Tagged: AAPL

Jekyll and Hyde

Your stock may collateralize long and short Exchange-Traded Funds (ETFs) simultaneously.

Isn’t that cognitive dissonance – holding opposing views? Jekyll and Hyde? It’s akin to supposing that here in Denver you can drive I-25 north toward Fort Collins and arrive south in Castle Rock. Try as long as you like and it’ll never work.

I found an instance of this condition by accident. OXY, an energy company, is just through a contested battle with CVX to buy APC, a firm with big energy operations in the Permian Basin of TX (where the odor of oil and gas is the smell of money).

OXY is in 219 ETFs, a big number.  AAPL is in 271 but it’s got 20 times the market-capitalization.  OXY and its short volume have moved inversely – price down, shorting up. The patterns say ETFs are behind it.

So I checked.

Lo and behold, OXY is in a swath of funds like GUSH and DRIP that try to be two or three times better or worse than an index. These are leveraged funds.

How can a fund that wants to return, say, three times more than an S&P energy index use the same stock as one wanting to be three times worse than the index?

“Tim, maybe one fund sees OXY as a bullish stock, the other as bearish.”

Except these funds are passive vehicles, which means they don’t pick stocks. They track a model, and in this case, the same model.  If the stock doesn’t behave like the ETF, why does the fund hold it?

I should note before answering that GUSH and DRIP and similar ETFs are one-day investments. They’re in a way designed to promote ownership of volatility. They want you to buy and sell both every day.

You can see why. This image above shows OXY the last three months with GUSH and DRIP.

Consider what that means for you investor-relations professionals counting on shares to serve as a rational barometer, or you long investors doing your homework to find undervalued stocks.

Speaking of understanding, I’ll interject that if you’re not yet registered for the NIRI Annual Conference, do it now!  It’s a big show and a good one, and we’ve got awesome market structure discussions for you.

Back to the story, these leveraged instruments are no sideshow. In a market with 3,500 public companies and close to 9,000 securities, tallying all stock classes, closed-end funds and ETFs, some routinely are among the top 50 most actively traded.  SQQQ and TVIX, leveraged instruments, were in the top dozen at the Nasdaq yesterday.

For those juiced energy funds, OXY is just collateral. That is, it’s liquid ($600 million of stock trading daily) and currently 50% less volatile than the broad market. A volatility fund wants the opposite of what it’s selling (volatility) because it’s not investing in OXY. It’s leveraging OXY to buy or sell or short other things that feed volatility.

And it can short OXY as a hedge to boot.

All ETFs are derivatives, not just ones using derivatives to achieve their objectives. They are all predicated on an underlying asset yet aren’t the underlying asset.

It’s vital to understand what the money is doing because otherwise conclusions might be falsely premised. Maybe the Board at OXY concludes management is doing a poor job creating shareholder value when in reality it’s being merchandised by volatility traders.

Speaking of volatility, Market Structure Sentiment is about bottomed at the lowest level of 2019. It’s predictive so that still means stocks could swoon, but it also says risk will soon wane (briefly anyway). First though, volatility bets like the VIX and hundreds of billions of dollars of others expire today. Thursday will be reality for the first time since the 15th, before May expirations began.

Even with Sentiment bottoming, we keep the market at arm’s length because of its vast dependence on a delicate arbitrage balance. A Jekyll-Hyde line it rides.

Hedging Bets

We’re in Steamboat Springs this week watching the moose on the snowbanks and letting the world slow down with them for a bit. 

It sets me to thinking. “Hedge funds would be better off doing nothing.”  So postulated (requires subscription) Wall Street Journal writer Laurence Fletcher last week after data from Chicago hedge-fund researcher HFR Inc. showed stock-betting funds that as a group manage about $850 billion lost money in 2016. 

You’re tempted to smirk. The smartest folks in the room can’t beat an algorithm! They can’t top the S&P 500 index fund your 401k owns.  Losers!   

Let’s rethink that perspective.  These are the professional athletes of finance. The New England Patriots of investing. If the best are failing, the ones sorting good companies from bad and chasing them either direction, then maybe we’re missing the real problem. 

Perhaps it’s not that hedge funds are losing but that the market isn’t what it seems.

And if hedge funds are confusing busy with productive, might we be too? The investor-relations profession shares common ground with them.  Great effort and time go into telling the story so it resonates. Hedge funds come at a cost because they’re ostensibly better at sorting fact from fiction. Both disciplines are about standing out.

Apple stands out for instance, touching a 52-week high yesterday following resurgent growth. Yet as my friend Alan Weissberger at fiendbear.com notes, Apple earned $8 billion less in 2016 than the year before and spent $20 billion buying back stock.

People are buying its future, is the retort. If by that one means paying more for less since it’s likely AAPL will continue to consume itself at better than 5% per annum, then yes. But that’s inflation – more money chasing fewer goods.

I’m not knocking our epochal tech behemoth. It’s neither pulp fiction nor autobiography to the market. AAPL is its pillar. Models aren’t weighing mathematical facts such as its 5.5 billion shares of currency out, 15% less than three years back. But who’s counting? Not SPY, the most actively traded stock, an exchange-traded fund and AAPL its largest component.

If the models needing AAPL buy it, the whole market levitates in a weird, creaking, unsteady way.  This is what hedge funds have missed. Fundamentals are now back seat to weighting. If you pack weight, the cool kids of the stock market, you rise. When you’re out of the clique, you fall.  Your turn will continually come and go, like a chore schedule.

Hedge funds are also failing to realize that there is no “long only” money today.  Not because conventional longs are shorting but because the whole market is half short – 48% on Feb 6. One of our clients was short-attacked this week with short volume 23% below the market’s average. We doubt the shorts know it. 

Hedge funds are chasing the market because they don’t understand it anymore. No offense to the smartest folks in the room. They’re confusing busy with productive, spending immense sums examining business nuances when the market is a subway station of trains on schedules.

There are two lessons here for investor-relations folks and by extension executives of public companies and investors buying them.  IR people, learn by observation. Don’t be like hedge funds, failing to grasp market structure and getting run over by the Passive train.  Learn how the market works and make it your mission to weave it into what you tell management. Structure trumps story right now.

Second, hedge funds show us all that there’s a mismatch between the hard work of studying markets and how they’re behaving.  Either work, smarts and knowledge no longer pay, or there’s something wrong with the market.  Which is it? 

Stay tuned! We’ll have more to say next time.