Tagged: investor relations

Surly Furious

Surly Furious would be a great name for a rock band. And maybe it describes stocks.  It’s for certain the name of a great Minnesota beer.

We are in Minneapolis, one of our favorite cities, where Midwest client services Director Perry Grueber lives, and where nature sprays and freezes into the artful marvel of Minnehaha Falls, and where over pints of Furious IPA from Surly Brewing we deconstructed investor-relations into late evening.

It got us thinking. ModernIR launched Sector Insights this week to measure how money behaves by sector. The data we track show all sectors topping save Consumer Staples.

“Wait, topped? The market has been declining.”

We’re not surprised that closing prices are reverting to the mean, the average, after big swings. You need to understand, public companies and investors, that the market isn’t motivated by your interests.

It’s driven by profit opportunity in the difference in prices between this group of securities or that, over this period or that.

How do we know?  Because it’s what market rules and investment objectives promote. Prices in stocks are set by the best bid to buy or offer to sell – which can never be the same – and motivated most times not by effort to buy or sell stocks but instead by how the price will change.

Who cares?  You should, investors and public companies.

Suppose I told you that in this hotel where you’re staying the elevator only goes to the 5th floor.  You decide it’s immaterial and you set out to reach the 6th floor. You lead your board of directors and executives to believe it should be their expectation that they can reach the 5th floor. Yet as you arrive at the elevator you learn it goes only to the 4th floor.

Whose fault is that?

The beer that put Minneapolis on the map is from Surly Brewing, an India Pale Ale called Furious. What’s better in a name than Surly Furious?  It’s worth drinking.

When the market is surly and furious, you should know it. We can see it first in Market Structure Reports (we can run them for any company), and then in Sector Insights (just out Dec 10) and in the broad market.

Number one question: How does it change what I do?  Investors, it’s easy. Don’t buy Overbought sectors or markets. Don’t sell Oversold sector or markets, no matter how surly and furious they may seem.

Public companies, we expend immense effort and dollars informing investors. Data suggest disclosure costs exceed $5 billion annually for US public companies.

If we discovered the wind blows only from the west, why would we try to sail west? If we discover passive investors are attracting 100% of net new investor inflows, and investors don’t buy or sell your stock, should you not ask what the purpose is of all the money you’re spending to inform investors who never materialize?

We can fear the question and call it surly, or furious. Or we can take the data – which we offer via Market Structure Reports and Sector Insights – and face it and use it to change investor expectations.

Which would you prefer? We’ve now released Sector Reports. If you’d like to know what Sentiment indicates for your stock, your sector — or the broad market — ask us.

Deal Data

From another rumor that game-maker Zynga might have a buyer, to a Trian bid for Papa John’s, to Bill Ackman’s stake in Starbucks, deals and rumors of them abound. Suppose it’s your company, investor-relations professionals. How do you add value for your executives?

These situations are often chess games.  Here’s an example, since much of the drama is now old news.  When Disney battled Comcast for 21st Century Fox and before bids were hiked, patterns of deal arbitrage signaled starkly that a war would ensue.

One could say it’s logical that the price would rise, and so it was.  But there is no certitude like the power of data – patterns of long bets, covered bets. They are stark in the market if one knows how to measure the data (which we do).

After Disney won the bidding war, data then showed high expectation Comcast would win Sky Broadcasting, the European unit partly owned by Disney.  Data then signaled a sudden turn toward accelerated bidding – before the UK Takeover Panel announced that a speeded process would indeed follow.

Think about the data-powered value investor-relations, so armed, delivers to those making important decisions.

I’ll give you more examples.  Two years ago, longtime client Energy Transfer tried a combination with The Williams Companies that would have created an energy giant. The deal-arbitrage data were woeful. Active money stopped buying. Massive short bets formed and never wavered. Ultimately, the firms called off the effort.

A later plan to consolidate Sunoco, an Energy Transfer unit, presented challenges. It would cut cash distributions by roughly a quarter.  Would holders support it?

Data patterns were opposite what we’d seen in the Williams deal – strong, long bets, solid Active investment. We were confident shareholders would approve. And they did.

The company is now consolidating its Master Limited Partnership into the general partner.  We highlighted big positive bets at September options expirations. A week later, both Glass Lewis and ISS came out in favor of the transaction.

Data are every bit as powerful an IR tool as telling the story.  Maybe more so, because we have a mathematical market today riven with behaviors that arbitrage events and track benchmarks passively, motivations fueled by mathematical probabilities and balances more than story.

Oh, did I mention? We have never yet missed an Activist in the data. We’ve always warned early. And we’ve seen a bunch of them.  We know legacy market intelligence struggles to find them because, as we wrote last week, routinely 98% of trading volume fails to manifest in settlement data.

In one instance years ago, Carl Icahn took a major stake in a pharmaceutical company that had two high-paid surveillance providers watching. Neither saw it. Suddenly, Icahn filed with over 8 million shares – accumulated without buying a single share (he used European-style puts.).

We showed the company Market Structure Analytics and the stark patterns of derivatives.  They hired us. Subsequently, our data showed investors were betting against Icahn. His proxy bid to put a slate of directors on the board failed.  We then tracked his gradual withdrawal in the data. Not through shares owned but in patterns of behavior (nearly realtime, at T+1).

Lips can lie. Data those behind it believe are hidden from view – but which shine like light through night-vision goggles for us – is truth.  We have an unfolding situation now where what hedge funds are doing and saying are diametrically opposite. That’s a negotiating tactic. Since management knows, they have the stronger hand.

That’s IR in the age of Big Data.  And it’s fun to boot!  Seeing patterns of behavior and reporting it to executives and board directors puts IR in the right-hand advisory seat.  Right where it belongs in this era of fast machines and market reavers.

If you want a confidential analytics assessment of what’s behind your price and volume (which are not metrics but consequences of behaviors), let us know.

Block Monopoly

This year’s rare midweek July 4 prompted a pause for the Market Structure Map to honor our Republic built on limited government and unbounded individual liberty. Long may it live.

Returning to our market narrative: Did you know that 100% of Exchange Traded Fund creations and redemptions occur in block trades?

If you’ve got 48 minutes and a desire to understand ETFs, catch my podcast (you can get our ETF White Paper too) with IR Magazine’s Jeff Cossette.

In stocks, according to publicly reported data, three-tenths of one percent (0.3%) of NYSE trades are blocks (meaning 99.7% are non-block).  The Nasdaq compiles data differently but my back-of-the-envelope math off known data says blocks are about the same there – a rounding error of all trades.

Blocks have shrunk due to market regulation. Rules say stock trades must meet at a single national price between the best bid to buy and offer to sell.  That price relentlessly changes, especially for the biggest thousand stocks comprising 95% of volume and market cap (north of $2.5 billion to make the cut) so the amount of shares available at the best price is most times tiny.

We track the data.  At July 9, the average Russell 1000 stock traded 13,300 times per day in 160-share increments.  If you buy and sell shares 200 at a time like high-speed traders or algorithmic routers that dissolve and spray orders like crop-dusters, it’s great.

But if you buy cheese by the wheel, so to speak, getting a slice at a time means you’re not in the cheese-wheel buying business but instead in the order-hiding business. Get it? You must trick everybody into thinking you want a slice, not a wheel.

The cause? Market structure. Regulation National Market System, the regime governing stock trades, says one exchange must send to another any trade for which a better price exists there (so big exchanges pay traders to set price. IEX, the newest, doesn’t).

Put simply, exchanges are forced by rules to share prices. Exchanges cannot give preference to any customer over another.

ETFs get different rules. Shares are only created in blocks, and only traded between ETF creators and their only customers, called Authorized Participants.

I’m not making this up. When Blackrock wants more ETF shares, they create them in blocks only.  From Blackrock’s IVV S&P 500 ETF prospectus: Only an Authorized Participant may engage in creation or redemption transactions directly with the Fund. The Fund has a limited number of institutions that may act as Authorized Participants on an agency basis (i.e., on behalf of other market participants).

Why can ETFs offer preference when it’s against the law for exchanges? Fair question. There is no stated answer. The unstated one is that nobody would make markets in ETFs if a handful of firms didn’t have an unassailable competitive advantage, a sure chance to make money (why ETF fees are so low).

Again from the IVV prospectus:

Prior to trading in the secondary market, shares of the Fund are “created” at NAV by market makers, large investors and institutions only in block-size Creation Units of 50,000 shares or multiples thereof.

Each “creator” or authorized participant (an “Authorized Participant”) has entered into an agreement with the Fund’s distributor, BlackRock Investments, LLC (the “Distributor”), an affiliate of BFA. A creation transaction, which is subject to acceptance by the Distributor and the Fund, generally takes place when an Authorized Participant deposits into the Fund a designated portfolio of securities (including any portion of such securities for which cash may be substituted) and a specified amount of cash approximating the holdings of the Fund in exchange for a specified number of Creation Units.

And down a bit further (emphasis in all cases mine):

Only an Authorized Participant may create or redeem Creation Units with the Fund. Authorized Participants may create or redeem Creation Units for their own accounts or for customers, including, without limitation, affiliates of the Fund.

Did you catch that last bit? The creator of ETF shares – only in blocks, off the secondary market (which means not in the stock market) – may create units for itself, for its customers, or even for the Fund wanting ETF shares (here, Blackrock).

And the shares are not created at the best national bid to buy or offer to sell but at NAV – Net Asset Value.

Translating to English: ETF shares are created between two cloistered parties with no competition, off the market, in blocks, at a set price – and then sold to somebody else who will have to compete with others and can only trade at the best national price, which continually changes in the stock market, where no one gets preference and prices are incredibly unstable.

It’s a monopoly.

Two questions:  Why do regulators think this is okay? The SEC issued exemptive orders to the 1940 Investment Company Act (can the SEC override Congress?) permitting it.

We wrote about the enormous size of ETF creations and redemptions. Which leads to Question #2: Why wouldn’t this process become an end unto itself, displacing fundamental investment?

Big Pillow Fight

I hope you enjoyed summer vacation from the Market Structure Map!

We skipped last week while immersed in NIRI National, the investor-relations profession’s annual bash, this year at the Wynn in Las Vegas, where at the ModernIR booth these passersby in feathers joined us for a photo (and Sammy Davis, Jr., whom I’d mistakenly thought had expired some time ago).

Speaking of feathers, a “big league” (bigly?) pillow fight has erupted over the SEC’s proposed Access Fee Pilot Program – we’ll explain – and the exchanges are stuffing the digital airwaves with nasal-clogging goose down over it.  How to blow the air clear?

Before we answer, you may be thinking, “Tim, didn’t you write about this June 6?” Yes. But I’ve had relentless questions about what the exchanges are saying.

The IR industry’s biggest annual event last week had nothing on market structure. Never has there been a session at NIRI National called “How Stocks Trade Under Reg NMS.”  You can earn an Investor Relations Charter designation, our version of the CFA, without knowing how stocks trade, because the body of knowledge omits market structure.

As one IR officer said to me, “It’s become acceptable today to not know how our stock trades, and that ought not be.”

No wonder our profession has officially taken a neutral position on something the listing stock exchanges generally oppose, and investors support – this latter lot the audience for IR, and ostensibly the buyers and sellers exchanges are knotting in matrimony.

Do you see?  We’re told the stock market matches investors with investments. Yet exchanges and investors have opposing views, and public companies, the investments of the market, are neutral. What could be more bizarre?

Well, okay. There are beings walking the hallways of casinos on the strip more bizarre than that. But follow me here.

As we explained last week, this trading study is intended to assess how fees and incentives affect the way stock-prices are set and how trades are circulated around the data network that our stock market has become today.

In 2004, when the current market structure was still being debated, the NYSE’s then CEO said trading incentives should be prohibited. The Nasdaq thought requiring a national best price would lead to “flickering quotes” and “quote shredding,” terms that describe unstable prices resulting purely from effort to set the price.

Step forward.  The exchanges are paying some $3 billion of combined (that includes amounts from CBOE, operator of four erstwhile BATS equity markets) incentives aimed at setting prices, and we have flickering and shredded quotes all over the market as evidenced by the SEC’s own data (Midas) on ratios of quotes to trades.

And both exchanges want these conditions to persist because both make money selling data – which is the byproduct of a whole bunch of prices.

This is the key point: Exchanges pay traders to set prices. Picture a table with marbles on it.  Exchanges are positioned at the corners. Consider incentives called trading rebates a weight that exchanges can lean on the corners to cause marbles to roll toward them.  The more rolling marbles, the more data revenue they capture.  So you see why exchanges want those payments to continue – and why they are pressing issuers hard for support.

Investors are the marbles. The incentives cause marbles to roll AWAY from each other, the opposite of what investors want. They want orders with big size and stable prices, a big marble pool.

The problem for issuers is that prices are set to create data revenues, not to match investors.  The culprit is a market that behaves like a flat table with marbles on it, when a market ought to encourage the formation of a big pool of marbles.

That the SEC wants to examine an aspect of this structure is itself encouraging, however.

Regulation National Market System, the Consolidated Tape Association Plan, and exchange order types coalesce to create the market we have now. We understand them.  Do your trusted sources of market information explain these things to you?  You cannot interpret the market without first understanding the rules that govern its function.

I don’t blame our friends at the exchanges for clinging to current structure. They have their own revenue streams in mind. Human beings are self-interested, the cornerstone of international relations from the beginning of time. But you should not count on unbiased information about your trading to come from trading intermediaries.

You can count on unbiased analytics from ModernIR, because we are the IR profession’s market structure experts.  If you want to see how your stock trades, ask us.

Liar’s Poker

We’re back! We recommend Barbados but we didn’t see Rihanna.

We also endorse floating around the Grenadines on a big catamaran turning brown and losing track of time. We had rum off the shore of Petit Tabac where Elizabeth set Captain Jack Sparrow’s rum store afire.

Meanwhile, back in reality the dollar rose and interest rates fell, and Italy slouched into confusion, and Argentina dodged a currency crisis for now, and Venezuela…well, Venezuela is like that rum fire Elizabeth set in Pirates of the Caribbean.

I at last read Liar’s Poker, Michael Lewis’s first book (and also Varina, by Charles Frazier, a lyrical novel that sighs like wind through live oaks, imagining life in the eyes of Mrs. Jefferson Davis).

With the boat and the sea taking us far from cell towers, we hit the power buttons and blinked out and I with cold Carib at hand, the beer of the Caribbean, sailed through Mr. Lewis’s time at Salomon Brothers in the bond frenzy of the 1980s.

Mr. Lewis explains how a Federal Reserve decision in Oct 1979 by then chairman Paul Volcker to fix the supply of money and float interest rates stuffed the turkey for Salomon. Overnight, bonds moved from conservative investments held to produce income, to speculative instruments driven by bets on big swings in prices.

For Salomon, the money was in toll-taking. They bought bonds from those selling at incorrect prices and sold them to others willing to buy at incorrect prices. They kept a middleman’s sliver. Do it enough and you’re rich. If you’ve not read the book, do so. There’s verisimilitude for today’s stock market.

The Fed abandoned floating interest rates in 1982, reverting to influencing the Fed Funds rate as it still does today (setting interest rates and flexing the money supply). But speculation on price-changes is now rampant, having spread into everything from currencies to equities.

It matters because anytime supply and demand are not the principal price-setters, a market cannot be depended on to offer reliable fundamental signals. The US stock market thanks to Exchange Traded Funds now may be the most arbitraged in human history.

You might be thinking, Tim, did time on the boat not dump your ETF cache? Also, why do I care?

I return to the ETF theme because investors and public companies continue to assign the market disproportionately fundamental interpretations. You should care because Salomon is gone, swept away on the tides of history because it didn’t keep up. Are we keeping up?

The motivation behind the two parties to every ETF creation and redemption – and neither one of them is you – is capturing a price-spread.  It’s not investment.  Yes, you as an investor may buy ETFs as an investment. But the parties creating and redeeming them are doing so to make money on how prices change.

That’s arbitrage. And what determines the value of investments isn’t who holds them but who buys or sells them (this is the flaw in thinking your stock reflects value assigned by buy-and-hold investors).

In a way, it’s what Mr. Lewis describes in Liar’s Poker, where Salomon merchandised the market’s ignorance about what priced bonds.

How many people understand that ETFs are not managing the money they spent buying ETF shares? ETFs have everyone believing they’re buying a pooled investment when it’s not. Whose fault is it?  Don’t we all bear a responsibility to understand what we’re buying, or what’s affecting the value of our traded shares, companies?

ETFs are the dominant stock financial vehicle of this very long bull market. What matters to those behind trillions of dollars of ETF share-creations and redemptions isn’t the objective of the ETF – but how the prices of ETFs change versus the underlying assets used to collateralize their creation.

Thus a fundamental tremor like trouble in Italy becomes volcanic, spewing molten lava all over stocks. The true driver is arbitrage. Bets. Liar’s Poker. Let’s not be fooled again.

Streaming Market

Spotify ditched convention yesterday with its direct listing on the NYSE. It didn’t raise money or ring the opening bell.  It gave shareholders a way out.  It’s a touchstone for the state of the capital markets.

CrunchBase says Spotify has raised $2.6 billion in 22 funding rounds in private markets where you don’t have to file 10-Ks and 10-Qs and fight proxy battles, meet a rising sea of disclosures from the impact of your business on the environment to how much more the CEO makes than the janitor.

No high-frequency traders. No passive investors ignoring your fundamentals but browbeating you over governance. No worrying about meeting expectations that somebody will game by spread-trading you versus the VIX.  No analyst models to tussle over.  No scripts or contentious Q&A over quarterly results. No Activists.

Spotify cut out all the banks save two to help with pricing and a bit of secondary market-making and let holders sell shares through a broker via the NYSE node on the market’s network and now they can trade anywhere.  Welcome to the new age.

It’s more proof of the decline and fall of the sellside, source of brokerage research. In the past 20 years, it’s been buffeted by a series of body blows:

-The Order Handling Rules in the late 1990s commenced a shift from valuable information to speed in trading markets.

Decimalization in 2001 gutted the intermediary margin paying for sellside analysts.

-Elliott Spitzer’s 2003 Global Settlement forcibly separated research from trading and with it went the glory era of the all-star sellside analyst and in its place came the age of trading technology.

-In 2007, Regulation National Market System transformed the stock market into a frenetic, automated blitzkrieg where competing markets are forced to share customers and prices, and market structure overtook story as price-setter, dealing another dire setback to analyst research.

-Over the ensuing decade with now prices made to trade at averages (the mandatory best-bid-and-offer model from Reg NMS imposed midpoints, averages, on the stock market), trillions of dollars dropped the sellside, shifting from information as key to beating benchmarks, to technology for tracking benchmarks, and average became better than superior.

Today Exchange Traded Funds, derivatives of underlying stock assets, drive 50% of market volume and have no connection to differentiating research. Blackrock, Vanguard and State Street have slashed active investment (and brokerage research), and most of their $13 trillion in combined assets follow models tracking benchmarks.

What’s all this got to do with Spotify?  If form follows function, Spotify is the future.  The function of the stock market isn’t capital formation anymore. That happens in private equity. Public markets are an exit strategy, where stocks go to trade. It’s what you do at the end of the beginning, so to speak, to give the first money in a way out.

Private equity is still built on vital information and differentiation, not averages. There is a vibrant and thriving capital market out there, but it’s not the stock market.

The stock market is a place to trade things. It’s what ETFs facilitate – arbitraging everything toward a mean. You don’t need banks and bells and big road trips to make things tradable. You just need a node on the network.  We’ll see more of it, I’m sure.

I wonder why we’re consuming so much time and energy on corporate disclosure if so much of the money ignores it.  ETFs offer Summary Prospectuses because nobody reads the prospectuses.  What about a Summary 10-Q? What about a slimline 10-K?

Let me be blunt: Why are public companies spending billions on disclosure if half the market volume is machines trading things? Isn’t that a waste of money?

These are questions somebody should be answering.

It should affect how we think about the skill set for investor relations in the future. Everything is data today. If you ride a bike, you’ve got data analytics. Post a job via LinkedIn? Data analytics. The IR people of tomorrow should be data analysts, not just storytellers. Quantify, track and trend the money, whether it follows the story or not.

We can’t stay back in the 1990s talking to a failing sellside. Spotify didn’t. And it’s the future, a streaming market.

Three Ways

Jakob Dylan (he of Pulitzer lineage) claimed on the Red Letter Days album by the Wallflowers that there are three ways out of every box.  Warning: Listen to the song at your own risk. It will get in your head and stay there.

Something else that should get in the heads of every investor, every executive and investor-relations professional for public companies, is that there are three ways to make money in the stock market (which implies three ways to lose it too).

Most of us default to the idea that the way you make money is buying stuff that’s worth more later. Thus, when companies report results that miss by a penny and the stock plunges, everybody concludes investors are selling because expectations for profits were misplaced so the stock is worth less.

Really? Does long-term money care if you’re off a penny? Most of the time when that happens, it’s one of the other two ways to make money at work.

Take Facebook (FB) the past two days.

“It’s this Cambridge Analytica thing. People are reconsidering what it means to share information via social media.”

Maybe it is.  But that conclusion supposes investors want a Tyrion Lannister from Game of Thrones, a mutilated nose that spites the face. Why would investors who’ve risked capital since New Year’s for a 4% return mangle it in two days with a 9% loss?

You can buy stocks that rise in value.  You can short stocks that decline in value. And you can trade the spreads between things. Three ways to make money.

The biggest? We suppose buying things that rise dominates and the other two are sideshows.  But currently, 45% of all market trading volume of about $300 billion daily is borrowed. Short.  In January 2016, shorting hit 52% of trading volume, so selling things that decline in value became bigger than buying things that rise.  That’s mostly Fast Trading betting on price-change over fractions of seconds but the principle applies.

Facebook Monday as the stock plunged was 52% short. Nearly $3 billion of trading volume was making money, not losing it.  FB was 49% short on Friday the 16th before the news, and Overbought and overweight in Passive funds ahead of the Tech selloff.

The headline was a tripwire but the cause wasn’t investors that had bought appreciation.

But wait, there’s a third item. Patterns in FB showed dominating ETF market-making the past four days around quad-witching and quarterly index-rebalances. I say “market-making” loosely because it’s a euphemism for arbitrage – the third way to make money.

Buying the gaps between things is investing in volatility. Trading gaps is arbitrage, or profiting on price-differences (which is volatility).  ETFs foster arbitrage because they are a substitute for something that’s the same: a set of underlying securities.

Profiting on price-differences in the same thing is the most reliable arbitrage scheme. ETF trading is now 50% of market volume, some from big brokers, some from Fast Traders, nearly all of it arbitrage.

FB was hit by ETF redemptions.  Unlike any other investment vehicle, ETFs use an “in-kind exchange” model. Blackrock doesn’t manage your money in ETFs. It manages collateral from the broker who sold you ETF shares.

To create shares for an S&P 500 ETF like IVV, brokers gather a statistical sampling of S&P stocks worth the cost of a creation basket of 50,000 shares, which is about $12 million. That basket need be only a smattering of the S&P 500 or things substantially similar. It could be all FB shares if Blackrock permits it.

FB is widely held so its 4% rise means the collateral brokers provided is worth more than IVV shares exchanged in-kind. Blackrock could in theory make the “redemption basket” of assets that it will trade back for returned IVV shares all FB in order to eliminate the capital gains associated with FB.

So brokers short FB, buy puts on FB, buy a redemption basket of $12 million of IVV, and return it to Blackrock, receive FB shares, and sell them. And FB goes down 9%.  The key is the motivation. It’s not investment but arbitrage profit opportunity. Who benefited? Blackrock by reducing taxes, and brokers profiting on the trade. Who was harmed? Core FB holders.

This is 50% of market volume. And it’s the pattern in FB (which is not a client but we track the Russell 1000 and are building sector reports).

The next time your stock moves, think of Jakob Dylan and ask yourself which of the three ways out of the equity box might be hitting you today. It’s probably not investors (and if you want to talk about it, we’ll be at NIRI Boston Thursday).

Day to Day

Here in CO we can count on sun much of the time but we still watch the weather forecast.

It would be a real pain to drag the skis out and drive up the mountain only to find the resorts bereft of snow.  For one, it’s an hour and a half on I-70 through the Eisenhower Tunnel to Summit County and the Arapahoe Basin, Keystone, Breckenridge and Copper Mountain ski resorts (and double that to our fave, Steamboat).

“You could use social media, Tim.  You can have the resorts text you about conditions.  You can go to onthesnow.com, opensnow.com, coloradoski.com—”

Right, I know that. I’m making a point about dealing with things as they come without thinking about the future. What’s called living day-to-day.  Some of us might want to do that. Get away from the schedule, the rat race. But it’s not a life strategy.

How come we do it with stocks?

Let me explain. Investor-relations folks, for the moment I’m talking to you.  (Investors, listen and see how it applies.) This is typically what you’ll get if you ask an exchange what’s happening with your stock:

The stock opened just above the blah blah blah level then broke out to the upside before basing around noon as profit-takers took over. The bulk of the volume occurred in the morning hours. There was one block, the opening trade, and BAML led most actives (880k), along with Interactive Brokers (615k), GSCO (325k) and JPM (70k).  IBKR often handles retail while the rest generally trade for institutions.

I’m not picking on exchanges. I’m asking what this tells you? It’s the same information I was getting fifteen years ago. No comparative forecast, no indication of what behavior set price, no trends, patterns. It’s a narrative suggesting the day is an end unto itself.

This is lugging skis to Breck on a shorts and flip-flops day.

Compare to the oft-maligned weatherperson.  They’re not always right but they give reliable forecasts. It’s math.  The weather keeps changing but we don’t stop reading forecasts. Right?

Like the weather, the stock market is continually changing. And like weather it’s got measurable patterns because it too is governed by mathematical principles.

Patterns abound. We give Wall Street general expectations of financial trends and patterns through guidance. The Peloton stationary web-connected exercise bike we love gives us troves of trend and pattern data on our performances (sometimes to our chagrin).

I know executives love trends and patterns because they tell me. They like to know what’s coming because they’re people responsible for outcomes and it’s how they think. They appreciate seeing patterns behind price-moves.

We have your trends, patterns and forecasts.  If you’d like to see them, let me know.

The stock market isn’t a set of disconnected events one upon the next called trading days that begin at zero, crescendo, and conclude at a finish line. It’s impossible for everything material to investment behavior to wrap by 4:00 p.m. Eastern Time each day. There’s a pattern at work you can be sure. The average stock trades 13,000 times per day in 200-share increments (and the last price of the day is the 13,000th then).

I’ll share some patterns and trends to finish. Broadly, the key behavior the past week driving big gains and yesterday’s intraday volatility is Risk Mgmt – the use of derivatives to protect and leverage portfolios. Second is Passive Investment. That combination means ETFs are responsible (passive money, plus a risk-transfer effort by market-makers).

Options expire tomorrow through Friday. The Sentiment trend in the market is white-hot growth behavior slamming into a ceiling, based on past trends and patterns. Shorting is rising, intraday volatility is rising.

While the market has persistent upside fervor, near-term volatility is baked in via behavior and options-expirations regardless of a government shutdown. Trends and patterns show it. It may change again next week. That’s how the market works.

If you’re an observer it’s nice to know what’s coming. If you’re an investor, it’s very material to know patterns and trends because your money is on the line. And if you’re in investor-relations, it’s your job.  You don’t want to live it day-to-day. That’s not a strategy.

Earning the Answers

It’s 8am Eastern Time and you’re in a conference room. Earnings season.

Executives around the table. The serious ones in suits and ties like usual. Others in shorts or jeans. Everybody reading the call script one more time. 

“You think we’ll get that question about inventory levels?” the COO says. 

“What’s the stock gonna do today?” says your CEO. 

All of us who’ve been in the investor-relations chair understand the quarterly grind. We practice, prepare, canvass probable questions, rehearse answers.  Try to get the execs to read the script aloud. We listen to competitors’ calls, seeking key queries.

Yet 85% of the volume in the market is driven by money paying no attention to calls.

“Not during earnings,” you say. “Active money is the lead then.” 

If it is, that’s a victory. It’s an anecdotal observation rather than hard statistical fact, but my experience with the data suggests less than 20% of public companies have Active money leading as price-setter on earnings days. 

I’m reminded of a classic example. One of our clients had screaming Sentiment – 10/10 on our index, slamming into the ceiling – and 68% short volume ahead of results. We warned that without the proverbial walk-off grand slam, nothing would stop a drop. 

Active money led, setting a new Rational Price, our measure of fair value, though shares closed down. In proceeding days the stock lost 8%. It wasn’t the story. It was the sector. Tech tanked. And shorting. And Sentiment.

Which leads us back to the carefully crafted earnings call. We’ve got a variety of clients with Activist investors, and I’ll give you two sharply contrasting outcomes that illustrate the importance of the answer to both your COO’s and CEO’s questions. 

One has been slashing and burning expenses (it’s what you do when somebody horns in with money and personality).  Still, heading into the call shorting was 69% and investors were wary. The company has a history of sharp pullbacks on results.

The only bull bets were from machines that leveraged hard into shares. No thought, just a calculated outcome.

Did you see the Wall Street Journal article yesterday on a massive VIX bet?  Some anonymous trader has wagered about $265 million that the VIX will be over 25 in October.  The trader could win big or lose big.

It’s the same thing. Traders, both humans and machines, bet on volatility, exacerbated by results.  Fast Traders wagered our client would jump about 8% (we could forecast it).  They were right. The buying that drove initial response came from quantitative money. Machines read the data and bought, and shorting dropped 20% in a day.

Rational investors have since been profit-takers.  Price moved so much on bets that buy-and-hold money turned seller.

In the other instance, price fell 15%. Risk Management was 15% of market capitalization ahead of the call because Activism tends to boost the value of the future – reflected in derivatives. But Activists have short attention spans. If you’re two quarters in without any meaningful catalyst, you’re asking for trouble.

Well, that was apparent in the data. They were 60% short every day for 50 days ahead of results, the equivalent of a tapping foot and a rolling eye. If you don’t give that audience a catalyst they’re going to take their futures and forwards and go home. 

Results missed and management guided down, and ALL of that 15% came out of market cap. Investors didn’t sell? No. How does it help long money to sell and slaughter price? They’d wreck months or years of commitment in a minute.

But the future was marked to zero because event-driven money dropped its rights to shares. And 15% of market cap held that way vanished.

The degree of uncertainty in all prices, not just ones at earnings season, are increasing because machines are betting on volatility, long and short, price-spreads.

It’s not rational. It’s gambling. Moral of the story? Prepare well, yes.  But prepare proportionally.  Keep it simple. A minority of the money listens now and cannot overcome the power of arbitrage (we need a better market. Another story.).

You might recoil at the idea. But if the market has changed, shouldn’t we too? Correlate outcomes to effort. Learn market structure. Measure the money. Set expectations. Prepare. But prepare wisely. Efficiently. Don’t confuse busy with productive.  

For your COO, the answer is yes, we’ll get that question, and for your CEO, the answer probably has no bearing on how shares will behave. Keep the answer short. (And yes, we can forecast how shares will behave and what will set price. Ask us.)

Realistic Expectation

How do you set realistic expectations about your shares for management?

I’ll give you examples.  One of our clients had a cyberattack and disclosed the impact, a material one degrading expected quarterly results.  What to expect?

Shares are up on strong volume.

That’s great but it makes execs scratch their heads. And the reverse can happen.

“The division heads tell their teams that growth will translate into share-price gains,” the investor-relations director told me. “They deliver, and the stock goes down 7%.”

I was having this conversation in Silicon Valley.  In fact, I had it twice the same day.

It illustrates a market transformation affecting investor-relations and investors. Fundamentals cannot be counted on to drive corresponding shareholder value.  Active stock-pickers and IR professionals have been slow to adapt, harming outcomes for both.

I was at the whiteboard in a conference room with another technology IR head, who was comparing revenue and margin drivers for his company and its key peers.

“How do I get these numbers to translate into the share price?” he said.

“You’re making the job harder than it has to be today,” I said. “And you might create unrealistic expectations from management for IR and for the company.”

There’s one more implication (we’ll answer them all before we wrap). Things like stocks behaving unexpectedly shouldn’t be ignored or glossed over.

For example, we found water dripping from the air-handler housing in the basement for the central air-conditioning system at our house. Great timing. July.

We could say, “Huh. That’s not what we were expecting.” And go on about what we’re doing.  But that’s a poor strategy, leaving us open to bigger troubles ahead.

When your stock doesn’t act as you expect, it’s water dripping from your air-handler, telling you, IR folks and investors, you’re missing something vital about the market.

Admit it.  Most of us know the market has got a drippy coil. But we go on with what we’ve been doing. We’d rather ignore the leak in the basement than address it.

For whom is that bigger trouble?  Your management team, IR. And your returns, investors. We should change what we’re doing, and revise expectations.

“I don’t want expectations for our stock,” you say. Would a board hire a CEO candidate who said, ‘Don’t expect anything from me’?

Back to our examples. In the cyberattack, Active money bought the news (bad clarity trumps okay uncertainty) but passive investment drove subsequent gains. The IR head appropriately differentiated the two and set expectations about trends and drivers. That’s good 21st century IR.

In the second example, don’t let the notion that growth will drive appreciation become an unmet expectation. Growth may boost the stock. But the IR Officer can go on the offensive with internal presentations showing how the market works and what role Story plays in setting price.

It’s up to IR to help management understand. If 80% of the time something besides Story sets price, doesn’t everybody internally have a right to know?  Don’t disillusion the team by letting incorrect expectations survive. That’s bigger trouble.

At the whiteboard with our IRO wanting to get the market to value results better, what about doing the opposite? It’s easier, less stressful, data-driven. Let the market tell YOU what it values. If 20% of the market values your numbers, measure when that 20% sets price. (We do that with Rational Price and Engagement metrics.)

Then measure how the rest of the money behaves that doesn’t pay attention to Story, and show your management team its trends and drivers. Now you’ll know when it’s about you, your management team will have data-driven views of what the money is really doing, and you, there in the IR chair, will have wider internal value.  And less stress.

That’s the right kind of realistic expectation.

What’s the market’s leaky coil? Two things.  Passive investment is asset-management, not results-driven stock-selection. Prices expand or contract with the rate of capital inflows and outflows for indexes and ETFs. You don’t control it. It controls you.

And over 50% of daily volume comes from fleeting effort to profit on price-differences or protect and leverage portfolios and trades (often in combo). It prices your stocks without wanting to own them.

And speaking of expectations, options are expiring today through Friday. It’s rarely about you when that’s happening. Set that realistic internal expectation (and stop reporting results the third week of each new quarter).