Tagged: Currencies

Swimming

Happy New Year!  There comes a time in life when, to quote a friend most adept at wordsmithing, “One hallmark of a great vacation is lying face-down in salt water, with snorkel and face mask, watching the peaceful, sparkling life of the reef.”

We love it any time and December took us to St Martin and a catamaran and a pleasant journey around Anguilla and down to St Barts, the sea waves a solace for body and soul.  If you’ve not yet been where the tradewinds are constant friends, go. It’ll remind you to appreciate life, and time.

As the Chambers Brothers would say, the time has come today (taking eleven minutes to make that musical argument in 1968, the year after my birth) to think about what’s ahead. I wrote a CNBC oped yesterday describing the risk in ETFs that your executives should understand as 2016 unfolds. A goodly portion of the nearly $600 billion of 2015 inflows to passive investment giants Vanguard and Blackrock went to these instruments, portions of which are likely laying claim to the same assets owned by active investors and the indexes ETFs track.

That’s no threat when more money is arriving than leaving, but as Warren Buffett once observed, you only find out who’s been swimming naked when the tide goes out (or something near that).

I don’t know if 2016 will be the Year of Swimming Naked.  Looking back, in Dec 2014 we wrote you readers who are clients: “There is risk that a strong dollar could unexpectedly reduce corporate earnings in Q414 or Q115, stunning equities.  The dollar too is behaving as it did in 2010 when a major currency was in crisis (the Euro, with Greece failing).  Is the Japanese yen next?  The globalization era means no nation is an island, including the USA.”

Money kept flowing but 2015 wobbled the orbits of multiple currencies. Switzerland dropped its euro peg, the euro dropped to decade lows versus the dollar (which hit 2001 highs), the yen became Japan’s last desperate infantryman for growth, and the Chinese yuan repeatedly rocked markets, most recently Monday.

These factors matter to the investor-relations profession.  Picture a teeter-totter.  Once, money was a stationary fulcrum upon which commercial supply and demand around the globe moved up and down.  Today, central banks continuously slide the fulcrum to keep the teeter-totter level. Into the markets denominating the shares of the companies behind commerce pours money following models: indexes and ETFs.

This is our world, IR folks. Fundamentals cannot trump passive investment or the perpetual motion of the money fulcrum. So we must adapt.  Our most important job is to deliver value to management in the market as it is, not as it was. Running a close second is to achieve the IR goal: To the degree we can influence the outcome, aim to maintain a fairly valued stock and a well-informed market – which decidedly doesn’t mean a rising stock.

Both what you can control and whether your stock is fairly valued in a dynamic market where price-setting is more quantitative than qualitative are measurable. But not with valuation models from when the preponderance of money setting prices was taking 10Ks home at night to find the best stocks.  IR must be data-driven in the 21st century.

As 2016 begins, are tides in or out? Our sentiment measures suggest a harsh January. The cost of transferring risk through derivatives is rising. The appreciation of stock-prices necessary to sustain the value of derivatives dependent on them is stalling. And currencies – the fulcrum for prices – show worrisome seismological instability.

Now maybe both January and the year will be awesome, and let’s hope so!  Whatever comes, great IR professionals stand out against a changing backdrop by providing management data points about the stock and the market that deliver calm confidence.

Interconnection

“I must say as to what I have seen of Texas it is the garden spot of the world.”

Davy Crockett said it and left it at the Alamo. So we’re glad to be inside Austin’s city limits sponsoring the NIRI Southwest Regional Conference.  We doubt temperatures will be kinder than New York’s last week though.

There’s a pattern to what’s unfolding in the market and it impacts us. There’s also chapter tapestry to the investor-relations profession spread unevenly over the fruited plain and knitted in spirit, a durable comforter made hardy by decades and camaraderie. We’re wired to see the world as story. It makes those in this pursuit exceptionally adept at translation.  It’s what we do.

Just as our corps is animated by the inexplicable genius of humanity, a most complex and marvelous machine, so is the evolving investment landscape.  At root, human intelligence presses the button, and the machines thus run.

I’ve given this considerable thought in preparation for my TED talk Thursday in Texas. I’ll speak on market structure of course, but it’s more. An aside, make it IR duty to hear this TED video of 15 minutes from Kevin Slavin, masterful on market structure without meaning to be.

Current stock-market distress would move Rod Serling the impresario because it’s a Twilight Zone merger of Man, money and machines. It scares us. Right? We all live by the ticker (so to speak). Our profession is interlaced but now so is the planet.

Ever played poker? You pay twenty bucks for a stack of chips and you play till you win or you’re out. Suppose we floated the value of chips. Rather than a fixed buy-in, every table’s pot value would float versus another table’s, and all the dealers at all the tables would continually add to or subtract from chips in every player’s pile to balance out positions versus players at other tables.

This is what the world is doing with currencies. Money. You need to understand it in the IR chair. We borrow money from China and then depreciate our currency and depress our interest rates to zero so the impact of borrowing will be minimal. China then devalues its currency to keep from losing money on the debt we owe.

On Aug 12, the Chinese government devalued the yuan. There are some $500 trillion of interest-rate and currency swaps globally and if a big currency moves, it’s a de facto change to interest rates.  Investors and their counterparties underwriting rights were caught out. So during options-expirations Aug 19-21, markets fell.  This is Man at work.

Now we come to Exchange Traded Funds, the chief investment vehicle of the modern era. ETFs post positions every day by law. It’s inconvenient to continuously change share-holdings so they routinely use derivatives like options and futures instead, which is permitted by law. And machines modulate it. We last had a material stock pullback in 2011, last saw a bear in 2008. ETF assets have doubled since 2012. We have no idea how ETFs will act in a down market, frankly.

But we just got a clue.  On Aug 24, the new series of options and futures marketwide began trading – and markets imploded. What happened? We think demand from ETFs for options and futures was so poor that markets simply imploded at the open. Lack of demand is as big a price-setter as selling (put that on a t-shirt).

Today, everything is connected.  If ETFs, which are ephemeral supply or demand, stop using derivatives, it means indexes are faltering, which means you and I are getting wary in our 401k’s, which means fast traders are shy about setting prices, and all of it comes back to floating currency values, pontoons upon which global consumption dances in a delicate balance.  Nobody knows what’s real.

It’s not one thing.  And yet it is.  Humans don’t like uncertainty so they transfer its risk to somebody willing to pay to cover it.  Now that process is starting to reverse after seven years.

What we don’t know is who ended up with the risk. What we do know is that IR better be able to explain it.  That’s market structure.  Not story. So don’t miss my session tomorrow in Austin.

The Fulcrum

The teeter-totter with the moving fulcrum never caught on.

The reason is it wasn’t a teeter-totter, which is simple addition and subtraction, but a calculus problem. The same mathematical hubris afflicted much talk surrounding US economic growth last autumn when it seemed things were booming even as oil prices were imploding.

“The problem is oil is oversupplied,” we were told, “so this is a boon for consumers.”

“What about the dollar?” we asked.

Oil prices are a three-dimensional calculus problem. Picture a teeter-totter.  On the left is supply, on the right is demand.  In the middle is the fulcrum: money. Here, the dollar.

In January 15, 2009 when the Fed began to buy mortgage-backed assets, the price of oil was near $36.  Supply and demand were relatively static but the sense was that economies globally were contracting. On Jan 8, 2010, one year later, oil was about $83. Five years removed we’re talking about the slow recovery. So how did oil double?

The explanation is the fulcrum between supply and demand. Dollars plunged in value relative to global currencies when the Fed began spending them on mortgages.  Picture a teeter-totter again. If I’m much heavier than you, and the fulcrum shifts nearer me, you can balance me on the teeter-totter.  Oil is priced in dollars. Smaller dollars, larger oil price, or vice-versa.

As the Fed shifted the fulcrum, the lever it created forced all forms of money to buy things possessing risk, like stocks, real estate, art, commodities, goods and services.

As we know through Herb Stein, if something cannot last forever it will stop. On August 14, 2014 the Fed’s balance sheet had $4.463 trillion of assets, not counting offsetting bank reserves. On Aug 21, 2014, it was $4.459 trillion, the first slippage in perhaps years.

Instantly, the dollar began rising (and oil started falling). At Jan 22, 2015, the Fed’s balance sheet is $4.55 trillion, bigger again as the Fed tries to slow dollar-appreciation. But the boulder already rolled off the ridge. The dollar is up 22% from its May 2014 low, in effect a 35% rise in the cost of capital – a de facto interest-rate increase. (more…)

Missing Volume

I’ve made South Dakota jokes – “fly-over state,” “waste of dirt that could have been used making Colorado larger,” etc.  Not again.

It’s but six hours by car from Denver and we love road trips, so we put a junket to Mount Rushmore on the calendar. Turns out there’s more to the “under God people rule” state than chiseled presidents. In Custer State Park (where never is heard a discouraging Ranger word) this fella ambled by while his brethren were at home on the range below Harney Peak and picturesque Sylvan Lake. Loved it. We’ll go back.

Speaking of gone, wither volumes? And should you worry?

A client yesterday asked about splitting the stock. Share volume is tepid, off nearly 75% since 2009, though dollar-volume (more important to us) is down less, about 40%. Should they do something to stimulate it, they wondered?

Weak volumes would seem cause for concern. It suggests a lack of consuming. It’s happening more on the NYSE than the NASDAQ.   In 2009, the NYSE averaged 2.6 billion shares daily, about $82 billion of dollar-flow. In 2014 so far, it’s 1.02 billion shares, about $40 billion daily.  The NASDAQ in 2009 saw about 2.5 billion shares and $60 billion daily compared to 2.0 billion shares and about $73 billion in 2014.

The big companies are concentrated on the NYSE, which has about 70% of total market cap.  Money is trading smaller companies, but not owning them, evidenced this year at least by sustained volumes for small-caps but weakness in the Russell 2000, down almost 2% this year with the S&P 500 up 7.5%.  Plus, shorting – renting – is rampant, with 44% of daily market volume the past 20 days, nearly half of trades, from borrowed shares.

Check the Pink Sheets and it’s stark. Volume is averaging about 14 billion shares daily in penny stocks in 2014, compared to about 2.3 billion shares daily in 2009.  Dollar volumes are small but have doubled in that time to $1 billion daily. KCG Holdings as a market-maker does over a 1.2 billion shares a day by itself in penny stocks.

And derivatives volumes have jumped since 2009. Global futures and options trading according to the Futures Industry Association totaled 21.6 billion contracts in 2013, up from 17.7 billion in 2009. More telling is where. In 2009, equity and equity-index derivatives volume was 12 billion contracts, identical to 2013. But energy, currency and metals derivatives trading has exploded, jumping 125% to 5.3 billion contracts in 2013.

The answer to where equity volumes have gone is into trading small caps and penny stocks and derivatives tied to energy, currencies and metals. Investors are searching for short-term differentiation and safety from uncertain asset values affected by massive currency infusions from central banks.

What’s it mean to you in the IR chair? Volume doesn’t define value. Witness Berkshire Hathaway Class A units trading 250 shares daily (about $47m). What matters is who drives it. Don’t give in to arguments for “more liquidity.” You’ll help short-term money, not long-term holders. We don’t think splitting your stock today improves liquidity or appeal to the money that matters.

Speaking of rational money, it averaged 14.5% of total equity volume the past 20 days. Tepid.  Where are active investors? Watching warily, apparently. What drives equity values right now is asset-allocation – the “have to” money that buys the equity class because the model says to.

And meanwhile that money is offsetting risk with derivatives in currencies, energies and metals. Take care not to draw the wrong conclusion about the value of your shares. It’s tied to things way beyond fundamentals at the moment.

Virtuous

The humans are the minority.

A three-month study of internet traffic by web-security firm Incapsula found that 61.5% of page views were generated by machines. Humans managed only 38.5% of web traffic.

It seems absurd but our own experience bears it out. We receive hundreds of comments on the blog version of these overwrought homilies but the machines are more opinionated than the humans. In recent months, automated “bots” have attempted to post over 1,500 comments. We’ve approved just the handful from actual humans.

Most of you readers with comments use a dark pool. By which I mean you reply to the email version when you opine on our assertions. In this fashion, you avoid displaying your comments where others can game them. Keep those nondisplayed orders coming!

The machines are good. You could at times almost buy that a person penned the prose. Speaking of skilled machines, Virtu Financial Inc., a dominant high-speed market-maker, intends to go public. Virtu filed confidentially, meaning it posted its regulatory filing quietly in December using a provision of the 2012 JOBS Act to omit the meat investors use to weigh business merits and prospects. (more…)

The Flood

The word of the week was “flood.”

Here in Colorado, Denver had a coup d’état by weather patterns from Portland, Oregon for a week but our streets never ran in torrents. Where the Rocky Mountain watershed empties to the flood plain from the Mesozoic Era, occupied by present-day Boulder, Loveland and Greeley and small towns like Evans and Lyons hugging the banks of normally docile tributaries, the week past reshaped history and landscape. It will take months to recover.

In the markets too there was and remains a flood that surfaces with rising intensity from its subterranean aquifers to toss debris into market machinery. It’s the spreading vastness of complex market data.

SIDEBAR: If you’re in St. Louis Friday, join us at the NIRI luncheon Sept 20 for a rollicking session on the equity market – how it works and why it fails at times.

Data is the fuel powering market activity. Globally, trading in multiple asset classes turns on computerized models that depend on uninterrupted streams of reliable data. This gargantuan global data cross-pollination affects trading in your shares. After all, there are two million global indexes, as the WSJ’s Jason Zweig noted in a poignant view last weekend on modern equities. (more…)

Infinite Money Theorem

“What do you see out there?”

Out here in Crested Butte, CO, where the overnight temperature was 35 degrees, we see vast beauty, perhaps unparalleled on the planet.

As for the other “out there,” it’s the No. 1 question we’ve gotten the past two weeks, even with clients reporting financial results. They’re most concerned with the macro view: What do we think will happen to the stock market if and when the Fed stops buying government-backed securities?

Some observers predict doom. If the Fed quits printing money, the helium goes out of the balloon and down it comes. Others see the opposite. Just yesterday Jim Paulsen at Wells Capital said the Fed’s exit means markets can normalize, shifting from arbitraging data to investing in economic growth. He says stocks will rise.

It’s important to understand what the Federal Reserve is doing. The Fed isn’t printing money per se. It’s in effect engaging in a massive derivatives swap – trading one thing for another, neither of which is a hard asset. The Fed buys about $85 billion of Treasury securities and government-backed mortgage derivatives every month. Since these instruments are backed by US taxpayers and derive from either future tax receipts or underlying mortgages, both are derivatives. (more…)

The Vessel

Will markets collapse?

We’re a day late this week, steering clear of election bipolarity marked by the vicissitudes of demography and the barest palimpsest of republicanism, a diaphanous echo of Madison and Jefferson and Hamilton, names people now think of as inner city high schools.

Back to markets. We’ve seen a curious change. A year ago, the top refrain from clients was: “What is our Rational Price?” For those not in the know, we calculate where active investors compete against market chaos to buy shares.

That’s not the top metric now. It’s this: “What’s your take on macro factors?” Management appears to have traded its focus on caring for trees for fearing the forest – so to speak. If so, the clever IRO will equip herself with good data.

We’ve been writing since early October about the gap between stocks and the US dollar. The dollar denominates the value of your shares. As the currency fluctuates in value, so do your shares, because they are inversely proportional.

In past decades since leaving the gold standard in 1971, those fluctuations have generally proven secondary to the intrinsic value of your businesses. But that changed in 2008. Currency variance replaced fundamentals as principal price-setter as unprecedented effort was undertaken by governments and central banks globally to refloat currencies.

Imagine currencies as the Costa Concordia, the doomed luxury liner that foundered fatally off the Tuscan coast. Suppose global forces were marshaled to place around it Leviathan generators blowing air through the ships foundered compartments at velocity sufficient to expectorate the sea and set the ship aright.

Thus steadied on air, the ship is readied for sail again, surrounded by a flotilla of mighty blowers filling the below-decks with air and keeping the sea back from fissures in the ravaged hull by sheer force. Passengers are loaded aboard for good times and relaxation and led to believe that all is again as it was. As seaworthy as ever.

That’s where we are. We are coming off the peak now of our fourth stocks-to-dollars inflationary cycle since 2008. In each case, markets have retreated at least 10%. The cycles are shortening. And despite retreat we right now retain the widest gap between the two since July 2008, right before the Financial Crisis.

Why does the pattern keep repeating? Because central banks keep juicing the blowers as the vessel wilts and founders. That’s what you saw yesterday after the election. The Euro crisis, having gone to the green room for a smoke is back center stage as it a year ago. Money – air – leaves variable securities for the dollar. As air leaves, stocks falter.

We don’t say these things to be discouraging. It is what it is. The wise and prudent IRO develops an understanding of market behavior – so the wise and prudent IRO will be cool in the IR chair and valuable to management and able to retain sanity and job security in markets depending on giant turbines.

If you’re relying on the same information you did in the past, you’re ill-prepared. We are in a different world now.

Macro Factors and IR

Congratulations, IR profession! It’s happened.

One of our ranks stepped up to the stock-exchange rule-filing plate, planted, and cracked that fastball out of the park. Thank you, Katie Keita, for commenting on the Nasdaq’s proposal for ETF sponsors to pay market-makers.

I hope it’s a trend. Your stocks underpin everything else. These are your markets.

More on that later. But speaking of trends, yesterday the dollar rose and stocks fell. When the greenback gains on other major currencies, things valued in dollars often decline. Stocks are stores of value, and value ebbs or flows according to the measuring tape – currencies. The dollar fell in April (after an early buck spike garroted equities), so stocks rose proportionally. Then as April ended, the dollar strengthened on mounting global worries (especially from Europe). Stocks shrank. It’s a macro effect that trumps stories.

How should you view macro factors from the IR chair? “Macro factors” is jargon for “how appraisers view the global neighborhood.” There was a good article on the Big Picture (page R9, “How the Big Picture Affects Stock Picks”) in the Wall Street Journal Monday May 7. Writer Suzanne McGee says macro factors shouldn’t make investors reflexive but can’t be ignored either.

You’re not investing, of course. But you’re selling to investors. If your target market is influenced by macro factors, and you’re not, you may be striking discordant notes. (more…)

The Theory of Value Relativity

There’s an old stock market joke. Every time one person sells, another buys, and they both think they’re smart.

Value is relative. And yet. Anybody in the IR chair pencils valuations for his or her shares. Isn’t this the battle – measuring value? Karen and I on a recent trip sat with a sharp IR pro who explained how the team had an internal valuation model for company stock.

Many consider historical price-to-earnings ratios of the S&P 500 (about 16 over 130 years but ranging from below 9 in 1933 and 1983, to 40-plus in 2000, the record). Some like the S&P earnings yield versus 10-year Treasurys (7% to 2%). On that basis, markets would seem to be a whopping good buy.

And yet the Dow was down 500 points in five days through Tuesday.

There are three immutable valuation meters. You’ve got future value of cash flows. For instance, somebody at Facebook determined that Instagram’s future cash flows discounted to present value are worth $1 billion rather than the current figure of zero.

There’s net worth. When Microsoft bought AOL patents this week for $1 billion, the market added the cash to AOL’s net worth and shares shot up about 20%. (more…)