Tagged: investor relations

What’s Going On

The most valuable thing is knowing what’s going on.

The country is closing amid Covid cases. Simultaneously, the Shiller PE ratio of earnings in the S&P 500 is 33, a level exceeded in history only at the bursting of the Internet Bubble in 2000.

What’s going on? (The picture here is Howelsen, our beloved Steamboat local ski hill since 1907…a way away from it.)

Stocks are screaming. In contrast, a country jumping in the mummy bag and zipping up suggests sharp impending economic contraction.

Right?

We’re a service society. That is, the bulk of jobs are in doing something for somebody. Bartending to window-washing. Yoga classes to yardwork. Street-sweeping and sanitation, and shearing hair and shearing sheep, and stocking shelves and fixing Internet problems.

Yes, there’s a big spike on the graph from “Information” or whatever you call it.

As income from hairdressing and table-waiting takes a hit, the stock market jumps to eternal highs.  It’s the sort of thing that leads to class envy.

Don’t fall for that.  Follow me here.

Payroll-protection-plan checks are gone, and the mayor or health department or somebody has said you can’t have more than 25% occupancy, everybody working dawn till dusk blending schedules. To make money.

My own stylist says hours are long, pay is down, and taxes are due because there’s not enough for the taxman and the mortgage.

And two weeks ago into the election there was a surge for stocks.

We told you it would happen, nothing to do with the National Haircutting Rate, the Countrywide Window-Washing Ratio. Or whatever.  We call it Sentiment, the way machines set prices.

It’s now topped, smoking cinders falling away.

Jim Cramer said on CNBC, “They just don’t want to sell, Mike.” (Mike Santoli in this case.)

I love Cramer’s iconoclastic verve. He never loses his confidence.

“The open-up trade is back on!” he shouts now to David Faber, who is stoic with a blink and a wan smile.

Who in the markets doesn’t love CNBC?

But they don’t know what’s going on.

Is the Shiller PE right?  Should we wring our hands?

How many body punches from government can the American Economy – hairdressers, restaurateurs, yoga instructors, window-washers, landscapers, on it goes – take before we snap enough ribs to drop to our knees?

It’s like everyone in government is playing craps around that possibility, party affiliation doesn’t matter.

And up goes the market.

Investor-relations professionals tell the c-suite, “We are delivering returns to our investors on superior financial results.”

Everyone shuffles uncomfortably.

Let’s stipulate that if your earnings are accelerating faster than your peers, your stock might do better, even if hairdressers are struggling to pay taxes and other bills.

Couldn’t we all screen for that and make those stocks the most valuable?

Yes. And no.  Yes, you can.  No, it doesn’t work.

A quant fund could screen for all the stocks with 25% annual EPS growth.  That’s got nothing to do with what you do, public companies. Just what you produce. And what if those funds decide to trade your options?

And earnings don’t guarantee stock-appreciation because the market has limited supply. Is GE a great company, BYND a lousy stock?  Explain, please?

I’m making the same point I’ve been making here at the Market Structure Map since 2006, when the whole market was ceded to machines by a rule called Regulation National Market System.

Stop telling your c-suite and Board that you’re flying or falling because of “operating margins.” It’s not true.

The world is math. You need to know what’s going on.

Investors, it’s the same for you. You believe, “Home Depot will be higher because people are buying home-improvement products at record levels.”

That’s not what’s going on.

As for society, we’re deciding if we’ll be a liberal democracy or not. Stock prices won’t decide it.  Knowing what’s going on will.

We can help. Some. (We can help you with knowing what’s going on, IR folks and traders. We have thoughts on society too. But that takes a group effort.)

 

 

Serenity

Moab, UT — photo courtesy Tim and Karen Quast, Oct 2020

On Nov 4, 2020, words commonly associated with a 12-step program come to mind.

Protestant theologian Reinhold Niebuhr, who received the Presidential Medal of Freedom in 1964, sometime in the 1930s during the Great Depression is said to have coined the words we today call the Serenity Prayer.

Ostensibly it might at the earliest have emphasized courage: Give us courage to change what must be altered, serenity to accept what cannot be helped, and the insight to know the one from the other.

It’s a good life rule, a thoughtful notion after elections. And a way to see the stock market.

For public companies, there are things one can change, influence, based on how the market works.  And things you have to accept.  You cannot control the fact that 85% of volume is motivated by something other than your skill at running a business.

You CAN control what, investor-relations professionals, your board and executives understand about the way the market works.  You can know when to accentuate and accelerate your contact with holders because the data indicate conditions are favorable for them. You can avoid wasting time when conditions signal trouble for your stock and the whole market.

I’ve written about it for years, so I ask that you serenely indulge my penchant for repetition.

The stock market ebbs and flows.  It will add to and remove from your shareholder value, and it will do that no matter how much time and money you spend on telling your story and propagating data on your environmental, social and governance achievements.

Why?  Because that’s the gravity of the stock market. It has immutable forces, like this planet, that remain in place and in effect no matter who’s in charge.

Serenity comes from recognizing what you can and cannot change. And being proactive in response to both.

These principles apply to investors and traders too.

Here’s an example.  If you followed simple principles of market structure to buy and sell MSFT between Feb 1, 2020, before the Pandemic slammed us, and Nov 2, 2020, you could have made 46%.

Buying and holding MSFT has produced a 17% return – a redoubtable outcome under any circumstances.  SPY, proxy for the S&P 500, was up 2% over that span.  It covers 191 trading days.

But our 46% return in MSFT came in just 107 trading days. The other 84 days we could have owned something else to add to our returns.

How and why? The market ebbs and flows.  MSFT spent 134 days at or above 5.0 on a supply/demand scale, and 57 days below it.  Owning MSFT when it was over 5.0 produced the gains. Selling it when it dipped back below 5.0 avoided the losses.

That had nothing to do, really, with MSFT’s success as a business. It’s supply and demand.  The product is stock.

Since Sep 1, MSFT is down 11% because it’s spent about as much time below 5.0 as above it.

For you ModernIR clients, that over 5.0/under 5.0 scale we’re talking about is Market Structure Sentiment™, your gauge of the balance of supply and demand for your stock (and we go further and show you the kind of money that’s responsible).

Is the story MSFT tells any different now?  No.  It’s market structure. It’s the gravity of the stock market – the ebb and flow of supply and demand.

I’m not suggesting you stop doing the things you do to drive shareholder value.  I am suggesting that without an understanding of market structure, those dollars and efforts can be Sisyphean.

Same for you, traders and investors. I can prove six ways to Sunday, as the saying goes, that buying and holding is inferior to using market structure to help you keep gains and avoid losses.

It’s just intelligent use of technology.

Sometimes the beginning point for better ways of doing things is the Serenity Prayer. You first must recognize what you can and cannot change – and you have to accept what that realization means.  Then you find the courage to change what you can.

With the election behind us now, Market Structure Sentiment™ is about 4.0. It was on the same trajectory we measured in Nov 2016, and with the Brexit vote in June 2016.  The pressure on stocks was machines, and the surge ahead of it was short-covering.

Now we begin the next chapter.  See you next week.

-Tim Quast

Boxes and Lines

 

In the sense that high-speed transmission lines connecting computerized boxes are the stock market, it’s boxes and lines.

Also, stock exchange IEX, the investors exchange, hosts a podcast called Boxes and Lines that’s moderated by co-founder Ronan Ryan and John “JR” Ramsay, IEX’s chief market policy officer. I joined them for the most recent edition (about 30 mins of jocularity and market structure).

In case you forget, the stock market is not in New York City.  It’s in New Jersey housed in state-of-the-art colocation facilities at Mahwah, Carteret and Secaucus.  It’s bits and bytes, boxes and lines.

It’s superfast.

What’s not is the disclosure standard for institutional investors.  We wrote about the SEC’s sudden, bizarre move to exclude about 90% of them from disclosing holdings.

The current standard, which legitimizes the saying “good enough for government work,” is 45 days after the end of the quarter for everybody managing $100 million or more.

We filed our comment letter Monday.  It’ll post here at some point, where you can see all comments. You can read it here now.  Feel free to plagiarize any or all of it, investors and public companies. Issuers, read our final point about the Australian Standard of beneficial ownership-tracing, and include it with your comments.

Maybe if enough of us do it, the SEC will see its way toward this superior bar.

Without reading the letter or knowing the Australian Standard you can grasp a hyperbolic contradiction. The government’s job is to provide a transparent and fair playing field.  Yet the same SEC regulates the stock market located in New Jersey. Boxes and lines.

FB, AAPL, AMZN, NFLX, GOOG, GOOGL, MSFT, AMD, TSLA and SHOP alone trade over 2.5 MILLION times, over $80 billion worth of stock. Every day.

And the standard for measuring who owns the stock is 45 days past the end of each quarter.  A quarter has about 67 trading days, give or take.  Add another 30 trading days.  Do the math.  That’s 250 million trades, about $7.9 trillion of dollar-flow.  In 10 stocks.

Why should the market function at the speed of light while investors report shareholdings at the speed of smell? Slower, really.

Do we really need to know who owns stocks?  I noted last week here and in our SEC 13F Comment Letter both that online brokerage Robinhood reports what stocks its account holders own in realtime via API.

That’s a communication standard fitted to reality. True, it doesn’t tell us how many shares. But it’s a helluva better standard than 97 days later, four times a year.

Quast, you didn’t answer the question.  Why does anyone need to know who owns shares of which companies? Isn’t everybody entitled to an expectation of privacy?

It’s a public market we’re talking about.  The constituency deserving transparency most is the only other one in the market with large regulatory disclosure requirements: Public companies.

They have a fiduciary responsibility to their owners. The laws require billions of dollars of collective spending by public companies on financial performance and governance.

How incoherent would it be if regulations demand companies disgorge expensive data to unknown holders?

As to retail money, the Securities Act of 1933, the legislative basis for now decades of amendments and regulation, had its genesis in protecting Main Street from fraud and risk.  The principal weapon in that effort has long been transparency.

Now, the good news for both investors and public companies is that you can see what all the money is doing all the time, behaviorally. We’ve offered public companies that capability for 15 years at ModernIR.

Take TSLA, now the world’s most actively traded – we believe – individual stock. SPY trades more but it’s an ETF.  Active money has been selling it.  But shorting is down, Passive Investment is down 21% the past week.  TSLA won’t fall far if Passives stay put.

That’s market structure. It’s the most relevant measurement technique for modern markets. It turns boxes and lines into predictive behavioral signals.

And investors, you can use the same data at Market Structure EDGE to help you make better decisions.

Predictive analytics are superior to peering into the long past to see what people were doing eons ago in market-structure years. Still, that doesn’t mean the SEC should throw out ownership transparency.

Small investors and public companies are the least influential market constituents. Neither group is a lobbying powerhouse like Fast Traders.  That should warrant both higher priority – or at least fair treatment. Not empty boxes and wandering lines.

PS – Speaking of market structure, if you read last week’s edition of the Market Structure Map, we said Industrials would likely be down. They are. And Patterns say there’s more to come. In fact, the market signals coming modest weakness. The Big One is lurking again but it’s not at hand yet.

Canary Prices

We’ve written of risks in stocks from proliferating Exchange Traded Funds (ETFs).

We’ve talked long about liquidity risks, here last October with CNBC’s Brian Sullivan.

So what, right?

The market has functioned well in this Coronavirus Pandemonium, argue regulators and reporters (WSJ subscription required).

What’s the definition of functioning?  Volume?  You longtime users of Market Structure Analytics rely on them so as not to confuse busy – volume – with productive – liquidity (and to know when story drives price, and doesn’t, and much more).

Refinitiv Lipper says some $20 billion left US equities the week ended Mar 6. Sounds big but it’s 1% of volume.

Add up shorting (borrowed stock) at 45.2% of daily S&P 500 trading the past week, and Fast Trading (machines hyper-trading intraday and ending flat), 53.3% of volume, and it’s 98.5% of market volume but not liquidity.

There’s your 99% (the difference is a rounding error).

This is why you should care about market structure, if you haven’t yet.

Volatility Monday triggered a marketwide stock circuit-breaker halting trading when stocks drop 7%. First time since the rule was implemented in 2013.

Volatility halts also stopped futures trading Monday. Both events derailed reads of VIX volatility, which depend on futures contracts and put/call pricing for freely trading S&P 500 components.

Maybe the VIX was over 100 Monday. We don’t know, as components stopped trading.

What’s more, volatility halts for stocks and ETFs cascaded to more than a thousand Monday and Tuesday, including pauses in large caps like OXY, stopped eight times. I think we surpassed the record-setting currency-driven (as is this) frenzy of Aug 24, 2015.

Many directional ETFs in energy, commodities, market vectors, bonds, leveraged instruments, were halted too.  Volatility halts are coal-mine canaries.

And we’re led to believe investors are panicking over the Coronavirus, and getting out, because markets are working. Anybody but ModernIR writing about volatility halts, paucity of liquidity? Do tell.

Market Structure Analytics exist, public companies and investors, to know what headlines don’t say.

It’s egregious disservice to tell everyone “the market is working great!” when volatility halts explode, most volume is transient trading, and nobody can get in or out.

Canaries falling in waves.

Active Investment declined in the S&P 500 from early Feb until Mar 6 and Mar 9, then ticked up 3% on selling – less than the 5.4% daily intraday volatility (spread between highest and lowest average prices) in components of the S&P 500.

Responding, the market suffered one of its greatest collapses.

People don’t care about insurance – a canary in the coal mine – until it’s needed. And then it’s too late.

Investors and public companies, if you’re lulled by quiescence like last autumn, you’ll be shocked by its departure regardless of the Coronavirus. You shouldn’t be.

ETFs are a principal cause for both market volatility and vanishing liquidity. Investors can sit on stocks – meaning they don’t circulate – and trade ETFs.  When the market lurched, ETF market-makers withdrew, as we’d reasoned from data.

Then investors wanted to sell.

Without the ETFs driving some 67% of trading volume normally, nobody was there to calculate prices. Markets spun crazily like a fighter jet hit by a missile.

And regulators tell us the market is working fine. What about these dying canaries everywhere?

Here is liquidity simply. Trade-size is down to 132 shares in the S&P 500. If you’re an investor trying to sell 100,000 shares, you fill 1% of it and the price gyrates away from you as Fast Traders jump ahead.

Now your pre-trade analytics are wrong. You can pull your trade. Or try to blitzkrieg it in a thousand 100-share trades “at the market,” the best bid.

Wham!

The market implodes a thousand points. Try to buy 10,000 shares and the market skyrockets, rising a thousand points.

Investor-relations people for Energy companies, how do your executives feel about this market?

Technology IR people, what if you’re next?  Tech is the biggest sector. Shorting rose 12% last week in the FAANGs (FB, AAPL, AMZN, GOOG/GOOGL, NFLX) and Active money was selling. FAANGs lead the market up and down. They topped Feb 14, bottomed Mar 3. And now?

(We have the answer. Ask us.)

Investors, is a market that can’t accommodate 1% of the audience into and out of the exits without shuddering the whole stadium and threatening its foundations okay?

Sentiment by our measures is the lowest we’ve ever recorded. Yesterday it was still falling but a day or two from bottom. Uncharted territory, yes. But ModernIR is continuously mapping behaviors, trends, spreads, more.  We have that data, right here.

What if markets zoom? Or don’t?

What’s it worth, public companies and investors, to know what the headlines don’t tell you?  What’s the price of a canary? Ask us. You’ll be surprised.

Proportional Response

Proportional Response is the art of defusing geopolitical conflict.

Proportional Response is also efficient effort. With another earnings season underway in the stock market, efficient effort should animate both investment decisions, and investor-relations for public companies.

I’ve mentioned the book The Man Who Solved the Market, about Jim Simons, founder of Renaissance Technologies. There’s a point where an executive is explaining to potential investors how “RenTec” achieves its phenomenal returns.

The exec says, “We have a signal. Sometimes it tells us to buy Chrysler, sometimes it tells us to sell.”

The investors stare at him.

Chrysler hadn’t been a publicly traded stock for years (they invested anyway – a proportional response).

That executive – a math PhD from IBM – didn’t care about the companies behind stocks. It didn’t bear on returns. There are vast seas of money rifling through stocks with no idea what the companies behind them do.

RenTec is a quant-trading firm. Earnings calls are irrelevant save that its models might find opportunity in fleeting periods – even fractions of seconds – to trade divergences.

Divergences, tracking errors, are the bane of passive money benchmarked to indexes. If your stock veers up or down, it’ll cease for a time to be used in statistical samples for index and exchange-traded funds (ETFs).

And hedge funds obsess on risk-adjusted returns, the Sharpe Ratio (a portfolio’s return, minus the risk-free rate, divided by standard deviation), which means your fundamentals won’t be enough to keep you in a portfolio if your presence deteriorates it.

Before your eyes glaze over, I’m headed straight at a glaring point.  Active stock-pickers are machinating over financial results, answers to questions on earnings calls, corporate strategy, management capability, on it goes.

On the corporate side, IR people as I said last week build vast tomes to help execs answer earnings-call questions.

Both parties are expending immense effort to achieve results (investment returns, stock-returns). Is it proportional to outcomes?

IR people should have their executive teams prepared for Q&A. But let’s not confuse 2020 with the market in 1998 when thousands of people tuned to Yahoo! earnings calls (that was the year I started using a new search engine called Google).

It’s not 2001 when about 75% of equity assets were held by active managers and some 70% of volume was driven by fundamentals.

It’s 2020. JP Morgan claims combined indexed money, ETFs, proprietary trading and quant funds are 80% of assets. We see in our data every day that about 86% of volume comes from a motivation besides rational thought predicated on fundamental factors.

Proportional Response for IR people is a one-page fact sheet for execs with metrics, highlights, and expected Q&A.  The vast preparatory effort of 20 years ago is disproportionate to its impact on stock-performance now.

Proportional response for investors and public companies alike today should, rather than the intensive fundamental work of years past, now incorporate quantitative data science on market structure.

IR people, don’t report during options-expirations. You give traders a chance to drive brief and large changes to options prices. Those moves obscure your message and confuse investors (and cause execs to incorrectly blame IR for blowing the message).

Here’s your data science: Know your daily short-volume trends and what behaviors are corresponding to it, and how those trends compare to previous quarters. Know your market-structure Sentiment, your volatility trends, the percentages of your volume driven by Active and Passive Investment and how these compare to past periods.

Put these data in another fact sheet for your executive team and board.  Provide guidance on how price may move that reflects different motivations besides story (we have a model that does it instantly).

Measure the same data right after results and again a week and a month later. What changed? If you delivered a growth message, did growth money respond? That’s quantitatively measurable. How long before market structure metrics mean-reverted?

Investors, data science on market structure isn’t another way to invest. It’s core to predicting how prices will behave because it reflects the demographics driving supply and demand.

There are just a thousand stocks behind 95% of market cap. You won’t beat the market by owning something somebody else doesn’t. You’ll beat it by selling Overbought stocks and buying Oversold ones.  Not by buying accelerating earnings, or whatever.

The stock market today reflects broad-based mean-reversion interspersed with divergences. RenTec solved the market, we’re led to conclude, by identifying these patterns.  The proportional response for the rest of us is to learn patterns too.

What Matters

Happy New Year!

I hope you enjoyed our gift:  A two-week break from my bloviating!  We’d planned to run best-of columns and thought better, because everybody deserves a respite.

We relished the season in the Colorado mountains, as this album shows (see world-class ski-race video too).  If the album eludes you, this is Steamboat Springs 2020, and us on snowshoes, and the view up high where it’s always 3 o’clock (a superb ski run).

I’m thinking about 2020.  And I’m reading “The Man Who Solved the Market,” about quant hedge fund Renaissance Technologies, by Wall Street Journal reporter Greg Zuckerman.  You should read it, too.

About 47% in, my Kindle says, Zuckerman writes, “One day, a data-entry error caused the fund to purchase five times as many wheat-futures contracts as it intended, pushing prices higher.

“Picking up the next day’s Wall Street Journal, sheepish staffers read that analysts were attributing the price surge to fears of a poor wheat harvest.”

There’s so much going on behind stock-prices that’s something other than we think. The point for IR people and investors is why do we do what we do?

In fact, it’s a human question. We do things on the belief they count.

For instance, the quarterly “Q&A bible,” the compendium of earnings-call questions, dominated holiday discussion in NIRI eGroups.

Discourse is great.  But does all that preparatory effort matter?

If we’re spending the same time and effort in 2020 on earnings-call Q&A that we did in 2000, well, why?  In 2000, more than 70% of the money was rational. Today it’s 14%.

Tesla is up 42% the past year, which included an earnings call where CEO Elon Musk trashed an analyst during Q&A.  The Twittersphere blew up.

The stock didn’t.

You should have your executive team prepared for questions, investor-relations professionals. But you don’t need a bible in 2020 because rational behavior is a paltry part of why stocks move.

Equal to preparation for questions should be the time directed to educating your executives and board on what can move price with results, and why, and what historical data indicate are risks, and why risk exists in the first place – and if you can mitigate it by changing WHEN you report and how you notify investors.

And if you’re 10/10 Overbought and 60% short before you report, put your best VALUE foot forward. Data, not Q&A, should driver call-prep.

Human beings do things because they ostensibly matter and produce returns.  If we’re going through motions because it’s tradition, then 2020 should be the year you change tradition.

And investors. What matters to you?  Returns, right?

The average S&P 500 component moves 36% every month, intraday (1.6% each day between highest and lowest prices), change often lost in closing prices.  In a perfectly modulated, utterly quantitative Shangri-La, you’d capture ALL of that by buying low and selling high.  You could make 432% per year.

That’ll never happen. Eugene Fama, legendary University of Chicago economics professor, who’s 80 years old and still teaching, won a Nobel Prize for demonstrating the return-diminishing pugnacity of volatility.

But if there’s so much volatility, why expend immense effort finding great companies when the odds are roughly 1% that doing so will produce market-beating returns?

Wouldn’t it be smarter – wouldn’t it matter more – to surf volatility waves in today’s market?

I find in traveling around the country – we’re headed to Austin Thursday – talking to IR people and investors that they’re depressed by these things.

If what we learned doesn’t matter, should we rend garments, gnash teeth and weep?

No.

That’s like being depressed by passing time.  Time is a fact.  We can make the most of it, or we can rue its passage.  What’s it gonna be?

So what, IR people, if you don’t need a 400-page Q&A document that requires a software package to manage?  A single Word page, stored to the cloud so you can cross-reference in future quarters, is proportionate.  You’ve saved TIME to do things that MATTER.

What matters?  If you want to be in the US equity markets in 2020 as a public company, an investor-relations professional, an investor, what matters is knowing what money is doing.

It’s a law of success.  It’s not what you know about YOU that matters.  It’s what you know about life, the environment you’re in, the job you’re doing, about how to build relationships.

Right?

We should stop spending all our time understanding our businesses, and none understanding the market that assigns value to them.  That’s the flaw of IR.  Nothing more.  Let’s change it in 2020.

And you investors, why all the Sisyphean work finding great businesses without first understanding how the market transforms those businesses into products with fleeting and ever-evolving value?

If you could capture just 10% of the daily volatility of the S&P 500 by buying stuff low and selling it high, you’d win. It’s provable, useful math. That matters.

Resolve to make 2020 the year you learn what the money is doing.  It matters. We at ModernIR figured out the road map. Ask us how to start on the journey.

Boxed Yellow Pencils

“How do you think about ESG?” said my friend Moriah Shilton at a San Francisco NIRI summit some weeks back with hedge fund Citadel.

Silence. The four panelists shifted around.  A couple whispered to each other. Finally, somebody offered with a throat-clearing cough, “It doesn’t factor into our portfolio decisions.”

For those not fluent in Investor Relations (IR) Speak, ESG is “Environmental, Social, Governance.”  NIRI is the National Investor Relations Institute, professional association for the liaison between public companies and Wall Street.

ESG dominates the contemporary IR educational platform. NIRI has made a policy statement on ESG. There are at least two ESG sessions here at the NIRI Senior Round Table meeting (and NIRI national board meeting) this week in Santa Barbara.

The ESG heat isn’t coming from stock-picking investors, the “long-only” audience of public companies spending billions annually on communication through compliance-driven reports like 10Ks, 10Qs, press releases and proxies and via proactive outreach aimed at increasing share-ownership.

Nor is it, apparently, coming from hedge funds like Citadel, the other key audience – and I’d argue now the vital IR constituency because of its capacity to compete with the Great Passive Investment Wave – for public companies.

In fact, the Citadel team later said, “We vote with management on proxy matters, or we vote with our feet by selling shares.”

It’s passive money that’s obsessed with ESG. Passive investment to us is any form of capital allocation for a day or more (by contrast Fast Trading is an investment horizon of a day or less) driven by rules. That’s index investing, Exchange Traded Funds, or any variety of quantitative investment, from global macro to statistical arbitrage.

True, passives may oppose a proxy measure that doesn’t comport with an ESG platform. They will, however, continue owning the stock. Index funds pegged to a benchmark like the S&P 500 are required to own the securities comprising the benchmark.

It’s cognitively dissonant to own things you oppose.

But aren’t they trying to promote practices that make companies better stewards for stakeholders?

From my first exposure to it, good business has been sound financial management, the right people, products, markets, capital structure, the advancement of the best interests of your customers, employees, communities. These are essential strands of business DNA.

In fact, turning those into a checklist promotes the possibility that mediocre firms are treated the same as stellar ones by virtue of filling out a form.  Rules breed uniformity.

Nowhere is that more apparent than in the stock market, where rules push prices toward a mean. Track the midpoint – as Passive money does – and returns become superior by pegging the average.

The investor-relations profession, the pursuit of excellence, Warren-Buffett-style investment strategies, are about unique differentiation.  What makes a company better, superior?

Rules-based investing makes things the same. Passive money has boomed because shares of companies are increasingly products defined by shared criteria, like ESG. The more of that there is, the greater the probability the market will become homogeneous.

Without dismissing its merits, I’m perplexed by why public companies and stock-picking investors would promote shared criteria like ESG (why not differentiate with ESG if you’re so moved?).  We don’t want the stock market to become a bunch of yellow pencils in a box.

I think a form of guilt has gripped the passive-investment colossus like what manifests among the Silicon Valley nouveau riche who ofttimes with minimal effort realize vast wealth, and then feel compelled to browbeat the rest about the “greater good.”

How one favors the greater good should be individually chosen, not directed by rules.

So from atop vast heaps of assets gained through doing nothing more than tracking a benchmark, Massive Passives are compelled to berate the market over purpose.

If that purpose is an ESG checklist, the purpose is a dictated set of rules.  The very thing passive investment promotes.  Ironic, right? By subtly suggesting moral superiority, passive investment advances its own self-interest: rules-based investing.

Rather than mindlessly embracing ESG as good for all, a sentient species capable of staggering creativity and achievement through the individual pursuit of happiness that inures to the benefit of the masses owes itself moments of objective reflection.

And the question to ponder is whether a uniform ESG blanket tossed over the capital markets furthers the pursuit of the excellence the IR profession and stock-pickers seek.

In Control

This is what Steamboat Springs looked like June 21, the first day of summer (yes, that’s a snow plow).

Before winter returned, we were hiking Emerald Mountain there and were glad the big fella who left these tracks had headed the other way (yes, those are Karen’s shoes on the upper edge, for a size comparison).

A setup for talking about a bear market?  No.  But there are structural facts you need to know.  Such as why are investor-relations goals for changes to the shareholder base hard to achieve?

We were in Chicago seeing customers and one said, “Some holders complain we’re underperforming our peers because we don’t have the right shareholder mix. We develop a plan to change it.  We execute our outreach. When we compare outcomes to goals after the fact, we’ve not achieved them.”

Why?

The cause isn’t a failure of communication. It’s market structure.  First, many Active funds have had net outflows over the last decade as money shifted from expensive active management to inexpensive passive management.

It’s trillions of dollars.  And it means stock-pickers are often sellers, not buyers.

As the head of equities for a major fund complex told me, “Management teams come to see my analysts and tell the story, but we’ve got redemptions.  We’re not buying stocks. We’re selling them. And getting into ETFs.”

Second, conventional funds are by rule fully invested.  To buy something they must sell something else.  It’s hard business now.  While the average trade size rose the past two weeks from about 155 shares to 174 shares, it’s skewed by mega caps.  MRK is right at the average.  But FDX’s average trade size is 89 shares.  I saw a company yesterday averaging 45 shares per trade.

Moving 250,000 shares 45 at a time is wildly inefficient. It also means investors are continually contending with incorrect prices. Stocks quote in 100-share increments. If they trade in smaller fractions, there’s a good chance it’s not at the best displayed price.

That’s a structural problem that stacks the deck against active stock pickers, who are better off using Exchange Traded Funds (ETFs) that have limitless supply elasticity (ETFs don’t compete in the market for stocks. All stock-movement related to creating and redeeming ETF shares occurs off-market in giant blocks).

Speaking of market-structure (thank you, Joe Saluzzi), the Securities Traders Association had this advice for issuers:  Educate yourself on the market and develop a voice.

Bottom line, IR people, you need to understand how your stock trades and what its characteristics are, so you and your executive team and the board remain grounded in the reality of what’s achievable in a market dominated by ETFs.

Which brings us to current market structure.  Yesterday was “Counterparty Tuesday” when banks true up books related to options expiring last week and new ones that traded Monday.  The market was down because demand for stocks and derivatives from ETFs was off a combined 19% the past week versus 20-day averages.

It should be up, not down.

Last week was quad-witching when stock and index options and futures lapsed. S&P indexes rebalanced for the quarter. There was Phase III of the annual Russell reconstitution, which concludes Friday. Quarterly window-dressing should be happening now, as money tracking any benchmark needs to true up errors by June 28.

Where’d the money go?

If Passive money declines, the market could tip over. We’re not saying it’s bound to happen.  More important than the composition of an index is the amount of money pegged to it – trillions with the Russells (95% of it the Russell 1000), even more for S&P indices.

In that vein, last week leading into quad witching the lead behavior in every sector was Fast Trading.  Machines, not investors, drove the S&P 500 up 2.2%, likely counting on Passive money manifesting (as we did).

If it doesn’t, Fast Traders will vanish.

Summing up, we need to know what’s within our control.  Targeting investors without knowing market structure is like a farmer cutting hay without checking the weather report.  You can’t control the weather. You control when you cut hay – to avoid failure.

The same applies to IR (and investing, for that matter) in modern markets.

Dragon Market

As the market fell yesterday like a dragon from the sky (Game of Throners, the data are not good on dragon longevity now), 343 companies reported results, 10% of all firms.

Market fireworks were blamed yet again on tariff fears. Every tantrum is the Fed or tariffs it seems, even with hundreds publishing earnings. What happened to the idea that results drive markets?

Speaking of data, on May 6, the market first plunged like a bungee jumper off a bridge – and then caromed back up to a nonevent.

Behind the move, 21% of companies had new Rational Prices – Active money leading other behaviors and buying. That’s more than twice the year-long average of about 9% and the third-highest mark over the entire past year.

Talk about buying the dip. Smart money doesn’t see tariffs as threats to US interests (and likes the economic outlook, and likes corporate financial results). We’ve been using them to fund government since the Hamilton Tariffs of 1789.

So if not tariffs, why did stocks fall?

Before I tell you what the data show: Come to the NIRI Annual Conference, friends and colleagues. I’m moderating a panel the first day featuring hedge-fund legend Lee Cooperman, market-structure expert and commentator Joe Saluzzi, and SEC head of Trading and Markets Brett Redfearn.

We’ll talk about the good and bad in market-evolution the past 50 years and what’s vital to know now.  Sign up here.

IR folks, you’re the chief intelligence officer for capital markets. Your job is more than telling the story. It’s time to lead your executive team and board to better understand the realities driving your equity value, from Exchange Traded Funds to shorting and event-driven trends. It’s how we remain relevant.

Before you report results, you should know what the money that’s about you, your story, your results, your strategy, is doing – and what the rest of it is doing too. 

Take LYFT, which reported yesterday for the first time. Just 8% of LYFT volume is from Active Investment. By contrast about 22% is quantitative event-driven money, and over 58% is fast machines trading the tick. The balance ties to derivatives.

From that data, one can accurately extrapolate probable outcomes (ask us for your Market Expectation, or LYFT’s, and we’ll show you).

Every IR team should be arming its board and executives with a view of all the money, not just musing on how core holders may react – which is generally not at all.

And investors, if you’re focused only on fundamentals without respect to market structure, you’ll get burned.  I can rattle off a long list of companies beating and raising whose shares fell. The reasons aren’t rational but arbitrage-driven.

Having kept you in the dark like a Game of Thrones episode, let’s throw light on the data behind the late equity swoon: Always follow the money (most in financial media are not).

ETFs are 50% of market volume.  There have been $1.4 trillion (estimating for Apr and May) of ETF shares created and redeemed in 2019 already.

ETF shares are collateralized with stocks, but ETFs do not pool investor assets to buy stocks. In exchange for tax-free collateral, they trade to brokers the right to create ETF shares to sell to investors. The collateral is baskets of stocks – that they own outright.

The motivation, the profit opportunity, for that collateral has got nothing to do with tariffs or earnings or the economy. It’s more like flipping houses.

An Invesco PowerShares rep quipped to one of our team, “You see that coffee cup? I’d take that as collateral if I could flip it for a penny.”

ETF sponsors and brokers in very short cycles flip ETF shares and collateral. As with real estate where it works

Tech Sector Composite Stocks — Behavioral Data

great until houses start to fall in value, the market craters when all the parties chasing collateral try to get out at once (and it happens suddenly).

ETF patterns for the top year-to-date sector, Tech, are elongated way beyond normal parameters (same for two of three other best YTD sectors). It suggests ETFs shares have been increasing without corresponding rises in collateral.

With the market faltering, there’s a dash to the door to profit on collateral before the value vanishes. One thing can trigger it. A tweet? Only if a move down in stocks threatens to incinerate – like a dragon – the value of collateral.

How important is that for IR teams, boards, executives and investors to understand?

Driverless Market

Suppose you were human resources director for a fleet of driverless taxis.

As Elon Musk proposes streets full of autonomous autos, the market has become that fleet for investors and investor-relations professionals.  The market drives itself. What we measure as IR professionals and investors should reflect a self-driving market.

There’s nothing amiss with the economy or earnings. About 78% of companies reporting results so far this quarter, FactSet says, are beating expectations, a tad ahead of the long-term average of 72%.

But a closer look shows earnings unchanged from a year ago. In February last year with the market anticipating earnings goosed by the corporate tax cut of 2017, stocks plunged, and then lurched in Q3 to heights we’re now touching anew, and then nosedived in the fourth quarter.

An honest assessment of the market’s behavior warrants questioning whether the autonomous vehicle of the market has properly functioning sensors. If a Tesla sped down the road and blew a stop sign and exploded, it would lead all newscasts.

No matter the cacophony of protestations I might hear in response to this assertion, there is no reasonable, rational explanation for the fourth-quarter stock-implosion and its immediate, V-shaped hyperbolic restoration. Sure, stocks rise and fall (and will do both ahead). But these inexplicable bursts and whooshes should draw scrutiny.

Investor-relations professionals, you are the HR director for the driverless fleet. You’re the chief intelligence officer of the capital markets, whose job encompasses a regular assessment of market sensors.

One of the sensors is your story.  But you should consistently know what percentage of the driving instructions directing the vehicle are derived from it.  It’s about 12% marketwide, which means 88% of the market’s navigational data is something else.

Investors, the same applies. The market is as ever driven by its primary purpose, which is determined not by guesses, theory or tradition, but by what dominates price-setting.  In April, the dominating behavior is Exchange-Traded Funds.  Active investment was third of four big behaviors, ahead only of Fast Trading (curious, as Fast Traders avoid risk).

ETF shares are priced by spreads versus underlying stocks. Sure, investors buy them thinking they are consuming pooled investments (they’re not). But the motivation driving ETFs is whether they increase or decrease in price marginally versus stocks.

ETF market-makers supply stocks to a sponsor like Blackrock, which grants them authority to create an equal value of ETF shares to sell into the market. They aim to sell ETFs for a few basis points more than the value of exchanged shares.

The trade works in reverse when the market-maker borrows ETF shares to return to Blackrock in exchange for a group of stocks that are worth now, say, 50 basis points more than the stocks the market-maker originally offered.

If a market-maker can turn 30-50 basis points of profit per week this way, it’s a wildly winning, no-risk strategy. And it can and does carry the market on its updraft. We see it in patterns.

If it’s happening to your stock, IR professionals, it’s your job to know. Investors, you must know too, or you’ll draw false conclusions about the durability of cycles.

Big Market Lesson #1 in 2019: Learn how to measure behaviors. They’re sensors. Watch what’s driving your stock and the market higher (or lower – and yes, we have a model).

Speaking of learning, IR people, attend the 50th Anniversary NIRI Annual Conference. We have awesome content planned for you, including several not-to-be-missed market-structure sessions on hedge funds, the overall market, and ETFs.  Listen for a preview here and see the conference agenda here.  Sign up before May 15 for the best rate.

Big Market Lesson #2: Understand what stops a driverless market.

ETF-led rallies stall when the spread disappears. We have a sensor for that at ModernIR, called Market Structure Sentiment™ that meters when machines stop lifting or lowering prices.

It’s a 10-point scale that must remain over 5.0 for shares to rise. It’s averaged 6.2 since Jan 8 and has not been negative since. When it stalls, so will stocks, without respect to earnings or any other fundamental sensor.

I look forward to driverless cars. But we’ll want perfected technology before trusting them. The same should apply to a driverless stock market.