Tagged: passive

440 Market

How durable is the US stock market?

It sounds like we’re talking about shoes.  Can I wear these hiking? Are they waterproof?

No, it’s a legitimate question, a fair comparison.  Public companies, your capacity to raise capital, incentivize your executives, and deliver returns to shareholders in large part depends on the stock market’s ability to reflect what you’re doing as a business.

And investors, how do you know you can trust the market?

Trust is the bedrock of commerce.  The founders of our republic thought you couldn’t have confidence in transactions involving the exchange of time for money, or goods for money, if the value of the money wasn’t constant.  It was thought back then essential to assure the people that their money would not be misused or devalued.

In the same sense, I think it’s right to expect assurances about the market.  Our retirement accounts are there, by the trillions.

I think pooling public capital and trusting its deployment to smart, seasoned people is a bedrock capitalist principle. People and money are the pillars of productivity – labor and capital.

Agreed?

We can generally concur that prudent deployment of capital is good. Putting money in the hands of smart, experienced people is a winning idea.

We agree, I expect, about the need for a system of uniform justice.  If a dispute arises about the way money has been handled, you’re owed recourse, redress, due process.

Right?

Then there’s the probity, the integrity, of the capital markets.  It’s as important to know you won’t be jobbed by the commercial market for your public investments as it is to have clear, speedy and reliable jurisprudence.

But the big question hangs there.  Do we have that kind of stock market?

To that point, I’m speaking to my dear investor-relations family, the NIRI Rocky Mountain Chapter, tomorrow as part of a program on macroeconomics and market structure. Guess which piece I’ve got? Come join us!  It won’t be boring.

It’s always been important to understand things.  Money.  Government.  Economics. Markets.  The harder these become to comprehend, the more we should ask why.

I understand the stock market.

Reminds me of a line about bitcoin I saw on Twitter, and I think I’ve shared it before so apologies: I’ve never understood bitcoin. On the other hand, I’ve never understood paper money either.

Rather than valuation metrics I see the stock market as machinery.  I grew up on a cattle ranch where the motto was “hundreds are nice, but we need thousands.”  We fixed everything, welded everything, patched everything.  We paid attention to the machinery because we owned it no matter how old it was, and our livelihood depended on it.

My point is it’s not valuation that necessarily determines the health of a market. It’s the machinery creating the valuation. 

Country singer Eric Church laid down a tune for the ages in 2016, Record Year. One of the best songs ever.  The following year, 2017, was a record for ETFs, which saw almost $500 billion of inflows, data show.

And between then and now, trillions of dollars more have followed, leaving the allure of superior Active returns for the durable machinery of Passive crowd-following.

Not surprisingly, Active Investment is down almost 40% as a percentage of daily US trading volume since 2017.

The weird thing, so is Passive Investment.

As market volume has risen from about $250 billion daily in 2017 to $625 billion so far in Jan 2021, investment of both kinds is down almost 75%.  And speculation and derivatives – substitutes for stocks – are up more than 50%.

Wow, right?

I think it means Passive money isn’t adjusting to rising valuations, leaving itself dangerously out over the skis, as we Alpine folks say on steep slopes.

I don’t think the machinery is about to collapse. But. Let me tell you one more story.

We had a gorgeous John Deere 440 that came with the ranch. It was old. And orange, and easy to drive and full of superfast hydraulics for the blade, the backhoe. Fine machinery.  And it left us too often with a slipped track supine in the river with the busted metal heavy on the fast-flowing river-bottom. Or on hillsides. And in ditches.

Love. Hate.  Like the stock market.

The stock market is sleek and lovely. But the hydraulics are hot and we’re crawling the tracklayer through fast waters. I’m concerned that Passive money isn’t keeping up, that the market is reliant on things that don’t last.

It’s not fear.  It’s prudence that leads me to keep an eye on the tracks and not the trading multiples.  And we have that data for you.

Don’t forget to join us at the NIRI Rocky Mountain session today!

The Actionable Hoax

What’s actionable?

It’s a buzzword of business and the investor-relations profession. And, yes, my title violates a rule of grammar because you can’t tell if the topic is a hoax about actionability or if a hoax out there has proved actionable.

We’ll answer using the market. Like this: Trade-war threats are wrecking markets!  Right?

Wrong.  Pundits tying moves in the market to headlines don’t understand market structure. Suppose you’re getting “actionable” information from pundits who don’t know how the market works. Are the recommended actions reliable?

While you ponder that, consider this: If trade concerns for tech stocks caused the correction in February, why did the Nasdaq hit an all-time high June 20? Did the same money that rejected the market back then on trade fears three months later without resolution to those concerns pay more?

You can say, “No, they were sellers.” Okay, so who bought?

Market experts are often offering actionable intelligence based on outdated ideas. But they have a duty to understand how the market works and what the money is doing.

In fact, these two pillars – how the market works, what the money is doing – should be the bedrock for understanding markets.

What’s the money doing?  It’s not choosing to be directed by rational thought. We know  because a vast sea of data on fund flows tells us so. If we as investors or investor-relations practitioners continue doing what we did before fund flows surged to passive money, who is the bigger fool?

Exchange Traded Funds (ETFs) are driving 50% of market volume now. They are passive vehicles. But they uniquely among investment products permit ETF creators like Blackrock and Vanguard a step-up in tax basis through creation and redemption.

How? Say NFLX is up 100% in three months, imputing tax costs to ETF shares. Creators of ETFs collateralized by NFLX shares will put it in redemption baskets exchanged to brokers for returned ETF shares.  (NOTE: If you don’t know how ETFs work, ask us for our ETF whitepaper.)  NFLX then plunges as brokers sell and short it.

Five days later, the ETF creator can bring NFLX back now in a creation basket of new ETF shares that it will issue only in exchange for NFLX – laundered of tax consequences.

Apply this to the Technology sector (or the whole market for that matter).  We just had Russell index rebalances, and Technology is a big part of market cap.  S&P indices rebalanced June 22 and Technology is over 25% of the S&P 500 now.

This week is quarter-end window-dressing. ETFs are trying to bleed taxes off runups in Tech stocks.  We could see it coming in Sentiment by June 14, when it topped, signaling downside, and when behavioral volatility indicated big price-swings. Data say we have another rough day coming this week.

Headlines may help prioritize what gets tax-washed, so to speak, but the motivation is not investment. It’s aiming at picking gains and packing off tax consequences.

The market is driven far more by these factors than rational thought, which we know by studying the data. ETF creations and redemptions are hundreds of billions of dollars monthly. Inflows and outflows from buy-and-hold funds are nonexistent by comparison.

Ergo, it can’t be rational thought driving the market no matter the talking heads declaiming trade threats.

It’s what lawyers call a “fact pattern.” ETFs dominate passive investment, drive 50% of market volume, depend on tax efficiency, which process is an arbitrage trade that involves a continual shift of hundreds of billions monthly in underlying assets, and a corresponding continual shift in collateralizing assets called stocks – with market-makers profiting, and ETF creators profiting – without regard to market direction.

It’s poor fodder for a 24-hour news cycle. But it explains market behavior. Moves have become more pronounced because money stopped pouring into US equities via ETFs this year. Volatility exploded because getting tax efficiency got harder.

Which brings us to the “actionable” hoax. The word “actionable” says consumers of products or services are fixated on a prompt, a push, an imprimatur.

Fine. But flinging the word around causes investors and IR professionals to miss what matters more, and first.  Investors and public companies should be asking: “How does this service or that tool help me understand what the money behind stocks is doing?”

Ask your service provider to explain how your stock trades. Then ask us to explain it.

If they don’t match, ask why. The beginning point of correct action is an understanding of what you can and cannot control, and how the environment in which you operate works.

Take the weather. We can’t control it. But it determines the viability of our actions. The same applies to understanding market structure. It determines the viability of actions.

If you want to learn market structure, ask us how, IR professionals and investors.  It’s the starting point. What you think is actionable may be a hoax. Compare how the market works to what you’re doing. Do they match? If not, change your actions. We’ll help you.