Tagged: investment

The Actionable Hoax

What’s actionable?

It’s a buzzword of business and the investor-relations profession. And, yes, my title violates a rule of grammar because you can’t tell if the topic is a hoax about actionability or if a hoax out there has proved actionable.

We’ll answer using the market. Like this: Trade-war threats are wrecking markets!  Right?

Wrong.  Pundits tying moves in the market to headlines don’t understand market structure. Suppose you’re getting “actionable” information from pundits who don’t know how the market works. Are the recommended actions reliable?

While you ponder that, consider this: If trade concerns for tech stocks caused the correction in February, why did the Nasdaq hit an all-time high June 20? Did the same money that rejected the market back then on trade fears three months later without resolution to those concerns pay more?

You can say, “No, they were sellers.” Okay, so who bought?

Market experts are often offering actionable intelligence based on outdated ideas. But they have a duty to understand how the market works and what the money is doing.

In fact, these two pillars – how the market works, what the money is doing – should be the bedrock for understanding markets.

What’s the money doing?  It’s not choosing to be directed by rational thought. We know  because a vast sea of data on fund flows tells us so. If we as investors or investor-relations practitioners continue doing what we did before fund flows surged to passive money, who is the bigger fool?

Exchange Traded Funds (ETFs) are driving 50% of market volume now. They are passive vehicles. But they uniquely among investment products permit ETF creators like Blackrock and Vanguard a step-up in tax basis through creation and redemption.

How? Say NFLX is up 100% in three months, imputing tax costs to ETF shares. Creators of ETFs collateralized by NFLX shares will put it in redemption baskets exchanged to brokers for returned ETF shares.  (NOTE: If you don’t know how ETFs work, ask us for our ETF whitepaper.)  NFLX then plunges as brokers sell and short it.

Five days later, the ETF creator can bring NFLX back now in a creation basket of new ETF shares that it will issue only in exchange for NFLX – laundered of tax consequences.

Apply this to the Technology sector (or the whole market for that matter).  We just had Russell index rebalances, and Technology is a big part of market cap.  S&P indices rebalanced June 22 and Technology is over 25% of the S&P 500 now.

This week is quarter-end window-dressing. ETFs are trying to bleed taxes off runups in Tech stocks.  We could see it coming in Sentiment by June 14, when it topped, signaling downside, and when behavioral volatility indicated big price-swings. Data say we have another rough day coming this week.

Headlines may help prioritize what gets tax-washed, so to speak, but the motivation is not investment. It’s aiming at picking gains and packing off tax consequences.

The market is driven far more by these factors than rational thought, which we know by studying the data. ETF creations and redemptions are hundreds of billions of dollars monthly. Inflows and outflows from buy-and-hold funds are nonexistent by comparison.

Ergo, it can’t be rational thought driving the market no matter the talking heads declaiming trade threats.

It’s what lawyers call a “fact pattern.” ETFs dominate passive investment, drive 50% of market volume, depend on tax efficiency, which process is an arbitrage trade that involves a continual shift of hundreds of billions monthly in underlying assets, and a corresponding continual shift in collateralizing assets called stocks – with market-makers profiting, and ETF creators profiting – without regard to market direction.

It’s poor fodder for a 24-hour news cycle. But it explains market behavior. Moves have become more pronounced because money stopped pouring into US equities via ETFs this year. Volatility exploded because getting tax efficiency got harder.

Which brings us to the “actionable” hoax. The word “actionable” says consumers of products or services are fixated on a prompt, a push, an imprimatur.

Fine. But flinging the word around causes investors and IR professionals to miss what matters more, and first.  Investors and public companies should be asking: “How does this service or that tool help me understand what the money behind stocks is doing?”

Ask your service provider to explain how your stock trades. Then ask us to explain it.

If they don’t match, ask why. The beginning point of correct action is an understanding of what you can and cannot control, and how the environment in which you operate works.

Take the weather. We can’t control it. But it determines the viability of our actions. The same applies to understanding market structure. It determines the viability of actions.

If you want to learn market structure, ask us how, IR professionals and investors.  It’s the starting point. What you think is actionable may be a hoax. Compare how the market works to what you’re doing. Do they match? If not, change your actions. We’ll help you.

Chasing Gaps

Have you ever set an important goal?

Whatever your objective, you must plan how to arrive at your final destination as though it were a journey and you were constructing a map or set of directions. And then you persevere, letting nothing deter your purpose.

We don’t all achieve our goals and any extended effort carries risk. You can fail. Your directions could be wrong. You may have underestimated the obstacles between aspiration and destination.  Or you stop caring. Right?

What if success instead constituted correctly tabulating the difference between planned and actual progress? Boy that would be a lot less stressful. And you would have an arbitrage formula!

Every week governments the world round disgorge data on employment, the real estate market, manufacturing, exports, imports, budgets, capital spending, commodities, corporate profits, relative values of currencies, economic growth and more.

Yesterday, markets in the US considered the balance of international trade, The Institute for Supply Management’s non-manufacturing index (fairly strong) and the Purchasing Managers Index of services (modest but new orders were abysmal). Today’s data smorgasbord features mortgage applications, oil inventories and the Federal Reserve’s Open Market Committee ledger called the FOMC Minutes about what central bankers said at the March meeting.

Economists and investors troll the data for indications of future economic growth or contraction. They’re looking for progress toward purpose. Arbitragers react to it differently, trading the spread between expectations and outcomes.

Fundamental investment dominates? If only. We measure market behaviors. Active investment is barely more than a third of the daily volume of arbitrage.

We could define arbitrage as the difference between planned and actual progress – how something is faring relative to goal, or expectation.  In practical terms, arbitrage funds seek spreads between the current price of stocks and their forward value reflected in a futures contract.  If a stock is considered undervalued now but likely to rise later (call that a goal), a trader will buy the stock and sell a futures contract for commensurate shares.

The less predictable the future is, the shorter the arbitrage timeframe. Weekly options and futures tied to equities, exchange-traded funds and indexes used to be a rounding error. Today they’re 35% of the options market. Trading in options has a notional value five times that of stock-market dollar-volume daily. Nearly 50% of options trace to one security: SPY, the giant S&P 500 ETF.

If the S&P 500 is the goal, the path, the standard, then options reflect the difference between the goal and the expectations, the progress. You see?

Alas, a marketplace with relentless data minutia and nearly infinite ways to bet money on the difference between goal and progress shifts the purpose of the market from goal-achievement to chasing gaps. Why focus on the long term with its pervasive risk and uncertainty when it’s cheaper and less risky to speculate on whether the PMI Services number will be up or down and how new short-term expectations will affect markets?

Now add this in:  Yesterday the Bank of Japan talked the yen down by suggesting it might take interest rates further negative. The Reserve Bank of Australia warned about currency strength, tantamount, too, to talking money down. The Reserve Bank of India cut rates to a five-year low. Money denominates stocks, bonds, derivatives, commodities. Moving money-values constantly shifts focus from the future to a pairs-trade.

Markets are packed with speculators because we’re obsessed with information that deviates the purpose of capital markets from goals to whether something has departed from a benchmark. It institutionalizes averages and promotes arbitrage – chasing gaps.

We could change it by stilling the tides of data and currencies. Prospects for that goal? Currently a number approaching zero. I believe I’ll take out a short futures position.

Smart Beta

“Management wants answers when we don’t trade with our peers.” This is a lyric from a song by the rock band Smart Beta.

Just kidding. But Smart Beta is as good a rock-band name as One Direction and each begets the other in the stock market. Because capital-markets globally have become variations on a barcode theme – call it one direction – investors are experimenting with ways to break away.

Just yesterday you could see a currency patina painting worldwide equities, with some Asian markets up equal to declines in European stocks. Then when US shares began trading, ours were both up and down, a sort of global convergence.  As currencies fluctuate, divergences spill into assets denominated by them, feeding short-term arbitrage. It’s still a pattern.

Back to the opening salvo, it’s a routine refrain: “My CEO wants to know why we’re down and our peers are up.”  Patterns vex not only IR folks trying to answer management but the scads of money entrusted to fund managers promising as they all do to “outperform the market.”

Enter Smart Beta.  Some call it “factor-driven investment,” others “strategic beta.” Beta in investment-speak defines comparative performance so smart beta implies better comparative performance. Beta 1.0 defines behavior for the whole market. Figures above or below 1.0 signal a security’s historical tendency to be more or less volatile than broad measures.

We get all that, right? It’s outdated. Beta no longer captures volatility well since any widely traded stock will have thousands of daily prices, the final one the closing price. We prefer to measure intraday volatility.

And our hunt for better metrics is like quantitative effort to break from the Blackrock/Vanguard pack. That’s smart beta. Vanguard itself is toying with the concept through funds like the Vanguard Dividend Appreciation ETF.  Founder Jack Bogle nonetheless scoffs, telling CNBC’s Tom Anderson in a March 2015 story, “Active managers are just trying to come back and say there is a better way to index, when they know damn well there isn’t a better way.” (more…)

Maybe we should leave more often. Out just one week, and both silver and Osama Bin Laden’s house go on the auction block.

Sunday night after flying back from Antigua by way of Newark, I reviewed a week’s worth of client stock alerts for perspective. Stepping through a side exit and closing the door on life’s cacophony for a week, time stops. The return, the jolt of the madding crowd, is revealing. It’s amazing what you see.

More in a moment, but I promised some of you I’d share what we saw beyond the Truman Show. Apparently you can’t get from Denver to the French West Indies in a day on one airline, (more…)

The Trouble with Liquidity

We can’t compete with beat-by-beat election updates, so we’ll keep it short and sweet.

Speaking of sweet, we came back last night from six days in the desert trinity—Moab, Sedona, Santa Fe. Hard to beat this time of year!

You heard the one about two guys getting robbed? They’re walking down the street, a mugger stops them and demands their wallets. As they’re complying, one reaches in his wallet before handing it over and says to the other, “Here’s that $20 I owe you.”

It may be like that with the obsession over liquidity in the trading markets. (more…)

IROs, Own Your Market Structure

“The CFO wants to know why our stock is down when it should be up.”

That’s the essence of conversations I had yesterday with two investor-relations officers. It’s tempting to suggest asking Al Gore about why things that should be up are instead down. But that’s an old joke. And it won’t make you more valuable in the IR chair.

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