Tagged: investor relations

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).

Dalhart vs Artifice

Texas is booming. We road-tripped it June 28-July 6, giving y’all a break from market structure.

We rolled the I35 corridor from frenzied Frisco north of Dallas, to Austin, now home to 950,000 people, to San Antonio, the fastest-growing Texas city last year, pushing 1.5 million.

From there on July 5 following fireworks the night before in three directions from Hotel Emma, our favorite in the country, we were up in Amarillo by evening (an oblique musical reference back past George Strait to Chris LeDoux, God rest him), and in Denver the next day.

You’d suppose Texas would be taking it in the nose on low oil prices. Yet bergs like Dalhart on the reaches of the Llano Estacado (yaw-no esta-kahdo), the vast plain staked over north Texas, bustle on Main Street and prosper on the boulevards.  If the world blows up, hunker between Texline and Masterson on Highway 87.

What’s Texas tell us about investor-relations, the stock market, investing, the Federal Reserve, the economy?  The farther you get into the heartland the less the things the people in charge think matter, matter.  Life goes on.

Of course, all of us gathered right here at this moment are rooted deep in the market, the Fed, the economy – even those of you in the heartland. We don’t have the – what’s the way to put it?  Convenience.  Of slipping off into the quiet purple of the fruited plain.

Looking from Dalhart, this strikes me:

The stock market.  Passive Investment depending on average prices is carrying the market beyond fundamentals, producing superior outcomes. Can average breed superior, sustainably? Malcolm Gladwell and reality both say no. So prepare for mean-reversion between fundamentals and prices.

When? Nobody knows.  It’ll come with no VIX signal, maybe as the Fed sells assets and spikes the dollar (The Fed trades bonds for dollars, so fewer dollars means higher dollar-value). It’s not that I’m pessimistic. I’m opposed to artifice in the economy, the market. I don’t think Dalhart would accept it. We don’t like it in people, politicians. Right?

Speaking of artifice, our estimable central bankers at the Federal Reserve have determined that after eight years of mediocre output we are ready to rock – though curiously weak inflation, they call it, vexes.

Say Sammy Hagar contended there were several ways to rock. We’d laugh. If I hear one more time that inflation is good, I’m heading to Dalhart.

Inflation is rising prices, which trims both buying power and productivity, the pillars of prosperity. The Fed might be underwhelmed by the increase but we’re paying more. For the same stuff. And calling it growth.

That’s artifice. A treadmill offering the illusion of forward progress, like confusing volume and liquidity (we’ll return to market structure next week so stay tuned).

The Fed should never have institutionalized economic mediocrity with eight years of training wheels. The Tour de France is underway coincidentally, drama on wheels turned by superlatives. You don’t reach the Tour on training wheels. You don’t become an economic tour de force by moseying.

Yet we can’t have an economic adult riding on training wheels. It just looks bad. So we’ll soon have the financial equivalent of a biker barreling into the shrubbery head over handlebars. Dalhart. Life goes on. We’d be better off without Fed artifice. Period.

Same with the stock market. The pursuit of average has become superior there, thanks to big training wheels (a good name for a rock band) from central bankers. Yet we value companies the same, engage in the same IR work. Why do we accept artifice?

Now pedaling toward the economic sludge, the training wheels are coming off the market. Central bankers believe they need only make a pronouncement that all is well and we’ll skim the muck.

The mistake we make is legitimizing it. But there’s reason for good cheer!  The quicker these things mash in a big dustup (and they will), the sooner we get back to Dalhart, and a prosperous global boulevard free of artifice where what’s real matters.

We’ll have to cross the Llano first. Put’er on cruise control, and keep driving.

BEST OF: IR Power

EDITORIAL NOTE: Whew! It’s 11pm here in Orlando (this view just off the patio at Highball & Harvest, The Ritz, Grand Lakes), and NIRI National, the annual confab for investor-relations professionals, has wrapped. The bars at the JW Marriott and Ritz Carlton Grand Lakes are full of IR folks — wait, let me rephrase. Post-conference relationship-building is occurring. We’re all about guidance and message, you know.

This is IR Power. It doesn’t mean what you think in a market where Blackrock, Vanguard, and State Street alone have $11.5 trillion of assets ignoring corporate message and sellside research. I’ll give you our view of NIRI National 2017 (and our fact-finding junket in Key West) next week. For now, IR pros and investors, read this. It’s among our most important posts. Cheers from sultry central FL!

First run:  May 17, 2017

“What’s eye are?  I haven’t seen that acronym.”

So said a friend unfamiliar with this arcane profession at public companies responsible for Wall Street relationships.  IR, for you investors who don’t know, is the role that coordinates earnings calls and builds the shareholder base behind traded shares.

Investor Relations is a vocation in transition because of the passive tide sweeping investment, money that can’t be actively built into a shareholder base. Money in models is deaf to persuasion. The IR job is Story. The market more and more is Structure.

But IR underestimates its power. There’s a paradox unfolding in the capital markets.  I liken it to shopping malls and Amazon.  Used to be, people flocked to department stores where earnest clerks matched people to products.

We still do it, sure. But nowadays seas of cash slosh onto the web and over to Amazon without a concierge. It’s passive shopping.  It’s moved by what we need or want and not by service, save that Amazon is expert at getting your stuff in your hands well and fast.

“You were saying we underestimate our power,” you reply, IR pro. “How?”

You’ve seen the Choice Hotels ad?  A guy with an authoritative voice declares that the Choice people should use four words: “Badda-book, badda-boom.”

The advertisement is humorously stereotyping the consultants, high-powered and high-paid pros who arrive on corporate premises to, buttressed by credibility and prestige, instruct managers on what they must do.

Whether it’s marketing and communications or management like McKinsey & Co., they command psychological currency because of real and perceived credibility, and confident assertion.

Might these people be buffaloing us? There’s probably some of that. But the point is they command respect and value with authority and expertise.

All right, apply that to IR.  Especially now, with the profession in a sort of identity crisis. It’s become the ampersand role.  You’re head of IR &…fill in the blank.  Strategy.  Corporate Development.  Treasury.  Financial Planning & Analysis.  Communications.

The ampersand isn’t causing the crisis. It’s the money.  Bloomberg reporters following the passive craze say indexes and Exchange Traded Funds (ETFs) may surpass active stock funds soon for assets under management.

They already crush stock-pickers as price-setters.  Passive investment is nearly twice as likely to set your price every day as your story.  Buy and hold money buys and holds. Your story isn’t changing daily.  But prices are. Sentiment is. Macro factors are. Risk is.  These and more breed relentless shifting in passive behavior, especially ETFs.

And here’s the IR powerplay.  You are the authoritative voice, the badda-book badda-boom on capital markets internally. With the behavior of money changing, you’re in the best position to be the expert on its evolution. To lead.

If you were the management consultant, you would lay out a plan and benchmarks for organizational transformation. If you were the widget product manager, you’d be providing executives regular data on the widget market and its drivers. You wouldn’t wait for the CEO to say, “Can you pull data together on what’s happening with widgets?”

Sometimes IR people pride themselves on how management never asks about the stock.  If you’re the expert, silence is not your friend. Get out in front of this transformation and lead it.  Don’t let them watch the stock, but help them consistently measure it.

What set of vital facts about passive investment should your management team understand? If you don’t have answers, insist on the resources needed to get them.

Don’t be timid. Don’t wait for management to say, “We want you to study and report back.” It’s too late then. You’ve moved from the expert to the analyst.

Instead, set the pace. See it as a chance to learn to use analytics to describe the market.  Make it a mission to wield your IR power as this passive theme changes our profession.

And we’ll catch you in two weeks!  We’re off to ride the tides on the Belizean reef, a weeklong Corona commercial catamaraning the islands.  We’ll report back.

As we leave, Market Sentiment has again bottomed so stocks rose with Monday’s MSCI rebalances and probably rise through expirations Wed-Fri before mean-reverting again. How many mean-reversions can a bull market handle?

IR Power

“What’s eye are?  I haven’t seen that acronym.”

So said a friend unfamiliar with this arcane profession at public companies responsible for Wall Street relationships.  IR, for you investors who don’t know, is the role that coordinates earnings calls and builds the shareholder base behind traded shares.

Investor Relations is a vocation in transition because of the passive tide sweeping investment, money that can’t be actively built into a shareholder base. Money in models is deaf to persuasion. The IR job is Story. The market more and more is Structure.

But IR underestimates its power. There’s a paradox unfolding in the capital markets.  I liken it to shopping malls and Amazon.  Used to be, people flocked to department stores where earnest clerks matched people to products.

We still do it, sure. But nowadays seas of cash slosh onto the web and over to Amazon without a concierge. It’s passive shopping.  It’s moved by what we need or want and not by service, save that Amazon is expert at getting your stuff in your hands well and fast.

“You were saying we underestimate our power,” you reply, IR pro. “How?”

You’ve seen the Choice Hotels ad?  A guy with an authoritative voice declares that the Choice people should use four words: “Badda-book, badda-boom.”

The advertisement is humorously stereotyping the consultants, high-powered and high-paid pros who arrive on corporate premises to, buttressed by credibility and prestige, instruct managers on what they must do.

Whether it’s marketing and communications or management like McKinsey & Co., they command psychological currency because of real and perceived credibility, and confident assertion.

Might these people be buffaloing us? There’s probably some of that. But the point is they command respect and value with authority and expertise.

All right, apply that to IR.  Especially now, with the profession in a sort of identity crisis. It’s become the ampersand role.  You’re head of IR &…fill in the blank.  Strategy.  Corporate Development.  Treasury.  Financial Planning & Analysis.  Communications.

The ampersand isn’t causing the crisis. It’s the money.  Bloomberg reporters following the passive craze say indexes and Exchange Traded Funds (ETFs) may surpass active stock funds soon for assets under management.

They already crush stock-pickers as price-setters.  Passive investment is nearly twice as likely to set your price every day as your story.  Buy and hold money buys and holds. Your story isn’t changing daily.  But prices are. Sentiment is. Macro factors are. Risk is.  These and more breed relentless shifting in passive behavior, especially ETFs.

And here’s the IR powerplay.  You are the authoritative voice, the badda-book badda-boom on capital markets internally. With the behavior of money changing, you’re in the best position to be the expert on its evolution. To lead.

If you were the management consultant, you would lay out a plan and benchmarks for organizational transformation. If you were the widget product manager, you’d be providing executives regular data on the widget market and its drivers. You wouldn’t wait for the CEO to say, “Can you pull data together on what’s happening with widgets?”

Sometimes IR people pride themselves on how management never asks about the stock.  If you’re the expert, silence is not your friend. Get out in front of this transformation and lead it.  Don’t let them watch the stock, but help them consistently measure it.

What set of vital facts about passive investment should your management team understand? If you don’t have answers, insist on the resources needed to get them.

Don’t be timid. Don’t wait for management to say, “We want you to study and report back.” It’s too late then. You’ve moved from the expert to the analyst.

Instead, set the pace. See it as a chance to learn to use analytics to describe the market.  Make it a mission to wield your IR power as this passive theme changes our profession.

And we’ll catch you in two weeks!  We’re off to ride the tides on the Belizean reef, a weeklong Corona commercial catamaraning the islands.  We’ll report back.

As we leave, Market Sentiment has again bottomed so stocks rose with Monday’s MSCI rebalances and probably rise through expirations Wed-Fri before mean-reverting again. How many mean-reversions can a bull market handle?

Expectations vs Outcomes

“Earnings beat expectations but revenues missed.”

Variations on this theme pervade the business airwaves here during earnings, currently at fever pitch.  Stocks bounce around in response. Soaring heights, crushing depths, and instances where stocks moved opposite of what the company expected.

Why?

Well, everyone is doing it – betting on expectations versus outcomes.  The Federal Reserve Open Market Committee meeting wraps today and much musing and a lot of financial betting swirls around what Chair Yellen is expected to offer as outcome.

Then Friday the world stops at 8:30am ET, holding its breath to see if the expectation for April US jobs matches the outcome.

And by the way, I will join Rick Santelli in Chicago Thursday morning, in between, on Squawk on the Street to pontificate fleetingly and I hope meaningfully.

Obsession with expectations versus outcomes in equity markets and across the planar vastness of economic and monetary data blots out long-term vision and fixes attention on directional bets.

It’s not investment. And it’s no way to plan the future, this mass financial pirouette around a data point.  But it’s the market we’ve got. We must understand it, like it or not.

Back to your stock. The reason that after you beat and raise your stock falls is what occurred ahead of your call.

It may have nothing to do with how you performed versus consensus. For proof, droves from the sellside are looking for IR jobs because trillions of dollars migrating from active portfolios into indexes and ETFs aren’t using sellside research. Or listening to calls.

It reminds me of the Roadrunner cartoons, Wile E. Coyote running off the cliff. Remember? Parts of Wile E. drop in order, the last thing remaining, his blinking eyes.

That’s to me like results versus consensus.  The eyes of Wile E. Coyote, last vestige of something fallen off the cliff of colossal change to investment and trading behavior. The sellside still has everybody thinking outcomes versus expectations matter to investors.

No, they matter to the hordes with directional bets – over 40% of the market.

They bet long or short, or on the spread between high and low prices. They may have fixed for floating swaps that pay if you beat, leading counterparties to sell your shares – and the bettors are short your stock too, so they make a fee on the bet and more covering as your stock falls.

And the CEO says to you, “What the heck?”

If your stock is 50% short (we measure it) and slamming the ceiling of Sentiment due to a marketwide derivatives surge after expirations – which happened Apr 24-25 – it doesn’t matter if you crush consensus. Structure trumps Story. Price will fall because bets have already paid thanks to the broad market.

The market makes sense when you understand what sets price.

Active investment leads less than 20% of the time. The juggernaut of indexes and ETFs rumbles through at about 34%, and it’s now distorting share-borrowing and Risk Management. The latter is 13-16% of your market cap – hopes for the future that can sour or surge on any little data point.

Let’s bring it back to the Fed and jobs and the economy. I said your stock will move based on what happened beforehand.  That can be a day or two, or a week or two.

The economy is massive. It will move on what happened beforehand too but the arc is years. No matter what may be occurring now, which in turn will manifest in the future.

The threat to the US economy and stocks is a lack of appreciation that tomorrow is a consequence of yesterday, not of tomorrow.  For the better part of a decade, furious fiscal and monetary effort promoted borrowing and spending so people would consume more.

But the consequence of borrowing and spending is debt and a lack of money. Which causes the economy to contract in the future. Stocks are pumped on past steroids. If the economy beats and raises, everything can still fall because of what happened yesterday.

We must first navigate consequences of yesterday before reaching the fruits from today.

Same for you. The stock market is awash in bets on divergences, even more when financial results mean opportunity blooms. Your active money clangs around in there, often as confused as you.

Your challenge and opportunity, IR professionals? Helping management develop an expectation of market form that matches the outcome of its function now.

Volatility Insurance

In Texas everything is bigger including the dry-aged beef ribs at Hubbell & Hudson in the Woodlands and the lazy river at Houston’s Marriott Marquis, shaped familiarly.

We were visiting clients and friends before quarterly reporting begins again. Speaking of which, ever been surprised by how stocks behave with results?

We see in the data that often the cause isn’t owners of assets – holders of stocks – but providers of insurance. To guard against the chance of surprises, investors and traders use insurance, generally in the form of derivatives, like options. 

Played Monopoly, the board game? A Get Out of Jail Free card is a right but not an obligation to do something in the future that depends on an outcome, in this case landing on the “go to jail” space. It’s only valuable if that event occurs. It’s a derivatives contract.

At earnings, if you shift the focus from growth – topline – to value – managing what’s between the topline and the bottom line – the worth of future growth can evaporate even if investors don’t sell a share.

Investors with portfolio insurance use their Get Out of Jail Free cards, perhaps comprised of S&P 500 index futures. The insurance provider, a bank or fund, delivers futures and offsets its exposure by selling and shorting your shares. It can drop your price 10-20%.

Writers Chris Whittall and Jon Sindreu last Friday in the Wall Street Journal offered the most compelling piece (may require registration — send me a note if you can’t read it) I’ve seen on this concept of insurance in stocks.

Investors of all ilks, not just hedge funds, protect assets against the unknown, as we all do. We buy life, auto, health, home insurance.  We seek a Get Out of Jail Free card for ourselves and our actions.

In stocks, we track this propensity as Risk Management, one of the four key behaviors setting market prices. It’s real and by our measures north of 13% of total market cap.

But the market has been a flat sea.  No volatility.  This despite a new President, geopolitical intrigue, global acts of terror, a Federal Reserve stretching after eight Rumpelstiltskin years, and a chasm between markets and fundamentals.

Whittall and Sindreu theorize that opposing actions between buyers and sellers of insurance explains the strange placidity in markets where the VIX, the so-called Fear Gauge derived from prices of options on stocks, has been near record lows.

The thinking goes that the process of buying and selling insurance is itself the explanation for absence of froth. Because markets seem inured to threats, investors stop buying insurance such as put options against surprise moves, and instead look to sell insurance to generate a fee. They write puts or calls, which generate cash returns.

Banks take the other side of the trade because that’s what banks do. They’re now betting volatility will rise. To offset the risk they’re wrong, they buy the underlying: stocks. If volatility rises the bet pays, but the bank loses on the shares, which fall. 

This combination of events, it’s supposed, is contributing to imperturbable markets. Everything nets to zero except the stock-purchases by banks and cash returns generated by investors selling insurance, so there’s no volatility and markets tend to rise.

Except that’s not investment. It’s trafficking in get-out-of-jail-free cards.

And despite low volatility, there’s a cost. We’ve long said there will be a Lehman moment for a market dominated by Risk Management.

We’ve seen hedge funds struggle. They’re big players in the insurance game. And banks have labored at trading. Maybe it’s due to insurance losses. Think Credit Suisse, Deutsche Bank, HSBC.  Someone else?

From Nov 9-Mar 1 the behavior we call Risk Management led as price-setter marketwide, followed closely by Active Investment. The combination points to what’s been described: One party selling insurance on risk, another buying it, and a continual truing up of wins and losses.  

Now, for perspective, the VIX is a lousy alarm system. It tells us only what’s occurred. And intraday volatility, the spread between daily high and low prices across the market, is 2.2%, far higher than closing prices imply.

We may reach a day where banks stop buying insurance from selling investors, if indeed that’s what’s been occurring.  Stocks will cease rising.  Investors will want to buy insurance but the banks won’t sell it.  Then real assets, not insurance, will be sold.

It’s why we track Risk Management as a market demographic, and you should too.  You can’t prevent risk. But you can see it change.