Tagged: buyside

Westworld

The smash HBO series Westworld is a lot like the stock market: It has the appearance of reality but is populated by machines (which are trying to take over in both places).

What the market lacks in gratuitous nudity it more than compensates for with a veneer that far exceeds what the Westworld operators call “the narrative.”  Most think the market’s narrative is headlines and fundamentals.  Examine what the money is doing, the rules of the market, the way exchanges match trades today, and it’s the opposite.

Fundamentals are the sideshow. The sellside has imploded. Blackrock, Vanguard and State Street cut costs by cutting them out. Index and exchange-traded funds (ETFs), dominating investment the past decade, don’t follow fundamentals.  We just hired a person from Janus because stock-picking is like the androids in Westworld: subject to repeated obliteration.

JP Morgan and Goldman Sachs both have said publicly that 10% of their trading volumes now are active investment. Sellside analysts in droves are trying to get investor-relations jobs. Why then is IR spending 85% of its effort on the buyside and sellside?

And the earnings-versus-expectations model is misdirection. It’s not for buy-and-hold investors. It’s for arbitragers. It’s an opportunity to bet. Investors don’t change their minds that way.

What’s exploded is the use of derivatives. The same handful of banks from Goldman Sachs to UBS that perpetuate earnings vs. expectations execute 90% of customer equity orders and handle 95% of the derivatives market.  They know the direction of equity flows so they can hedge long or short. Their best customers are hedge funds and high-speed firms profiting on price-changes.

These same big firms are ETF authorized participants, which have created and redeemed some $2 trillion of ETF shares already this year, contributing to whopping market volatility. Actual inflows to equities are 2% of that figure! It’s arbitrage.

We’ve become the hosts – as the androids in Westworld are called. Unwitting contributors to a storyline. What if we suspended all our effort at outreach to the buyside and sellside…and nothing happened?

Berkshire Hathaway doesn’t hold an earnings call. Tesla’s Elon Musk went off over banal analyst questions, but questions don’t buy or sell stocks and TSLA is right where the math signaled (about $301), up on – you guessed it – ETF creations, arbitrage.

You don’t want to hear this? Do you prefer to live in Westworld, hosts for a narrative not of your design? Don’t do that.  IR is the chief intelligence function. You’re supposed to know what’s going on.  We rarely stress it here, but I’m saying it today. Market Structure Analytics, which we invented, can tell you everything you need to escape Westworld:

-What’s setting your price every day

-The demographic composition of your volume by behavior

-The trends of behavioral change

-When Active money buys or sells, and if it’s growth, GARP or value

-If your investors are engaged

-The risk from directional bets and whether they’re long or short

-The presence of deal arbitrage, Activism and short attacks (and likely success)

-Borrowing trends in your shares

-How passive investment affects stock performance

-Visual indications of short-term market cycles including how ETFs work

-Key trends and drivers

-Key metrics for knowing if your equity is healthy or not

-Forecasted prices (with 95% accuracy five days out)

-Earnings expectation models

-Predictive Sentiment for Overbought and Oversold conditions

-Why your shares behave differently than peers or the market

You might say, “So?”

Public companies have a fiduciary responsibility to act in the best interest of shareholders, which includes understanding how the market is using those shares.  If IR was a business division, we’d expect nothing less than a full SWOT disposition. IR is the equity product manager – arguably as vital as any business division. You need data.

Analytics should first enable you to see important trends and drivers – in consumer behavior, in a business, in your equity.  That’s the starting point for actions. IR has fallen into a rut of saying it wants actionability – but without first understanding equity drivers.

Public companies have over the past 20 years let intermediaries make rules that work well for intermediaries like exchanges selling data and technology services but poorly for ourselves and long-term money. The problem is IR behaves still like it’s 20 years ago.

We remedy that deficiency.  If you want to see how, give us 15-30 minutes by web meeting to show you why Market Structure Analytics should be considered a vital part of being public today (and you investors, we’ll soon have a solution for you too!).

Trading Through

Memorial Day is a time for reflection.

We marked it by viewing American Sniper, introspective cinema on prolonged war.  There comes a point along that continuum where people begin to feel helpless, caught by something they can neither fix nor change.

That of course got me thinking about the first Equity Market Structure Advisory Committee meeting, convened May 13 without anyone from the issuer community on hand.  Chair Mary Jo White tasked the team with weighing Rule 611.

Fight the eye-glaze urge that overwhelms at mere sight of the name. If you’re a participant in the equity market as all public companies are, you need to know how the market for traded shares works.

Rule 611 is one of four key tenets of Regulation National Market System, the regime behind our current terrific marketplace, and says trades cannot occur at prices worse than those displayed at another market in the national system. We say Order Protection Rule or Trade Through Rule because it prohibits “trading through” a better price.

The thinking was if brokers were jobbing clients with inferior prices, how do you stop it? The old-fashioned way of doing that is how you buy a car. You do some comparison-shopping, and enterprising folks create apps like TrueCar (which is what ECNs were!).

Perhaps concluding that humans buying and selling stocks are just too busy to take responsibility for getting a good deal themselves, the SEC decreed that all orders capable of setting market prices must be automated and displayed by exchanges. As the memo’s authors write, “If a broker-dealer routes an order to a trading venue that cannot execute the order at the best price, the venue cannot simply execute the order at an inferior price.”

This is why algorithmic and high-frequency trading exploded. But the SEC deserves credit here. In an unusually blunt and rather readable treatise prepared for Committee members, the SEC admits its rules “significantly affect equity market structure.”

What the SEC really wanted through Rule 611 was more limit orders, or stock-trades at defined prices instead of whatever one is best at the moment. “The SEC believed,” the memo says, “that greater use of displayed limit orders would improve the price discovery process and contribute to increased liquidity and depth.”

The opposite happened, and the SEC is again forthright, saying “limit orders interact with a much smaller percentage of volume today than they did prior to Rule 611. This development may suggest that Rule 611 has not achieved the objective…”

Supporting that conclusion, earlier this year Fidelity and fellow investing giants said they will launch a marketplace for stocks called Luminex Trading & Analytics. Other members are Blackrock, Bank of New York Mellon, Capital Group, Invesco Ltd., JPMorgan Asset Management, MFS Investment Management, State Street Global Advisors and T. Rowe Price Group Inc. The cadre manages assets topping $15 trillion.

These are your owners. The stock market isn’t working for them. The SEC is talking about it – even admitting errors. All the major exchanges in the past year – NYSE, Nasdaq, BATS Global Markets – have proposed big changes.  IEX, famed from Flash Boys, is working to create a radically different exchange model.

Yet 90% of CEOs and CFOs at great American public companies don’t know investors are unsatisfied or that everyone else in the equity market is talking about fixes. That’s not because they can’t grasp it. They don’t know because IR isn’t explaining it.  You can’t expect exchanges to do it. They serve multiple constituencies and we’re the least economically meaningful, to be frank.

This can be the Golden Age of IR if we seize the opportunity to command a role in market-evolution. IR sells products – shares of your stock. If they were widgets, we’d know every intimate detail about the widget market (executives would expect nothing less).

So why not the stock market? (Hint: We can help you drive this organizational change!)

Tray Dat

We’ll be listening in the car to a song on satellite radio’s The Pulse, trying to keep current, and I’ll say to Karen, “Do you understand what he’s saying?”

You may feel the same way about equity-market rules. Take for instance the Trade-At Rule.  No it’s not Tray Dat, but I think I heard that in a song on The Pulse.  We didn’t hear something sounding like Tray Dat during the Little River Band concert Sunday at Denver’s Hudson Gardens, the band touring 39 years with a revolving cast still delivering goose-bump harmonies on Lady, Take It Easy on Me, Cool Change and Reminiscing.

Anyway, the Trade-At Rule matters to IR because it sharply impacts the buyside and sellide – your two core constituencies. And if the CFO stops you in the hallway and says, “What do you think of this Tray Dat thing the SEC is considering?” you don’t want to stammer.

So here’s what’s happening.  The SEC in June directed exchanges and Finra, the regulatory body for brokerages, to develop a plan for testing wider spreads in stocks. The SEC wants three test groups for a year-long pilot program.  All three will include stocks with market caps under $5 billion, volume below one million daily shares, and prices over $2.

One group, the control, will trade as it does now.  The second will have greater tick sizes, or spreads between prices for buying and selling shares, called the best Bid (to buy) and Offer (to sell). The plan is still conceptual – the SEC in June gave market participants 60 days to craft their proposal – but it’s probable we’d see five-cent spreads.

The third group will incorporate along with bigger ticks another idea: The Trade-At Rule. Best way to describe it? If you’ve read the book Flash Boys, there’s a story Brad Katsuyama tells about seeing 25,000 shares for sale on his screen, and readying his own order to buy those 25,000 shares. His finger is poised over the keyboard, counting down, 5-4-3-2-1…click. He presses the button to buy – and the orders disappear and he gets but a small portion of what he could clearly see was available.

The Trade-At Rule would ostensibly remedy this problem by prohibiting somebody from front-running the displayed price. It would seem to force trades out of dark pools where prices can’t be seen, onto exchanges, where they can. There are exemptions for big block dark pools like Liquidnet and Aqua, and for exchanges with the best price right before the new “marketable” order arrives. (more…)

Enlist Investors

We assume investors know how markets work. What if they don’t?

Patrick Armstrong, new president of the Securities Traders Association of New York (STANY), told Traders Magazine yesterday that the buyside has been absent from the market-structure debate.

What debate? If you joined the IR profession in the past 15 years, you may be unaware that stocks today trade radically unlike any other time in the general history of capital markets. It’s not a technology question. Things change. Machines convert human processes to automated ones. That’s normal.

When steamboats flourished on the Mississippi River, what had been hard – rowing upstream – became an easy ride. Travel took on an aspect of leisure. It moved from essential to enjoyable (air travel has gone the other way, as I was reminded yet again flying yesterday from Denver to Newark). It was still travel, though.

What’s the purpose behind trading stocks today? Don’t listen to what somebody tells you. Look at the data – which you do if you use Market Structure Analytics. The data say that the purpose of trading markets is to move things around for profit. That’s 85% of your volume.

If the exchange listing your shares had told you that the fees you pay would give you access to a bunch of short-term traders moving your shares around so the exchange could profit on data revenues, would it have changed your view of the market?

“I want [the buyside] to tell me their opinion on the direction of our market structure. I believe that those who are for the status quo, those who say everything is fine, are the ones to be wary of,” Armstrong said. (more…)