Tagged: Michael Lewis

Predictive Knowledge

Why don’t I trade like my peers?

The CEO is sure it’s because investors don’t understand something – how you manage inventory, your internal rate of return targets. Pick something.

Investors ask the same question. Why does that stock lag the group? For answers, they root through financials, technology, leadership, position in the market, to find the reason for the discount (or opportunity).

What if these assumptions are wrong?

At prompting from friend and colleague Karla Kimrey in the Rocky Mountain NIRI chapter (which we sponsor) who knows I’m a data geek, I’m reading Michael Lewis’s The Undoing Project, his latest. It’s a sort of sequel to Moneyball, about how baseball’s Oakland A’s changed professional sports with data analytics (read both and you’ll see that ModernIR is Moneyball for IR).

The Undoing Project focuses on why incorrect assumptions prevail.  I don’t have the punch line yet because I’m still reading. But I get the point already and it’s apropos for both investor-relations professionals and investors in markets that often seem to defy what we assume is the rationale behind stocks and the whole market.

Perception overwhelms reality.

The CEO, the IR professionals, investors, are all focused on the same thing. The collective assumption is that any outcome varying from expectations is a deficiency in story.  Personal perceptions have shaped our interpretation of the market’s behavior.

Yet statistically, rational thought is a minority in market volume – about 14% of it, give or take. When markets surged Monday, the Dow Jones Industrials up 183 points, we were told it was enthusiasm about earnings.

The data showed the opposite – Asset Allocation. Money that pays no attention to earnings. It’s 33% of market volume.

Why would it buy now? Because options are expiring today through Friday (and derivatives directly influence 13% of trading volume marketwide).  Asset Allocation uses options and futures to nimbly track benchmarks, and with markets down it’s probable that derivative positions were converted to the actual stocks.

But then it’s over.  Mission accomplished.  Yesterday the market gave back 114 points to go with 138 points last Thursday. The qualitative assumption – the gut instinct – that earnings enthusiasm lifted stocks Monday was not supported by subsequent data.

Daryl Morey, general manager of the Houston Rockets, gives The Undoing Project a literary push in the early pages. An MIT man and not a basketball player, Morey came into the job because team owner Leslie Alexander wanted “a Moneyball type of guy.”

He sought data-driven results.  And it worked.  Houston is in the top ranks for success with draft picks and getting to the playoffs, and other teams have copied them.

Morey says knowledge is prediction. We learn things to understand what may happen. It’s a great way to think about it. Suppose it works in IR and investing too.

It starts with questioning assumptions.  What gut instincts do you hold about your stock that you can’t support with data?  How do they compare to the data on market volume?

I know there’s a swath of people in every walk including IR and investing who think data is BS. Who cares? they’d say.  I go with my instincts. Besides, what difference does it make if we know or don’t?

Knowledge is prediction. Data align perception and reality. In Undoing, Lewis uses the Muller-Lyer illusion. Your mind perceives one line longer. Nay. Measurements prove it.

I’ll leave you with this data on the market. I wrote last week about volatility insurance.  Now we’ve got volatility.  Insurance policies are expiring right now, with the VIX today kicking off April expirations through Friday. Our Sentiment Index trend is like mid-2014.

We don’t know what may come. But we’re thinking ahead. Assumptions are necessary but should be the smallest part of expectation.

That’s a good rule of thumb in life, investing and IR (and if you want help thinking about what IR assumptions may be wrong, ask us. We may not have the answer. But we’ve got great data analytics to help sort reality from perception).

First Things First

If you’re in a tree sawing off a branch, note which side of it you’re standing on.

The guy studying the branch was Brad Katsuyama, CEO at dark pool IEX, which has designs on exchange-hood. He was speaking along with others before that folksy and fashionable Washington DC club, the Senate Permanent Subcommittee on Investigations (you get a titular sense our republic is engaged in perpetual sleuthing – and how do you conclude a hunt when its sponsor is permanent?).

Katsuyama, who called markets “rigged” in Michael Lewis’s Flash Boys, said yesterday, “IEX was created within the current regulatory framework.”

Translation: “We invested big bucks finding a solution that helps investors and complies with rules and we won’t cut off our noses to spite high-speed faces.”

Wait a minute. Doesn’t IEX hate the current framework? For those who’ve not read Flash Boys yet, I won’t spoil it. Ronan Ryan, who earns his own “problem” chapter, entertained a big NIRI National breakout session last week. Karen (beloved spouse and ModernIR COO) thought it was the best one ever at NIRI. Even with the f-bombs.

I’m not knocking IEX! Love ‘em. But a point has been missed. In order to facilitate what should naturally occur – buyers finding sellers – IEX had to perform unnatural acts. Let me rephrase. There are rules governing stock orders. To comply, IEX created the Magic Shoe Box, a 38-mile fiberoptic hampster wheel to neutralize fast-trading’s version of location, location, location.

Why is some crazy Rube Goldberg contraption necessary to structure a market so it appeals to real investors? Today’s equity market defies Occam’s Razor, which at risk of offending you experts on philosophy I’ll dumb down to “simplest is best.” For proof, the outfit heralded with restoring fairness must perform technological gymnastics to achieve it.

Having committed effort to solving a problem that only exists through synthetic warping-by-market-rule, IEX now is in a quandary. It can’t call for an end to something for which it just found a solution.

We here at ModernIR have long decried how arbitrage prices stocks. The role of the consolidated tape in prices, how data revenues are shared among market centers, and what makes data and circuits at exchanges valuable cements that reality. This foundation now underpins the US stock market with its ETFs, its 44% short volume daily, and its tens of trillions of dollars annually.

It may be an SOB. But to paraphrase political leaders of past generations describing distasteful foreign dictators who were allies: it’s our SOB.

The Senate hearing spotlighted “maker-taker,” about which we’ve written much and often. It describes incentives paid to traders to bring their orders to markets. The NYSE is on the record calling for its end.

We remain uncertain if the new owners of the NYSE understand how the market works. Remove incentives at the NYSE, and why would anyone do business there? It’s a marketplace lacking any native orders. It imports 100% of its goods, with rebates.

“Quast has gone round the bend,” you say. “He’s for HFT.”

Not at all! But first things first. Before we outlaw maker-taker (happy to explain what this means – just send me a note), we had better disconnect markets from each other, and remove the requirement that trades match between the best bid and offer. If we don’t, we will have a stunning disaster. Public companies should care about that.

And if the SEC is unprepared to loosen its grip so the market may function as a free one should, where buyers and sellers match at prices within the natural limits of supply and demand, then we best get used to the SOB we’ve got.

Either way, IROs, do you measure markets the way they work now? Monitor behavioral market-shares, short-volume and dynamic fair value. If you’re tracking ownership and moving averages, you’re missing most of what’s actually occurring.

The Recovery

It’s all in the recovery.

That’s the philosophy put forth by a friend of mine for dealing with unpleasant facts.

I think the chief reason for the recent swoon in stocks was not anemia in the job market but a sort of investor outrage. You can’t troll a trading periodical or blog or forum without wading through rants on why Michael Lewis, author of the bombshell book Flash Boys on high-speed trading, is either guilty of torpid whimsy (a clever phrase I admit to swiping from a Wall Street Journal opinion by the Hudson Institute’s Christopher DeMuth) or the market’s messiah.

What happens next? Shares of online brokerages including TD Ameritrade, E*Trade and Schwab have suffered on apparent fear that the widespread practice at these firms of selling their orders to fast intermediaries may come under regulatory scrutiny.

What about Vanguard, Blackrock and other massive passive investors? Asset managers favor a structure built around high-speed intermediation because it transforms relentless ebbs and flows of money in retirement accounts from an investing liability to a liquidity asset. Asset management is about generating yield. Liquidity is fungible today, and it’s not just Schwab selling orders to UBS, Scottrade marketing flow to KCG and Citi or E*Trade routing 70% of its brokerage to Susquehanna.

It would require more than a literary suspension of disbelief to suppose that while retail brokers are trading orders for dollars, big asset managers are folding proverbial hands in ecclesiastical innocence. The 40% of equity volume today that’s short, or borrowed, owes much to the alacrity of Vanguard and Blackrock. The US equity market is as dependent on borrowing and intermediation as the global financial system is on the Fed’s $4 trillion balance sheet.

Hoary heads of market structure may recall that we wrote years ago about a firm that exploded onto our data radar in 2007 called “Octeg.” It was trading ten times more than the biggest banks. Tracing addresses in filings, we found Octeg based in the same office as the Global Electronic Trading Co., or GETCO. Octeg. Get it? (more…)

Flash Boys

I don’t skateboard. But the title of Michael Lewis’s new book on high-speed trading, Flash Boys, made me think Lewis could’ve called it DC-town & Flash Boys.

Legendary skateboarder Stacy Peralta directed the 2001 documentary Dogtown & Z-boys chronicling the meteoric rise of a craze involving slapping wheels on little boards and engaging in aerobatic feats using public infrastructure such as steps and handrails. From Dogtown, slang for south Santa Monica near Venice Beach, Peralta’s Sean-Penn-narrated film tracked the groundbreaking (and wrist-breaking) 1978 exploits of the Zephyr skateboarding team, thus the “Z-boys.”

Skateboarding has got nothing to do with trading, save that both are frantic activities with dubious social benefit. We’ve been declaiming on these pages for more than a half-decade how fast intermediaries are stock-market cholesterol. So, more attention is great if the examiner’s light shines in the right place.

If you missed it, literary gadfly Lewis, whose works as the Oscar Wilde of nonfictional exposé include Moneyball (loved the movie), Blindside, Liar’s Poker and the Big Short, last week told 60 Minutes the US stock market is rigged.

The high-frequency trading crowd was caught flat-footed. But yesterday Brad Katsuyama from IEX, a dark pool for long investors that rose out of RBC, dusted it up on CNBC with Bill O’Brien from BATS/Direct Edge, an exchange catering to fast orders.

Which brings us to why Lewis might’ve called his book DC-town & Flash Boys. The exploitation of speedy small orders goes back to 1988. In the wake of the 1987 crash, volumes dropped because people feared markets. The NASD (FINRA today) created the Small Order Execution System (SOES – pronounced “soze”) both to give small investors a chance to trade 100 shares electronically, and to stimulate volume. Banditry blossomed. Professionals with computers began trading in wee increments. Volume returned. The little guy? Hm.

Regulators have always wanted to give the little guy opportunity to execute orders like the big guys. It’s admirable. It’s also impossible. Purchasing power is king. Attempt to make $1 and $1,000 equal in how trades execute, and what will happen is the big guys will shift to doing things $1 at a time. The little guy will still lose out but now your market is mayhem confusing busy with productive.

These benighted gaffes seem eerily to originate in Washington DC. Michael Lewis says big banks, high-speed traders and exchanges have rigged markets. We agree these three set prices for everybody. But they’re following the rules. (more…)

Moneyball in Your Shares

We missed part of the Super Bowl tromping snowshod through a chamber-of-commerce snapshot 3,000 feet above Denver. We’ve tallied 20 inches of grade-A, premium Rockies powder the past five days.

Speaking of grade A, have you seen the movie Moneyball? If not, rent it. For story, cast, script, direction and acting, we don’t think better has been done in years. We were riveted.

“Moneyball” is a term writer Michael Lewis (The Big Short, Liar’s Poker, Blindside) coined to describe the application of statistics to baseball-team construction. Pressed to deliver returns economically, Billy Beane, manager of the Oakland Athletics, turned to proprietary data analytics, aided by a young gun from Harvard with a degree in economics. It changed baseball.

Before Beane, who’d heard of OBP or OBA? – on-base percentage or on-base average. Baseball teams bought players on how they looked, how they swung, their runs batted in, their average, even if they had a good-looking girlfriend (sign of confidence). Classic old-school fundamentals. (more…)