Editorial Note: A giant thank you to Client Services Director Perry Grueber for penning last week’s Map. He’ll be back regularly, by popular demand. This week you’re stuck again with me. -TQ
Something is worth what another is willing to pay for it.
That’s the lesson of the maelstrom in financial markets, from wood pulp futures, to bitcoin, to GME, to AMC, to wherever the next Dutch tulip bulb of the 21st century showers the shocked with inflationary sparks.
Before we get to that, we’re back from riding the trade winds around Antigua, where high season in the Caribbean looks like turnout for a vegan tour at an abattoir. Nobody is there. And the Caribbean has no central bank doling out cash for sitting home trading in a Robinhood account. We did our best to offer economic support.
Oh, and you’ll recall that my Jan 27 Map said, “Congrats, Tom Brady. We old folks relish your indomitable way.” When you’re going to sea, always bet on the buccaneers. And the old guy.
We were saying a thing is worth what somebody is willing to pay.
Yesterday GME closed at $50.31. On the Benzinga Premarket Prep Show Jan 25, right before we grabbed our flipflops and duffle bags and bolted with our Covid19 negatives for the airport, I told the audience, “Market Structure shows GME is going to go up.”
I didn’t know it would rise to $483 while we were at sea. But somebody was willing to pay more. Until they weren’t.
Right now, AMC, BB, BBBY, NOK, and so on, are outliers. What if the scatterplot gets crowded?
Most of the people on what Karen calls the “What Do You Think of THIS Stock?” TV shows are still talking about the PE ratio. Earnings growth. Secular trends. Economic drivers. You get the idea.
Investor-relations people, are you prepared for a market full of Gamestops – surging highs, avalanche tumbles? How about you, investors?
In physics and electronics, “metastability” is the capacity of a system to persist in unstable equilibrium. That is, it seems solid but it’s not. Like the stock market.
Don’t blame Reddit. I love the flexed muscle of the masses. I’d like to see it in society elsewhere, frankly. A horde of people who refuse to be told what to do or told they can’t. A mob of unruly traders is wholly American.
But all those people, and all the rest of us in the capital markets, ought to understand the metastability that makes a GME or an AMC possible.
Most retail orders are sold to intermediaries trading at extreme speeds. Those firms aren’t calculating PE ratios. They’ll pay somebody for a trade so long as they know somebody else in the pipeline is willing to pay more.
Hordes of limit orders hit the pipeline, and intermediaries see the whole hierarchy. They race prices up, skipping swaths of limits by raising the price past them. So those traders, if they’re greedy and willing to chase, jump out of line and enter new, higher limit orders.
And mania ensues because somebody is willing to pay more.
When the high-speed intermediaries see that limit orders to buy and sell are equalizing, they stop filling limit orders, they short stocks, and they skip limit orders on the way down, and the whole cavalcade reverses.
And it’s not just retail flow or big high-speed penny-pickers in the middle. Quant firms do it. Hedge funds do it.
Two factors make a metastable stock market possible. First, rules require a spread between the bid to buy and offer to sell. So somebody will always have a split-second motivation to pay more for something than somebody else.
Indeed, it’s what regulators intended. How do you foster a market that never runs out of goods? Give them a reason to always buy and sell (exchanges pay them for best prices to boot). And regulators let those Fast Traders manufacture shares – short them – that don’t exist, and persist at it for weeks.
The market is nearly riskless at any price for the raciest members moving unseen through the Reddit ranks. They bought the trades. They know what everybody is doing.
And that’s why we have a metastable market.
The alternative? You might not be able to buy FB or sell NFLX at times.
Would we rather have a false market with ever-present orders or a real market occasionally without them? Regulators chose the former. So did the Federal Reserve, by the way.