Tagged: VIX

Hidden Volatility

Volatility plunged yesterday after spiking last week to a 2017 zenith thus far. But what does it mean?

“Everybody was buying vol into expirations, Tim,” you say. “Now they’re not.”

Buying vol?

“Volatility. You know.”

It’s been a long time since we talked about volatility as an asset class. We all think of stocks as an asset class, fixed income as an asset class, and so on.  But volatility?

The CBOE, Chicago Board Options Exchange, created the VIX to drive investment in volatility, or how prices change. The VIX reflects the implied forward volatility of the S&P 500, extrapolated from prices investors and traders are paying for stock futures. The lower the number the less it implies, and vice versa.

(If you want to know more, Vance Harwood offers an understandable dissection of volatility and the VIX.)

For both investor-relations professionals and investors, there’s a lesson.  Any effort to understand the stock market must consider not just buying or selling of stocks, but buying or selling of the gaps between stocks. That’s volatility.

It to me also points to a flaw in using options and futures to understand forward prices. They are mechanisms for buying volatility, not for pricing assets.

Proof is in the VIX itself. As a predictor it’s deplorable. It can only tell us about current conditions (though it’s a win for driving volatility trading). Suppose local TV news said: “Stay tuned for yesterday’s weather forecast.”

(NOTE: We’ll talk about trading dynamics at the NIRI Southwest Regional Conference here in Austin on Lady Bird Lake Aug 24-25 in breakout sessions. Join us!)

Shorting shares for fleeting periods is also a form of investing in volatility. I can think of a great example in our client base. Earlier this year it was a rock star, posting unrelenting gains. But it’s a company in an industry languishing this summer, and the stock is down.

Naturally one would think, “Investors are selling because fundamentals are weak.”

But the data show nothing of the sort! Short volume has been over 70% of trading volume this summer, and arbitrage is up 12% while investment has fallen.

Isn’t that important for management to understand? Yes, investing declined. But the drop alone prompted quantitative volatility traders to merchandise this company – and everyone is blaming the wrong thing. It’s not investors in stocks. It’s investors in volatility. Holders weren’t selling.

“But Tim,” you say. “There isn’t any volatility. Except for last week the VIX has had all the enthusiasm of a spent balloon.”

The VIX reflects closing prices. At the close, all the money wanting to be average – indexes and ETFs tracking broad measures – takes the midpoint of the bid and offer.

Do you know what’s happening intraday?  Stocks are moving 2.5% from average high to low. If the VIX were calculated using intraday prices, it would be a staggering 75 instead of 11.35, where it closed yesterday.

What’s going on? Prices are relentlessly changing. Suppose the price of everything you bought in the grocery store changed 2.5% by the time you worked your way from produce to dairy products?

Volatility is inefficiency. It increases the cost of capital (replace beta with your intraday volatility and you’ll think differently about what equity costs).  Its risk isn’t linear, manifesting intraday with no apparent consequence for long periods.

Until all at once prices collapse.

There’s more to it, but widespread volatility means prices are unstable. The stock market is a taut wire that up close vibrates chaotically. Last week, sudden slack manifested in that wire, and markets lurched. It snapped back this week as arbitragers slurped volatility.

It’s only when the wire keeps developing more slack that we run into trouble. The source of slack is mispriced assets – a separate discussion for later. For now, learn from the wire rather than the tape.  The VIX is a laconic signal incapable of forecasts.

And your stock, if it’s hewing to the mean, offers volatility traders up to 2.5% returns every day (50% in a month), and your closing price need never change.

When you slip or pop, it might be the volatility wire slapping around.  Keep that in mind.

Half the Market

I’ve seen at least four Wall Street Journal stories in May alone about a quiescent VIX.

The CBOE’s volatility index derived from options pricing on the S&P 500 hit a low Monday last seen in Dec 1993, the WSJ said (subscription required). It moved lower still yesterday, 9.58 intraday.

Implicit in the storyline is a bull market, since one roared from 1993 to the bursting of the dot-com bubble. But the conclusion violates the Law of Small Numbers, the human propensity to assign undue value to insignificant data sets.  As proof, the VIX was a hair’s breadth from record low in Jan 2007.

Remember that? Lehman, little did we know, was failing. The financial crisis thereafter manifested in markets like a Hollywood blockbuster action movie where the hero outruns the explosion as the structure dissolves in showering computer-generated fantasia.

Since we can make equal bull or bear cases with the same data, it supports neither.

Aside: The investor-relations profession has a notorious proclivity toward the Law of Small Numbers. Stock’s down 3%, so we call somebody to learn why. You’re chasing the exception. Track instead the central tendency in the whole data set so you can see what changed before the stock fell 3%.

And assigning rational motivation to the VIX defies the data.  Less than 20% of daily market volume comes from rational thought. The rest is tracking the mean, arbitraging spreads back to the mean, or hedging departures from the mean.

Where everything is average, volatility vanishes. Thus a dead VIX fits. It offers little predictive value (save higher volatility always follows very low) and simply points to low spreads.

The reason is market structure. Passive investment tracks benchmarks and so seeks the mean – average price. Arbitragers look for departures from the mean to trade for profit. The market is riven with arbitrage so few mean-divergences survive to the close. But boy is there opportunity. You’ll see soon.

Meanwhile, those managing risk offload exposure to someone else, which produces equal and offsetting trading – which reinforces the mean.

And here’s a shocker. We track daily share-borrowing – shorting – as a percentage of total trading volume. Short shares are 48.1% of volume, which means long trades are 51.9%. In other words, nearly half the market is short.

Locked markets, or trades where the bid to buy equals the asking price to sell, are prohibited, so there will always be a spread, a dab of volatility. Arbitragers are almost guaranteed gains by being long and short everywhere.

We also measure intraday volatility, the spread between average intraday high and low prices. It’s 2.5% – astonishing arbitrage fodder.

For perspective, the S&P 500 rose 0.5% the last ten sessions. That means stocks are 400% more volatile every day than the ten-day change in closing prices.

Arbitragers are making tremendous gains by consuming intraday volatility.

It may be that Exchange-Traded Fund (ETF) market-makers are responsible. It explains why ETF costs are so low: Arbitrage gains are additive.

And ETF sponsors can rent out liquidity, shares accounting for the 48% of trading that’s borrowed – boosting returns. There’s support in the data. We track passive-investment patterns and correlate them to short volume, and there’s agreement.

ETF market-makers have four arbitrage opportunities: a) ETF net asset value versus ETF price; b) ETF versus underlying index; c) ETF price versus prices of components of the index; d) ETF price versus options and futures on components and the index.

By the close, ETFs and indexes want to peg the measure so divergences converge at average.

It’s a circumstantial case. But evidence piles up that ETFs are consuming spreads while simultaneously driving stock-prices and deflating the VIX.

What’s the risk?  Mortgage-backed securities did the same thing to real estate.  There was a finite asset, homes. With cheap mortgages, lots of money wanted exposure. So home loans were securitized – replicated – to expand demand, delivering great returns to those selling them. It worked till home prices stopped rising. Then replicated value evaporated. Half the market.

There are less than 3,600 US public companies when ETFs, multiple share classes and closed-end funds are removed. Low rates have created high demand. To expand access, ETFs replicate exposure, and are booming. It works so long as stocks rise.

When that stops at some sure point, extrapolated value will be marked to zero. Half the market.  Won’t arbitragers save the day? Not if volatility jumps as average prices plunge.

Rational Signals

The market message appears to be: If you want to know the rest, buy the rights.

While rival Nintendo is banking on Pokemon Go, Sony bought the rights to Michael Jackson’s music catalog for an eye-popping $750 million. This may explain the sudden evaporation of Jackson family discord. Cash cures ills.

In the equity market, everybody buys the rights to indexes and exchange-traded funds. TABB Group says indexes and ETFs drove 57% of June options volume, with ETFs over 45% of that and indexes the balance. TABB credits money “rushing into broad-market portfolio protection” around the Brexit.

Could be.  But that view supposes options are insurance only.  They’re also ways to extend reach to assets, tools for improving how portfolios track underlying measures and substitutes for stock positions. I’ve wondered about the Russell rebalances occurring June 24 as the Brexit swooned everything, and whether indexers were outsized options buyers in place of equity rebalancing – which then aided sharp recovery as calls were used.

We can see which behaviors set price every day.  On June 24, the day of the dive, Asset Allocation – indexes and ETFs primarily – dominated.  On June 27 Fast Traders led but right behind them was Risk Management, or counterparties for options and futures.

The tail can wag the dog. The Bank for International Settlements tracks exchange-traded options and futures notional values. Globally, it’s $73 trillion (equaling all equity markets) and what’s traded publicly is about half the total options and futures market.

Sifma, the lobbying arm of the US financial industry, pegs interest-rate derivatives, another form of rights, at more than $500 trillion. You’d think with interest rates groveling globally (and about 30% of all government bonds actually digging holes) that transferring risk would be a yawn.  Apparently not.  You can add another $100 trillion in foreign-exchange, equity and credit-default swaps tracked by Sifma and the BIS.

Today VIX derivatives expire. The CBOE gauge measures volatility in the S&P 500.  Yesterday VXX and UVXY, exchanged traded products (themselves derivatives), traded a combined 90 million shares, among the most actively traded stocks. Yet the VIX is unstirred, closing below 12. Why are people buying volatility when there’s none? For perspective, it peaked last August over 40 and traded between 25-30 in January and February this year and again with the Brexit in late June.

The answer is if the VIX is the hot potato of risk, the idea here isn’t to hedge it but to trade the hot potato. And for a fear gauge the VIX is a lousy leading indicator.  It seems only to point backward at risk, jumping when it’s too late to move. Maybe that’s why everybody buys rights?  One thing is sure: If you’re watching options for rational signals, you’ll be more than half wrong.  Might as well flip a coin.

We learned long ago that rational signs come only from rational behavior. In the past week right through options-expirations starting Thursday the 14th, Active Investment was in a dead heat with Risk Management, the counterparties for rights. That means hedge funds were everywhere trying to make up ground by pairing equities and options.

But options have expired.  Do hedge funds double down or is the trade over?  Short volume has ebbed to levels last seen in November, which one might think is bullish – yet it was the opposite then.

Lesson: The staggering size of rights to things tells us focus has shifted from investment to arbitrage. With indexes and ETFs dominating, the arbitrage opportunity is between the mean, the average, and the things that diverge from it – such as rights.

Don’t expect the VIX to tell you when risk looms. Far better to see when investors stop pairing shares and rights, signaling that the trade is over.

Vinnie the Face

How do you know macroeconomists have a sense of humor?  They use decimal points.

While you ponder, it’s that time again when the Federal Reserve meets to wring its figurative hands over decimal points, VIX expirations hit as volatility explodes anew, and Brits consider telling Europe to pound sand.  Wait, that last part is new.

And by the way, what’s with these negative interest rates everywhere?

I’d prefer to tell you how computerized high-speed market-makers have made “the rapid and frequent amending or withdrawing of orders…an essential feature of a common earnings model known as market making,” according to Dutch regulators studying fast trading (that nugget courtesy of Sal Arnuk at Themis Trading). If you as a human do that, they throw you in jail for spoofing. If it’s a machine programmed by humans, all’s well.

We’ll instead talk macro factors today because they’re dominating. Negative interest rates, the Brexit, currencies, stocks, share a seamless narrative.

First, the Brexit looms like a hailstorm in Limon, Colorado, not because the UK and Europe are terminating trade. No, nerves are rattled because it represents a fracture in the “we’re all in this together” narrative underpinning global monetary policy. All that’s needed – infinitely – if everybody lives within their means are currencies that don’t lose value over time. There’s not a single one like that right now.

Suppose on your street some neighbors were prosperous and others deep in financial trouble, and block leaders built a coalition around a mantra: The only way for us all to prosper is if the neighbors with money give some to the neighbors without.

It altruistic. It’s also untrue.  That will ensure nobody prospers. The EU strategy has been to get countries like the UK to agree to principles that let wastrel nations offload their profligacy on responsible ones.  It doesn’t matter how one views it ideologically. What matters is the math and the math doesn’t work.

The UK is threatening to quit the block coalition on a belief that the best way to ensure that the UK prospers is to stop taking responsibility for others.

Negative interest rates tie to the EU strategy. Contrary to what you hear from droning economists and central bankers, low interest rates aren’t driven by low growth prospects. If growth prospects are low and therefore risky, capital costs should be high.  Low growth is a product of lost purchasing power, defined as “what your money buys.” If what your money buys diminishes, you’ll be buying less, which leads to low growth.

The reason money buys less is because governments are filching from their citizens by trading money for debt, and falling behind on their payments.

I’ll explain in simple terms.  If you miss a credit card payment, your creditor doesn’t receive money it’s owed. Driving interest rates to zero is tantamount to skipping payments because it reduces the amount owed.  Interest is money owed.

Suppose you told your credit card company, “I will pay you only 1% interest.” That would be nice but generally debtors don’t get to set the terms.

The world’s largest debtors are governments, and they do get to control the terms.  What’s more, they alone create money. Heard of the California Gold Rush, the Alaska Gold Rush?  Why none now?  Governments outlawed the use of gold as money. Gold is valuable, yes. But it’s not legal tender. So you can’t mine for legal tender anymore.

It’s a great gig if you can get it, spending all you want and borrowing and telling creditors what you’ll pay, and then whipping up a batch of cash to buy out your own debt.

Except even governments can’t just prestidigitate cash like a single item in a double-entry ledger. It used to be central banks offset created cash with things like gold.  Now, the entire global monetary system including the dollar, euro, UK pound, Japanese yen, Chinese yuan, etc., is backed by debt.

What does that mean?  To create money, central banks manufacture it and trade it for debt. Why? Because much of what is measured as growth today is really just rising prices. So if prices stop rising, growth stalls, and economies slip into recession and then governments have an even harder time funding bloated budgets.

More money chasing goods drives up prices. So central banks attempt to encourage spending and borrowing by creating money to buy the debts of their governments and now private companies too. The idea is to relieve banks and businesses of debts, thus enabling them to borrow and spend more, which, the thinking goes, will produce growth.

This cycle creates extreme demand for debt, which becomes so valuable that the interest rates on it turn negative.  What happens to ordinary people who borrow and spend beyond their means is the opposite. The cost of debt keeps rising until you’re paying Vinnie the Face the 20% weekly vig in an alley as he smacks a baseball bat in a hand.

So you see, it’s all related. The strangest part is that all financial crises are products of overspending.  Yet governments and central banks cannot manufacture money to save us from our largess unless we rack up debts they can buy with manufactured money.

It’s like an episode of CNBC’s American Greed in which people engage in bizarre and irrational behavior to perpetuate fraud. The world’s money is entirely dependent on more debt. It manifests for you and me in how little our money buys now.  That’s stealing as sure as someone reached in your wallet and took money out. I was just commiserating with a client about the cost of NIRI National.  Our money doesn’t go as far as it did.

What’s it mean for the equity market? It fills up with arbitragers, who see uncertainty as opportunity rather than threat.  They’re not trading fundamentals but fluctuations. They can sustain stocks for a while. But sooner or later Vinnie the Face shows up with a bat.

Janus ETFs

Everybody adapts, including institutional investors like Janus.

Rattle off a top-ten list of the best active stock pickers visited by teams of company execs and investor-relations pros trundling through the airports and cities of America, and Denver’s Janus likely makes the cut.

Ah, but.  In 2014 Janus bought VelocityShares, purveyor of synthetic exchange-traded products.  Just as a drug manufactured in a laboratory rather than from the plant that first formed its mechanism of action is a replica, so are these lab-made financial instruments. They replicate the act of investment without actually performing it.

It’s neither good nor bad per se, as I explained yesterday to the NIRI San Diego chapter. But synthetics are revolutionizing how public stocks trade – without owning public stocks. Describing its effort at adaptation, Janus says on its website that it’s “committed to offering distinctive strategies for today’s complex market environment. Leveraging almost a half century of investment experience, we are now pleased to make our expertise available through Exchange Traded Funds.”

Janus says it’s intending to offer a range of returns beyond simple capital-appreciation, including “volatility management” and “uncorrelated returns.” Janus’s VelocityShares directed at volatility aim to produce enhanced or inverse returns on the VIX, an index called the “fear gauge” for reflecting volatility in forward rights to the S&P 500.

But traders and investors don’t fear volatility. They invest in it.  On Monday May 16, four of the top 20 most actively traded stocks were exchange-traded products leveraging the VIX.  Those offered by Janus aren’t equity investments but a debt obligation backed by Credit Suisse. Returns derive from what is best described as bets using derivatives.

The prospectus for the most active version is 174 pages, so it’s hard to decipher the nature of wagers. It says: “We expect to hedge our obligations relating to the ETNs by purchasing or selling short the underlying futures, listed or over-the-counter options, futures contracts, swaps, or other derivative instruments relating to the applicable underlying Index…and adjust the hedge by, among other things, purchasing or selling any of the foregoing, at any time and from time to time, and to unwind the hedge by selling any of the foregoing, perhaps on or before the applicable Valuation Date.”

Got that?  Here’s my attempt at translation: “We’ll do the exact opposite of whatever return we’ve promised you, to keep from losing money.”

During the mortgage-related financial crisis there was a collective recoil of horror through media and into Congress that banks may have been betting against their clients. Well, come on.  It’s happening in equities every day!  Exactly how do we think somebody who says “sure, I’ll take your bet that you can make double the index without buying any assets” can possibly make good without farming the risk out to someone else?

In the mortgage crisis we learned about “credit default swaps” and how insurers like AIG were on the hook for hundreds of billions when real estate stopped rising. Who is on the hook for all these derivatives bets in equities if stocks stop rising? It’s the same thing.

Last Friday the 13th, five of the top 20 most actively traded instruments on the Nasdaq and NYSE were synthetic exchange-traded products attempting to produce outsized returns without correlating to the market. That’s 25% of the action, in effect.

For stock-picking investors and public companies it means a significant contingent of price-setting trades in the stock market are betting on moves uncorrelated to either fundamentals or markets. You’ll find no explanation in ownership-change.

What do you tell management and Boards about a market where, demonstrably, top price-setting vehicles like TVIX owned by conventional stock-pickers aren’t buying or selling stock but betting on tomorrow’s future values using derivatives?

In fact, everyone is betting against each other – traders, banks, investors. I take you back to the mortgage-backed securities crisis. The value of underlying assets was massively leveraged through derivatives the values of which bore no direct connection to whether mortgages were performing assets.  That by any definition is credit-overextension. A bubble.  A mania. Then homes stopped appreciating. The bubble burst two years later.

Look at stocks. They’ve not risen since Nov 2014. Is anyone out there listening or paying attention to the derivatives mess in equities?


You’ve heard the saying that’s it all in your perspective. It applies to volatility.

Volatility is up 150% since the post-financial-crisis nadir of 10.32 for VIX Volatility in mid-2014. The “Fear Index” closed yesterday over 26, the highest since August 2015 when it topped 28 (way below 43 in 2011 and nearly 80 in 2008). VIX expirations are hitting today.

I’ve been seeing Mohamed El-Erian, whom I admire, chief economic advisor to Allianz and former right hand to Bill Gross at PIMCO, also now gone from the bond giant, on the business TV circuit saying central banks are ending programs designed to dampen financial volatility.

I think he’s got a point, and he means they’re starting to broaden trading ranges in everything from interest rates to currencies (as if we want them setting prices). But volatility is price-uncertainty reflecting evolving valuation.  Conventional measures often fail to reveal change because behaviors in markets morph while the metrics used to understand them don’t.

Figure 1

Figure 1

I can prove it.  In the first chart here (Figure 1), a small-capitalization technology stock on the Nasdaq hasn’t moved much in the year ended Dec 16, 2015 (I’ll explain that date shortly) but the stock rose from a 200-day average price of $20.67 to a five-day mean of $21.05, up 1.8%.  Not too great – but the Russell 2000 Index was off 1.3% in the year ended Dec 16, 2015. Perspective matters.

Now notice:  Daily volatility, or the difference between highest and lowest prices each day, is greater than the change in average price in all four periods.  Think about that. The price changes more every day than it does in moving averages for months and quarters.

Now see Figure 2 showing short volume Dec 1, 2015-Jan 15, 2016 for the same stock. The upper half is long volume (owned shares), the bottom short volume, or rented stock. The blue line is closing price. The data further back show short volume over the trailing 200 days averaged 60.2% daily.

Figure 2

Figure 2

Combine the charts. The stock moved less than 2% on average over the entire period but 60% of the shares trading every day were borrowed, and the spread between high and low prices was nearly 3% every single day.

Do you understand? On the surface this stock is not volatile. But up close it’s torrid – on rented shares. For a solid year, traders have kept this stock in stasis by borrowing and trading, borrowing and trading, because the cost of borrowing was substantially lower than daily price-movement. That’s market-neutral arbitrage.

Everything changed recently. Short volume in Figure 2 plunged Dec 22, 2015.  On Dec 16 (here’s that date now) the Federal Reserve bumped short-term rates to 0.25-0.50%. On Dec 17-18 vast swaths of interest-rate swaps tied to options-expirations lapsed. On Dec 21, the new series of options and futures (and interest-rate swaps) began trading. And on Dec 22, our small-cap’s short volume imploded, finally landing at 33% Jan 11, down from 71% Dec 10, a decline of 54%.

We’ve slung numbers here, I know. But the conclusion is simple. Whatever traders were doing in this small-cap, the Fed’s rate-hike ended it.  We think that’s good. But markets have been addicted for years to cheap credit, which includes borrowing shares for next to nothing, which shifts attention from long-term owning to short-term renting. That changed when the Fed bumped rates. And equites corrected.

There’s another lesson by extension.  What sets your stock’s price may be radically different than you think.  We’ve offered one example that shows short-term borrowing fueled persistent volatility trading masked by apparent long-term placidity. When interest rates crept up minutely, the strategy stopped working.

What’s your stock show?  Price-performance isn’t story alone, perhaps even over the long run, as we’ve just shown. There’s so much to see when measurements reflect current behavior (as ours do). Volatility is price-uncertainty that thanks to policies promoting short-term behavior is now concentrated intraday.  Sorting this out will take time. We won’t change seven fat years with a lean month. The good news is it’s all measurable.

Behavioral Volatility

I recall knowing one particularly volatile fellow. I should have called him VIX.

Speaking of the VIX, options on that popularly titled Fear Gauge expire today as a raft of S&P components report results. Many will see sharp moves in share-prices and attempt to put them in rational context.

Volatility derivatives are no sideshow but a mainstream fact. Yesterday the top five  most active ETFs included the SPDR S&P 500 ETF (SPY) a Standard & Poor’s Depositary Receipt from State Street that traded 68 million shares, more than any single stock including Apple ahead of results, and the VIX Short-Term Futures ETN iPath (VXX), with 38 million shares, matching Facebook’s volume (out-trading all but seven stocks).

Louis Navellier turned the concept of volatility into quantitative analytics for investment at his Reno advisory firm managing $2.5 billion. Oversimplifying, rising volatility signals change. Mr. Navellier used increasing volatility as a signal to sell highs and buy lows.

By the same token, when your shares break through moving averages, it’s at root a volatility signal. Your price is changing more than the historical central tendency.  But what causes volatility?

This is why we introduced Market Structure Alerts in June for our clients. They’re predicated on the seminal principle that volatility signals change. Rising standard deviation is a pennant pointing to developments you should know. But we want more than surface answers.  Measuring tides alone offers no reasons. So we measure behavioral volatility, not price or volume volatility – which is a byproduct of the former.

When the ocean rolls or roars, we understand that it reflects something else ranging from the gravitational pull of the earth and the moon to earthquakes undersea. We use these facts to shape our understanding of how our ecosystem called earth functions.

A conversation I have often with IR professionals is what I’ll call Story versus Structure.  “My CEO wants to understand why we’re underperforming our peers.”  We have a simple answer and an elementary model that demonstrates it. Yet it can be hard to let go of the notion that underperformance traces to a fundamental feature, the Story. “Our return on equity trails our peer group, so that’s got to be the reason.”

Now sometimes Story is the problem. When it is, it manifests in behavioral change. But don’t forget that the biggest investors are Blackrock and Vanguard. We’re told they’re perpetual holders. No, they’re perpetual trackers of benchmarks like the S&P 500 so they are perpetually in motion, relentlessly sloshing like tides. When these tides crash more violently it’s because money in 401ks and pensions is uniformly beginning to buy or sell, producing disparate impact in stocks.

It’s not Story but Structure. The market functions in a defined way, according to a set of measurable mathematical rules, just like the universe. If we omit some part of market function because it’s complicated it doesn’t cause the behavior to cease to exist. Every IR program today should measure behavioral change.

How many ETFs own your shares?  Our smallest client with market cap of $200 million is in 14. Most are in 30, 40 or more, some over 100. Each of these probably has options and futures and tracks an underlying index, which also has options and futures. All the components of each ETF and underlying index likely have options and futures, just as your shares might. There are exchange-traded notes that directionally leverage indexes and ETFs. Swaps that substitute returns in baskets of these for proceeds in other asset classes. Traders pair futures with stocks and change them each day. And throughout, Blackrock and Vanguard and the rest of their asset-allocation kin behind two million global index products move like massive elephants ever crossing the Serengeti.

Sound dizzying?  It’s your ecosystem. The good news is we’ve reduced its complexities to a set of central tendencies and now we have Alerts that signal when these change.

Why should you care in the IR chair? We’ve got a friend who’s a realtor in Steamboat Springs. She knows everything about it, down to the details of any house you can mention that’s on the market. She knows which neighborhoods get sun in the afternoon, where you should be for easy access to amenities. She knows her market.

We want you to know yours. We hope to help you move from seeing price and volume as a tide moved by mysterious forces to understanding your ecosystem and what distinct behavioral change is behind volatility.

That in turn makes you a powerful expert for your Board and management team. You don’t have to do it, of course. But the quest to be better, to know what there is to know about the market you serve is the difference between something that can become mundane and an enterprise ever fresh and new, an exhilarating exploration.  Some volatility, so to speak, is refreshing!


“Why is our stock underperforming the peer group?”

Ever got that question from your CFO or CEO?

We hear it too. Speaking of questions, if you’re in Atlanta come throw them at the panel on High Frequency Trading for NIRI’s chapter breakfast, Friday Nov 16 at Maggiano’s in Buckhead. I’ll be there, and even better, so will the Nasdaq’s Jay Heller and the NYSE’s Rich Barry. We believe our story will rival this David Petraeus thing.

Just kidding. Back to the start, the answer most times lies in fine shades of difference. If program trading for funds and models in your stock is just 1% lower than the average in your peer group, spread over a month you might trail it by 10%.

The good news for IR folks, it’s not because you’re falling down on the job. It’s just math – which you might shake by targeting potential holders with shorter horizons and more aggressive trading proclivities.

Left unattended, these patterns tend to intensify. Mathematical models, identifying discrepancy, reweight allocations and the pattern reverses. It then repeats in shrinking cycles until something rattles the whole market and things reset.

Speaking of resets, high correlation, or uniform trading patterns, is a harbinger of looming group stampedes. Now, don’t worry. We don’t hear a thundering herd. We just see curious and repeating correlations.

Correlation in US stocks hit a record 88% in 1987 during the market crash. Before it happened, correlation soared to 81%, about the same level we saw in 2008 when Lehman left for the big brokerage in the sky and markets went the other direction. (more…)

The Epic Divide

Thrilling. Arduous. Rewarding. Draining. Spectacular.

No, not the Federal Reserve Open Market Committee meeting concluding today with a soliloquy before public microphones from the chairman.

We mean our grand cycling adventure riding the Rockies on the high backbone of the fruited plain last week. After 1,500 training miles we clocked several hundred more and about 25,000 vertical feet climbing a collection of the globe’s great mountain passes. The desire accomplished is sweet to the soul (one of my favorite sayings because it reflects the human spirit). Here are Independence Pass, the rim of the Black Canyon of the Gunnison, atop Ute Pass northwest of Silverthorne, and aspens outside Aspen.

Speaking of epic, NIRI this year again reminded me about the divide between how markets work now and – take no offense, it’s just a refrain from IR pros – what most of us know about them.

Here’s a current example. Why were prices and markets swinging wildly Tuesday, with disparity between major measures and extreme moves in stocks? Rational investment? Most of us intuitively know investors aren’t responsible.

What is? Fluctuating currencies, yes (hour-by-hour now). But did you know that VIX futures expire today? Last Thursday and Friday, other options and futures expired, and S&P indexes rebalanced.

Behaviorally, expirations are seismic (we study trading behaviors at a mathematical level) because trading is global, 24-hour, and multi-asset-class. When an instrument like a futures contract expires, there’s a ripple effect. (more…)

Predictable Outcomes

It was 85 degrees Sunday in Denver when Karen and I rode up local landmark Lookout Mountain on bikes to pay respects at Buffalo Bill’s grave. We woke to snow Tuesday.

Speaking of hot and cold, we told clients to expect a good start Monday for the new quarter, followed by the strong likelihood of a big move Tuesday or Wednesday as imbalances from the quarter exited broker-dealers. The Dow was down more than 100 points intraday Tuesday.

Why are these outcomes predictable?

In answer, ever heard of Mexican film maker Alejandro Gonzalez Inarritu and writer Guillermo Arriaga? The duo sadly parted ways after making Babel (Brad Pitt, Cate Blanchett), the third film following Amores Perros (Benicio del Toro) and 21 Grams (Naomi Watts, Sean Penn) with disparate threads woven into haunting themes on life and meaning.

Markets have recently given us disparate threads that can be loomed into predictive thematic raiment. Rumblings continue about the dramatic BATS Exchange IPO debacle March 23. The market-structure bugs at Zero Hedge advanced a theory that a deliberate algorithmic tactic torpedoed the IPO. (more…)