Tagged: Trading

Growth vs Value

Are you Value or Growth?  

Depends what we mean, I know. S&P Dow Jones says it distinguishes Value with “ratios of book value, earnings and sales to price.”

It matters because Growth is terrorizing Value.  According to data from the investment arm of AllianceBernstein, Growth stocks outperformed Value stocks by 92% between 2015-2020.  Morningstar says it’s the biggest maw on record, topping the 1999 chasm.

If you’re in the Growth group, you’re loving it.  But realize.  By S&P Dow Jones’s measures, anybody could be a Value or Growth stock at any time.  It’s all in the metrics.

The larger question is why the difference?  AllianceBernstein notes that the traditional explanation is earnings growth plus dividends paid.  That is, if your stock is up 50% more than a peer’s, it should be because your earnings and dividends are 50% better.

If that were the case, everybody would be a great stock-picker. All you’d need do is buy stocks with the best earnings growth. 

Well, turns out fundamentals accounted for just ten percentage points of the difference.  The remaining 82% of the spread, as the image here from AllianceBernstein shows, was multiple-expansion.  Paying more for the same thing.

Courtesy AllianceBernstein LP. https://www.alliancebernstein.com/corporate/en/insights/investment-insights/whats-behind-the-value-growth-performance-gap.html

Put differently, 90% of the time Growth stocks outperform Value stocks for no known reason. No wonder stock-picking is hard.

Take Vertex (VRTX) and Fortinet (FTNT), among the two very best and worst stocks of the past year.  I don’t know fundamentally what separates them. One is Tech, the other Healthcare.

I do know that running supply/demand math on the two, there’s a staggering behavioral difference.  FTNT spent 61 days the past year at 10.0 on our ten-point scale measuring demand called Market Structure Sentiment.  It pegged the speedometer 24% of the time.

VRTX spent five days at 10.0.  Two percent of the time.  You need momentum in today’s stock market or you become a Value stock.

We recently shared data with a client who wondered why there was a 20-point spread to the price of a top peer.  We ran the data.  Engagement scores were about the same – 85% to 83%, advantage to our client. Can’t say it’s story then.

But the peer had a 20% advantage in time spent at 10.0.  The behavioral patterns were momentum-style. Our client’s, GARP/Value style.

Okay, Quast.  Suppose I stipulate to the validity of your measure of supply and demand, whatever it is.  Doesn’t answer the question. Why do some stocks become momentum, propelling Growth to a giant advantage over Value?

I think it’s three things. I can offer at least some data, empirical or circumstantial, to support each.

Let’s call the first Herd Behavior.  The explosion of Exchange Traded Funds concentrates herd behavior by using stocks as continuously stepped-up collateral for ETF shares.  I’ll translate.  ETFs don’t invest in stocks, per se.  ETFs trade baskets of ETF shares for baskets of stocks (cash too but let’s keep it simple here). As the stocks go up in value, ETF sponsors can trade them out for ETF shares. Say those ETF shares are value funds.

The supply of Value ETF shares shrinks because there’s less interest in Value.  Then the ETF sponsor asks for the same stocks back to create more Growth ETF shares.

But the taxes are washed out via this process. And more ETF shares are created.  And ETFs pay no commissions on these transactions. They sidestep taxes and commissions and keep gains.  It’s wholly up to traders and market-makers to see that ETF shares track the benchmark or basket.

The point? It leads to herd behavior. The process repeats. Demand for the same stuff is unremitting.  We see it in creation/redemption data for ETFs from the Investment Company Institute. ETF creations and redemptions average over $500 billion monthly. Same stuff, over and over. Herd behavior.

Second, there’s Amplification.  Fast Traders, firms like Infinium, GTS, Tower Research, Hudson River Trading, Quantlab, Jane Street, Two Sigma, Citadel Securities and others amplify price-moves.  Momentum derives from faster price-changes, and Fast Traders feed it.

Third is Leverage with derivatives or borrowing.  Almost 19% of trading volume in the S&P 500 ties to puts, calls and other forms of taking or managing risk with derivatives. Or it can be borrowed money. Or 2-3x levered ETFs. The greater the pool of money using leverage, the larger the probability of outsized moves.

Summarizing, Growth beats Value because of herd behavior, amplification of price-changes, and leverage.

By the way, we can measure these factors behind your price and volume – anybody in the US national market system.

Does that mean the Growth advantage is permanent?  Well, until it isn’t. Economist Herb Stein (Ben’s dad) famously said, “If something cannot last forever, it will stop.”

And it will. I don’t know when. I do know that the turn will prompt the collapse of leverage and the vanishing of amplification. Then Growth stocks will become Value stocks.

And we’ll start again.

Passive Pitfalls

We’re back!  We relished upstate New York and Canandaigua Lake. 

If you’ve never been to Letchworth and Watkins Glen parks, put them on your list.  See photo here from the former, the Upper Falls there. Alert reader Deb Pawlowski of Kei Advisors, a local resident, said in pragmatic investor-relations fashion, “Beautiful area, isn’t it?”

Boy, indeed.

Letchworth State Park – Tim Quast

And it was month-end.  Companies were demolishing earnings expectations, a thousand of them reporting last week, sixteen hundred more this week.  Most big ones pile-driving views and guidance saw shares fall.

But how can that be?  Aren’t markets a reflection of expectations?

Tim.  Come on.  You buy the rumor, sell the news.

If that’s how you’re describing the market to your executive team and board…um, you’re doing IR like a caveman.  Rubrics and platitudes ought not populate our market commentary in this profession.

Use data.  Everybody else does (except certain medical-science organizations, but let’s just step lightly past that one for now).

Last week across the components of the S&P 500, Active Investment was up 0.0%. Unchanged.  Passive Investment – indexes, Exchange Traded Funds, quants, the money following a road map – fell 7%.  The use of derivatives, which should be UP during month-end when indexes use futures and options (quarterly options and monthly futures expired Jul 30) to true up tracking instead fell 2%.

No biggie? Au contraire.  A combined 9% drop in those behaviors is colossal. In fact, Passive money saw the steepest drop Jul 30 since Aug 3, 2020.

I’ll come back to what that means in a moment. 

Finishing out the Four Big Behaviors behind price and volume, the only thing up last week besides short volume, which rose to 45% Friday from a 20-day average of 44% of S&P 500 volume, was Fast Trading. Machines with an investment horizon of a day or less. Up 4%.

Think about all the economic data dominating business news.  The Purchasing Managers Index came in at 55 versus expectations of 56. Jobless claims unexpectedly jumped above 400,000.  Inflation came in hotter than expected at a seasonally adjusted 5.4%, annualized. Egads!

As Ronald Dacey in the Netflix series Startup would say, “You feel me?”

I’m just saying data abounds and so do reactions to it. Yet we talk about the stock market like it’s got no measurable demographics or trends driving it.

Well, of course it does!  Why is there not a single report Monday – except mine on Benzinga’s “Market Structure Monday” segment on the Premarket Prep Show – driven by data?

By the way, on Monday Aug 2, Passive Investment surged more than 14%. New month, new money into models.  The reason the market didn’t goose into the rafters was because it filled the giant Friday Passive hole I just described.

Broad Market Sentiment at Aug 2 is 5.4 on our 10-point market-structure scale of waxing and waning demand. That’s exactly what it’s averaged for more than ten years.  The market is not a daily barometer of reactions to data.  But it IS a reflection of what money is observably doing.

And what it’s observably doing to the tune of about 90% of all market volume is not picking stocks. The money follows models.  The money speculates. The money transfers risk. Because time is risk. The riskiest of all market propositions is buying and holding, because it leaves all the price-setting to stuff that’s much more capricious.

The least risky thing to do in the stock market is trade stuff for fractions of seconds, because your money is almost never exposed to downside risk. This is how Virtu famously disclosed in its S-1 that it made money in 1289 of 1290 days.  Stock pickers just want to be right 51% of the time.

What’s the lesson? Everything is measurable and trends manifest precisely the way money behaves.  It’s darned well time that boards and executive teams – and investors – understand the market as it is today.

Oh, and why is the Jul 30 drop in Passive money, the biggest in a year, a big deal? Because the market corrected in September 2020. The so-called FAANG stocks (FB, AAPL, AMZN, NFLX, GOOG/L) fell 35% in three days.

There is Cause. Then a delay. Then the Effect.  There is DEMAND and SUPPLY.  If DEMAND declines and SUPPLY rises, stocks fall.  In fact, those conditions uniformly produce falling prices in any market.

We measure it. Sentiment is demand. Short Volume is supply. 

So. The stock market is at 5.4. Right at the average. But if the supply/demand trends don’t improve, the market is going to correct.  Can’t say when. But the data will give us a causal indication.

If you want to know, use our analytics. We’ll show you everything!

Rewards of Risk

Investor relations involves risk.  And that’s good. 

Don’t you mean investing involves risk, Tim? And why is it good?

Well, yes, investing is a risky endeavor. But I mean the role of “investor relations,” the liaison to Wall Street at public companies, requires taking risk.

It’s not a “yes” job.  You’ll need the courage and occasional temerity to tell your executive team and board what each needs to understand about the equity market – and occasionally what not to do.

Time would fail me to tell you about all the times I’ve had conversations with IR folks who say, “I’m not sure my Board is willing to….” Pick your thing.

In my case, it happens when I explain that 10% of trading volume is rational stock-picking.

Some recoil in horror.  What am I going to do if the executives know 90% of our trading volume is something we can’t control?

If they don’t know, you’ll face unrealistic expectations.  Considered that possibility?  If your board and executive team don’t know how the stock market works, is that a good thing or a bad thing?

We’re still getting to what’s good about risk.

It’s our job to know how the stock market works and to be able to articulate what’s controllable and what’s not. Take the so-called meme stocks like AMC.  I credit AMC leadership for raising capital while the market embraces the stock.  They didn’t make the rules that permit crazy trading. They’re adapting.

And do you know how a stock with 450 million shares outstanding can trade 650 million in a day?  Yes, Fast Trading, in part.  Machines moving the same shares over and over.

But the big reason reaches back to the basics of how today’s stock market works under contemporary rules.  All shares must pass through a broker-dealer. All stocks must trade between the best bid to buy and offer to sell.  And all brokers who are registered to trade stocks must make a minimum bid and offer, both, of 100 shares.

Well, what if there aren’t 100 shares available?  There are no appliances available to install tomorrow in your house.  The electrical market is running out of GFCI outlets. Sherwin Williams is running out of paint.  You may not be able to get a load of lumber.

Yet somehow, magically, there is always 100 shares of your stock for sale. 

It’s not magic. It’s rules.  Rules require brokers and stock exchanges to connect to each other electronically. If they’re registered and not using “Unlisted Trading Privileges” to bid or offer rather than do both, brokers must commit to 100 shares each direction.

Well, it’s impossible. There aren’t 100 shares of everything available at every moment without artificial intervention.

So the SEC let’s brokers create shares under Rule 203(b)(2), the market-maker short-locate exemption, in order to assure 100 are always available.  Well, technically they’re shorting it without having to locate it.  Those trades have to be marked short.  And AMC has had short volume of 50-60% of total trading for two weeks running.

Brokers are manufacturing stock. That’s how the meme stocks scream. Brokers are selling buyers shares that don’t exist. If you’re in the IR profession, should you know these things?

So, why is risk good?  Mitch Daniels, President of Purdue University and ever a ready source for well-turned phrases, told graduates last month, “Our faculty has determined that data analysis, as we now call it, should be as universal a part of a Boilermaker education as English composition.”

We IR people are good at English composition. We need to be great at data.  Because, quoting President Daniels, certainty is an illusion. Just like those shares of AMC, and a swath of the whole market.

But leaders offer the capacity to understand the knowns and unknowns and make confident choices and recommendations.

I think data analytics are as vital to the IR job now as knowing Reg FD and Sarbanes-Oxley. The market translates our companies into digital value.  We need to understand it.

Otherwise we’ll be too fearful to lead our execs and boards boldly through the market we’ve got today.  Sure, there’s risk.  But the rewards of bold leadership never go out of style.  And we need that now more than ever.

Something Wicked

When I was a kid I read Ray Bradbury’s novel, Something Wicked this Way Comes, which plays on our latent fear of caricature. It takes the entertaining thing, a traveling carnival, and turns it into 1962-style horror.

Not 2021-style of course. There’s decorum. It stars a couple 13-year-olds after all.

The stock market also plays on our latent fear of caricature.  It’s a carnival at times.  Clowns abound.  As I said last week, companies can blow away expectations and stocks fall 20%.  That’s a horror show.

Courtesy The Guardian

Devilish winds have been teasing the corners of the tent for a time.  We told our Insights Reports recipients Monday about some of those.

The Consolidated Tape Association, responsible for the data used by retail brokers and internet websites like Yahoo! Finance and many others last week lost two hours of market data.  Gone.  Poof.

Fortunately, about 24 hours later they were able to restore from a backup.  But suppose you were using GPS navigation and for two hours Google lost all the maps.

So that was one sideshow, one little shop of horrors.  I don’t recall it happening before.

Twice last week and six times this year so far, exchanges have “declared self-help” against other markets.

It’s something you should understand, investor-relations professionals and traders.  It’s a provision under Regulation National Market System that permits stock exchanges to stop routing trades to a market that’s behaving anomalously, becoming a clown show.

Rules require all “marketable” trades — those wanting to be the best bid to buy or offer to sell — to be automated so they can zip over to wherever the best price resides. And exchanges must accept trades from other exchanges. No exceptions.  It’s like being forced to share your prices, customers, and even your office space with your competitors.

The regulators call this “promoting competition.” Sounds to me like a carnival.

But I digress. Exchanges must by law be connected at high-speed, unless declaring self-help.

An aside, I’ll grant you it’s a strange name for a regulatory term.  Self-help?  Couldn’t they have come up with something else?  Why not Regulatory Reroute? Data Detour?

Anyway, last week the trouble occurred in options markets.  First the BOX options market went down. It’s primarily owned by TMX Group, which runs the Toronto Stock Exchange.

Then last Friday CBOE — Chicago Board Options Exchange, it used to be called — failed and the NYSE American and Arca options markets and the Nasdaq options markets (the Nasdaq is the largest options-market operator) declared self-help. They stopped routing trades there until the issue was fixed.

Now maybe it’s no big deal.  But think about the effect on the algorithms designed to be everywhere at once.  Could it introduce pricing anomalies?

I don’t know.  But Monday the Nasdaq split the proverbial crotch of its jeans and yesterday the so-called “Value Trade” blew a gasket.

I’m not saying they’re related. The market is a complex ecosystem and becoming more so. Errors aren’t necessarily indicative of systemic trouble but they do reflect increasing volumes of data (we get it; we’re in the data business and it happens to us sometimes).

And we’d already been watching wickedness setting up in our index of short-term supply and demand, the ten-point Broad Market Sentiment gauge.  It’s been mired between 5.8-6.1 for two weeks.

When supply and demand are stuck in the straddle, things start, to borrow a line from a great Band of Horses song, splitting at the seams and now the whole thing’s tumbling down.

And here’s a last one:  Exchange Traded Funds (ETFs) have been more volatile than the underlying stocks for five straight weeks, during which time stocks had risen about 5% through last Friday. Since we’ve been measuring that data, it’s never happened before.

Doesn’t mean it’s a signal. It’s just another traveling freak show. Clowns and carnivals. ETFs are elastic and meant to absorb volatility. Stocks are generally of fixed supply while the supply of ETFs fluctuates constantly.  You’d expect stocks most times to thus move more, not less.

I think this feature, and the trouble in options markets, speaks to the mounting concentration of money in SUBSTITUTES for stocks.  It’s like mortgage-backed securities — substitutes for mortgages.  Not saying the same trouble looms.  We’re merely observing the possibility that something wicked this way is coming.

Our exact line Monday at five o’clock a.m. Mountain Time was: “There’s a lot of chaos in the data.”

Son of a gun.

I don’t know if we’re about to see a disaster amongst the trapezes, so to speak, a Flying Wallendas event under the Big Top of our high-flying equity market.  The data tell me the probability still lies some weeks out, because the data show us historically what’s happened when Sentiment hits stasis like it’s done.

But. Something is lurking there in the shadows, shuffling and grunting.

And none of us should be caught out. We have data to keep you ahead of wickedness, public companies and traders. Don’t get stuck at the carnival.

Suez on Wall

The stuff Archegos used expires today. Sound like Greek?

Courtesy SEC.gov

Let me explain. A hedge fund blew up. Its counterparties are taking huge hits. There are ramifications. What happens?  Maybe nothing. Maybe everything.

First, let’s understand “counterparty.”  A counterparty accepts the risk of the opposite of your desired trade. That is, if you want to bet something rises, somebody else will necessarily have to bet it falls by selling a put – a right to sell a stock.

Do you follow? It’s why winning trades are hard.  Somebody is always taking a countermanding risk (as ever, market structure matters because you can see the ODDS on which way things go).

And public companies, bets are pervasive.  One of these lately punctured the time-space continuum of the market.  Hedge fund Archegos (“guiding light” in Greek) gambled on derivatives tied to stocks and lost.

I won’t recapitulate details. Stories abound. What matters is WHY NOW, and what does this event mean to you as public companies and investors?

We wrote about CFDs – Contracts for Difference – in 2012.  Total return swaps are a type of CFD. These contracts give funds – I don’t say “hedge funds,” because, reading prospectuses for Blackrock and others, they too can use them – a way to put money on Red 34, but where Red 34 is half the spots on the Roulette wheel.

Why would a counterparty take that bet?  Because they too – Goldman Sachs, Morgan Stanley – make bets on the outcomes to offset the risk that Red 34 comes up.  Remember, Lloyd Blankfein, erstwhile Goldman Sachs CEO, said in the aftermath of the 2008 debacle, “We’re in the risk-transfer business.”

I think it’s the HOPE of the markets biggest participants that nobody understands this stuff – because everybody would be outraged.  I’m not a cynic. I’m looking at the data. Trading unrelated to how your business performs, public companies, pops eyeballs from sockets. Investors, if you don’t know, you’ll be a popped eyeball.

Remember the mortgage-backed securities pandemic?  The movie and book The Big Short? Why would banks sell credit default swaps and then bet against the outcome they just sold?

Because you can always offload your risk.

Until you can’t.

Friday was an “until you can’t” moment for the market.  I’m surmising based on the available data that hedge funds bet certain stocks in a limited period of time expiring today – Mar 31 – would outperform some benchmark by a defined percentage.

Banks took that bet.  Other banks unaware of the size of the bet lent money to the firm making the bet, making it massively larger than anyone comprehended.

To offset risk, banks require collateral. The hedge fund in question put up its portfolio, which the banks shorted – which raised cash and hedged exposure.

I suspect the fund first pledged the SAME collateral to the banks lending money, but then actually assigned it to GS and MS, firms backing swaps.

Here’s the WHY NOW answer. As expirations drew nigh – Mar 31 – it became apparent to the banks selling the swap to the hedge fund and to the hedge fund itself that it was going to fail.  Banks holding collateral sold it.

Those with just a pledge held only the bag they’d been left holding. This is why Credit Suisse and Nomura face big losses, it seems to me (it could be some variation on this theme of course).

But that’s not the heart of the problem here.

This is the Suez Canal converging with Wall Street.

If you’ve somehow missed it, a cargo ship longer than the Empire State Building got stuck in the Suez, blocking everything. God freed it. That is, engineers used a combination of the Worm Moon, a super moon and its incumbent high tides, and a lot of tugging. It’s free now. But the damage is done.

In the stock market, as in the Suez Canal, there’s not much liquidity – not much floating things. And a handful of banks serve the bulk of transactions in Treasurys, currencies, bonds, derivatives (like swaps), commodities, equities, ETFs.

Indexes need to true up tracking right now for the quarter. They depend on these banks. Investors want to lock quarterly results. Massive futures obligations are expiring that the same banks back, to true up index-tracking.

What if something just can’t get done? Which thing do they pick to let go?

Maybe they can juggle it all.  The Suez couldn’t. Maybe Wall Street can. If not, there’s a CHANCE of severe dislocation for markets between today and Apr 6, when books will be all square.

Sailing Away

Sailing takes me away to where I’ve always heard it could be just a dream and the wind to carry me.

Christopher Cross said it (youngsters look it up). In this pandemic we said, “That boy might have it figured out.”

TQ and KQ sailing

So, with two negative Covid tests in hand, we’re currently near 17 degrees North, 62 degrees West readying our 70-foot catamaran for a float with friends.  Chef, bar, crew, trade winds blowing our hair around, azure waters, sunrise, sunset. We’ll catch you after, Feb 8.

And in between, let’s have a look at the market.  The big buzz is GME, Reddit now dominating chatter with WallStreetBets (y’all can look that up too), the stock streaking, a push-pull among longs and shorts, and Andrew Left from Citron cannonballing into the discourse and an pool empty.

It may be a sideshow.  GME is up because Fast Trading, the parties changing bids and offers – shill bids, I call it – and buying retail volume surged from 38% of GME trading to over 57%.

At the same time, Short Volume, daily trading that’s borrowed, plunged from 47% to 34%. The funny thing is it happened AFTER the news, not before it.

The Reddit WSB crew has the sort of solidarity I wish we’d direct at being free. Nobody says to them the words “allow,” or “mandate,” and I love that.

But.

In a free stock market, your actions as traders are known before you make them.

That is, plow millions of limit orders into the market from retail brokerage accounts, and the firms like Citadel Securities buying them know before they hit the market.  They will feed the fire, blowing on the conflagration until it runs out of fuel.

And BBBY is up 50% in two weeks.  But it’s not the same, looking at market structure (the behavior of money behind price and volume in context of rules). Quantitative money plowing into BBBY to begin the year ignited the surge.

Could the actions of machines be misunderstood by humans?  Of course. Already the pattern powering GME has reverted to the mean.  In BBBY, Short Volume is up already on surging Fast Trading, the same machines we just talked about.

All but impossible is beating trading machines. They know more, move faster.

However, they are, paradoxically, unaware of market structure beyond fractions of seconds into the future.

Humans have the advantage of knowing what’s days out.  And on Fri Jan 29, the largest futures contract in the market comes due.  It’s designed to erase tracking errors. This is a much bigger deal than GME and BBBY but not as much fun.

Tracking errors are the trouble for Passive investors, not whether they’re “beating the benchmark,” the goal for Active stock-pickers.

A tracking error occurs when the performance of a fund veers from its benchmark.  The aim is generally less than 2%.  Yet S&P 500 components are 2.5% volatile daily, the difference between highest and lowest average daily prices. For those counting, daily average exceeds monthly target).

It’s why Passives try to get the reference price at market-close. But the market would destabilize if all the money wanting that last price jammed into so fleeting a time.  It would be like all the fans in Raymond James Stadium pre-pandemic – capacity 65,618 – trying to exit at the same time.

Congrats, Tom Brady. We old folks relish your indomitable way.

Like Brady’s achievements, everybody leaving RJ Stadium at once is impossible in the real world.

So funds use accounting entries in the form of baskets of futures and options.  ModernIR sees the effects.  The standard deviation between stocks and ETFs in 2019 was about 31%.  The difference reflects the BASKET used by the ETF versus ALL the stocks. To track that ETF, investors need the same mix.

Well, it’s not possible for everyone in the market to have the same quantity of shares of the components. So investors pay banks for options and futures to compensate for those tracking errors.  The more errors, the higher the demand for true-up derivatives.

In 2020, the average weekly spread rose to 71%, effectively doubling.  In the last eight weeks since the election it’s up to 126%.

The paradoxical consequence is that increasing volatility in benchmark-tracking is creating the illusion of higher demand for stocks, because options and futures are implied DEMAND. 

And so we’re

sailing away. You guys hold the fort. Keep your heads down.  We’ll catch you after the last Antigua sunset.

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!

On the Skids

If electoral processes lack the drama to satisfy you, check the stock market.

Intraday volatility has been averaging 4%. The pandemic has so desensitized us to gyrations that what once was appalling (volatility over 2%) is now a Sunday T-shirt.

Who cares?

Public companies, your market-cap can change 4% any given day. And a lot more, as we saw this week.  And traders, how or when you buy or sell can be the difference between gains and losses.

So why are prices unstable?

For one, trade-size is tiny.  In 1995, data show orders averaged 1,600 shares. Today it’s 130 shares, a 92% drop.

The exchanges shout, “There’s more to market quality!”

Shoulder past that obfuscating rhetoric. Tiny trades foster volatility because the price changes more often.

You follow?  If the price was $50 per share for 1,600 shares 25 years ago, and today it’s $50 for 130 shares, then $50.02 for 130 shares, then $49.98 for 130 shares, then $50.10 for 130 shares – and so on – the point isn’t whether the prices are pennies apart.

The point is those chasing pennies love this market and so become vast in it. But they’re not investors.  About 54% of current volume comes from that group (really, they want hundredths of pennies now).

Anything wrong with that?

Public companies, it demolishes the link between your story and your stock. You look to the market for what investors think. Instead it’s an arbitrage gauge. I cannot imagine a more impactful fact.

Traders, you can’t trust prices – the very thing you trade. (You should trade Sentiment.)

But wait, there’s more.

How often do you use a credit or debit card?  Parts of the world are going cashless, economies shifting to invisible reliance on a “middle man,” somebody always between the buying or selling.

I’m not knocking the merits of digital exchange. I’m reading Modern Monetary Theory economist Stephanie Kelton’s book, The Deficit Myth.  We can talk about credit and currency-creation another time when we have less stuff stewing our collective insides.

We’re talking about volatility. Why stocks like ETSY and BYND were halted on wild swings this week despite trading hundreds of millions of dollars of stock daily.

Sure, there were headlines. But why massive moves instead of, say, 2%?

The stock market shares characteristics with the global payments system.  Remember the 2008 financial crisis? What worried Ben Bernanke, Tim Geithner and Hank Paulson to grayness was a possibility the plumbing behind electronic transactions might run dry.

Well, about 45% of US stock volume is borrowed. It’s a payments system. A cashless society. Parties chasing pennies don’t want to own things, and avoid that by borrowing. Covering borrowing by day’s end makes you Flat, it’s called.

And there are derivatives. Think of these as shares on a layaway plan.  Stuff people plan to buy on time but might not.

Step forward to Monday, Nov 9. Dow up 1700 points to start. It’s a massive “rotation trade,” we’re told, from stay-at-home stocks to the open-up trade.

No, it was a temporary failure of the market’s payments system. Shorting plunged, dropping about 4% in a day, a staggering move across more than $30 trillion of market-cap. Derivatives trades declined 5% as “layaways” vanished.  That’s implied money.

Bernanke, Geithner and Paulson would have quailed.

Think of it this way. Traders after pennies want prices to change rapidly, but they don’t want to own anything. They borrow stock and buy and sell on layaway.  They’re more than 50% of volume, and borrowing is 45%, derivatives about 13%.

There’s crossover – but suppose that’s 108% of volume – everything, plus more.

That’s the grease under the skids of the world’s greatest equity market.

Lower it by 10% – the drop in short volume and derivatives trades. The market can’t function properly. Metal meets metal, screeching. Tumult ensues.

These payment seizures are routine, and behind the caroming behavior of markets. It’s not rational – but it’s measurable.  And what IS rational can be sorted out, your success measures amid the screaming skids of a tenuous market structure.

Your board and exec team need to know the success measures and the facts of market function, both. They count on you, investor-relations professionals. You can’t just talk story and ESG. It’s utterly inaccurate. We can help.

Traders, without market structure analytics, you’re trading like cavemen. Let us help.

By the way, the data do NOT show a repudiation of Tech. It’s not possible. Tech sprinkled through three sectors is 50% of market-cap. Passive money must have it.

No need for all of us to be on the skids.  Use data.  We have it.

-Tim Quast

Placid

The data are more placid than the people.

When next we write, elections will be over. We may still be waiting for the data but we’ll have had an election. Good data is everything.  Story for another time.

The story now is how’s money behaving before The Big Vote? Depends what’s meant by “behave.” The Wall Street Journal wrote for weeks that traders saw election turmoil:

-Aug 16:  “Traders Brace for Haywire Markets Around Presidential Election.” 

-Sep 27: “Investors Ramp Up Bets on Market Turmoil Around Election.”

-Oct 3: “Investors Can Take Refuge from Election Volatility.”

Then the WSJ’s Gunjan Banerji wrote yesterday (subscription required) that volatility bets have turned bearish – now “low vol” rather than higher volatility. Markets see a big Biden stimulus coming.

It’s a probable political outcome.

However.

The shift in bets may be about prices, not outcomes.  When there is a probability somebody will pay you more for a volatility bet than you paid somebody else for it, bets on volatility soar.  It hits a nexus and reverses. Bets are ends unto themselves.

On Oct 26, S&P Global Market Intelligence offered a view titled, “Hedging costs surge as investors brace for uncertain election outcome.”

It says costs for hedges have soared. And further, bets on dour markets are far more pronounced in 2021, implying to the authors that the market fears Covid19 resurgence more than election outcomes.

Two days, two diametric opposites.

There’s the trouble. Behaviors are often beheld, not beatified.

One of our favorite targets here in the Market Structure Map, as you longtime readers know, is the propensity among observers to treat all options action as rational. The truth is 90% of options expire unused because they are placeholders, bets on how prices change, substitutes. They don’t mean what people think.

S&P Global says the cost of S&P 500 puts has risen by 50% ahead of the election. Yet it also notes the open interest ratio – difference between the amount contracts people want to create versus the number they want to close out – is much higher in 2021 than it is around the election.

The put/call ratio can be nothing more than profiting on imbalances. And what behavior is responsible for an imbalance, valid or not? Enter Market Structure Analytics, our forte.  You can’t look at things like volume, prices, open interest, cost, etc., in a vacuum.

Let me explain. Suppose we say, “There is a serious national security threat from a foreign nation.”

Well, if the foreign nation is Switzerland, we laugh. It’s neutral. Has been for eons.  If it’s China or Iran, hair stands up.

Context matters. I said the behaviors were more placid than the people. I mean the voters are more agitated than the money in US equities.

Standard deviation – call it degree of change – is much higher in the long-run data for all behaviors, by 20% to more than 130%, than in October or the trailing 30 trading days back before September options-expirations.

Meaning? Eye of the beholder. Could be nothing. Could mean money sees no change.

Remember, there are four reasons, not one, for why money buys or sells. Investment, asset-allocation, speculation, taking or managing risk. None of these shares an endpoint.

Active money is the most agitated and even it is subdued. But it’s sold more than bought since Sep 2.  I think it means people read the stuff other people write and become fearful. It’s not predictive.

The other three behaviors show diminished responsiveness.  Yes, even risk management.

I could read that to mean the machines that do things don’t see anything changing.  The machines may be right in more ways than one! The more things change, the more they stay the same.

One thing I know for sure. I’ve illustrated how headlines don’t know what’s coming.  It’s why investor-relations and investment alike should not depend on them.

The data, however, do know.  And every investor, every public company, should be metering behavior, be it volatile or placid. We have that data.  I just told you what it showed.

Now, we’ll see what it says.

Oh, and this is placid to me, the Yampa River in CO, anytime of the year, and this is Oct 27, 2020.

In Control

What can you control?

Courtesy IEX

It’s a question largely abandoned in the modern era under the assumption humans can control everything.  Arrogance often precedes experience-induced humility.

But we’re talking specifically about the stock market.  Public companies. Share-performance.  Investor relations. What’s within your sphere of influence?

There’s a big difference between your capacity to drive shareholder value rationally in a quantitative market – and the value you provide internally to your board and executive team about what depends on story, and what turns on the product, your shares.

I’ll talk in practical terms about it Thursday at the NIRI Chicago 2020 IR Workshop, the first virtual edition. Join us for the event! I’m on about 1:30pm ET Thursday the 24th.

Market structure plays a key role.  Supply and demand affect stocks the same way they do products in any market. Yet the supply of product – shares – is almost never a consideration for public companies and investor-relations professionals, who suppose that telling the story to more investors will create volume and drive the price up.

Our friends at IEX here explain the difference between volume and liquidity (and we described liquidity and volatility last week). The more parties between the sources of supply and demand, the more volume compounds (especially with derivatives, leverage via borrowing, Exchange Traded Funds).

But volume doesn’t create more supply of the product.  This by the way is how stocks soar and lurch today (we touched on it last week).

SHOP, the big Canadian e-commerce company, saw shares plummet about 30% in a week on a share-offering. The stock then skyrocketed yesterday.  Shares were trading near $1,140 to start September, fell to $850 after the news, and were near $960 yesterday.

Rational thought?

No, supply and demand. SHOP is the 7th most liquid stock in the US market (a reason why we cluster it with close cousins the FAANGs). In fact, supply is so tight in SHOP that it depends on borrowed stock.

Most times stocks with high short volume – borrowed shares – underperform the market.  Shorting adds supply to the market.  If demand falls, short volume weighs on price.

Short volume is at a basic level rented inventory. Traders who deal shares in fractions of seconds rent stocks to sell to others, profiting on the differences in price.  At some point before the close they buy it back and return it, aiming to make more getting between buyers and sellers – see the IEX video – than they spend renting stocks and covering that borrowing.

In SHOP, the demand has been so great that even high shorting isn’t dragging the price down. They’re an outlier, and edge case (and that data clearly indicate they can afford to continue issuing stock, by the way). There’s more to be made trading SHOP every day than the cost of constantly covering borrowed shares.

Disrupt that supply chain with a stock offering and the whole SHOP market for shares shudders.

That’s why it’s essential for investor-relations professionals to help executives and boards understand what’s controllable.  If your market capitalization is less than roughly $4 billion, you’re outside where 95% of the money plays, which is in the Russell 1000.

You can either get bigger and get into the top thousand, come up with something that makes you a screaming growth play that’ll compound your trading and limited liquidity into $4 billion of market cap – or set realistic internal expectations for your team.

Data can help you make a difference with your liquidity. Use it to time your outreach to investors. Aiming to attract buyers when it’s 62% short – unless you’re SHOP – is wasting time. Wait till liquidity improves.

I’ll use a great example to kick off the Chicago discussion tomorrow. And if you’re on hand live and we have the data, I’ll tell you your liquidity ranking.

Bottom line, IR should be captaining liquidity. You’re the chief intelligence officer. Supply and demand determine your price. Know your liquidity.  Ask us, and we’ll help.