Tagged: Investor Relations

Core Reality

“Our stock dropped because Citi downgraded us today.”

So said the investor-relations chief for a technology firm last week during options-expirations.

For thirty years, this has been the intonation of IR. “We’re moving on the Goldman upgrade.”  “UBS lifted its target price, and shares are surging.” “We’re down on the sector cut at Credit Suisse.”

But analyst actions don’t buy or sell stocks.  People and machines do. Thirty years ago you could be sure it was people, not machines.  Now, machines read news and make directional bets. And why is a sellside firm changing its rating on your stock smack in the middle of expirations?

We’ll get to that. Think about this. Investors meet with you privately to learn something about your business or prospects somebody else might overlook.  Analyst actions are known to all. You see it on CNBC, in new strings, from any subscription feed.

How could it be uniquely valuable information proffering investment opportunity?

Let me phrase it this way. Why would a sellside firm advertise its views if those are meant to differentiate?  If you’re covered by 50 analysts with the same view, how is that valuable to anyone?

Indexes and exchange-traded funds track benchmarks. Call them averages.  Brokers must give customers prices that meet averages, what’s called “Best Execution.” If most prices are average, how are we supposed to stand out?

Now we get to why banks change ratings during expirations. Citi knows (Citi folks, I’m not picking on you. Bear with me because public companies need to learn stuff you already know.) when options expire. They’re huge counterparties for derivatives like options, swaps, forwards, reverse repurchases.

In fact, yesterday’s market surge came on what we call “Counterparty Tuesday,” the day each month following expirations when the parties on the other side of hedged or leveraged trades involving derivatives buy or sell to balance exposure. They were underweight versus bets (our Sentiment Index bottomed Monday, signaling upside).

Sellside research is a dying industry. Over 40% of assets now are in passive-investment instruments like index and exchange-traded funds that don’t buy research with trading commissions as in the old days.

How to generate business?  Well, all trades must pass through brokers.  What about, say, nudging some price-separation to help trading customers?

How?  One way is right before the options on stocks are set to lapse you change ratings and tell everyone.  No matter who responds, from retail trader, to high-speed firm, to machine-reading algorithm, to counterparty backing calls, it ripples through pricing in multiple classes (derivatives and stocks).  Cha-ching. Brokers profit (like exchanges) when traders chase spreads or bet on outcomes versus expectations.

We’re linear in the IR chair. We think investors buy shares because they might rise, and sell them when they think they’re fully valued. But a part of what drives price and volume is divergences from averages because that’s how money is made.

In this market of small divergences, your shares become less an investment and more an asset to leverage. Say I’m a big holder but your price won’t diverge from the sector. I get a securities-lending broker and make your shares available on the cheap.

I loan shares for trading daily and earn interest. I “write” puts or calls others will buy or trade or sell, and if I can keep the proceeds I boost yield.

I could swap my shares for a fee to the brokers for indexes and ETFs needing to true up assets for a short time.  I could sell the value of my portfolio position through a reverse repurchase agreement to someone needing them to match a model.

Here’s why traders rent. Say shares have intraday volatility – spread between daily highest and lowest prices – of 2%, the same as the broad market. A high-speed algorithm can buy when the price is 20 basis points below intraday average and sell when it’s 20 basis points over (rinse, repeat).

If the stock starts and finishes the month at $30, the buy-and-hold investor made zero but the trader capturing 20% of average intraday price volatility could generate $4.80 over the month, before rental fees of say half that (which the owner and broker share).  That’s an 8% return in a month from owning nothing and incurring no risk!

Let’s bring it back to the IR chair.  We’d like to think these things are on the fringe. Interesting but not vital. Across the market the past twenty days, Asset Allocation was 34% of daily volume. Fast Trading – what I just described – was 37%. Risk Management (driving big moves yesterday) was almost 14% of volume.

That’s 85%. The core reality. Make it part of your job to inform management (consistently) about core realities. They deserve to know! We have metrics to make it easy, but if nothing else, send them an article each week about market-function.

Metrics

How many of you wear a Fitbit?

I remember the last time I saw Jeff Morgan, erstwhile NIRI CEO.  I said, “Jeff, you’ve lost weight. You’re a lean machine!”

He tapped his wrist, and said, “Fitbit. You can appreciate it, Tim. It’s just measuring data, right? Burn more than you take in.”

When we were roaming Barcelona last September, Karen’s phone was a cheering section congratulating us for achieving footstep goals.  Because there’s an app for that of course.

We’ve now bought a Peloton for our home gym, a finessed stationary bike replete with interaction and data. You can measure everything. You mark progress and capability.

On Friday the 13th the Wall Street Journal ran a story about online life insurance. Companies are using algorithms that parse lifestyle data from prescription-drug, motor-vehicle and credit-card sources to meter risk in place of testing blood and urine.

Data reveal facts about conditions. That’s the starting point. The next step is comparing data gathered in one period with the same metrics from another to see what’s changed. It’s what your doctor does.

And it’s the heart of financial reporting. We can debate the flaws of the requirement, but every quarter public companies are providing metrics to investors and analysts, who in turn model the data to understand business outcomes.

In fact, it’s the beat of the market. Every week data pours forth from governments and central banks on producer-prices and purchasing managers and jobs and consumer sentiment and on and on it goes.

I think it’s too much, promoting arbitrage on expectations versus outcomes. But think of the cognitive dissonance in our profession, investor-relations.  While everyone is measuring short-term, IR is trying to manage long-term. Yes, we want long-term commitment to our shares.  But that’s not how prices are set.

Unless you measure something the way it functions, you’ll get incorrect conclusions.

Much of the IR community isn’t measuring at all. We react. Right? The stock moves, and we call people for explanations.  How can answers be accurate without comparatives?  You don’t know what’s changed. No Fitbit is delivering data supporting conclusions.

The key to good management is consistent measurement. It’s the only way to understand an ecosystem and sort what you can control from what’s systemic.

Suppose I declare that I will float across the room.  Well, gravity, the rule governing the movement of bodies in this universe, says on this planet my pronouncement is flawed.

The gravity of the stock market is Regulation National Market System.  It defines how money moves from point A to point B.  We can observe those movements.

I showed a company yesterday how shares climbed from $60 to $70 during election week last November on Asset Allocation, and from $70 to $72 on Risk Management. That means ETFs and derivatives boosted shares.  Active money didn’t buy until the stock was at $75, even though it was selling the stock at $61 right before the election. Active money didn’t know what to do.

What followed? Fast Traders sold and shorted because the last fools to the party were the Active stock-pickers unaware of how the market works now.  No wonder many lag the averages.

If investors making rational decisions set the prices of stocks more than 50% of the time, the market can be called rational. Otherwise, it’s got to be called something else.  IR professionals, it’s your job to help management see the market realistically.

All the people talking about stocks are of a breed. The sea of money using models isn’t telling others what it’s doing!  But it’s setting prices.

You must measure now. What’s your Fitbit for the IR job?  Is it calibrated to the market we have today or one that no longer exists?

Case in point: I told a healthcare company recently that the data showed they would be unable to hold any gains until short volume were no longer consistently 65%.

“But our short interest is well below sector averages,” they said.

“That measure is from 1975,” I said. “It doesn’t reflect how the market works now.”

The stock dropped 8% yesterday and remains at the same average price it’s had since short volume rose over 60% well more than a quarter ago. The data – the Fitbit for IR – will tell them when conditions have changed.  Fitness can be measured in IR as it is elsewhere.

Measurement is management.  Put key metrics in front of your management regularly. Don’t wait to be asked for information – then it’s too late and you’ve lost control and become a glorified assistant (and they’ll define the job for you).

Create anticipation with metrics. “We’ve had a nice run but Fast Traders are leading, we’re Overbought, and short volume is over 50%, so expect some pressure next week.”

That’s what you should be doing.  Stop calling people for wild guesses unsupported by data AFTER something has occurred. Start measuring and setting expectations – especially around earnings, or events like options-expirations today through Friday.

You can only set expectations if you’re first consistently measuring and comparing key data points. This is evolved IR.  You can invent your own metrics. But we’ve already done that for you.

Two Pillars

I hit a nerve.

What sparked the tempest was my assertion last week that investor-relations professionals can’t be just storytellers when over 80% of trading is not Active investment.  (For you investors, it’s why stock-picking is performance-challenged.)

It’s not that respondents raged against the machines of the markets, or at me. Folks just wondered what to do instead.

A good friend and respected veteran in communications prodded me.  “You need to be specific,” he said. “You do a good job explaining the market, but don’t fade to generalities at the finish.”

I’m paraphrasing. In my mind, I’m clear. Perhaps on paper I’ve been less so. I conceded that he must be correct. So as the new year begins with the prospect of blessings, here are two firm principles for IR:

Rule No. 1: Build a diverse palette of institutional relationships strategically, then consistently match product to consumer tactically.

The market at some point will treat your shares, which are a product, in a manner that departs from the story you tell to support them. Broaden the audience.

Investors, think about this from a stock-picking perspective. You can select companies with great fundamentals but if Asset Allocation models don’t like them, expect the stocks to lag.

And yes, it’s possible to know what kind of money moves into and out of which stocks or sectors. We do it every day. We’ll come to that with some real examples.

Now match product to consumer, which is good relationship-management. Make this tactic a simple weekly action. We lay out a plan for you. It turns on metrics.

Nordstrom doesn’t randomly call people when the new Eton shirts are in, or whatever. They know which customers buy those shirts because they measure and track behavioral data. IR should too, and can.

Say you’re a growth story. But your shares are falling. The data show it’s Fast Traders shorting your shares, not investors selling. You can only affect active money, but get specific. Call the kind that likes Eton shirts. Deep-value high-turn hedge funds.

Every IR team should build (strategy) three or four such relationships. Tactically follow up only when your product matches. Help them achieve their investment objectives. They’ll help your shares recover so you’re a growth stock matching story.

Rule No. 2:  Measure the kind of money setting price, and make it part of management’s thinking (which takes persistence).

We’ve made it simple with six key metrics. The stock market is not a single monetary demographic, and it’s not long-term. Facts. Not threats to IR.

Copernicus said the earth was orbiting the sun, not the other way around. People wanted to go on doing what they always had.  Help your management team adapt to the real world. Yes, they’ll resist. Don’t let them revert to incorrect practices.

Example: A health care company has for the last five of seven weeks had Fast Trading as the leading price-setter, and short volume is consistently 65%.  Price reverts repeatedly.

The IR professional should tell management so executives won’t waste money on trying to reach more investors or blame IR for communicating ineffectually.

The data say investors are not responsible. Sure, the team might pick relationships to call that buy Eton shirts – aggressive, able to take risks in trading ranges.  But high short volume signals investors prefer renting shares out to investing more money in them.

The vital action item here is to set realistic expectations for management – perhaps flat tell them that the story and strategy need adjustment if investors are to engage again.  That’s powerful. And cost-effective.

A big client did a massive deal. For months the data showed investors hated it. No matter what they said with their lips, their money was not setting prices. The team tracked data and tweaked message and finally behavior changed. The deal closed. Powerful data.

Another client tracked investor-engagement for a year through a short attack and industry disfavor but ended with Superb investor-engagement using our measure called Gamma.  Awesome success metric.

Another had become a momentum growth stock without a momentum growth story, thanks to industry expectations. Data showed the dilemma ahead of a call that would likely recalibrate expectations. It showed big downside risk. But the transition out by growth money and the point where value investors set price were measurable, helping the IR team consistently inform management despite a painful reset to price.

The most important effort in any management discipline is understanding how the ecosystem functions. It’s impossible to make good decisions by guessing.  IR is a product manager.

There are two pillars to great IR in the 21st century. Build and manage diverse institutional relationships, matching product to consumer. Measure the data, understand the behavior setting price, and communicate it to management relentlessly.

You can’t run a truly 21st century IR program without knowing what kind of money is setting your price.  And why would you?  I didn’t say you can’t run a program. But it’s that vital, essential.

You can know what sets price. You can see how money changes over time.  You can use it to run your IR program efficiently and proactively (it’s our plan to bring behavioral analytics to investors in 2017 too). And you can look cool and feel less stressed.

That’s a darned good 2017 strategy, resting on big pillars.

The Math

“Making investment decisions by looking solely at the fundamentals of individual companies is no longer a viable investment philosophy.”

So said Steve Eisman, made famous in Michael Lewis’s book The Big Short, upon shutting down his new investment fund in 2014.  Actor Steve Carrell portrayed Eisman as Mark Baum in last year’s hit movie from the book.

Michael Burry, the quirky medical doctor running Scion Capital in the book and the movie (played by Christian Bale), first earned street credibility via posts about stocks on Silicon Investor, the online discussion forum huge before the dot-com bubble burst.

But in the ten years after Regulation National Market System transformed the stock market in 2005 from a vibrant human enterprise into a wide-area data network, 98% of all active stock-pickers failed to beat the S&P 500, proving Mr. Eisman correct.  You can’t pick stocks on merits alone now.

That’s contrary to the legacy objective of the investor-relations profession, which is to stand the company’s story apart from the rest.

As with finding the root of the mortgage-industry rot, today the market is all about data.  Everything is.  Google Analytics examines internet traffic patterns.  ZipRecruiter is analytics for hiring. Betterment is analytics for personal investing.  HomeAdvisor and Angie’s List are analytics for home-repair. Pandora is analytics for music you like.

Pick your poison. Everything is data. So why, ten years after Reg NMS, is the IR profession calling someone to ask, “How come my stock is down today?” All trades pricing the market under Reg NMS must by law be automated.

If you’re calling somebody to ask about your stock, I’m sorry but you’re doing IR like a caveman. And, paraphrasing Steve Eisman, running the IR department solely by telling the story to investors is no longer a viable industry philosophy.

Why? Because it begins with the flawed premise that the money buying and selling your shares is motivated by fundamentals alone.  For the past decade – the span of Reg NMS – trillions have departed active stock-picking portfolios and shifted to indexes and Exchange-Traded Funds, because tracking a benchmark is a better path to returns.

Take yesterday.  All you had to do was buy technology and materials stocks.  Today it might be something else. The most widely traded stock on the planet is SPY, the S&P 500 ETF.  It traded $7 billion of volume yesterday, ten times BAC, the most active stock.

Here’s another. XLU, the Utilities ETF, was among the 25 most actively traded issues yet the sector barely budged, up 0.04%. Why active then? ETFs fuel arbitrage.  Profiting on price-differences. It’s not where prices close but how they change intraday.

Best trade yesterday?  NUGT, the leveraged gold ETF, was up 7.5% even though gold has been a bust the past month.  The S&P 500 took the whole year to gain 10% and then only on the Trump Bump. Between Dec 30 and Oct 31, the S&P 500 eked out 2% appreciation. You could triple that in a day with NUGT so why invest long-term?

“Boy, Quast,” you say. “It’s the holiday season! What are you, The Grinch?”

Not at all! The opposite in fact. I’m on a quest to make IR central to public companies again. We invented Market Structure Analytics, data for the IR profession to address the demise of IR as Storyteller.  The future for our profession isn’t a command of fundamentals but knowledge of market form and function.

Let me be blunt. Anybody can tell the story. Only IR professionals dedicate themselves to knowing how the market works – and that’s job security, a transferrable skill set.

The way IR shifts back from a rotational role to vital standalone profession is through knowledge of the stock market. If you want to be a biologist, study and understand biology. If you want to be a biology reporter, you just need to know some biologists (no offense to biology reporters).

Which will the IR profession be in 2017?

Having threshed trading data for 15 years now through the regulatory and behavioral transformation of the equity market, I feel a tad like those guys in The Big Short who studied mortgage numbers and concluded it was irrefutable: It was going to blow up.

These data are irrefutable: Over 80% of your volume most days is driven by something much shorter-term than your business strategy.  Ergo, if all you tell your Board and management is how your strategy influences the stock, you’ll at some point be in trouble.

This is the lesson of 2016.  Make 2017 the year IR transforms how the people in the boardrooms of America understand the stock market. That is an invigorating challenge that will breathe value into our profession. The math doesn’t lie.

Verve and Sand

The whole market is behaving as though it’s got an Activist shareholder.

In a sense it does.  More on that in a minute.

We track the effects of Activism on trading and investment behaviors both before it’s widely known and afterward. A hallmark of these event-driven scenarios is behavioral volatility. That is, one or more of the big four reasons investors and traders buy and sell stocks routinely fluctuates day-over-day by more than 10% in target companies.

(Aside: Traders and investors buy and sell stocks for their unique characteristics, when they have characteristics shared by others, to profit on price-differences, and to leverage or protect trades and portfolios. The market at root is just these four simple purposes.)

Event-driven stocks can override normal constraints such as Overbought conditions, high short volume, or bearish fundamentals.  In fact, short volume tends to fall for catalyst stocks because the cost of borrowing shares rises as more want to own rather than rent, and unpredictability of outcomes makes borrowing shares for trading riskier.

Currently in the broad market, shorting trails the 200-day average marketwide. The market has manifested both negative and overbought sentiment and has still risen.

And behavioral volatility is off the charts.

Almost never does the broad market show double-digit fluctuations in behavior because it’s a giant index smoothing out lumps. With quad-witching and quarterly index rebalances Dec 16, Asset Allocation ballooned 16.3% marketwide, signaling that indexes and ETFs are out of step with assets (and may be substituting).

Also on Dec 16, what we call Risk Management (protecting or leveraging trades and portfolios) jumped 12%. It’s expected because leverage with derivatives has been pandemic in markets, with Active Investment and Risk Management – a combination pointing to hedge funds – currently leading.

Here’s the thing. The combined increase for the two behaviors last Friday was an astonishing 28%.  Then on Dec 19 as the new series of marketwide derivatives issued, Fast Trading – profiting on price-differences – exploded, jumping 25%.

A 25% change for a stock trading $100 million of dollar-volume daily is a big deal. The stock market is about $300 billion of daily dollar-volume.

Picture a skyscraper beginning to sway.

Looking back, Risk Management jumped 16% with July expirations, the first after searing Brexit gains. The market fell from there to September expirations when again behavioral volatility exploded. The market recovered briefly before falling all the way to the election. With expirations Nov 18, Risk Management shot up 11.2%.

Behavioral volatility precedes price-volatility. We have it now, monumentally.

What’s happened in the broad market is a honeymoon before the wedding. The incoming Trump administration has sparked an investing surge betting on a catalyst – exactly the way Activist investors affect individual stocks.  Fundamentals cease to matter.  Supply and demand constraints go out the window. A fervor takes hold.

The one thing our long bull market has lacked is fervor. It’s the most hated – and now second longest ever – bull market for US stocks because so many have loathed the monetary intervention behind ballooning asset prices.

That’s all been forgotten and a sort of irrational exuberance has set in.

Those who know me know I embrace in libertarian fashion broad individual liberty and limited government because it’s the environment that promotes prosperity best for all. I favor a future with more of it.

We should get the foundation right though. I’ll use a metaphor.  Suppose a giant storm lashes a coast, burying it in sand. Some return to the beach to rebuild homes and establishments but much lies listlessly beneath a great grainy coat.

Then a champion arrives and urges people to build. The leader’s verve lights a fire in the breasts of the people, who commence building a vast structure.

Right on the sand.  Which lies there still unmoved, a shifting layer beneath the mighty edifice rising upon it.

It’s better to remove the sand – all the central-bank buildup from artificial prices, the manufactured money, the warped credit markets.  Otherwise when the next wave comes the damage will be that much greater.

So call me wary of this surge.

Bang the Close

I find myself in an uncomfortable position.  I’m siding with a high-frequency trader.

There’s a key lesson here for investor-relations professionals about how prices are set, and it dovetails with why the bulk of volume concentrates around the open and close.

The title of this piece would be a great name for a rock band but it refers to submitting securities trades during the last 15 minutes of trading to affect how average prices are calculated. That’s “banging the close,” it’s said.

Venerable Chicago high-speed firm DRW, a proprietary trader focused on derivatives markets, has been accused by commodities regulators of manipulating prices on a key interest-rate swap. The alleged malfeasance occurred in 2011.

Normally firms settle with regulators when charged with rule-breaking. Founder Donald R. Wilson, a prominent figure in Chicago, insists DRW did nothing wrong and is battling the US Commodities Futures Trading Commission in court.

The CFTC says DRW submitted a thousand orders over seven months that didn’t conform with other prices during the vital last 15 minutes when “settlement prices,” or average prices for contracts and broker margin-requirements, are calculated. A broker serving as counterparty might have to furnish more capital if the price moves.

The CFTC is miffed because it believes DRW made money even though none of its bids produced a matched trade.  DRW says it was simply profiting on differences between the futures contract and the same product traded over-the-counter (that is, by brokers). The swaps contracts pay buyers (DRW was always the buyer) a fixed fee and sellers a floating one. Floaters lost, among them the now-defunct MF Global.

Let’s summarize for those who like me need an adult beverage after sorting this matter. The CFTC claims DRW manipulated prices for gains by putting in bids that weren’t like other bids. DRW says it bids what it thinks things are worth, not whether the price conforms to others’ views, and sometimes someone loses. That’s my interpretation.

What’s this got to do with IR and stock-trading? The IR job is predicated on helping investors understand why your shares are worth more than somebody else’s.  Are you manipulating prices then?  Of course not. And sometimes stocks decline.

Secondly, one reason Blackrock and Vanguard routinely beat your active holders for investment returns is because of stupid rules forcing prices to averages at the expense of those looking for outliers. Without outliers in markets, there’s no room for stock-pickers – the lifeblood of the IR profession. The market should reflect all prices, not averages.

It’s partly why volume is big in the morning and at the close.  Those prices are used to calculate averages. Your shares often move up or down early, toward the mean between, and then up or down into the close (see yesterday’s trading).  It could be argued that many algorithms are banging the close, which means banging is no aberration – or that the whole market is a series of continuous manipulations (don’t answer that!).

If DRW is a manipulator, then so was George Soros in the British pound. So are trading algorithms pursuing volume-weighted average prices because they undermine your effort to help your stock diverge from averages.

So is the Federal Reserve. The Fed sets artificial interest rates to manipulate broader ones, which it will likely do again Dec 14 (with $460 billion of reverse-repurchases on its balance sheet, another manipulation scheme, the Fed signals hike intentions). How is that different from DRW bidding at prices it believes reflect appropriate value?

If DRW is a price-manipulator, so was my dad.  On the cattle ranch of my youth, we’d take our animals to market and bid on them to push the price up to a level we thought proper. If the buyers didn’t like it, we bought the cattle back and took them home.

This would apparently have earned CFTC accusations of manipulating cattle prices.

Pardon me for bluntness but let’s knock off the crap, shall we? Rules that force all prices to the mean – which proliferate in equities and everywhere else now – defy supply and demand, foster mediocrity and promote sudden and irrational reversions to a mean.

I don’t prefer proprietary traders committing no long-term capital to budding businesses.  But.  If we want to reduce risk in the capital market, here’s an idea:  Let any buyer or seller price as he or she wishes. Suppose brokers could do it too. Maybe that would bring aftermarket support back to IPOs, creating new IR jobs again.

That’s my suggestion for the incoming SEC chair.

Best Of: The GRAR

Editorial Note: Happy Thanksgiving!  We hope you reflect gratefully this season, as we will.  And speaking of reflecting, you might think with markets hitting new all-time highs after the election that we’ve beaten a retreat (what the military calls without irony “advancing to the rear”) from our two-year declamation about coming risk-asset revaluation. We’re by no means complaining about gains. We think prospects for the USA merit giving thanks. 

But there will be no escaping the consequences of artificial asset-price inflation. You can’t blow a balloon full of air and suppose it’ll float forever.  Runs here in November will have a profound reversal magnified by the meteoric dollar-rise. Whether it happens in days or weeks, it’s coming. The question for the new administration will be whether it possesses the fortitude to let prices find proper equilibrium so the economy can actually find “escape velocity” finally, in its aftermath.  -TQ

Originally posted Nov 9, 2016:

Power changed hands in the USA today.

I don’t know in what way yet because I’m writing before election outcomes are known, and about something for the market that will be bigger than which person sits in the oval office or what party holds congressional sway.

The GRAR is a lousy acronym, I admit. If somebody has got a better name, holler.  We started talking about it in latter 2014.  It’s the Great Risk Asset Revaluation. We had the Great Recession. Then followed the Great Intervention. What awaits the new Congress and President is the GRAR.

I’ll give you three signs of the GRAR’s presence.  Number one, the current quarter is the first since March 2015 for a rise in earnings among the S&P 500, and the first for higher revenues since October 2014. Until now, companies have been generating lower revenues and earning less money as stocks treaded water, and the uptick still leaves us well short of previous levels.

Since 1948, these recessions in corporate financials of two or more quarters have always accompanied actual recessions and stock-retreats. The GRAR has delayed both.

Second, gains off lows this year for the Dow Jones Industrial Average have come on five stocks primarily. One could use various similar examples to make this point, but it’s advances dependent on a concentrated set of stocks.  This five – which isn’t important but you can find them – include four with falling revenues and earnings. Counterintuitive.

Finally, the market is not statistically higher (adding or subtracting marketwide intraday volatility for all prices of nearly 2% daily) than it was in December 2014.

That’s remarkable data.  It says prices are not set by fundamentals but intervention.

We might think that if earnings growth resumes, markets will likewise step off this 2014 treadmill and march upward. And that’s independent of whatever may be occurring today – soaring stocks or falling ones, reflecting electoral expectations versus outcomes.

In that regard, our data showed money before the election positioned much as it was ahead of the Brexit vote:  Active buying, market sentiment bottomed, short volume down – bullish signals.

You’ve heard the term “delayed gratification?” It means exercising self-discipline until you’re able to afford desired indulgences.  Its doppelganger is delayed consequences, which is the mistaken idea that because nothing bad arises from bad decisions that one has escaped them.

The bad decision is the middle one – The Great Intervention.  The Great Recession was a consequence arising from a failure to live within our means. When we all – governments, companies, individuals – spend less than we make, nobody ever needs a bailout.

But you don’t solve a profligacy problem by providing more access to credit.  The breathtaking expansion of global central-bank balance sheets coupled with interest rates near zero is credit-expansion. To save us from our overspending, let’s spend more.

If I held in my palms a gold coin and a paper dollar and I said to you, “Pick one,” which would you take?

If you said “the dollar bill,” I can’t help you and neither can Copernicus, who first described this phenomenon that explains the GRAR 500 years ago. Nearly everybody takes the gold, right? We inherently know it’s more valuable than the paper, even if I tell you they have the exact same value.  This principle is called Gresham’s Law today.

Credit does not have the same value as cash.  But assets in the world today have been driven to heights by credit, the expansion of which diminishes the value of cash.

What happens when the people owning high-priced assets such as stocks, bonds, apartments in New York, farmland in Nebraska and so on want to sell them?  All the cash and credit has already been consumed driving prices up in the first place.

What will follow without fail is the GRAR. Depending on who got elected, it might come sooner or later.  But without respect to the winner, it’s coming.  The correct solution for those now in power is to avoid the temptation to meet it with credit again, and to let prices become valuable and attractive. Painful yes, but healthy long-term.

That’s the path out of the GRAR. I hope our winner has the discipline to delay gratification.

A Rational Market

The market appears to have become the Walking Dead.

I don’t mean a collection of bodies reduced to bloody pulp by a barbed-wire encased baseball bat. That would be the Presidential election. (Aside: you who watched the new Dead episode know with nauseating certainty what I mean.)

No, market volume is a zombie compared to the summer. Volume was 6.7 billion daily shares Jun-Aug 2016.  Now we’re eking out 5.8 billion, a drag-footed, scar-faced amble.

Usually it’s the other way around.

Meanwhile, business media has been fixated (somewhat ironically) on the Passive invasion that’s digging a giant hole and burying stock-pickers. The Wall Street Journal last week ran a half-dozen stories on the death-grip indexes and exchange-traded funds have laid on investing. Not to be outdone, CNBC covered the big lurch into market passivity all last week.

Both reported how Blackrock has amassed $5 trillion of assets (while, we’d add, ignoring the sellside, discounted cash-flows and earnings calls).  A WSJ article titled Passive Can Be Very Active described how leveraged ETFs classified as passive vehicles drive immense daily volume (we told you about these things a long time ago).

But volume is moseying. So wither the wither?  It looks like Passive is responsible. Now, the market is a uniform beast in which every barcoded thing must behave like the rest or regulators fine it for looking different, by which I mean failing to trade at the averages. If any stock so much hints at departing from the crowd it’s immediately volatility-halted.

I exaggerate for dramatic effect but only some. Rules create uniformity that makes standing out difficult. So over time stocks cluster around the averages like, well, zombies. The world’s most widely traded equity by a country mile is SPY, State Street’s ETF proxy for the S&P 500.  It routinely manages $25 billion of daily volume.

But that was last summer. Monday with the November series of options and futures trading marketwide – routinely it’s hectic with new derivatives – it managed about $11 billion, just 45% of its summertime tally.

We measure the share of daily volume driven by Passive investment marketwide. It’s not down a lot, 100 basis points or so. But that’s every day. And it ripples into options and futures that counterparties back with equity-trading as placid measures mean indexes and ETFs use fewer of them to true up positions. Weaker Fast Trading follows, and anemic ETF market-making. Pretty soon it’s the walking dead.

But there’s a storyline of survival. While the corpus of passivity has shriveled like bacon in a hot pan, or perhaps more accurately like one of those flex hoses when you shut the water off, underneath there is a turgid Active current.

I mean Active investment. We’re a data-analytics firm so we measure everything.  We know each day what percentage of our clients earn new Rational Prices (fair value) when Active stock-pickers buy.

Amidst listless Passive volume, we have seen surging Rational Prices.  On Oct 13, a stunning 32.7% of our client base had new Rational Prices even as volume wilted like pumpkin leaves after the first frost.

Last Friday, the 21st, the penultimate Friday before Halloween and fittingly hosting triple-witching, an impressive 15.5% of our clients were valued rationally by Active investment.

There’s a post-mortem here, a timeless market-structure lesson. First, volume that’s not Rational distorts fair value. Stuff that pursues averages hurts stock-pickers.

And if volume decreases while Active Investment improves its price-setting authority, volume does not equal value.  What matters is the kind of money setting price. With less competition from zombies, the enterprising can make supply runs.

That’s really great news for the investor-relations profession. Our civilization will endure. You don’t need big volume. In fact, if you have big volume the old convention that “you have a big holder buying or selling” is more often wrong than right.  Active money doesn’t want others to know it’s buying. If it does, you better be wary. That’s what Activists do.

There’s more good news.  Where Passive money that puts no thought into its movement is incapable of knowing what lies ahead and can slouch unsuspecting right off cliffs, that Active money bought October brings comfort. There’s Rational Thought in that forest that so often we can’t see for the trees.

Yes, the market like the storyline in the show depends on the zombies. They move the broad measures from one point to the next. You have to be prepared for the occasional slaughter while recognizing that the humans win in the end.  Rational thought trumps.

Volume and Interest

In the five trading days ended Oct 17, 49.1% of average daily stock volume was short.

“Wait, what?” you say.  “Half the stock market is short?”

Yes, that’s right.  Short volume last topped 49% marketwide in mid-April. The market glided gently downward from there to May options-expirations. Speaking of expirations, we’re in them for October this week, so it’s a good time to talk about shorting.

Short volume hit a last marketwide low July 12 at 43%, which roughly corresponded to the high point of the Brexit Bounce.  At Nov 30 last year short volume was 42.9% and December and January were horrific for markets.  And on Jan 7, 2016, short volume was 52%. A month later the market bottomed and soared till April.

If short-volume history is a guide, the market is nearing a temporary bottom. It’s unwise to use a single data point, and we don’t (we use six key measures, plus a small supporting cast, as you clients know). The flow and behavior of money count, and we track both.

“Back up,” you say.  “You lost me at ‘short volume.’ What do you mean by that?”

Short volume is trading derived from borrowed shares.

“I read back in August on Zero Hedge that nobody’s short stocks. Trading from borrowed shares is 2% of the S&P 500, near a three-year low.”

You’re talking about short interest, the long-in-the-tooth risk-assessment tool derived from a 1975 Federal Reserve rule called Regulation T. Shorting and derivatives exploded after the US scrapped the gold standard and the Feds wanted to track margin accounts.

“Are we talking about the same short interest? The amount of total shares outstanding or float that’s borrowed and sold and not yet covered?”

Yes. Forty-one years later it’s still a standard market-risk measure. Yet it’s largely useless predictively. It didn’t shoot up until well after Bear Stearns foundered. In late 2007 it was 1.6%.

“So you’re saying it’s a crappy measure. What’s short volume then?”

Short volume is the amount of daily trading volume that’s borrowed. If a stock trades a million shares a day and short volume is 53%, then 530,000 shares of it were borrowed.  With over 40% of all market volume coming from Fast Traders wanting to own nothing, a great deal of this is short-term trading.

“Okay, I’m following. But what’s it tell me?”

Short volume signals several things but in sum it’s what you think: High short volume, lower price.  Why? Shorting is at root the continual adding of supply to the market. So if demand doesn’t keep up, price falls.

Here’s more:

High short volume means weak expectation for gains. No matter what company fundamentals are, if more volume comes from borrowed shares than owned shares, Fast Traders weighing tick data with high performance machines predict investors would rather lend shares for a return than spend money buying and holding them.

High short volume points to rotation. If the machines want to be short, they’re betting holders are selling and trying to hide it by passing shares through multiple brokers. The converse is true too: If you’ve been short and shorting falls, rotation is probably done.

Persistent high shorting reflects uncertainty about corporate strategy.  Not to pick on Tesla (because it’s not alone by any stretch) but its 200-day average short volume is 55%. Investors say it’s a trading vehicle, not an investment opportunity.  By contrast Qualcomm’s 200-day average is 42%. The two have inverse performance the past year.

Tangentially, high short volume CAN mean ETFs are seeing outflows. Exchange Traded Funds don’t directly buy or sell stocks but they create big volume because ETFs track other measures, such as indexes, that are in turn composed of other issues, such as stocks.

Traders measure deviation between ETFs and these other things and arbitrage (profit on price-differences) the spreads.  When investors sell ETF shares, ETF market makers or authorized participants (parties designated to create and redeem ETF shares) might short components to raise cash in order to buy ETF shares and retire them to rebalance supply.

In sum, short volume is a sensor situated near the beating heart of the money behind price and volume. And while algorithms driving trades today are designed to deceive, they can often be unmasked through short volume (with a couple other key measures).

For the rest of this week though, don’t be surprised if the market shows us not a beating heart but expirations-related palpitations.

Market Serfdom

Last week a stock strategist said passive investment is worse than Marxism.

That’s a way to get attention at risk of offending Marxists. It did (get attention). CNBC covered it. Jason Zweig did too in the Wall Street Journal weekend edition.

It’s relevant to investor relations because passive investment is sweeping the planet. We call it “the elephant in the room” because public companies sometimes seem paralyzed as mass capital inured to the sellside and results and road shows floods stocks.

The shift is huge. Mr. Zweig noted that in the past year $300 billion left active stock-picking portfolios as $400 billion flowed to indexes and exchange-traded funds.  Over the trailing decade, data from the Investment Company Institute show it’s trillion of dollars routing from active funds to passive vehicles.

You’ve seen the Betterment ads?  This “robo advisor” let’s investors precisely tailor exposure to various assets the same way architects use CAD systems to design structures.

At Sanford Bernstein in London, senior analyst Inigo Fraser-Jenkins released a report borrowing economist Friedrich Hayek’s phrasing called “The Silent Road to Serfdom: Why Passive Investing Is Worse Than Marxism.” I thought immediately of “The Princess Bride” as I’d never encountered anyone named Inigo save Montoya (Mandy Patinkin) in that film pursuing the six-fingered man.

Mr. Fraser-Jenkins, erstwhile head of quantitative strategy at Nomura, thinks the six-fingered threat from passive investment is its lack of judgment for committing capital.

Brilliant point. The equity capital market formed so people with money could take risks on businesses that might improve the human lot.  The brokers pooling capital then supported these endeavors with research so investors could make informed decisions.

Enter Blackrock and Vanguard. No, they’re not Trotsky and Lenin papered in currency. But they’re massive through efficiency, market rules, monetary policy (a system, not good judgment, makes it work), not prowess or wisdom.

Mr. Zweig says Vanguard reported owning 6% of all US shares. Assume Blackrock is about 7%. Combined, they’re 10-15% holders of everything. Dictators.

“What happens when everybody indexes?” John Bogle, Vanguard founder, said to Mr. Zweig.  “Chaos, chaos without limit. You can’t buy or sell, there is no liquidity, there is no market.”

Mr. Bogle adds that we’re a long way from there.  Indexes would have to grow to 90% of the market from between 5-10% now. Oh? We’ll come back to this point to conclude.

When money is directed by a model to equities, there’s a shift in purpose from giving to taking.  How? Models take a piece. Investors commit.

The market first formed so entrepreneurs needing risk-taking capital could find it. A market priced around the willingness of investors to accept risks combined with the capacity of businesses to deliver results is the heartbeat of efficient capital-allocation.

Models don’t care about that relationship. They take, then leave. So invention happens on private equity, which removes from the American capital model its defining egalitarianism for the masses and instead concentrates it in ever fewer hands.

Your job just took on added importance, IR pros. You alone can track the impact and evolution of asset-allocation. Move beyond telling the story to measuring quantitative investment. It’s the job of IR to apprise executives and boards of important facts about the equity market.  It’s our market. No index will tell you something is amiss.

So The Elephant slouches toward serfdom.

In that shadow, any company considering itself a yield investment has Big Data looming tomorrow after the close. Most REITS will separate into a new industry classification from Financials.  That’s like a massive index-rebalance playing out over coming weeks.

Concluding, Mr. Bogle is wrong about how much bigger indexing can get before markets are paralyzed.  We’re now pushing limits. Indexes and ETFS are currently 32-33% of daily volume, combined (our measures). At 40% there will be no room for anything but machines. Stocks are needed to satisfy stock-pickers, fast traders, counterparties for derivatives and trading leverage. It’s already so finely balanced that most stocks don’t trade more than 200 shares at once.

You’re the frontline, IR. This is your fight. Report on it (we can help). Solution? Remove rules making averages the goal. Stock-picking would soar anew.  Else? Serfdom.