Tagged: investor relations

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.

 

Activism Science

In fourteen years, we’ve not missed an Activist.

“Chest-thumping, Quast?” you say.

No, a market structure lesson, a way for investor-relations professionals to be valuable.

Activism has become the de jour Value Investment proposition for modern markets. Our data indicate 10% of all US stocks – just 12% of daily volume is driven by Active Investment – have footprints of Activism.

Think about the enormous sums spent on Activism defense.  Surveillance firms that (no offense, friends!) almost never catch Activist presence proactively because Activists have had 35 years to know how to hide their footprints from settlement-based market intelligence.

The lawyers.  The bankers. The proxy solicitors. The communications consultants.  The running taxicab meter for expenses.

I’m not saying these advisors are pointless by any stretch. But wouldn’t it be prudent to observe what the money is actually doing?  I can offer a litany of examples (scores, but here just a few).

We saw footprints of Activism more than a quarter ahead of the advent of Activism in a small-cap.  Nine months later, the Activist pushed the company into a merger with a competitor.

Maybe a deal was best. But clunky Activist steps were crudely apparent in the data. We’d see a burst of derivatives bets – and five days later the Activist would issue some public declamation. So we could always tell the company when the Activist was about to spout off again.

At no point during the process were investors enthusiastic – but management quit early. The data clearly indicated they could win. The bankers didn’t have that data. Neither did surveillance or the proxy solicitors. I don’t know what those advisors told the team. Isn’t it wise to check and balance your advisors too?

Our data in the hands of a management team with temerity would have produced a fight – and maybe a much better deal.

Market Structure Analytics are like an EKG. We can see how the heart of investment is responding. Is there a burst of adrenaline? We’ll measure it. Apathy? We’ll see that too.

We warned another small-cap two quarters before Elliott showed up in 13Fs (and surveillance was utterly unaware throughout). We have algorithms that remove subjectivity. They are indiscriminate in identifying hedge funds, which half the time are not nefarious. But it’s better to know than not, right?

Advance warning put management in a strong position, and while that situation too also concluded in a deal, the company drove it rather than the other way around, which is always best for executive teams. And too, investor-relations is frontline defense, chief of intelligence for its boards and executive teams. That earns rewards, kudos.

In a high-profile case, we observed pervasive deal-arbitrage in a large-cap with a controlling shareholder. We told the IR team we were flummoxed, but the data were irrefutable. People were betting on a deal. They had no answer.

Then they and we both learned that indeed a deal was in the works that no one (apparently not no one!) ostensibly knew about, including the IR team.

Then an Activist manifested. Every time the Activist would publicly oppose the plan, we saw short-covering and long bets hidden behind headline selling – telling us the Activist really favored the plan but wanted a bone, an appeasement.

That data was vital for decision-making and led to a solution favorable to all parties.

Behavioral data isn’t a silver bullet freeing you from the travails of event-driven behavior (Market Structure Analytics are equally effective at predicting deals and their success, signaling where arbs expect news, predicting and tracking the arc – including success or failure – of short attacks, and spotlighting big bets on surprises around financial results).

The market is mathematical. It’s unwise in event-driven situations to spend all your resources on qualitative input from wildly expensive advisors, when affordable quantitative data offers the most accurate, predictive, unvarnished and timely view of success, failure, threats, opportunities.

If you want to know how we see Activism, deal-arbitrage, short attacks and more, ask us. We can look back historically and show patterns around your own experiences – which lays the foundation for future warning. And we have a compendium of event-driven situations we’ve addressed.

What’s better than glimpses into the future? Would that we had more of them in life – but you can have them in the stock market. It’s math. And science.

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).