Tagged: Stocks

Man vs Machine

If you’ve never been to Sedona, AZ in April, go but guard yourself because it will lay hold on your spirit and make it captive to unrelenting beauty.

How does the French election, yet unfinished, help US stocks?

Wait, no. It’s not the French election causing US stocks to soar, we’re told. It’s corporate earnings. Investors are loving good numbers.

Except investors didn’t set prices Monday when the market surged. Fast Traders did. The machines.

Saying the market is up because investors like Macron’s chances to win the French presidency reflects nothing fundamental. It’s an explanation fitted to an outcome.  Saying investors are gushing over corporate earnings is also finding a cause for an effect.

What data support the conclusion stocks jumped because people prefer the Frenchman Macron over the Frenchwoman Le Pen?  What data say investors are pouring money into stock because of strong earnings?  Earnings aren’t strong. They’re just better than weak results a year ago.

The data supporting those views, it turns out, is the market itself.  It’s up. So it must be that investors like something. The French election.  No?  How about US corporate earnings?  Market direction becomes a cause for humans, even when humans are not its cause.

Many suppose prices in the stock market can’t be set by machines. The opposite is true. Prices in the market can’t be set by humans. Under Regulation National Market System, it’s impossible for a human being to walk around the stock market trying to make a trade.

The rules say any “marketable trade,” a stock order wanting to be the best bid to buy or offer to sell, must be run by machines. Why? Because a human cannot keep pace with the market’s speed, and the order must be able to move fluidly to best price, So, the regulators said, it must be automated. Run by machines.

No matter where shares are listed, your stock can trade anywhere, from a private market operated by Credit Suisse, to the newest exchange, IEX.  The rules say simply that orders to buy and sell must move seamlessly to wherever the best price resides.

Well, humans devised machines with one purpose: setting price.  Humans themselves can set prices, sure. But they try to be in the middle, between the best bid to buy and offer to sell.  Yet we go on treating both events as though they are the same.

Understanding both the broad market and your own shares requires recognizing that while self-driving cars are a ways off yet, self-driving stocks are here now. When we all sit around talking about it, trying to find some rational explanation, we become weirder than the market. It’s as though we’re making excuses for the monster we crafted.

Since Fast Traders who want to own nothing set the pace, don’t be surprised if the pace disappears all at once.  And ask yourself every day: Are humans setting my stock price today, or is it the machines?  The answer is eminently measurable.

High Speed Risk

Is the era of high-frequency trading over? 

While you ponder whether “High Speed Risk” might be a good name for your garage rock band, let’s reflect on stocks. We said last week: “Our Sentiment is negative for the first time since the election. It’s a weather forecast.  No need for panic, only preparation.”

We measure the short-term movement of money with a 10-point scale. It was about 5.0 or higher from the election until Mar 9, 80 trading days. Last week it dipped below 4.5.

And weather arrived yesterday before today’s VIX expirations. It’s not news about the Trump administration.  It’s the end of a long, leveraged run. Monthly options and futures expired Friday the 17th.  New options traded Monday, Mar 20.

Yesterday was what we call Counterparty Tuesday. If counterparties have estimated demand Monday for new options incorrectly, they true up on Tuesday. Since markets fell, counterparties overshot demand.  

Derivatives have featured prominently in gains since the election. Investors have been buying both stocks and rights to more of them in the future. That additional implied future demand breeds higher current stock prices.

For the first time since the election, investors didn’t buy more future rights.  Does this mark an end to that pattern?  Certainly for the moment.  And it dovetails with the state of high-frequency trading.

For you new readers, let’s canvass high-frequency trading.  In 2007 after Regulation National Market System, a firm calling itself Octeg splashed through the data. In Intel alone, Octeg was driving 35% of monthly volume, crushing Goldman Sachs.

Who is Octeg, we wondered? The firm defied what we knew about brokers, which always wanted to hang a sign out, advertise that they had products for sale. We couldn’t find even a phone number for Octeg.  It was like stumbling on an unmarked warehouse in the suburbs packed to the ceiling with all the stuff you tried to buy at the mall.

While rooting through regulatory filings we found an address in Chicago and then another firm in the same suite called Global Electronic Trading Co (GETCO). 

And then we got it.  Octeg was GETCO spelled backward. The two were the same firm.

Getco dominated trading through the financial crisis, profiting on two ideas. First, exchanges began paying traders to sell shares on their markets. Think of it like a store coupon: Do business with us and we’ll give you a discount. Getco cashed coupons. In gargantuan manner. Exchanges paid them in coupons for relentless volume.

Second, Getco realized that it could be first to set price. So why not set as many prices as possible, forcing big institutions to chop their trades into smaller pieces?

Volume exploded. 

But it wasn’t investment.  Getco had no customers. It was using computers and mathematical calculations to continuously set prices in the stock market, getting paid to buy and sell stocks while simultaneously changing the price ever faster to force big investors into chopping up stock orders into smaller pieces so Getco and its burgeoning ilk could sit in the middle buying low and selling high in fractions of seconds.

At the pinnacle in 2009, we pegged this behavior, high frequency trading, at 70% of volume. Now high-frequency trading by our measures is less than 40% of volume.

The entire market the past decade is built on it. On the floor of the NYSE, four big high-speed firms price all NYSE stocks at the open. At the Nasdaq, a larger number does the same, trading prices for coupons.

The problem is high-frequency traders don’t have customers. They aren’t “working orders” for investors. They are buying low and selling high in fleeting fashion, for profit. Mistake these prices for ones from investors, and you mentally misprice stocks.   

You read that high-frequency traders are “market makers.” They’re “furnishing liquidity.” Traders with no customers can’t make markets. They can only exploit what others in the market don’t know. In 2007, it was easy. Now it’s not.

That’s because big stock brokers are doing the same thing with Exchange Traded Funds, rapidly repricing them, and index funds, and the stocks comprising them, and the options and futures derived from them. The big brokers are better at it than high-frequency traders because they have customers and can make longer directional plays by reading what customers are doing.

In a market without high-frequency trading, all stocks would trade like Berkshire Hathaway Class A shares.  About 400 shares daily.  It would be better for investors. But all the exchanges would go broke. Ironic, isn’t it?

High-frequency trading isn’t done. But with the market we’ve got, the harder it is for high-speed machines to price stocks, the greater the risk of big moves.

The Rising

Can’t see nothing in front of me. Can’t see nothing coming up behind. 

Those of you who know me know I would never write “can’t see nothing.” But Bruce Springsteen can get away with it.

He and the E Street Band put out the eponymous album on July 30, 2002, and it was appropriate for the stock market as the S&P 500 bottomed October 4, 2002 at 800 and proceeded with The Rising, traveling steadily upward to 1,561 by October 12, 2007. 

We didn’t return until Mar 2013, taking longer to get back than to arrive in the first place.

Now we’ve had variations on a Rising theme for eight years. The market bottomed this week in 2009, on Mar 6, at 683 for the S&P 500, lower than when our troubadour from Long Branch, NJ first commanded in gravel and guitar that we come on up for the rising.   

As with the last lyric in Bruce the Bard’s melody, it’s on wheels of fire that we’ve come rolling down here to 2017 in the stock market, blistering records and burning up the tape. 

We at ModernIR study equity data in our inimitable way, the cross of our calling, Bruce might say.  And that’s all the poetry I can muster.  But I’ve got some facts.

We measure Sentiment on a purely mathematical basis, tracking how the four big reasons people buy and sell interact with market prices and where these wax and wane.

We’re good at capturing short-term asset-price changes. We’ve been doing it for a long time. Our five-day forecasts are roughly 95% correlated to the actual average prices for stocks after the five projected days have elapsed – statistically interchangeable.  

Putting it in English, in short spans we can foretell the future, using math, because the money in the market is using math in ways we can observe with precision. 

Here’s what we know about market Sentiment and short-term prices. For 77 consecutive days now, back to Nov 14, 2016, the stock market has been about 5.0 or higher on our 10-point Sentiment Index.  Since June 2012, some 1,200 trading days, 715 have been 5.0 or higher. It’s been a bull market.  But ten percent are in a row since the election. 

Remarkable. (Aside: If you want to kick this around, catch me Friday at the NIRI Silicon Valley Spring Seminar.)

To our knowledge, the previous record for extended neutral or better Sentiment without a single tip to negative was 53 days, from Feb 22 to May 6 last year.  Back in 2013 when we had a momentum stock market, our Sentiment gauge would carom from below 4.0 to over 9.0 – a rocking Richter event – about every month. 

Here’s the thing:  When last year’s epic Sentiment run concluded in May, we were never able to rise sustainably again – until November. It required an extraordinary catalyst in the form of the Wildly Unexpected Donald Trump. The S&P 500 finished October 2016 lower than it wrapped May 2016. Even with another massive catalyst, the Brexit Boomerang, between. 

This is not scientific. It’s not fundamental. It’s not a factor model. But it IS mathematical, and it does reflect how money behaves today. Here’s my conclusion: Without an extraordinary event, a catalyst, when this long Sentiment run atop 5.0 stops, it will mark the end of this particular bull market. 

What’s a real-world application for investor-relations people? We track Sentiment for you.  When you’re Overbought your price will fall, absent a catalyst. When you’re Oversold, barring a tsunami, your shares will rise. It’s not rational. It’s math.  

You can use this data to your advantage.  When you’re a 10, call a couple of your good value holders to check in, because you’re likely to dip, and if your holder buys (you will be on their minds), you might revert to 5.0 quicker – and 5.0 stocks are the bedrock of solid investment portfolios. 

And vice versa. You’re 1.0?  Pick up the phone. The first investor to buy probably makes money (and will remember to look when next you call) and you’ll return to 5.0. It’s not what you say. It’s that you call that counts. Put yourself on the screen.

Won’t that work for the market? Sure.  At Feb 11 last year, the market was a 1.0/10.0. Great time to buy, turned out.  It was a Rising. 

We don’t know what’s ahead. Don’t know what’s coming up behind. But the math says we’ve had it good for a record stretch. It’s hard to keep setting records. 

Metrics

How many of you wear a Fitbit?

I remember the last time I saw Jeff Morgan, erstwhile NIRI CEO.  I said, “Jeff, you’ve lost weight. You’re a lean machine!”

He tapped his wrist, and said, “Fitbit. You can appreciate it, Tim. It’s just measuring data, right? Burn more than you take in.”

When we were roaming Barcelona last September, Karen’s phone was a cheering section congratulating us for achieving footstep goals.  Because there’s an app for that of course.

We’ve now bought a Peloton for our home gym, a finessed stationary bike replete with interaction and data. You can measure everything. You mark progress and capability.

On Friday the 13th the Wall Street Journal ran a story about online life insurance. Companies are using algorithms that parse lifestyle data from prescription-drug, motor-vehicle and credit-card sources to meter risk in place of testing blood and urine.

Data reveal facts about conditions. That’s the starting point. The next step is comparing data gathered in one period with the same metrics from another to see what’s changed. It’s what your doctor does.

And it’s the heart of financial reporting. We can debate the flaws of the requirement, but every quarter public companies are providing metrics to investors and analysts, who in turn model the data to understand business outcomes.

In fact, it’s the beat of the market. Every week data pours forth from governments and central banks on producer-prices and purchasing managers and jobs and consumer sentiment and on and on it goes.

I think it’s too much, promoting arbitrage on expectations versus outcomes. But think of the cognitive dissonance in our profession, investor-relations.  While everyone is measuring short-term, IR is trying to manage long-term. Yes, we want long-term commitment to our shares.  But that’s not how prices are set.

Unless you measure something the way it functions, you’ll get incorrect conclusions.

Much of the IR community isn’t measuring at all. We react. Right? The stock moves, and we call people for explanations.  How can answers be accurate without comparatives?  You don’t know what’s changed. No Fitbit is delivering data supporting conclusions.

The key to good management is consistent measurement. It’s the only way to understand an ecosystem and sort what you can control from what’s systemic.

Suppose I declare that I will float across the room.  Well, gravity, the rule governing the movement of bodies in this universe, says on this planet my pronouncement is flawed.

The gravity of the stock market is Regulation National Market System.  It defines how money moves from point A to point B.  We can observe those movements.

I showed a company yesterday how shares climbed from $60 to $70 during election week last November on Asset Allocation, and from $70 to $72 on Risk Management. That means ETFs and derivatives boosted shares.  Active money didn’t buy until the stock was at $75, even though it was selling the stock at $61 right before the election. Active money didn’t know what to do.

What followed? Fast Traders sold and shorted because the last fools to the party were the Active stock-pickers unaware of how the market works now.  No wonder many lag the averages.

If investors making rational decisions set the prices of stocks more than 50% of the time, the market can be called rational. Otherwise, it’s got to be called something else.  IR professionals, it’s your job to help management see the market realistically.

All the people talking about stocks are of a breed. The sea of money using models isn’t telling others what it’s doing!  But it’s setting prices.

You must measure now. What’s your Fitbit for the IR job?  Is it calibrated to the market we have today or one that no longer exists?

Case in point: I told a healthcare company recently that the data showed they would be unable to hold any gains until short volume were no longer consistently 65%.

“But our short interest is well below sector averages,” they said.

“That measure is from 1975,” I said. “It doesn’t reflect how the market works now.”

The stock dropped 8% yesterday and remains at the same average price it’s had since short volume rose over 60% well more than a quarter ago. The data – the Fitbit for IR – will tell them when conditions have changed.  Fitness can be measured in IR as it is elsewhere.

Measurement is management.  Put key metrics in front of your management regularly. Don’t wait to be asked for information – then it’s too late and you’ve lost control and become a glorified assistant (and they’ll define the job for you).

Create anticipation with metrics. “We’ve had a nice run but Fast Traders are leading, we’re Overbought, and short volume is over 50%, so expect some pressure next week.”

That’s what you should be doing.  Stop calling people for wild guesses unsupported by data AFTER something has occurred. Start measuring and setting expectations – especially around earnings, or events like options-expirations today through Friday.

You can only set expectations if you’re first consistently measuring and comparing key data points. This is evolved IR.  You can invent your own metrics. But we’ve already done that for you.

Verve and Sand

The whole market is behaving as though it’s got an Activist shareholder.

In a sense it does.  More on that in a minute.

We track the effects of Activism on trading and investment behaviors both before it’s widely known and afterward. A hallmark of these event-driven scenarios is behavioral volatility. That is, one or more of the big four reasons investors and traders buy and sell stocks routinely fluctuates day-over-day by more than 10% in target companies.

(Aside: Traders and investors buy and sell stocks for their unique characteristics, when they have characteristics shared by others, to profit on price-differences, and to leverage or protect trades and portfolios. The market at root is just these four simple purposes.)

Event-driven stocks can override normal constraints such as Overbought conditions, high short volume, or bearish fundamentals.  In fact, short volume tends to fall for catalyst stocks because the cost of borrowing shares rises as more want to own rather than rent, and unpredictability of outcomes makes borrowing shares for trading riskier.

Currently in the broad market, shorting trails the 200-day average marketwide. The market has manifested both negative and overbought sentiment and has still risen.

And behavioral volatility is off the charts.

Almost never does the broad market show double-digit fluctuations in behavior because it’s a giant index smoothing out lumps. With quad-witching and quarterly index rebalances Dec 16, Asset Allocation ballooned 16.3% marketwide, signaling that indexes and ETFs are out of step with assets (and may be substituting).

Also on Dec 16, what we call Risk Management (protecting or leveraging trades and portfolios) jumped 12%. It’s expected because leverage with derivatives has been pandemic in markets, with Active Investment and Risk Management – a combination pointing to hedge funds – currently leading.

Here’s the thing. The combined increase for the two behaviors last Friday was an astonishing 28%.  Then on Dec 19 as the new series of marketwide derivatives issued, Fast Trading – profiting on price-differences – exploded, jumping 25%.

A 25% change for a stock trading $100 million of dollar-volume daily is a big deal. The stock market is about $300 billion of daily dollar-volume.

Picture a skyscraper beginning to sway.

Looking back, Risk Management jumped 16% with July expirations, the first after searing Brexit gains. The market fell from there to September expirations when again behavioral volatility exploded. The market recovered briefly before falling all the way to the election. With expirations Nov 18, Risk Management shot up 11.2%.

Behavioral volatility precedes price-volatility. We have it now, monumentally.

What’s happened in the broad market is a honeymoon before the wedding. The incoming Trump administration has sparked an investing surge betting on a catalyst – exactly the way Activist investors affect individual stocks.  Fundamentals cease to matter.  Supply and demand constraints go out the window. A fervor takes hold.

The one thing our long bull market has lacked is fervor. It’s the most hated – and now second longest ever – bull market for US stocks because so many have loathed the monetary intervention behind ballooning asset prices.

That’s all been forgotten and a sort of irrational exuberance has set in.

Those who know me know I embrace in libertarian fashion broad individual liberty and limited government because it’s the environment that promotes prosperity best for all. I favor a future with more of it.

We should get the foundation right though. I’ll use a metaphor.  Suppose a giant storm lashes a coast, burying it in sand. Some return to the beach to rebuild homes and establishments but much lies listlessly beneath a great grainy coat.

Then a champion arrives and urges people to build. The leader’s verve lights a fire in the breasts of the people, who commence building a vast structure.

Right on the sand.  Which lies there still unmoved, a shifting layer beneath the mighty edifice rising upon it.

It’s better to remove the sand – all the central-bank buildup from artificial prices, the manufactured money, the warped credit markets.  Otherwise when the next wave comes the damage will be that much greater.

So call me wary of this surge.

Fed Up

We’re in New York hoping to run into Janet Yellen because today the Federal Reserve probably raises rates.

In December last year the Fed hiked, and markets jumped – and then imploded. Worst January start ever for the stock market.

If you’re not right now feeling a deadening of your senses, you’re an outlier. Assemble a focus group and you’ll find folks have roughly the same reaction to the words “monetary policy” that they do to “dental appointment.”  It’s all floss, scraping and blood.

With stocks at all-time highs due more to the growth of the Fed’s balance sheet than verve in the economy, one wonders if it’s held together with dental floss. The world’s leading currency manipulator by my estimation isn’t China but us. The USA.  We micromanage the supply of dollars, and all currencies turn on the value of the dollar.

So we have to talk monetary policy. If the supply of money expands faster than the economy, inflation will show up somewhere. Inflation simply means your money doesn’t go as far as it used to.  See everything from real estate to education to stocks now.

The Fed from 2009-15 increased the supply of dollars by 62% while the economy grew 24% (about 2% per year). The adult population expanded 7%. Those employed increased 10% (but only 4% if you back up to peak mid-2008 pre-crisis jobs).

The only way an economy grows faster than population is if productivity – doing more with less – increases. Our most productive year by far in recent times was…wait for it…2009.  Yes, when the economy imploded and the value of the dollar exploded, suddenly our money went farther, and the bloat came out, and productivity spiked 5.5%.

But the Fed immediately shoved the entire economy full of bucks. Productivity nose-dived because our money didn’t go as far as it used to, as prices for everything from houses to stocks climbed sharply.  Productivity since has averaged less than 1% growth per year and totals but 5% from 2010 through the third quarter this year.

So if the supply of money is the only thing growing rapidly, we have an economy built on what the sellside analysts call multiple-expansion, which is just another name for your money doesn’t go as far as it used to.  You’re paying more for the same thing.

This, while we’re at it, is how income inequality increases.  When governments expand the supply of money, people with more (the rich) spend it on houses and cars and art and stocks, increasing the prices of those things, and the rich get richer.

But for the poor who do not have assets, the money they have doesn’t go as far because stuff like toilet paper and cereal and toothpaste costs more.  So they have less (we thus have a curious confluence in which the Fed rails against income inequality while promoting it with policies).

The ideal structure is for money to have timeless value so that technology for making things boosts productivity, and prices come down some over time (prices declined by 50% from 1800-1900 and we had our most explosively productive stretch ever) and everybody’s money goes a little farther.

The Trump administration brings a message of opportunity. That unstoppable force of hope is slamming into the immovable object of economic fact. Stocks are up some 10% without underlying change. It says how much we long for the good times to roll again.

There are two questions here as we conclude. First, do we want to build the future atop a giant pile of wobbly Fed pillows stuffed full of cash, or would it be better to ground it firmly on economic output?  Hope is a powerful elixir but it’s not empirical. Empirically, there should be a massive sale – everything must go – in America before we begin again.

And question number two is will that happen?  The US dollar strengthened sharply before the Internet bubble burst in 2001, putting everything on sale. We have valuations now matched only by those then.  The dollar is at the strongest level since then.

The strong dollar will mean weaker Q4 revenue and profits for multinationals and if it continues into Q1 next year, the economy will first slow before Trump policies may put wind in the sails. When record stock markets mash into falling corporate profits and slowing economic outcomes, expect trouble.

I’m excited about the future in America. Before it comes, we should first get Fed up.  Dump these asset prices created by a vast accumulation of cash.  Start fresh. Will it happen?  That’s the unknowable part.

Long December

Are you a Counting Crows fan?

Karen and I saw the band years ago at Red Rocks, our fabled foothills venue. Front man Adam Duritz lived, he said, in Denver as a child.  One great song goes, “It’s a long December and there’s reason to believe that this year might be better than the last.”

On this last day of November I’m thinking back.  On November 30, 2015, marketwide short volume – daily trading on borrowed shares – was about 43%, a low number versus trailing standards. By January 2016 it had risen to 52%. At Nov 28 this year its 43%, the same as last year.

The dollar then as measured by the DXY Index was the strongest in a decade, at 100.5.  It’s at 101.0 now, a fourteen-year high.

Let’s pause. What’s a strong dollar mean? Using an analogy, a football field is one hundred yards long. Suppose your team is way behind, down 30-0. So the referees shorten the field to 60 yards to give you a chance to catch up.

A strong dollar is a long field. A weak dollar is a short field. Weak dollars shorten play by making prices rise, earnings from abroad converted back to dollars appear stronger, and borrowing cheaper.

From 2009-14, the USA played on a short field, thanks to the Federal Reserve. We were down 30-0. By latter 2014 we trailed about 30-14.  I use that score because by historical measures – housing starts, GDP growth, discretionary income, retail sales (excluding autos), industrial output, productivity and more – we are half what we were.

But we’re catching up, so the Fed is getting set to stretch the field again (Aside: We should never shorten the field. If you’re used to running 60 yards in practice but the games play at 100, your training is all wrong. A steady dollar is what we need.).

DXY

Courtesy Dow Jones Marketwatch

 

Getting back to our December comparisons, in 2015 the Fed inched the cost of overnight borrowing called the Fed Funds Rate up to 0.25%-0.50% (it settles sort of in the middle), the first hike in ten years.  This December it’s widely expected the Fed will mosey the rate up another 25-50 basis points.  Simpatico again.

In December 2015, the bond market was weak, with interest rates on the 10-year US Treasury at 2.33%, up from 1.7% in January, a 39% increase (prices and rates move inversely, so when people sell bonds, rates rise and when they buy them, rates fall). As November 2016 ends, the 10-year Treasury is 2.32%, from 1.4% in July (68% rise).

And the S&P 500 is about 5% higher now. (Speaking of stocks, don’t miss our NIRI webinar tomorrow called Hide and Seek: The Incredible But True Story of How Big Institutions Buy and Sell Your Shares.)

There is one major difference between then and now. Using our long-field/short-field analogy in a different way, when the Fed’s balance sheet has big bank reserves, that’s a short field. Low bank reserves, long field. Between early December 2015 and early January 2016, the Fed took $500 billion out of bank reserves, pushing the playing field to the full hundred yards as it tightened rates.

The whole globe rocked.

Stocks imploded and money screamed into bonds, driving rates down. For awhile at the end of January it seemed downside for the market was bottomless.

By pushing the entire $500 billion back into reserves and chopping the playing field to 60 yards, the Fed got stocks to reverse and soar all the way to the Brexit (they overdid it).

This time they’re starting December where they began January, with a long field and low reserves. They believe they can hike rates December 14 and hack the playing field down to 60 yards by boosting bank reserves, and thus next year will be better than the last.

They might be right.

I’ll tell you the risk should they get it wrong and what would set it off:  If the economy lurches sharply down – despite headlines this week there’s a real chance of a recession next year looking at trends – then the Trump Rally will be a big belly well out over the Fed’s skis as winter hits. If that happens this current year will be better than the next.

I’m hoping for a short December.

Best Of: The GRAR

Editorial Note: Happy Thanksgiving!  We hope you reflect gratefully this season, as we will.  And speaking of reflecting, you might think with markets hitting new all-time highs after the election that we’ve beaten a retreat (what the military calls without irony “advancing to the rear”) from our two-year declamation about coming risk-asset revaluation. We’re by no means complaining about gains. We think prospects for the USA merit giving thanks. 

But there will be no escaping the consequences of artificial asset-price inflation. You can’t blow a balloon full of air and suppose it’ll float forever.  Runs here in November will have a profound reversal magnified by the meteoric dollar-rise. Whether it happens in days or weeks, it’s coming. The question for the new administration will be whether it possesses the fortitude to let prices find proper equilibrium so the economy can actually find “escape velocity” finally, in its aftermath.  -TQ

Originally posted Nov 9, 2016:

Power changed hands in the USA today.

I don’t know in what way yet because I’m writing before election outcomes are known, and about something for the market that will be bigger than which person sits in the oval office or what party holds congressional sway.

The GRAR is a lousy acronym, I admit. If somebody has got a better name, holler.  We started talking about it in latter 2014.  It’s the Great Risk Asset Revaluation. We had the Great Recession. Then followed the Great Intervention. What awaits the new Congress and President is the GRAR.

I’ll give you three signs of the GRAR’s presence.  Number one, the current quarter is the first since March 2015 for a rise in earnings among the S&P 500, and the first for higher revenues since October 2014. Until now, companies have been generating lower revenues and earning less money as stocks treaded water, and the uptick still leaves us well short of previous levels.

Since 1948, these recessions in corporate financials of two or more quarters have always accompanied actual recessions and stock-retreats. The GRAR has delayed both.

Second, gains off lows this year for the Dow Jones Industrial Average have come on five stocks primarily. One could use various similar examples to make this point, but it’s advances dependent on a concentrated set of stocks.  This five – which isn’t important but you can find them – include four with falling revenues and earnings. Counterintuitive.

Finally, the market is not statistically higher (adding or subtracting marketwide intraday volatility for all prices of nearly 2% daily) than it was in December 2014.

That’s remarkable data.  It says prices are not set by fundamentals but intervention.

We might think that if earnings growth resumes, markets will likewise step off this 2014 treadmill and march upward. And that’s independent of whatever may be occurring today – soaring stocks or falling ones, reflecting electoral expectations versus outcomes.

In that regard, our data showed money before the election positioned much as it was ahead of the Brexit vote:  Active buying, market sentiment bottomed, short volume down – bullish signals.

You’ve heard the term “delayed gratification?” It means exercising self-discipline until you’re able to afford desired indulgences.  Its doppelganger is delayed consequences, which is the mistaken idea that because nothing bad arises from bad decisions that one has escaped them.

The bad decision is the middle one – The Great Intervention.  The Great Recession was a consequence arising from a failure to live within our means. When we all – governments, companies, individuals – spend less than we make, nobody ever needs a bailout.

But you don’t solve a profligacy problem by providing more access to credit.  The breathtaking expansion of global central-bank balance sheets coupled with interest rates near zero is credit-expansion. To save us from our overspending, let’s spend more.

If I held in my palms a gold coin and a paper dollar and I said to you, “Pick one,” which would you take?

If you said “the dollar bill,” I can’t help you and neither can Copernicus, who first described this phenomenon that explains the GRAR 500 years ago. Nearly everybody takes the gold, right? We inherently know it’s more valuable than the paper, even if I tell you they have the exact same value.  This principle is called Gresham’s Law today.

Credit does not have the same value as cash.  But assets in the world today have been driven to heights by credit, the expansion of which diminishes the value of cash.

What happens when the people owning high-priced assets such as stocks, bonds, apartments in New York, farmland in Nebraska and so on want to sell them?  All the cash and credit has already been consumed driving prices up in the first place.

What will follow without fail is the GRAR. Depending on who got elected, it might come sooner or later.  But without respect to the winner, it’s coming.  The correct solution for those now in power is to avoid the temptation to meet it with credit again, and to let prices become valuable and attractive. Painful yes, but healthy long-term.

That’s the path out of the GRAR. I hope our winner has the discipline to delay gratification.

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.

Two Faces

In Roman mythology, Janus is the two-faced god of beginnings and endings.  In Denver, Janus is the god of investing. In the news, Janus is merging with UK money manager Henderson.

The move reflects the two faces of the stock market, beginnings and endings and gates and doorways, like the figure from Rome’s old religion.  Today’s market is the inverse of the one prevailing when Tom Bailey launched Janus from a one-room Denver office in 1969, choosing the front-range town over New York to avoid Wall Street GroupThink.

For the next three decades, Janus boomed through a culture of camaraderie built around proprietary financial modeling to find the most dynamic, well-run companies. Janus was a stock-picker of the highest caliber with a penchant for bucking the crowd and going long, big.  Star fund manager Tom Marsico epitomized the Janus style with his Focus Fund backing typically 20 stocks.

Janus embraced the New Economy and chased technology. Though Marsico left in 1997 in a dispute with management, Janus, which was then owned by Kansas City Southern before spinning out publicly as part of Stilwell Financial, became the best mutual-fund company in the business, peaking at $330 billion of assets in 1999.

Then the Internet Bubble burst. In latter 2000 as tech stocks cratered, Janus was losing $1 billion a day in asset-value. In 2001, the firm cut half its staff and saw assets under management dip below $200 billion. The name Stilwell, a moniker fashioned to honor rail tycoon Arthur Stilwell, went away and the two-faced god returned as a public firm.

But the US stock market emerged from the 20th century fundamentally altered, a National Market System. Well, there is no “market system.” It’s one or the other. A market is organic commercial interaction – a dynamic environment where shrewd analysis and the search for the best is a recipe for the success that bred Janus. A system is a process and method. Success in a system turns on stripping out cost and following a model.

The National Market System today is a process and method. GroupThink. Exactly what Janus eschewed. Blackrock and Vanguard have roared past yesterday’s stock-picking heroes like Janus by stripping cost out and tracking averages, thriving at GroupThink.

It’s remarkable testament to the state of the market that being average is the key to being best. And how did we get a market where average is king? Process and method. Rules.

The Order Handling Rules in 1997 decreed that stock markets must display prices set by Electronic Communications Networks, which obliterated a fixture of exchanges back to the 1792 Buttonwood Agreement that brokers not undercut each other on price.  Regulation ATS required all trades to occur through brokers or exchanges, putting the brokers who created exchanges into competition with their progeny. Decimalization in 2001 wiped out the market-making spread necessary for investment banks to fund small-cap stock research (small-cap IPOs plunged by 90%).

Then Regulation National Market System, a product of Congressional legislation, crafted a single marketplace functioning like a data network around the best national bid or offer. A network of linked nodes isn’t competition. It’s a system. The process and method for navigating the network determines success. Machines navigate it best, so the biggest source of volume today is Fast Trading, which writes no research, carries no inventory, underwrites nothing.

In the decade ended Dec 31, 2015 spanning the creation of the National Market System, 98% of all stock-pickers have failed to beat the average – the S&P 500.  The reason isn’t prowess from passives but how indexes and ETFs strip out cost and construct portfolios around the average prices that now securities regulators require (“Best Execution”).

If you’re looking for outliers like Janus, this market is the wrong one for you (and if you seek that money as the investor-relations profession does, it’s stacked against you too). So money is rushing with great sound and fury from them and into indexes and ETFs.

Mergers are driven by effort to strip out cost.  Henderson is paying $2 billion for Janus to form a manager with $300 billion of assets – smaller than Janus in 1999. Ironically, the amount Henderson is paying equals the investment outflows from the two in 2016.  Janus CEO Dick Weil will co-head the company with Henderson CEO Andrew Formica and will move from Denver to London.

Regulators: Is there not one of you paying attention? You did this. You are wrecking the market for stock-picking, for small-caps, for American capitalism. Now you’ve driven Janus out of Denver.  We don’t need a two-faced market where just one smiles.  Keep this up and you’ll foster the mother of all backlashes.