Tagged: tariffs

Euripides Volatility

Question everything.

That saying is a famous Euripides attribution, the Athenian playwright of 2500 years ago. The Greeks were good thinkers and their rules of logic prevail yet today.

Let’s use them.  Blue chips dropped over 600 points Monday and gained 200 back yesterday. We’re told fear drove losses and waning fear prompted the bounce.

What do you think the Greeks would say?

That it’s illogical?  How can the same thing cause opposing outcomes?  That’s effectively the definition of cognitive dissonance, which is the opposite of clear thinking.

The money motivated to opposite actions on consecutive days is the kind that profits on price-differences. Profiting on price-differences is arbitrage.

Could we not infer then a greater probability that arbitragers caused these ups and downs than that investors were behind them?  It’s an assessment predicated on matching outcome to motivation.

Those motivated by price-changes come in three shades. The size of the money – always follow the money, corollary #1 to questioning everything – should signal its capacity to destabilize markets, for a day, or longer.

There are Risk Parity strategies.  Simon Constable, frequent Brit commentator on markets for the Wall Street Journal and others, suggested for Forbes last year following the February temblor through US stocks that $500 billion targets this technique designed to in a sense continually rebalance the two sides of an investing teeter-totter to keep the whole thing roughly over the fulcrum.

Add strategies designed to profit on volatility or avoid it and you’ve got another $2 trillion, according to estimates Mr. Constable cites.

The WSJ ran a story May 12 (subscription required) called “Volatility in Stocks Could Unravel Bets on Calm Markets,” and referenced work from Wells Fargo’s derivatives team that concluded “low-vol” funds with $400 billion of assets could suddenly exit during market upheaval.

Add in the reverse. Derivatives trades are booming. You can buy volatility, you can sell it, you can hedge it.  That’s investing in what lies between stocks expected to rise (long bets) and stocks thought likely to fall (short bets).

This is the second class:  Volatility traders. They are trying to do the opposite of those pursuing risk-parity. They want to profit when the teeter-totter moves. They’re roughly 60% of daily market volume (more on that in a moment).

The definition of volatility is different prices for the same thing.  The definition of arbitrage is profiting on different prices for the same thing.

The third volatility type stands alone as the only investment vehicle in the history of modern capital markets to exist via an “arbitrage mechanism,” thanks to regulatory exemptions.

It’s  Exchange-Traded Funds (ETFs). ETFs by definition must offer different prices for the same thing. And they’ve become the largest investment vehicle in the markets, the most prolific, having the greatest fund-flows.

EDITORIAL NOTE: I’m hosting a panel on ETFs June 5 at the NIRI Annual Conference, one of several essential market-structure segments at the 50th anniversary event. You owe it to your executive team to attend and learn.

Size matters. Active Investment, getting credit for waxing and waning daily on tidal trade fear, is about 12% of market volume. We can’t precisely break out the three shades of volatility trading. But we can get close.

Fast Trading, short-term profiteering on fleeting price-changes (what’s the definition of arbitrage?), is about 44% of volume. Trades tied to derivatives – risk-parity, bets on price-changes in underlying assets – are 19%.  Passive investment, the bulk of it ETFs (the effects of which spill across the other two), is 25%.

One more nugget for context:  Options expire May 16-17 (index, stock options expirations), and May 22 (VIX and other volatility bets). Traders will try to run prices of stocks to profit not on stocks but how puts, calls and other derivatives increase or decrease far more dramatically than underlying stocks.

The Greeks would look at the math and say there’s an 88% probability arbitrage is driving our market.

Euripides might call this market structure a tragedy. But he’d nevertheless see it with cold logic and recognize the absence of rational thought.  Shouldn’t we too?

Dragon Market

As the market fell yesterday like a dragon from the sky (Game of Throners, the data are not good on dragon longevity now), 343 companies reported results, 10% of all firms.

Market fireworks were blamed yet again on tariff fears. Every tantrum is the Fed or tariffs it seems, even with hundreds publishing earnings. What happened to the idea that results drive markets?

Speaking of data, on May 6, the market first plunged like a bungee jumper off a bridge – and then caromed back up to a nonevent.

Behind the move, 21% of companies had new Rational Prices – Active money leading other behaviors and buying. That’s more than twice the year-long average of about 9% and the third-highest mark over the entire past year.

Talk about buying the dip. Smart money doesn’t see tariffs as threats to US interests (and likes the economic outlook, and likes corporate financial results). We’ve been using them to fund government since the Hamilton Tariffs of 1789.

So if not tariffs, why did stocks fall?

Before I tell you what the data show: Come to the NIRI Annual Conference, friends and colleagues. I’m moderating a panel the first day featuring hedge-fund legend Lee Cooperman, market-structure expert and commentator Joe Saluzzi, and SEC head of Trading and Markets Brett Redfearn.

We’ll talk about the good and bad in market-evolution the past 50 years and what’s vital to know now.  Sign up here.

IR folks, you’re the chief intelligence officer for capital markets. Your job is more than telling the story. It’s time to lead your executive team and board to better understand the realities driving your equity value, from Exchange Traded Funds to shorting and event-driven trends. It’s how we remain relevant.

Before you report results, you should know what the money that’s about you, your story, your results, your strategy, is doing – and what the rest of it is doing too. 

Take LYFT, which reported yesterday for the first time. Just 8% of LYFT volume is from Active Investment. By contrast about 22% is quantitative event-driven money, and over 58% is fast machines trading the tick. The balance ties to derivatives.

From that data, one can accurately extrapolate probable outcomes (ask us for your Market Expectation, or LYFT’s, and we’ll show you).

Every IR team should be arming its board and executives with a view of all the money, not just musing on how core holders may react – which is generally not at all.

And investors, if you’re focused only on fundamentals without respect to market structure, you’ll get burned.  I can rattle off a long list of companies beating and raising whose shares fell. The reasons aren’t rational but arbitrage-driven.

Having kept you in the dark like a Game of Thrones episode, let’s throw light on the data behind the late equity swoon: Always follow the money (most in financial media are not).

ETFs are 50% of market volume.  There have been $1.4 trillion (estimating for Apr and May) of ETF shares created and redeemed in 2019 already.

ETF shares are collateralized with stocks, but ETFs do not pool investor assets to buy stocks. In exchange for tax-free collateral, they trade to brokers the right to create ETF shares to sell to investors. The collateral is baskets of stocks – that they own outright.

The motivation, the profit opportunity, for that collateral has got nothing to do with tariffs or earnings or the economy. It’s more like flipping houses.

An Invesco PowerShares rep quipped to one of our team, “You see that coffee cup? I’d take that as collateral if I could flip it for a penny.”

ETF sponsors and brokers in very short cycles flip ETF shares and collateral. As with real estate where it works

Tech Sector Composite Stocks — Behavioral Data

great until houses start to fall in value, the market craters when all the parties chasing collateral try to get out at once (and it happens suddenly).

ETF patterns for the top year-to-date sector, Tech, are elongated way beyond normal parameters (same for two of three other best YTD sectors). It suggests ETFs shares have been increasing without corresponding rises in collateral.

With the market faltering, there’s a dash to the door to profit on collateral before the value vanishes. One thing can trigger it. A tweet? Only if a move down in stocks threatens to incinerate – like a dragon – the value of collateral.

How important is that for IR teams, boards, executives and investors to understand?