Tagged: Market Structure

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).

Long and Short

Here’s a riddle for you: What’s long and short at the same time?

Your shares, public companies (investors, the shares of stocks you own too).  You saw that coming, right.  The problem is you don’t know who’s long or short.

Let me rephrase that. You can know in 1975 fashion who’s long.  That year, Congress required investors to report holdings, amending the Securities Exchange Act with section 13F.  Investors with more than $100 million of assets had to report positions 45 days following quarter-end.  Back then, investment horizons were long.

The problem is we have the same standard. Why? Bigger question: Why aren’t more companies asking?  After all it’s your market. You deserve to know who owns your shares, who’s long or short, and where your shares trade.  You also should know what kind of money trades them since a great deal of your volume is for the day, not owned (this part we’ve solved!).

Back to ownership, Exchange Traded Funds post positions every day by law. Why doesn’t everybody else?

“Quast, come on,” you say.  “Investors need some time to buy and sell positions without everyone knowing, if they’ve got longer horizons.”

We’re market structure experts. I can assert: nearly every time investors try to buy or sell in the market, traders know it. That’s why we measure what traders know instead of considering them “noise” like everybody else.

Fast Traders detect buying or selling, often before it happens. I liken it to driving down the road on cruise control. Your exit is coming up so you tap the brakes or take your car off cruise.  Anybody behind you can conclude you’re planning to exit.

Fast Traders observe how behavior slows. It’s how we knew June 5 that the tech sector was about to decline. And they see algorithms accelerating to merge onto the freeway. There’s a buyer. Let’s start lifting the price.  We observe all this in patterns.

Back to the point. If the problem with disclosing positions is a desire to protect investment plans, why is the most popular investment vehicle of our era, ETFs, doing it?

“Those are models,” you say. “They track benchmarks.”

Yes, but all over this country boards and management teams are getting quarterly shareholder reports from 13Fs and concluding that these investors are setting prices.  They’re inexcusably out of step with how markets work.  Isn’t that our profession’s fault? It’s part of the IR job to inform management about equity drivers.

Congress is trying to inform itself. We don’t want to be trailing Congress!  Yesterday there was a big hearing about equity market structure in the House Financial Services Subcommittee on Capital Markets.  They like long titles, you know.

Thanks to good friend Joe Saluzzi of Themis Trading, who testified live – read what he said – we were invited to offer written testimony from an issuer perspective on the state of markets and what would help issuers have fairer and more transparent participation.

It’s the first time ModernIR has been read into the official congressional record and I don’t whether to be elated over the opportunity or melancholy that it’s necessary.

You should read it. It’s how the market works today. In fact, read all the testimony. They say what we write here every week. Everyone’s in the know but the issuer community.

You deserve better, public companies. It’s your market and you’re excluded by those merchandising your shares from having a say in how it functions.

We made three simple proposals:  Move 13Fs up to monthly reports (we didn’t call for daily info!) and make them both long and short.  It’s been proposed before. Maybe this time we’ll get someplace.

We also proposed daily disclosure of trading data by broker. There’s no reason Fast Traders or anyone should be able to hide. Canada requires disclosure. Why do we have a lesser standard (none, in fact)? And we asked Congress to direct the SEC to form an issuer advisory committee so companies have a voice.

What’s central and imperative to this effort at better transparency for the IR job and the management of public companies?  Knowing how the market works.  We’re experts on it. That we were asked to offer an issuer perspective – nobody else from IR was – speaks to it.

The starting point is learning market structure. It’s a core part of the IR job in today’s market.  That’s the long and short of it. Ask us and we’ll help you help your executives.

David Copperfield

The days are getting shorter. We’ve passed the longest one of 2017, Summer Solstice. Imperceptibly now the sun will move off its zenith.

Karen and I marked it here in Minneapolis before the NYSE’s Rich Barry and I talk market structure for the Edison Electric Institute’s investor-relations meeting today at the offices of host Xcel Energy downtown.

Last night in lovely and mild Minnesota at Café Lurcat off Loring Park south of central city, a group of us IR people were talking about measuring IR outcomes today.

“You track your owners in 13fs,” said one utility IR professional. “And you correlate your meetings with them, and we saw this one four times and their holdings went down, and this one over here not at all and they doubled positions.”

The problem isn’t IR.  It’s what’s being measured, and how it’s tracked.

Okay, we could go one step further.  If public companies were half as engaged in monitoring the market as the exchanges and high-frequency traders that have profited enormously from its opacity, we’d persuade officials to improve rules.

In fact, I’ve been invited to submit testimony for a congressional hearing next week on problems with financial markets such as the startling absence of companies from all rulemaking processes. Yes, congressional staffers see it just like we do.

I intend to articulate in the starkest terms how issuers are misled about the nature of their trading.  There’s no excuse for it. It continues because issuers are, paraphrasing that country song, treated like mushrooms. Google that.

Realistically, changing the rules takes time. What can we do right now?  You can know why intensive effort to track outreach and correlate it to ownership-change renders lousy results. What you’re measuring doesn’t reflect how markets work.

First, 13f ownership data is an act of Congress – from 1975. Forty-two years later everything has changed but the data used to measure ownership.  We had circular-dial phones then. Today your phone will talk to you.

Yet the 13f lives on (it’s Section 13f of the Securities Exchange Act, legislation expressly prohibiting discrimination against issuers). The measure was designed for a market where investors bought companies. Today 85% of trading volume daily comes from purposes and machines seeing stocks as products not stories.  About 48% of volume is borrowed every day – which doesn’t show up in ownership data.

Many hedge funds don’t have to report holdings because managed assets fall outside regulatory minimums. Exchange Traded Funds (ETFs) are posting assets daily while settlement data follows four days later – and 13fs post positions 45 days after the end of the quarter.  Half of daily volume has an investment horizon of a day or less.

About 13% of daily trading ties to derivatives, which don’t manifest in 13Fs. To wit, markets surged Monday and pundits declared it a return of enthusiasm for economic outcomes. The data showed a 17% increase in Fast Trading – an investment horizon of a day or less – drove Monday’s gains.

Machines were inflating equities to reprice the new series of options and futures trading Monday.  Yesterday counterparties were selling assets to cover short-term trading losses.

None of that is investment.  Much is sleight of hand. So is data that lacks answers.

What’s more, much trumps story. Interest rates, relative currency values, economic expectations and geopolitics, political elections and housing starts, central-bank actions and inflation and policy speeches, and blah, blah blah.

So what do you do?  First, start measuring the right data.  Ownership information cannot tell you what sets price.  Stop expecting miracles from your surveillance provider.  They’re great professionals but the rules around data make it a functional impossibility for you to find what you’re looking for in that data set.

Second, stop looking backward. Instead, do two things well from a messaging view.  Tell your story to a diverse palette of institutional relationships. Have a good follow-up plan.

Make these ideas science – matching product to consumer – and you’re helping the buyside find opportunities and the buyside in turn is helping you achieve the IR goal: A fairly valued stock and a well-informed market.

We have that science. We know every day what part of your volume is driven by passive investment and active investment. If you want help understanding the market, ask us. We do one thing well. Market structure.

Summarizing: Are the measures you’re using to benchmark your IR efforts a reflection of contemporary financial markets? If not, why not?

And why is your exchange, which makes money from rapid-fire trading, focusing your attention on shareholdings 45 days after quarter-end?  Feels like David Copperfield. Resist the illusion. You can and should have better information. Demand it.

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?

Building Signals

We’re back from the Belizean reef, living like pirates among the stars. Refreshing! When your home is this, and your view is that, and sweet critters are resident below, even I can forget about market structure.

But not for long!  While we sailed with phones in airplane mode and minds in Caribbean mode, the Wall Street Journal launched a journalistic barrage about “the quants,” traders using computers.  I counted 18 items in the series May 21-26.

They missed one big thing. We’ll come to it.

Lead writers Gregory Zuckerman and Bradley Hope with support from a cast describe how algorithms have commandeered Wall Street. It’s not just that computerized instructions are behind the largest slice of stock market activity now – developments we’ve been writing about for more than 12 years.

“Everybody in this industry is suddenly saying: ‘Couldn’t a robot do that?’” said Sean McGould, president of Lighthouse Investment Partners, in a story titled This Old School Hedge Fund is Going Quant by reporter Rob Copeland about Magnetar Capital.

Turns out robots can power a retail day trader’s long-short statistical arbitrage portfolio, trade probabilities in deal arbitrage, market Exchange Traded Funds (ETFs) to investors. And a lot more.

“What if we could take what was in our head and our database and make rules out of it?”

So said Magnetar founder and Citadel alum Alec Litowitz in the same piece. (Aside: This is precisely what we do at ModernIR – take cumulative human market knowledge and experience and translate it into software code that infuses measures of market behavior with objectivity and consistency. Meaning is in patterns, rules-based comparatives.)

Investor relations professionals, if you want to understand the market for the product you manage – your shares – you should read them. We also cover the same subject matter in our Market Structure 101 and 201 classes.

Investors, you should read too. And there’s a convergence for both sets of professionals. The WSJ did a nice job here. They’ve demonstrated the correct role for investigative journalism: To uncover facts and arrange them coherently so readers gain knowledge.

The biggie that’s gone missing I’ll set up by casting far back. Walt Kelly for over 25 years wrote a famous comic strip in newspapers called Pogo. It ended in 1975. Among its vast accumulation of one-liners was this, phrased variously: “We shall meet the enemy, and not only may he be ours, he may be us.”

It’s been translated: “We have met the enemy and he is us.”

From smart-beta ETFs to Blackrock to the vast scope of hedge-fund management, investors are relying on mathematicians and computer scientists and Ph.D. data miners to build the next signal by plumbing troves of economic and business data.

They ARE the signals. It’s like wondering what keeps casting shadows on the wall and finding it’s you.

I’ll give you three building blocks for comprehending modern stock-trading. Number one, all trades must meet between the best bid to buy or offer to sell. Number two, all trades wanting to set the bid or the offer must be automated so they can move fluidly around the National Market System.

And number three, algorithms are designed to deceive. Put those together.  The entire stock market is constructed around a single price for any security, which will be set by machines, which will also be trying to deceive others.

Yet everybody mistakenly thinks they’ll find some signal by threshing data. No, signals are trades. Period. Deceptive ones.

Investors, you’re after differentiating fundamentals.  IR professionals, you’re promoting differentiating fundamentals.

And everybody is building signals. It’s a crossroads in both these professions.  If what you’re doing is at loggerheads with how prices are set, what should you do?

I have a full answer but not enough time for it. A key part is you can’t keep doing what you’ve always done while expecting a different result. You’re then just a buoy on the channel. No more open water.

It’s your market, investors and public companies. Are you ceding it to the signal-chasers?

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?

Weathering Change

Everyone complains about the weather but nobody does anything about it.

Mark Twain often gets credit for the clever quip but Twain’s friend Charles Dudley Warner said it.  We’re not here to talk weather though the east coast is wishing someone would do something about it.

Like the weather, there’s a relentlessness to stock-market evolution from fundamentally powered capital-formation to procurement process in which vast sums plug into models that pick, pack and stack stocks in precisely indexed packages.

Blackrock, Vanguard and State Street oversee $11.5 trillion that’s generally blind to sellside research and deaf to the corporate story. It’s a force of nature, more like a weather pattern than investment behavior.

Investor-relations folks say: “What do we do about it?”

Alert reader Karen Quast found a paper from Goldman Sachs advising Boards to respond to the rise of passive investment:

The recent decline in active single-stock investing raises important considerations for corporate boards of directors. The decline has been driven by a shift toward ‘passive investing’ and other forms of rule-based investing, such as index funds, factor-based investing, quantitative investing and exchange-traded funds (ETFs).

The decline of active investing means that, in many cases, stock prices have become more correlated and more closely linked to a company’s ‘characteristics,’ such as its index membership, ETF inclusion or quantitative-factor attributes. As a result, companies’ stock prices have become less correlated to their own fundamental performance.

Goldman Sachs is urging preparation. You can’t change the weather. You can only weather the change. The weather forecast isn’t a call to arms. It’s information we use to adapt to conditions. We prepare for discomfort.  We set realistic expectations.

That’s how investor-relations should view passive investment. We call it Asset Allocation because it’s a behavior that directs dollars to equities according to a model apportioning resources for opportunity and risk.

One way to help the board and the management prepare is to present the idea that there’s not just one behavior buying and selling shares. We ran data for an anonymous company whose share-price is 4% higher today than a year ago, trailing the broad market.

There are four purposes behind buying and selling, one of which is Asset Allocation, and all have equal capacity to set price. After all, market rules today prohibit preference (IR people should understand rules governing how shares are priced and traded and we’ll be discussing it at the Twin Cities NIRI chapter next week – join us!).

There are 50 weeks and in each a behavior led, and bought or sold (one week, Active Investment led and price didn’t change, rotation from growth to value).

It’s eye-opening. The behavior “winning” the most weeks was Fast Trading, short-term machines profiting on price-differences rather than investing.  It led 16 weeks, or 32% of the year, and bought more frequently than it sold.

Active Investment – your stock pickers – and Asset Allocation (indexes, ETFs, quantitative investors) were tied, leading 12 weeks each, but where Asset Allocation bought and sold equally, Active Investment sold more than it bought.

Finally, Risk Mgmt, counterparties to portfolio insurance and trading leverage with derivatives, led 10 weeks, or 20% of the year, but bought 70% of the time.  Put them together and the reason the stock is up a little is because the combined demographics behind price and volume bought 26 times and sold 23 times.

You laugh?  These data are telling! If not for other behaviors, Active Investors would have lowered price. Maybe that’s a message for the board and management team – but show this data to them and it will forever change how they think about the market.

The point isn’t changing the market but understanding how it works, measuring it consistently and adapting to reality.  Fundamentals do not rule now.

But with data analytics, it remains profoundly under the purview of investor-relations. That should bring great comfort to all of us in the profession.  Passive investment isn’t something to fear but to measure.

Market Sentiment:  The Federal Reserve likely hikes rates today, and options expire tomorrow and Friday, the latter the first quad-witching session of 2017. Also, S&P and Nasdaq indexes rebalance. VIX expirations still loom next week.

And our Sentiment is negative for the first time since the election. It’s a weather forecast.  No need for panic, only preparation. We’ll all weather change.

Story Versus Store

When you’re in a store, how often do you ask for help finding a product?

Now think about that, investor-relations professionals, and investors.  You former are in the business of telling the story – helping people in the store find a product.  You latter are the shoppers seeking products.

Before I go further, on Mar 10 the IR professionals in Silicon Valley are hosting the annual Spring Seminar with content assembled by crack practitioners Kevin Kessel, Kate Scolnick and friends, and it’s one of the most compelling IR agendas I’ve seen in my 22 years in this profession. We’ll be there (ModernIR sponsors). You should be too.

Back to Story vs. Store.  A hundred years ago farmers came to town and handed a list to the proprietor of the general store, who assembled groceries while buyers were at the livery or the brothel or whatever. 

Today you enter your list at Amazon.com or Jet.com or whatever and a couple days later – we had two shipments yesterday at the office – your stuff shows up (probably not while you’re at the livery or the brothel but follow me here).

Apply to investing. Once long ago, you went to Merrill Lynch and while you were at the livery or the brothel or whatever your financial advisor assembled some stocks for you. Today you go to Wealthfront or Betterment and you enter your criteria and algorithms assemble exchange-traded funds for you. 

The IR profession is founded on effective storytelling. As the impresario for Wall Street, you help it find you.  But the money asking for help finding products is plunging.  Active stock pickers cannot win (a separate story about structure over prowess).  The robots are crushing it. 

The IR profession is at a crossroads. Yes, keep telling your Story. But the STORE is the leviathan today.  Not the Story.  Amazon is massive. Call it The Store. Walmart bought Jet.com for $3.3 billion because people don’t need an impresario, the clerks on the floor.

Blackrock and Vanguard don’t use the impresario of Wall Street: Research from investment banks.  But you can click on the little icon for many Web apps and get customer service, most of it outsourced to somebody outside The Store. 

Do we want to be Amazon, or that little icon? We won’t be the Big Dogs in either IR or investment by being better impresarios. Success in the 21st century is ironically about minding the Store. for IR, that means data analysis is the vital key to the future.

And investors, the secret to success in this market is tracking what’s moving into and out of The Store – Blackrock and Vanguard and ETFs are the amazons of equities. 

I’ll give you a case in point. A big client was a juggernaut for two weeks – nothing but green metrics, hitting the forecasts every day. Then short volume doubled in two days. Investment tumbled.

That’s Store. Not Story. You can say you don’t care about the short-term. Well, the Store does. Management does. Who’s minding the store? IR professionals, that’s you.  Ignore the amazons, the leviathans, the temporal distortions at your own peril.

Let’s not be the “click here for support” icon, IR pros. Let’s be Amazon. How? Your equity is a product used by consumers wanting less help from clerks and impresarios. They’re renting it, sharing it, trading it, leveraging it more than you ever imagined. 

If you’re bewildered, ask us for help. But let’s not become little icons at the bottom of screens. That’s no strategy for Boardroom domination.  Let’s be amazons. Love The Store.

The Clash

On Friday Feb 10, behavioral-change in the stock market rocked the Richter.    

Stocks themselves seem rather to be rocking the Casbah, Clash-style (obligatory Grammy Awards Week musical reference, and showing my age I reached back to 1982).  Plus it’s that time again: Options expire today through Friday.

Naturally, Janet Yellen picked this week to tell the market – I say “tell” loosely since her utterances are so inscrutable that we’re left to construe and guess – a rate-hike is coming.

I find it troubling that the regulator of the world’s most important banking system appears to be ignorant of how markets work. Why hint at momentous monetary matters two days before volatility bets lapse?  Then again, maybe it’s purposeful.    

And far easier than ruminating on Chair Yellen’s comments for signals is checking the Fed’s balance sheet. Want to know if the Fed will raise rates?  Look for big moves in either Reverse Repurchases or Excess Bank Reserves.

Let me interrupt here:  Investor-relations folks and investors, I return to the Fed theme because it remains the linchpin of the market. We’ll make it an intriguing visit!

On the Fed’s balance sheet, sure enough – big changes.  Excess Reserves have risen from about $1.8 trillion in January to $2.2 trillion last week (huge numbers, yes. For the 20 years before the financial crisis, excess reserves averaged about $10 billion). 

That’s a $400 billion push, almost as big as the $500 billion the Fed heaved at the market last January and February when it was collapsing under the weight of the mighty buck following the Fed’s first rate-hike in ten years.

You can hardly remember, right?  Back then, the top price-setter (followed by Fast Trading) was Asset Allocation – selling by indexes and ETFs jammed up at the exits.

It stopped because the buck didn’t. The dollar fell. When the dollar weakens, stocks generally rise because they are denominated, like oil, in dollars. Smaller dollar, bigger price.

And vice versa. The dollar strengthened ahead of the 1987 stock market crash.  Ditto the Internet Bubble. In May 2010, the dollar rose right ahead of the famed Flash Crash. Last January’s swoon? The dollar surged in November and December with the rate-hike.

From Mar 2009 until Aug 2014 the dollar was weak as the Fed trampled it, and stocks, commodities, bonds, housing and so on all rose.  Then abruptly in latter 2014 the Fed stopped beefing up dollar-supplies. Stocks statistically flatlined till Nov 9 last year.  The Dow was 18,000 in Dec 2014 and 17,888 Nov 4, 2016.

Since the Fed is no longer creating new dollars rapidly by buying debt, it instead moves money into or out of the counted supply.  Excess reserves increase the counted supply of money, which decreases dollar-value.  And yup, from early January to last week, the dollar dropped 4% (using the DXY, the dollar-futures contract from The ICE).

Why does that signal a rate-hike? Because increasing interest rates is akin to reducing the supply of money.  The Fed hopes the yin of bigger reserves will mesh with the yang of higher rates and stop the buck in the middle.

But the buck is back up 2% already. We come to the Richter move I mentioned to start.  We track the four big reasons people buy and sell stocks. From Nov 9 to Feb 9 as stocks soared, the leading price-setter was Active Investment. Rational people are bullish on American economic prospects.

But the Number Two price-setter is Risk Management – portfolio leverage with derivatives. And it’s nearly as big as Active Investment.  Investors are buying the present and betting on the future, which means both present and future back current stock-prices.

The problem arises if the future isn’t what it used to be, to paraphrase Yogi Berra.  And one axiom of Market Structure is that behavioral volatility precedes price volatility.  Much like clouds gather before a storm.

On Feb 10 clouds formed. Risk Management marketwide jumped almost 18%. It’s unusual to see a double-digit move in any behavior, and this is among the biggest one-day moves we’ve ever seen for Risk Management. Is money questioning the future?

It came right ahead of the Grammys. And more importantly, before Options Week and Janet Yellen.  Were we monitoring the Ring of Fire for seismic events, we’d be predicting a temblor.

Of course, in the same way that seismic activity doesn’t mean The Big One is coming, it might be nothing.  But stocks are near a statistical top in our 10-point Behavioral Sentiment Index again and the buck is rising toward a March rate-increase. Sooner or later, the present and the future will clash. 

Life will go on.  And we’ll be measuring the data.