Tagged: investor relations

Hedging Bets

We’re in Steamboat Springs this week watching the moose on the snowbanks and letting the world slow down with them for a bit. 

It sets me to thinking. “Hedge funds would be better off doing nothing.”  So postulated (requires subscription) Wall Street Journal writer Laurence Fletcher last week after data from Chicago hedge-fund researcher HFR Inc. showed stock-betting funds that as a group manage about $850 billion lost money in 2016. 

You’re tempted to smirk. The smartest folks in the room can’t beat an algorithm! They can’t top the S&P 500 index fund your 401k owns.  Losers!   

Let’s rethink that perspective.  These are the professional athletes of finance. The New England Patriots of investing. If the best are failing, the ones sorting good companies from bad and chasing them either direction, then maybe we’re missing the real problem. 

Perhaps it’s not that hedge funds are losing but that the market isn’t what it seems.

And if hedge funds are confusing busy with productive, might we be too? The investor-relations profession shares common ground with them.  Great effort and time go into telling the story so it resonates. Hedge funds come at a cost because they’re ostensibly better at sorting fact from fiction. Both disciplines are about standing out.

Apple stands out for instance, touching a 52-week high yesterday following resurgent growth. Yet as my friend Alan Weissberger at fiendbear.com notes, Apple earned $8 billion less in 2016 than the year before and spent $20 billion buying back stock.

People are buying its future, is the retort. If by that one means paying more for less since it’s likely AAPL will continue to consume itself at better than 5% per annum, then yes. But that’s inflation – more money chasing fewer goods.

I’m not knocking our epochal tech behemoth. It’s neither pulp fiction nor autobiography to the market. AAPL is its pillar. Models aren’t weighing mathematical facts such as its 5.5 billion shares of currency out, 15% less than three years back. But who’s counting? Not SPY, the most actively traded stock, an exchange-traded fund and AAPL its largest component.

If the models needing AAPL buy it, the whole market levitates in a weird, creaking, unsteady way.  This is what hedge funds have missed. Fundamentals are now back seat to weighting. If you pack weight, the cool kids of the stock market, you rise. When you’re out of the clique, you fall.  Your turn will continually come and go, like a chore schedule.

Hedge funds are also failing to realize that there is no “long only” money today.  Not because conventional longs are shorting but because the whole market is half short – 48% on Feb 6. One of our clients was short-attacked this week with short volume 23% below the market’s average. We doubt the shorts know it. 

Hedge funds are chasing the market because they don’t understand it anymore. No offense to the smartest folks in the room. They’re confusing busy with productive, spending immense sums examining business nuances when the market is a subway station of trains on schedules.

There are two lessons here for investor-relations folks and by extension executives of public companies and investors buying them.  IR people, learn by observation. Don’t be like hedge funds, failing to grasp market structure and getting run over by the Passive train.  Learn how the market works and make it your mission to weave it into what you tell management. Structure trumps story right now.

Second, hedge funds show us all that there’s a mismatch between the hard work of studying markets and how they’re behaving.  Either work, smarts and knowledge no longer pay, or there’s something wrong with the market.  Which is it? 

Stay tuned! We’ll have more to say next time.   

Open Water

If you want to be creeped out – and who doesn’t? – see the movie “Open Water.” It explains the problem with Board reports in investor-relations too.

American director Chris Kentis based his 2003 film on real events. A couple go scuba-diving and are left behind at sea.  He spent $500,000 making it and earned $55 million at the box office. That’s not the part resembling Board reports, unfortunately.

I don’t want to spoil the movie if you’ve never seen it, but I won’t because it’s a psychological drama depending not on action but implication that takes place in one spot on the sea.  Imagine you went scuba diving miles from shore and surfaced and everyone was gone and the current kept you out?

Now suppose as an investigator later it was your job to measure what happened to the couple. You had at your disposal film of the very spot on the ocean that the couple had occupied. You play back four three-month time-lapse slices of film at high speed.

Nothing. Open water.  It’s all you see. Sky whizzes by, days and nights are nearly indistinguishable, the sea appears as an unmarked surface moving across time.

It’s the wrong measure.  To understand what happened to the scuba divers you’d have to zoom in and watch spare increments.  Then you’d see – wait, there.  Are those specks in the water?  Sure enough, two people.  What are they doing?  Now let’s watch….

And that’s what’s wrong with Board reports.  They don’t measure the stock market the way it works. Executives have long strategic horizons and companies are generally benchmarking progress every quarter and looking at years of stock performance.

But your stock is like scuba divers bobbing on the water and your business is as timeless as the sea by comparison to what sets price. Blink.  Okay, blink again. That’s 350 milliseconds, give or take.  Many stocks trade 500 times in one blink.

No, don’t report to the Board every blink in your trading. But if we’re going to impart understanding – the point of providing information – of how shares change in value over time, the measures must reflect the way the ecosystem for your stock functions.

Your buy-and-hold investors have the same horizons you do.  But that’s not the money setting prices most days. Because it buys, and holds.

About 40% of the volume in your stock aims at horizons of a day or less, and generally just fractions of seconds to catch a penny spread a thousand times. Another 33% moves with the ocean, indexes deploying and removing money metronomically with a model. Another 13% or so pegs opportunity to instruments derived from your shares such as options, futures, forwards and swaps with horizons of days or weeks at most.

So just 14% of your market cap traces directly to your long-term strategy.

You say, “That cannot be true.”

In 2006, half the value of the housing market traced to real estate and the rest reflected rights to homes via mortgage-backed securities, and in some markets it was more than 80%. We know because that’s how much home-values declined.

On May 6, 2010, the Flash Crash, the Dow Jones Industrial Average lost a thousand points, or about 10% of its value, in mere minutes, because the money with tiny horizons disappeared from the market.

On August 24, 2015, some exchange-traded funds diverged by 30% or more from the underlying value of assets because money with horizons far shorter than the business strategy of any of the stocks giving them derivative value left. Briefly.

Those are outliers but lesser manifestations are a thrumming reef of vibrancy every day in your stock. At ModernIR, we measure price-setting in one-day and five-day increments because it’s the only way to see the scuba divers bobbing in the water – or the Activists, the fleeting shift in risk-management behavior reflecting deal-arbitrage, the evaporation of momentum, the abrupt drop in index-investment, the paired behaviors indicative of hedge funds coming or going.

Were we to paint stocks with bold brush strokes, the nuances responsible for price-changes would be as flat and impenetrable as open water. And meaningless to the Board and the management team.

The next time you ready information for the Board, think about the ecosystem, which is frenetic – in stark contrast to business strategy.  If nothing else, make sure they recognize that at any given moment, price depends on the 85% oblivious to strategy.

That might seem frightening, like sharks. Like the sharks it’s but a fact of the stock ecosystem, something to be understood rather than feared (and if you want to learn about the ecosystem, ask us!).