In 1975, there were no electronic exchanges in the United States. Now the average S&P 500 component trades electronically 17,000 times daily in 134-share increments totaling a mean of $500 million of stock.
Yet public companies still have a 1975 standard of shareholder disclosure from the SEC, called 13F filings, referencing the section of the Securities Act with instructions for investment advisors of specified size to report positions 45 days after each quarter-end.
It’s a reality disconnect. Retaining this standard says to executive teams and boards for public companies that “regulators and legislators want you to believe this is what’s driving your share-value.”
You can’t believe what the market is telling you on a given day, let alone over a quarter. We’ll come to that.
In 1975, there were no Exchange Traded Funds, no Fast Traders. The first index fund open to the public launched Dec 31, 1975, from Vanguard, with $11 million of assets.
Today, index investing has surpassed active stock-picking in the US for assets under management. ETFs are the phenomenon of the era, with growth surpassing anything modern markets have ever seen. There is one ETF for each Russell 1000 stock now.
Total US market capitalization is more than $30 trillion, and 1% of it trades every day – over $300 billion of stock. By our measures, ETFs are responsible for roughly 60% directly or indirectly. ETFs are priced by arbitrage. Arbitrage blurs delineation between Fast Traders and ETF “market-makers.” Both make trade decisions in 10 nanoseconds.
None of this money we’ve just highlighted pays attention to earnings calls or reads 10-Ks and 10-Qs or press releases. It’s rules-based investing. Asset allocation. Trading.
As money has shifted tectonically from Active to Passive, regulatory and disclosure costs for public companies – to serve Active investors – have gone the opposite direction.
We estimate costs related to quarterly and annual reporting, associated public reviews and audits, and Sarbanes-Oxley and Dodd-Frank and other regulations total $5-6 billion annually. For the roughly 3,400 companies traded nationally, investor-relations budgets consumed by communications tools, travel, reports and services are $3-4 billion.
Unless the point of regulation is busywork, the rules are confusing busy with productive. As the money ceases to listen – there’s been a diaspora of sellside analysts from Wall Street to the IR chair because the buyside has gone passive – the chatter from companies has exponentiated.
The Securities Act says no constituency of the national market system including issuers is to be discriminated against. Failing to modernize data to reflect reality is a disconnect.
Summing up, public companies, beset by a leviathan load of regulatory costs for investors, which are moving in math-driven waves and microseconds, wait to see what funds file 13F records of shareholdings 45 days after the end of each quarter.
There’s more. The average stock has four distinct trading patterns per month, meaning traders unwind and return, funds rebalance, derivatives bets wax and wane, in 20 trading days. Not over a quarter.
About 45% of all trading volume is borrowed. Another 45% comes from Fast Trading machines (with heavy overlap as machines are automated borrowers) that close out 99% of positions before the trading day ends.
All told, 87% of market volume comes from something other than stock-picking. The disclosure standard supposes – because it dates to 1975 – that all volume is rational.
The reality disconnect is so bad now that machines look like humans. As we wrote last week, the whole of financial punditry has been caught up in a vast reputed momentum-to-value shift.
Except it didn’t happen.
Sure, momentum stocks plunged while value stocks surged. Yet as this story from Marketwatch yesterday notes (I’m a source here too), AAPL is a core component of flying value indices. Isn’t AAPL a growth stock?
Here’s the kicker. The principal reason for swooning momentum and soaring value was a rush by Fast Trading machines that spread through markets, and a corresponding short-squeeze for ETF market-makers, which routinely borrow everything but were caught out in ripping spreads between ETFs and component stocks.
What if today’s Federal Reserve monetary policy decisions reflect belief money has shifted to value? What if investment decisions are incorrectly recalibrated? What if observers falsely suppose growth is slowing and crow anew about impending recession?
The market is disconnected from 13Fs. How about modernizing them, regulators? I’ll be going to Capitol Hill and the SEC with the NIRI delegation next week to make this case.
Meanwhile, be wary of markets. The Fed was intervening yesterday and likely cuts rates today by 25-50 basis points, just as volatility expirations hit now, and before a raft of stock, index, ETF, currency, Treasury and interest-rate derivatives expire through Friday. And Market Sentiment is topped.
Maybe it’s nothing. But if the market rolls, there are data-driven reasons. And it’s about time disclosures took a leap forward past the reality disconnect for public companies.