Tagged: Jim Simons

Infected Stocks

Coronaviruses are common throughout the world. So says the US Centers for Disease Control and Prevention.

The market didn’t treat news of spreading cases in China and the first in the USA (from a Chinese visitor) that way though. Airline and gaming stocks convulsed yesterday.

There’s as ever a lesson for investor-relations practitioners and investors about how the stock market works now. News compounds conditions but is infrequently causal. Investors, there are opportunities in divergences. IR pros, you need to know what’s real and what’s ripple-effect, because moves in stocks may not reflect rational sentiment.

Airline and leisure stocks demonstrate it. Active Investment pushed airlines up 2.4% last week, industry data we track (with proprietary analytics) show.

But.

Shorting rose, and demand for derivatives used to protect or leverage airline investments fell 7% into last week’s options-expirations (know the calendar, folks). That’s a signal that with new options trading yesterday, counterparties would shed inventory in those stocks because demand for options was down.

Both facts – Active buying last week, weak demand for leverage – run counter to the narrative of investor-fear. The data say these stocks would have been down anyway and news is simply compounding what preceded it.

No doubt some investors knee-jerked to headlines saying investors were selling, and sold. But it’s not the cause. It’s effect.

We can’t isolate gaming in GICS data but leisure stocks shared behavioral characteristics with airlines. Investment was up last week, led by Passive money rather than Active funds (Active rose 2% too). But Risk Management, the use of leverage, declined 3%. And the pattern of demand changed.

What if the real cause for declines in these industries is the rising cost of leverage?

I’ll make my last plug for the book The Man Who Solved the Market. Near the end, one of Jim Simons’s early collaborators at Renaissance Technologies observes, “I don’t deny that earnings reports and other business news surely move markets. The problem is that so many investors focus so much on these types of news that nearly all of the results cluster very near the average.”

He added that he believed the narratives that most investors latch onto to explain price-moves were quaint, even dangerous, because they breed misplaced confidence that an investment can be adequately understood and its future divined.

I’ll give you two more examples of the hubris of using headlines to understand stocks. The S&P 500, like airline and leisure stocks, experienced a 2% decline in demand for derivatives into expirations last week. Patterns changed. Ten of eleven sectors had net selling Friday even as broad measures finished up.

If the market is down 2% this week – and I’m not saying it will fall – what’ll be blamed? Impeachment? Gloomy views from Davos? The coronavirus?

One more: Utilities. These staid stocks zoomed 4% last week, leading all sectors. They were the sole group to show five straight days of buying. We were told the market galloped on growth prospects from two big trade agreements.

So, people bought Utilities for growth?

No, not the reason. Wrapped around the growth headlines was a chorus of voices about how the market keeps going up for no apparent reason. Caution pushes investors to look for things with low volatility.

Utilities move about 1.4% daily between intraday high and low average prices. Tech stocks comprising about 24% of the S&P 500 are 2.6% volatile – 86% more!

Communication Services, the sector for Alphabet, Facebook, Twitter and Netflix, is 2.8% volatile every day, exactly 100% more volatile than Utilities.

The Healthcare sector, stuffed with biotechnology names, is 4.8% volatile, a staggering 243% greater than Utilities.

These data say low-volatility strategies from quantitative techniques, to portfolio-weightings, to Exchange-Traded Funds are disproportionately – and simultaneously – reliant on Utilities. If volatility spikes, damage will thus magnify.

IR people, you’ve got to get a handle on behaviors behind price and volume (we can show you yours!). Headlines are quaint, even dangerous, said the folks at Renaissance Technologies, who earned 39% after-fee returns every year for more than three decades.

Investors, you must, too (try our Market Structure EDGE platform). None of us will diagnose market maladies by reading headlines. The signs of pathology will be deeper and earlier. In the data.

Hummingbird Wings

I recall reading in high school that the military’s then new jet, the FA-18 Hornet, would fall out of the sky if not for computers.

Could be that’s exaggerated but the jet’s designers pushed the wings forward, creating the probability of continual minute turbulence events too frequent for human responses.  Why do that? Because it made the plane vastly nimbler in supersonic flight.

You just had to keep the computers on or the craft would go cartwheeling to earth.

As we wrap a remarkable year for stocks in a market too fast for humans and full of trading wings whipping fleeting instances of turbulence, we’re in a curious state where the machines are keeping us all airborne.

I don’t mean the market should be lower.  Valuations are stretched but not perverse. The economy is humming and the job market is great guns. And while the industrial sector might be spongy, the winds in the main blow fair on the fruited plain.

So why any unease about stocks, a sense the market is like an FA-18 Hornet, where you hope the computers keep going (ironic, right)?

It’s not just a feeling.  We at ModernIR as you longtime readers know are not touchy-feely about data. We’re quantitative analysts. No emotion, just math.  Data show continual tweaking of ailerons abounds.

You see it in fund flows. The WSJ wrote over the weekend that $135 billion has been pulled from US equities this year. Against overall appreciation, it’s not a big number. But the point is the market rose on outflows.

And corporate earnings peaked in real terms in 2014, according to data compiled by quantitative fund manager Julex Capital. We’ve got standouts crushing it, sure.  But if earnings drive stocks, there’s a disconnect.

I’m reading the new book on Jim Simons, the “man who solved the market,” says author and WSJ reporter Greg Zuckerman. Simons founded Renaissance Technologies, which by Zuckerman’s calculations (there’s no public data) has made more than $100 billion the past three decades investing in stocks. Nobody touches that track record.

It’s a riveting book, and well-written, and rich with mathematical anecdotes and funny reflections on Simons’s intellectually peripatetic life.

Renaissance is not a stock-picking investment firm. It’s a quant shop. Its guys and gals good at solving equations with no acumen at business or income statements proved better at investing than the rest.

It’s then no baseless alchemy to propose that math lies at the heart of the stock market.

And son of a gun.

There’s just one kind of money that increased the past year.  Exchange Traded Funds (ETFs). This currency substituting for stocks is $224 billion higher than a year ago and about a trillion dollars greater the past three years.  As we learned from Milton Friedman and currency markets, more money chasing the same goods lifts prices.

Stocks declined in 2018, yet ETF shares increased by $311 billion, more than this year.  In 2017, ETF shares increased by $471 billion.

Behind those numbers is a phantasmagorical melee of ETF creations and redemptions, the ailerons keeping the market’s flight level through the turbulent minutia flying by.

I’ve explained it numerous times, so apologies to those tiring of redundancy. But ETFs are substitutes for stocks.  Brokers take a pile of stocks and give it to Blackrock, which authorizes the brokers to create and sell to the public a bunch of ETF shares valued the same as the pile of stocks.

If you sell ETF shares, the reverse happens – a broker buys the ETF shares and gives them to Blackrock in trade for some stocks of equal value.

This differential equation of continuous and variable motion doesn’t count as fund-turnover. But it’s massive – $3.2 trillion through October this year and $10.7 trillion, or a third of the market’s total value, the past three years.

Why the heck are there trillions of ETF transactions not counted as fund flows? Because our fly-by-wire stock market is dependent on this continuous thrum for stable harmonics.

That’s the hummingbird wings, the Butterfly Effect, for stocks.

We can see it.  In July a seismic ripple in behavioral patterns said the market could tumble. It did. Dec 3-5, a temblor passed through the movement of money behind prices. The market faltered.

If the ETF hive goes silent, we’ll cartwheel.  It won’t be recession, earnings, fundamentals, tariffs, Trump tweets, blah blah.  It will be whatever causes the computers to shut off for a moment.  It’s an infinitesimal thing.  But it’s why we watch with machines every day.  And one day, like a volcano in New Zealand, it’ll be there in the data.

Jim Simons proved the math is the money. It’s unstable. And that’s why, investor-relations pros and investors, market structure matters.