly, is the amount of a thing that will trade before the price changes. Put an offer on a house.  What’s the spread between the price you’d pay, and the last that somebody else paid?

I’ve just debunked the idea that low spreads reflect quality.  For the seller, a high spread is a reflection of quality.

Low spreads help parties with short horizons.  If my investment horizon is 250 milliseconds, a spread of a penny is wildly attractive. How many pennies can I make, in how many different issues, every quarter-second?

But if my horizon is more than a day, a wider spread reflects higher quality.  How come stock exchanges don’t mention that?

Let’s go one step further. To me, the measures we traditionally look to for guidance about market quality need revamping. For instance, beta, a measure of volatility, has the same flaws as our current economic measures of inflation.  Beta measures how a stock moves from close to close in relation to the market.

Terrible measure of market quality.  WMT, for instance has a beta score of 0.19, 20% of the volatility of the market. Yet its intraday volatility the past 20 days is 2.9%. The S&P 500 is 2.7% volatile over the same time (intraday high and low).

WHEN an investor buys during the day could in theory be nearly 3% different from somebody else’s price.  And WMT, contradicting beta, is not a fifth as volatile as the market but 7% more volatile.

The truth is low spreads PROMOTE frequent price-changes, which is the definition of volatility. The parties driving low trading spreads are ensuring volatility. Creating it.  And telling us it signals market quality.

They mean well. But good intentions pave roads to oblivion.

(Editorial note: Inflation isn’t the rate at which prices increase. It’s whether you can buy things.  All over the economy, people now buy on credit. Debt has exploded. That’s the evidence of inflation. Not the Fed’s equivalent of beta.)

And liquidity isn’t volume. That’s confusing busy with productive. Volume is stuff changing hands. Liquidity is how MUCH of it changes hands.  The most liquid stock in the market is AMZN (not counting BRK.A, a unique equity), at $70,000 per trade.

The mean component of the S&P 500 trades about $17,000 at a time.  But here’s the kicker. Just 50 companies, 10% of the index, trade MORE than $17,000 per trade. That’s the list from AMZN to DPZ. Everybody else trades less.

Including now, AAPL. It used to be in the top ten. Now it’s 146th post-split, trading about $12,000 per transaction on average.  TSLA was top five but post-split is now 49th at $17,600, well behind 32nd-ranked MSFT at $20,100.

Splits don’t foster liquidity. They breed volume. And price-changes. Volatility. We’re not anti-split. We’re anti-volatility, which increases risk for investors and the cost of capital for companies.

Why does the market promote one at the expense of the other? It’s a question owed an answer. All investors, every public company, should know liquidity. We have the data.

Minnows

Softbank bet big on call-options and Technology stocks are sinking.

So goes the latest big story. Business-reporting wants a whale, a giant trade that went awry.  A cause for why Tech stocks just corrected (off 10%).

In reality the market today rarely works that way.  Rather than one big fish there are a thousand minnows, swimming schools occasionally bringing the market down.

We wrote about this last week, regarding short volume. You should read it. We highlighted a key risk right before the market fell.

The same things driving stocks up unassailably toward the heavens, which should first have gotten our attention, often return them to earth. But we humans see no flaws in rising stocks.

Back to Softbank. If you’ve not read the stories, we’ll summarize. CNBC, the Wall Street Journal and other sources have reported on unconfirmed speculation the big Japanese private equity firm bet the equivalent of $50 billion on higher prices for Tech stocks.

Maybe it’s true.  Softbank owned about $4 billion of Tech stocks in the last 13Fs for the quarter ended June 30 (the filings the SEC wants to make less useful, by the way).

Rumor is Softbank levered those holdings by buying call options, rights to own shares at below-market prices if they’re worth more than a threshold level later, on big Tech stocks like MSFT and AAPL.

Here’s where the story ends and market structure begins. The truth is the market neither requires a leviathan to destabilize it, nor turns on this colossus or that. It’s minnows.

It’s always thrumming and humming in the lines and cables and boxes of the data network called the stock market.  And everything is magnified.

A single trade for a single stock, coupled with an order to sell options or buy them, sets off a chain of events.  Machines send signals like radar – ping! – into the network to learn if someone might take the other side of this trade.

Simultaneously, lurking mechanical predators are listening for radar and hearing the pings hitting a stock – MSFT! Wait, there are trades hitting the options market.  Get over to both fast and raise the price!

Compound, compound, compound.

Prices rise.  Retail traders say to themselves, “Let’s buy tech stocks!  Wait, let’s buy options too!”

And the same lurking machines buy those trades from the pipelines of online brokerage firms, assessing the buy/sell imbalance. They rush to the options market to raise prices there too, because once the machines own the trades from retail investors, they are no longer customer orders.  And the machines calculate demand and run prices up.

And index futures contracts rise, and the options on those. Then index funds using options and futures to true up index-tracking lift demand for options and futures, magnifying their own upside.

Read prospectuses, folks. Most index funds can spend up to 10% of assets on substitutes for tracking purposes, and a giant futures contract expires the last trading day of each month that helps indexed money square its assets with the benchmark.

And then the arbitragers for Exchange Traded Funds drive up the prices of ETF shares to keep pace with rising stocks, options, futures.

And there are options on ETFs.

Every price move is magnified by machines.  Up and up and up go stocks and people wonder does the stock market reflect reality?

The thing about prices is you never know precisely when they hit a zenith, the top of the arc. The last pump of your childhood legs in the playground swing, and that fleeting weightlessness.

And then whoosh!  Down you come.

Did Softbank make money or lose it?  I don’t know and it makes no difference. What I just described is relentlessly occurring every fraction of every second in the stock and options markets and there comes a moment of harmonic convergence after long arcs up and down, up and down, like children on swing sets.

It’s a thousand cuts, not a sword. Schools of minnows, not a whale.  The problem isn’t Softbank. It’s a market that depends on the machine-driven electromagnification of every action and reaction.

The reason we know is we measure it. For public companies, and investors. You can wait for stories after the fact surmising sea monsters swam through. Or you can watch it on the screen and see all the minnows, as we do (read last week’s MSM).

What’s next? The same thing. Again.