Tagged: Federal Reserve

Influencing behaviors in your trading

In politics, Bill Clinton perfected the “trial balloon.” You float an idea of one shade because you’re planning on getting people to embrace an idea of another larger construct.

In fiction writing, authors will create portent by ending a chapter with something like: “She could never have imagined the consequences of her decision.” You can’t wait to turn the page to find out what she couldn’t imagine. The writer has subtly influenced your behavior.

The Fed is always trying to influence our behavior. Market performance October 4 (today) was mostly about Fed influence. Affirming commitment as lender of last resort – which sounds good but means “we will print endless piles of cash” – is the same as devaluing the dollar. So the dollar plunged in the last hour of trading, and stocks soared. (We all want stocks to rise but think about a teeter-totter. That’s stocks and dollars.)

In trading markets, exchanges continuously toy with behaviors by changing the spreads between fees for taking shares away and credits for bringing them to sell (this is the root cause of high-frequency trading). Exchanges are influencing behaviors.

Why does it matter? IR is about influencing behavior. In the past, we did it mostly with operating results, investment thesis and investor-targeting. Today, it must go further. Do you consider the impact of Fed policy and adapt your institutional outreach to match your investment thesis to impending changes in behavior? You should. If programs stall, don’t keep talking to growth money; shift to high-turn, deep-value money. (more…)

Follow the Cash

Headline at 2:34 p.m. Eastern Time today: “Fed Pledges Low Rates Through 2013.”

How many recognize this as a currency-devaluation? Markets jumped 4% here in the U.S. as the DXY, the dollar index, dropped.

Last Sunday, the European Central Bank pledged to monetize debts of Italy and Spain. Monday, markets plunged globally. That’s a currency-devaluation. The central bank is promising to increase the supply of currency without a corresponding increase in economic output.

Most blamed S&P’s downgrade of US debt. But the dollar strengthened, and Treasurys increased in value. Why would the diminished instruments be more valuable?

Because that’s not what caused markets to tank. (more…)

Dividends and Buybacks

Would you rather ride your road bike in the sun or the rain?

What if riding in the sun means peddling across Death Valley in the summer, while the rain is a passing shower in the Italian Dolomites?

Context is essential. Let’s apply the same thinking to decisions about stock-repurchases and dividends. Conventional wisdom has long held that both actions appeal to the kinds of stock buyers who hold securities and count on fundamentals.

No argument there. But ponder the third dimension in the IR chair. The first dimension is your story – what defines and differentiates your investment thesis. The second is targeting the kind of money that likes your story. The third dimension is the state of your equity store.

Your equity is a product, competing with other products, with unique supply and demand constraints. If you suppose that your story is correct for a particular buyer without considering whether the buyer can act on interest in your story, you’re leaving money on the table. So to speak.

For instance, if I want four Keith Urban tickets at Pepsi Center in October for no more than $50 each, I’m already sold on the investment thesis – “Keith Urban puts on a good show.” What if there are only two tickets available at $50? Well, I’m not the right buyer for the investment thesis, then. (more…)

Take the Pulse of Your Stock

Coming to NIRI National 2011 next week? Please visit us at Booth 304! We have no helicopter rides or trips to the Bahamas to give, but we do have a really cool microfiber for keeping those ubiquitous touchscreen pads and smartphones sharp.

June launched by kicking markets right in the rump. We blamed economic data. It’s true but not that simple. Behind the data at the behavioral level, institutions decided against equities roughly May 13. We don’t make this up, we just observe it in the way trades execute. When methodologies, purposes or time horizons change, it manifests in trade executions.

Money didn’t hedge with options expirations May 18-20 either. If you decide not to insure your house against loss, what might that mean? That you expect to sell it shortly, that risk is nonexistent, or that insurance is too darned expensive. As an analogy, two of those three are negatives and the middle one doesn’t exist on Wall Street.

(more…)

Exchanges Depend on Arbitrage

What if some mathematical calculations in the market are just there to get a reaction?

Traders have not to my knowledge named them “Charlie Sheen.” But alert reader Walt Schuplak at the Market Intelligence Group in New York sent an item about rogue algorithms. Our friend Joe Saluzzi at Themis Trading wrote on it yesterday.

Joe explains that certain trading practices create arbitrage opportunity. Profiting from divergence isn’t bad of itself, Joe notes. But if the chance to profit is fostered where divergence could not or would not occur on its own, it raises fundamental questions.

Bloomberg writer Nina Mehta wrote today about the Australian government’s initial rejection of the Singapore Exchange’s effort to buy the Oz stock market. Singapore is a shareholder-owned exchange. The Deutsche Bourse is public. Same with the InterContinental Exchange, throwing in with the Nasdaq on a bid for the NYSE, both of which are public too. The London and Toronto markets are run by public companies. BATS may IPO. (more…)

Karen and I are getting in boat shape ahead of a trip to Antigua (Motto: “Don’t ever say the name ‘Allen Stanford’ around here”). But we’ve encountered obstacles to the cycling part of the regimen: Wind and fire. One more, such as earth, and we’ve have a good name for a rock band. It’s been bone-dry and breezy on the Front Range, and already several range fires have burned black swaths.

Speaking of fires, we’re marching through them with the Issuer Data Initiative. The Number One Need is more names behind it. If you haven’t committed support for better trading data, do so today. Your peers will thank you someday, and you can remind them then that they owe you.

Before we get to what happened Mar 16-21 in trading markets, a word on BATS Exchange. The Kansas City operator of the third-largest American trading venue has made no secret of its interest in listing companies for public trading. BATS made it official today, announcing plans to offer IPOs another path to global liquidity.

Provided BATS offers competitive listing prices and good data, it can compete. We hope exchange executives will consider the key data points in the Issuer Data Initiative. BATS has a reputation for data excellence already, providing a great deal of free data to its trading clients.

We see too that BATS filed a proposed rule change with the SEC last month that will require customers to mark trades as principal (for their own accounts), agency (on behalf of others) or riskless principal (buying from or selling to a customer). See, issuers? Exchanges file rules to change how things are done. Issuers are participants in markets too. If they want something changed, they too can ask.

What drove trading markets roughly March 16-21 also speaks to the importance of good data. Somebody always must execute the trade and report it. That’s the way we all know the volume for any stock. On March 16, the G-7 countries announced a concerted effort to devalue the Japanese yen by flooding markets with currency. March 16-18 also included the monthly options-expirations cycle, and S&P quarterly index rebalances.

During the same period, we observed uniformity in trading activity for a set of “primary dealers” that work with central banks in the United States, Europe and Japan. Across the market-cap and sector spectrum, the same behavior occurred for this set of primary dealers.

We surmise that central banks armed these large brokerages with cash, which is how central banks engage in “quantitative easing.” The brokerages, also all commercial banks today, deployed it by buying securities from selling institutions. It had the desired effect, stabilizing equity markets and reducing upward pressure on the yen.

We’ve seen that many stocks have returned to their pre-March-10 “rational price” levels. But the behaviors producing those prices aren’t rational. If these were riskless principal transactions, do governments now own a bunch of equities with taxpayer dollars? Or were these all principal trades and so the brokers now have high levels of inventory?

Let’s suppose it’s the latter. Fine, so long as markets rise. Brokers can sell inventory as more buyers return to equities. It’s bad, however, if, say, Portugal defaults, causing the Euro to weaken and the dollar to rise. US equities would slide, and brokers would dump inventory to protect themselves as markets fell.

So everybody get out there and buy something made in Portugal.

It May Not Be About You

In Denver we get sun, rain, snow, sleet, hail. And then comes the next day. Today, a clear, bright and breezy 75 degrees Fahrenheit, photographers out snapping chamber of commerce pictures, the power goes out. It’s put us behind schedule.

Speaking of power outages, starting April 22 equity markets developed voltage problems. IR professionals, we’ve got two words for when you meet the CFO in the hallway and she asks, “What’s up with the stock market?”

Risk Management. What two words did you think we were going to offer? “Risk Management” is why the same stocks that were up yesterday can be down today. We saw surging European and Asian inflows April 22, and a reversal of the same inflows on April 27.

From the IR chair, it’s flummoxing. Your nearest peer, in the same industry, about the same market cap, doing similar things, reports results on April 22 and beats expectations and soars 10% in a day. You then report the same good results almost pound-for-pound, a handy beat. And your stock declines three percent.

What gives?

Time for those two words: “Risk Management.” Large portfolio trading schemes such as pension and investment funds may hold an array of securities. Let’s say euro-zone bonds, currency futures, US Treasuries and US growth stocks. Suppose these investments are protected with risk metrics software from SAS, and trading-desk level systems from prime brokers JP Morgan and Deutsche Bank. These systems are designed to monitor and maintain portfolio risk and return within certain parameters.

Greece’s bailout is approved. The systems determine that this will strengthen the US dollar, thus weakening inflows to US equities from European and Asian sources. The systems themselves execute automated trades, complete with offsetting derivatives, to control risk.

This behavior causes a domino effect. The same securities the system said to buy last week are now the ones it sells. That triggers other limit orders and stop-losses, changes the nature and size of passive market-making trades, and attracts statistical arbitragers finding fleeting imbalances. And because ONE variable in the overall risk-management schematic is different – maybe a risk metric is the ratio of dollars on reserve at the European Central Bank, which has just returned a bundle of them to the US Federal Reserve – it over-corrects.

The next day, the system tries to rebalance the overcorrection, producing a spike in US securities again. Commentators bray about renewed enthusiasm for US economic growth, which in fact plays almost no role. Leveraged ETFs had just today adapted to yesterday’s big risk-management change. Now those are out of balance.

Suddenly, inefficiencies abound. Passive market-making systems aren’t getting liquidity to the right spots fast enough. Stat arbs are executing simultaneous offsetting trades in ten different market centers, creating the illusion of movement where none exists.

And the next day, the risk-management system tries to rebalance again.

This is how you get great volatility in markets designed to function smoothly and efficiently.

You don’t need to explain it in detail to your CFO. But you should be able to say, “We have integrated global markets. Our results, which were great for our active investors, now are secondary to global risk management. That’s the reason we’re under pressure. It’s a portfolio problem.”

But portfolio problems are our problems too. What’s the answer? We invite your suggestions. Meantime, be sure management doesn’t take it personally. It’s not always about you.

Loveland Ski Resort an hour up I-70 from downtown Denver logged 26 inches of snow in the past five days. We’ve had to cover patio plants the past two nights as temperatures dipped to 30. It’s bright and clear. But winter has had a hard time letting go this year.

Meanwhile in Europe, Morgan Stanley launched a lending book for European Exchange Traded Funds (ETFs) today. Here is the key to understanding financial reform currently mucking up Congress. It encapsulates everything that’s wrong with today’s capital markets. (more…)

The derivative we need is a weather swap. The Winter Olympics would pay a premium for that spare snow lying around unused on the east coast.

Speaking of derivatives, the dollar retreated today, and US equities rebounded. We all want it to be about investing. Commentary everywhere today polished bullishness to an economic sheen. But that won’t make it reflect reality. Money keeps buying short-term love because the direction of the dollar is like a blacksmith’s bellows on equities. (more…)