Tagged: Short Volume

Borrowed Time

“If a stock trades 500,000 shares daily,” said panelist Mark Flannery from hedge fund Point72 last Thursday on my market-structure panel, “and you’ve got 200,000 to buy or sell, you’d think ‘well that should work.’ It won’t. Those 500,000 shares aren’t all real.”

If you weren’t in Austin last week, you missed a great NIRI Southwest conference.  Mr. Flannery and IEX’s John Longobardi were talking about how the market works today.  Because a stock trades 500,000 shares doesn’t mean 500,000 shares of real buying and selling occur.  Some of it – probably 43% – is borrowed.

Borrowing leads to inflation in stocks as it does in economies.  When consumers borrow money to buy everything, economies reflect unrealistic economic wherewithal. Supply and demand are supposed to set prices but when demand is powered by borrowing, prices inevitably rise to unsustainable levels.  It’s an economic fact.

All borrowing is not bad. Borrowing money against assets permits one to spend and invest simultaneously.  But borrowing is the root of crises so watching it is wise.

Short interest – stock borrowed and sold and not yet covered and returned to owners as a percentage of total shares outstanding – isn’t unseemly. But it’s not a predictive indicator, nor does it describe risk. The great majority of shares don’t trade, yet what sets price is whoever buys or sells.

It’s far better to track shares borrowed as a percentage of total traded shares, as we described last week. It’s currently 43%, down one percentage point, or about 2.3%, as stocks have zoomed in latter August.

But almost 30% of stocks (excluding ETFs, routinely higher and by math on a handful of big ones averaging close to 60%) have short volume of 50% or more, meaning half of what appears to be buying and selling is coming from something that’s been borrowed and sold.

In an up market, that’s not a problem. A high degree of short-term borrowing, much of it from high-speed firms fostering that illusory 500,000 shares we discussed on the panel, means lots of intraday price-movement but a way in which short-term borrowing, and covering, and borrowing, and covering (wash, rinse, repeat), may propel a bull market.

In the Wall Street Journal Aug 25, Alex Osipovich wrote about how Goldman Sachs and other banks are trying to get a piece of the trading day’s biggest event: The closing auction (the article quotes one of the great market-structure experts, Mehmet Kinak from T Rowe Price). Let’s dovetail it with pervasive short-term borrowing.

We’ve mapped sector shorting versus sector ETF shorting, and the figures inversely correlate, suggesting stocks are borrowed as collateral to create ETFs, and ETFs are borrowed and returned to ETF sponsors for stocks.

A handful of big banks like Goldman Sachs are primary market-makers, called Authorized Participants (as opposed to secondary market-makers trading ETFs), which create and redeem ETF shares by moving stock collateral back and forth.

The banks give those using their versions of closing auctions the guaranteed closing price from the exchanges.  But it’s probably a great time to cover short-term ETF-related borrowings because trades will occur at an average price in effect.

The confluence of offsetting economic incentives (selling, covering borrowings) contribute to a stable, rising market. In the past week average intraday volatility dropped to 1.9% from a 200-day average of 2.5% at the same time shorting declined – anecdotal proof of the point.

What’s the flip side?  As with all borrowing, the bill hurts when growth stalls. When the market tips over at some future inevitable point, shorting will meet shorting. It happened in January 2016 when shorting reached 52% of total volume. In February this year during the correction it was 46%. Before the November election, short volume was 49%.

The point for both investors and public companies is that you can’t look at trading volume for a given stock and conclude that it’s equal and offsetting buying and selling. I guarantee you it’s not.

You don’t have to worry about it, but imbalances, however they may occur, become a much bigger deal in markets dependent on largescale short-term borrowing. It’s another market-structure lesson.

Going Naked

Today this bull market became the longest in modern history, stretching 3,453 days, nosing out the 3,452 that concluded with the bursting of the dot-com bubble.

Some argue runs have been longer before several times. Whatever the case, the bull is hoary and yet striding strongly.

Regulators are riding herd. Finra this week fined Interactive Brokers an eyebrow-raising $5.5 million for short-selling missteps. The SEC could follow suit.

Interactive Brokers, regulators say, failed to enforce market rules around “naked shorting,” permitting customers to short stocks without ensuring that borrowed shares could be readily located.

Naked shorting isn’t by itself a violation. With the lightning pace at which trades occur now, regulators give brokers leeway to borrow and sell to investors and traders to ensure orderly markets without first assuring shares exist to cover borrowing.  I’m unconvinced that’s a good idea – but it’s the rule.

Interactive Brokers earned penalties for 28,000 trades over three years that failed to conform to rules. For perspective, the typical Russell 1000 stock trades 15,000 times every day.

What’s more, shorting – borrowed shares – accounts for 44% of all market volume, a consistent measure over the past year.  Shorting peaked at 52% of daily trading in January 2016, the worst start to January for stocks in modern history.

In context of market data then, the violations here are infinitesimal. What the enforcement action proves is that naked shorting is not widespread and regulators watch it closely to ensure rules are followed. Fail, and you’ll be fined.

“Wait a minute,” you say.  “Are you suggesting, Quast, that nearly half the market’s volume comes from borrowed shares?”

I’m not suggesting it. I’m asserting it.  Think about the conditions. Since 2001 when regulations forced decimalization of stock-trading, there has been a relentless war on the economics of secondary market-making. That is, where brokers used to carry supplies of shares and support trading in those stocks with capital and research, now few do.

So where do shares come from?  For one, SEC rules make it clear that market makers get a “bona fide” exemption from short rules because there may be no actual buyers or sellers. That means supply for bids and offers must be borrowed.

Now consider investment behaviors.  Long-term money tends to buy and hold. Passive investors too will sit on positions in proportion to indexes they’re tracking (if you’re skewing performance you’ll be jettisoned though).

Meanwhile, companies are gobbling their own shares up via buybacks, and the number of public companies keeps falling (now just 3,475 in the Wilshire 5000) because mergers outpace IPOs.

So how can the shelves of the stock market be stocked, so to speak? For one, passive investors as a rule can loan around a third of holdings. Blackrock generates hundreds of millions of dollars annually from loaning securities.

Do you see what’s happening?  The real supply of shares continues to shrink, yet market rules encourage the APPEARANCE of continuous liquidity.  Regulators give brokers leeway – even permitting naked shorting – so the appearance of liquidity can persist.

But nearly half the volume is borrowed. AAPL is 55% short. AMZN is 54% short.

Who’s borrowing? There are long/short hedge funds of course, and I’ll be moderating a panel tomorrow (Aug 23) in Austin at NIRISWRC with John Longobardi from IEX and Mark Flannery from Point72, who runs that famous hedge fund’s US equities long/short strategy.  Hedge funds are meaningful but by no means the bulk of shorting.

We at ModernIR compare behavioral data to shorting. The biggest borrowers are high-frequency traders wanting to profit on price-changes, which exceed borrowing costs, and ETF market-makers.  ETF brokers borrow stocks to supply to ETF sponsors for the right to create ETF shares, and they reverse that trade, borrowing ETF shares to exchange for stocks to cover borrowings or to sell to make money.

This last process is behind about 50% of market volume, and hundreds of billions of dollars of monthly ETF share creations and redemptions.

We’re led to a conclusion: The stock market depends on short-term borrowing to perpetuate the appearance of liquidity.

Short-term borrowing presents limited risk to a rising market because with borrowing costs low and markets averaging about 2.5% intraday volatility, it’s easy for traders to make more on price-changes (arbitrage) than it costs to borrow.

But when the market turns, rampant short-term borrowing as money tries to leave will, as Warren Buffett said about crises, reveal who’s been swimming naked.

When? We’d all like to know when the naked market arrives. Short-term, it could happen this week despite big gains for broad measures. Sentiment – how machines set prices – signals risk of a sudden swoon.

Longer term, who knows? But the prudent are watching short volume for signs of who’s going naked.

Three Ways

Jakob Dylan (he of Pulitzer lineage) claimed on the Red Letter Days album by the Wallflowers that there are three ways out of every box.  Warning: Listen to the song at your own risk. It will get in your head and stay there.

Something else that should get in the heads of every investor, every executive and investor-relations professional for public companies, is that there are three ways to make money in the stock market (which implies three ways to lose it too).

Most of us default to the idea that the way you make money is buying stuff that’s worth more later. Thus, when companies report results that miss by a penny and the stock plunges, everybody concludes investors are selling because expectations for profits were misplaced so the stock is worth less.

Really? Does long-term money care if you’re off a penny? Most of the time when that happens, it’s one of the other two ways to make money at work.

Take Facebook (FB) the past two days.

“It’s this Cambridge Analytica thing. People are reconsidering what it means to share information via social media.”

Maybe it is.  But that conclusion supposes investors want a Tyrion Lannister from Game of Thrones, a mutilated nose that spites the face. Why would investors who’ve risked capital since New Year’s for a 4% return mangle it in two days with a 9% loss?

You can buy stocks that rise in value.  You can short stocks that decline in value. And you can trade the spreads between things. Three ways to make money.

The biggest? We suppose buying things that rise dominates and the other two are sideshows.  But currently, 45% of all market trading volume of about $300 billion daily is borrowed. Short.  In January 2016, shorting hit 52% of trading volume, so selling things that decline in value became bigger than buying things that rise.  That’s mostly Fast Trading betting on price-change over fractions of seconds but the principle applies.

Facebook Monday as the stock plunged was 52% short. Nearly $3 billion of trading volume was making money, not losing it.  FB was 49% short on Friday the 16th before the news, and Overbought and overweight in Passive funds ahead of the Tech selloff.

The headline was a tripwire but the cause wasn’t investors that had bought appreciation.

But wait, there’s a third item. Patterns in FB showed dominating ETF market-making the past four days around quad-witching and quarterly index-rebalances. I say “market-making” loosely because it’s a euphemism for arbitrage – the third way to make money.

Buying the gaps between things is investing in volatility. Trading gaps is arbitrage, or profiting on price-differences (which is volatility).  ETFs foster arbitrage because they are a substitute for something that’s the same: a set of underlying securities.

Profiting on price-differences in the same thing is the most reliable arbitrage scheme. ETF trading is now 50% of market volume, some from big brokers, some from Fast Traders, nearly all of it arbitrage.

FB was hit by ETF redemptions.  Unlike any other investment vehicle, ETFs use an “in-kind exchange” model. Blackrock doesn’t manage your money in ETFs. It manages collateral from the broker who sold you ETF shares.

To create shares for an S&P 500 ETF like IVV, brokers gather a statistical sampling of S&P stocks worth the cost of a creation basket of 50,000 shares, which is about $12 million. That basket need be only a smattering of the S&P 500 or things substantially similar. It could be all FB shares if Blackrock permits it.

FB is widely held so its 4% rise means the collateral brokers provided is worth more than IVV shares exchanged in-kind. Blackrock could in theory make the “redemption basket” of assets that it will trade back for returned IVV shares all FB in order to eliminate the capital gains associated with FB.

So brokers short FB, buy puts on FB, buy a redemption basket of $12 million of IVV, and return it to Blackrock, receive FB shares, and sell them. And FB goes down 9%.  The key is the motivation. It’s not investment but arbitrage profit opportunity. Who benefited? Blackrock by reducing taxes, and brokers profiting on the trade. Who was harmed? Core FB holders.

This is 50% of market volume. And it’s the pattern in FB (which is not a client but we track the Russell 1000 and are building sector reports).

The next time your stock moves, think of Jakob Dylan and ask yourself which of the three ways out of the equity box might be hitting you today. It’s probably not investors (and if you want to talk about it, we’ll be at NIRI Boston Thursday).

Volume and Interest

In the five trading days ended Oct 17, 49.1% of average daily stock volume was short.

“Wait, what?” you say.  “Half the stock market is short?”

Yes, that’s right.  Short volume last topped 49% marketwide in mid-April. The market glided gently downward from there to May options-expirations. Speaking of expirations, we’re in them for October this week, so it’s a good time to talk about shorting.

Short volume hit a last marketwide low July 12 at 43%, which roughly corresponded to the high point of the Brexit Bounce.  At Nov 30 last year short volume was 42.9% and December and January were horrific for markets.  And on Jan 7, 2016, short volume was 52%. A month later the market bottomed and soared till April.

If short-volume history is a guide, the market is nearing a temporary bottom. It’s unwise to use a single data point, and we don’t (we use six key measures, plus a small supporting cast, as you clients know). The flow and behavior of money count, and we track both.

“Back up,” you say.  “You lost me at ‘short volume.’ What do you mean by that?”

Short volume is trading derived from borrowed shares.

“I read back in August on Zero Hedge that nobody’s short stocks. Trading from borrowed shares is 2% of the S&P 500, near a three-year low.”

You’re talking about short interest, the long-in-the-tooth risk-assessment tool derived from a 1975 Federal Reserve rule called Regulation T. Shorting and derivatives exploded after the US scrapped the gold standard and the Feds wanted to track margin accounts.

“Are we talking about the same short interest? The amount of total shares outstanding or float that’s borrowed and sold and not yet covered?”

Yes. Forty-one years later it’s still a standard market-risk measure. Yet it’s largely useless predictively. It didn’t shoot up until well after Bear Stearns foundered. In late 2007 it was 1.6%.

“So you’re saying it’s a crappy measure. What’s short volume then?”

Short volume is the amount of daily trading volume that’s borrowed. If a stock trades a million shares a day and short volume is 53%, then 530,000 shares of it were borrowed.  With over 40% of all market volume coming from Fast Traders wanting to own nothing, a great deal of this is short-term trading.

“Okay, I’m following. But what’s it tell me?”

Short volume signals several things but in sum it’s what you think: High short volume, lower price.  Why? Shorting is at root the continual adding of supply to the market. So if demand doesn’t keep up, price falls.

Here’s more:

High short volume means weak expectation for gains. No matter what company fundamentals are, if more volume comes from borrowed shares than owned shares, Fast Traders weighing tick data with high performance machines predict investors would rather lend shares for a return than spend money buying and holding them.

High short volume points to rotation. If the machines want to be short, they’re betting holders are selling and trying to hide it by passing shares through multiple brokers. The converse is true too: If you’ve been short and shorting falls, rotation is probably done.

Persistent high shorting reflects uncertainty about corporate strategy.  Not to pick on Tesla (because it’s not alone by any stretch) but its 200-day average short volume is 55%. Investors say it’s a trading vehicle, not an investment opportunity.  By contrast Qualcomm’s 200-day average is 42%. The two have inverse performance the past year.

Tangentially, high short volume CAN mean ETFs are seeing outflows. Exchange Traded Funds don’t directly buy or sell stocks but they create big volume because ETFs track other measures, such as indexes, that are in turn composed of other issues, such as stocks.

Traders measure deviation between ETFs and these other things and arbitrage (profit on price-differences) the spreads.  When investors sell ETF shares, ETF market makers or authorized participants (parties designated to create and redeem ETF shares) might short components to raise cash in order to buy ETF shares and retire them to rebalance supply.

In sum, short volume is a sensor situated near the beating heart of the money behind price and volume. And while algorithms driving trades today are designed to deceive, they can often be unmasked through short volume (with a couple other key measures).

For the rest of this week though, don’t be surprised if the market shows us not a beating heart but expirations-related palpitations.

Feedback

You’ve got to know what to measure.

Every time I interact with anybody from an airline to my company’s communications providers, I get a survey. “How’d we do?”

It drives me crazy. It’s like Claymation customer service:  Move something, take a picture.  Move something, take a picture. You’ve seen clay animation?  Wallace & Gromit popularized cartoonish clay caricature (and cheese!). Each picture contributed to forming movement and emotion. Every snapshot is feedback that when viewed together become the story. It works in cartoons but isn’t a good customer-service model.

We’re inundated with market information in the investor-relations profession.  The feedback loop is so intensive that it can somewhere morph from meaningful to white noise. You don’t know what you’re measuring or hearing. The sequence of snapshots doesn’t translate to meaningful film. There’s no narrative in the data.

Back when I was in the IR chair, I’d hear all the time that we’d broken through moving averages.  Initially, I exclaimed, “Oh!” and added, “Thank you!” It was only later that I realized moving averages told me little and certainly weren’t entertaining like Claymation. What should I tell management?  “Unfortunately, there’s been a breakdown in our moving averages, prompting a sharp shift in perception.”

Really?

Here’s another metric that confuses busy with productive. We have clients with high short interest. The measure derives from a 1974 regulation from The Federal Reserve to track borrowing in marginable securities accounts as part of aggregate money supply.

Borrowing is a good measure of risk. To that end, if you’re interested in a riotous three-minute explanation of what’s wrong in Europe, click here (it’s a video clip so be appropriately prepared).

But what if we’re not measuring borrowing correctly? Short volume, or trading with borrowed shares instead of owned shares, is roughly 43% of the total market. This measure wasn’t created by the Fed in 1974. It’s current. It’s Claymation. We’ve studied short interest and short volume and found that the former often is inversely correlated with price-movements, suggesting that it’s a lagging indicator of risk (and thus a lousy one). Not so with short volume.

The ownership measure extant today, 13Fs, was created in 1974 as well. It’s deplorable as feedback on institutional behavior, coming 90 trading days after it might have occurred. Today, over $1.7 trillion of assets are held by Exchange-Traded Funds that post ownership positions daily, yet trades clear “T+3,” or potentially four days out.

Do you think about these things in the IR chair? Perception is, “Our price continuously reflects rational thought.” Reality is something else, demonstrably and statistically.  Speaking of which, I’m hoping to take the NIRI Arizona chapter on a rollicking safari through market structure today. Process is more influential than purpose.

What you don’t want to do with your IR forensics is confuse busy with productive. You can track vast seas of data that neither offer narrative nor animate it.  What’s the right feedback mechanism? Reality! What is money doing right now and what’s the likely impact in the future, and what’s that mean to actions in my IR program and what I communicate to management? (more…)

Autocallable

It’s time we had The Talk.

Candid discussions can be uncomfortable. They broach subjects we prefer to avoid. But we can’t ignore the facts of life.

One such fact is Contingent Absolute Return Autocallable Optimization Securities. We’re more comfortable talking about diarrhea, right? Bring them up at a party and the crowd disperses. Try talking to your teenager about them and she’ll roll her eyes and turn up One Direction in her ear buds.

Why the public disdain? Look at the name. Need we say more? They’re wildly popular though with issuing banks including JP Morgan, UBS, Barclays, Morgan Stanley, RBC and others – just about anyone who offers “structured products.”

This particular version of structured product (“a financial instrument crafted by a brokerage to achieve a particular investment objective for clients ranging from short-term yield to long-term risk-mitigation” is how we’d describe them) achieved both infamy and scrutiny after Apple shares slumped in latter 2012. Big banks had sold hundreds of millions of dollars of Contingent Autocallable Securities paying a yield of about 10% and tied to the performance of Apple shares. Buyers got stuck with shares that had dropped 30% in value and lost principal to boot.

I’ll give you my simplest understanding of how these instruments work and why you should care from the IR chair. It’s a debt instrument and it’s unsecured. It tends to pay high interest, like 10% annualized in a basis-points world. Whether it pays out turns on two things: How long you hold it, and whether the underlying equity to which it’s paired declines below a trigger price.

There are two problems for IROs. First, because regulators consider it debt, if it “converts” there’s no equity trade. These things are not responsible for big percentages of volume so there’s no vortex looming in your share-counts. But still, decisions and strategies impacting shares are resulting from instruments you can’t track. (more…)

Rotation

You’ve heard of 99-year leases?

Karen’s grandfather has had an exceptional lease on life. We were in Nashville last weekend as he marked the calendar a 99th time. Remarkably, in his lifetime headlines have been made by WWI, inventor Nikola Tesla, the Great Depression (he was a divinity student at Yale then) and Adolph Hitler.

Speaking of a lease, in a sense that’s what short volume is. We’re not talking about short interest, periodic reads on short positions outstanding. That metric today struggles for statistical significance. Short volumes marketwide the past 20 days averaged 44%. In our client base, the highest daily average was 63%, the lowest, 28%.

Recently, a noted client received public attention from a prolific Short (an investor who in the old-fashioned way borrows and sells shares to raise cash on a belief exposure can be covered later at a lower cost for an arbitrage profit between selling and buying). In weeks leading up, our client’s volume marked short instead of long (a trade is one of those two, or exempt from the rules, the latter true for less than 1% of all trades so 99% of volume is long or short) rose from 39.9% short daily to 71.9% the day before the news.

It’s hard to fathom so large a portion of daily volume short – leased, or borrowed. Yet consider other assets. Most Americans borrow to buy cars and houses and major appliances. We borrow to buy dinner by paying with credit when we eat out. Banks borrow to make loans today (not generally true before the Fed). Governments borrow for everything. In buying $3 trillion of Treasury bonds and mortgage-backed securities, the Federal Reserve borrowed from Americans’ future earnings and productivity. Borrowing is rampant (and no harbinger of health, but that’s another story).

Stocks are the same save that the ratio still favors owning over renting (at 44% to 56% the divide is no chasm). Tracking borrowing alone tells one little except that your stock’s health is dependent on or derived from borrowing. (more…)

Binary IR

There’s a joke software engineers tell. There are 10 kinds of people in the world. Those who can count in binary and those who can’t.

Nerd jokes (no offense, technology friends!) are often neither immediately nor apparently funny. But the point is binary understanding, a sort of either/or perspective.

Suppose you were planning a vacation. After much research, you decide like Tiger Woods that you’re going to Cayo Espanto, off Belize. You reserve its luxurious accommodations, arrange for transit from the mainland, plan for time out of the office, purchase clothing and other supplies, even get your scuba certification so you can plumb the depths of the Great Blue Hole off Lighthouse Reef while there. Last, as an afterthought, you look for airline tickets.

And there are none.

If you’re Tiger Woods, you don’t need no stinking airline tickets (grammatically impaired colloquialisms are never accidental here). All analogies break down somewhere. But you get the point, right. Reserving rooms and laying plans before determining if the trip is possible is getting the horse and cart confused. And there is requisite order to the effective horse-and-cart combination.

Which brings us to investor relations and market structure. IR has always considered its objective to be singular. In geopolitical parlance, Message enjoys regional hegemony. There are no other considerations. (more…)

Great Expectations

Happy New Year! Hope you spent the two-week break from these pages joyfully.

We’ve descended this week from the high Denver backbone of the continent to visit west in Santa Monica and sponsor NIRI’s Fundamentals of IR program. Following our New York trip before Christmas, we’ve marked the turn of the calendar by touching both coasts.

We’ll kick off the year with a story. I’ve just finished Charles Dickens’s Great Expectations on my Kindle. Yes, I realize it was first published in serial form in 1860 (the year the cattle ranch on which I grew up was homesteaded). I have a long reading list. It took me awhile to get around to it.

Lest I spoil excitement for the other three or four of you planning on it still, I’ll say simply that it’s a masterful narrative assemblage of plot points, the connections between which one would never fathom at the outset. Great storytelling never gets old.

The market is like that too. As you begin 2014 in the IR chair, remember that in a market dominated by algorithms – the principal purpose of which is to deceive – things are rarely as they seem.

Take trading from Dec 9-31, 2013. The US equity world it seemed was gathered in knots and pockets like people in an old west town where the gunslinger was expected anytime to ride through. Tones were hushed, gestures animated. A pregnant air of expectation hung like a storm.

Would the Fed finally taper? And if it did, what then?  (more…)

The Short Fed Story

Is the Federal Reserve fueling stock-market gains?

When St. Louis Fed president James Bullard addressed the Bowling Green, KY, Chamber of Commerce in February 2011, he pinpointed correlation between Ben Bernanke’s September 2010 Jackson Hole speech on “QE2,” the Fed’s second easy-money program, and the stock-market rebound that followed. Classical effects of monetary easing include rising equity prices, Mr. Bullard said.

The Fed wanted market appreciation because people feel better when the stuff they own seems more valuable. But I think we’re having the wrong debate. The question isn’t if Fed intervention increases stock prices, but this: Can prices set by middle men last?

Before actor Daniel Craig became the new James Bond he starred in a caper flick called Layer Cake that posited a rubric: The art of the deal is being a good middle man. The Fed is the ultimate global middle man. Since the dollar is the world’s reserve currency, the Fed as night manager of the cost and availability of dollars can affect everybody’s money. After all, save where barter still prevails, doing business involves money. Variability in its value is the fulcrum for the great planetary teeter-totter of commerce. The risk for the Fed is distorting global values with borrowing and intermediation.

In the stock market, we’re told it’s been a terrible year for “the shorts” – speculators who borrow shares and sell them on hopes of covering at a lower future price. The common measure is short interest, a twice-monthly metric denoting stocks borrowed, sold, and not yet covered. Historically, that’s about 5% of shares comprising the S&P 500. (more…)