August 27, 2014

Beyond Curiosity

Let’s talk about houses.

Let me explain. Twice yesterday I encountered an issue, not a new one though. We were discussing it on a conference call too, preparing for a market-structure session Sept 9 at the NIRI Southwest Regional Conference here in Denver – which if you care about market structure is not to be missed. A highlight, Rajeev Ranjan, central banker with the Chicago Federal Reserve and former algo trader, will explain why the Fed cares whether high-speed traders are gaming equities and derivatives.

Anyway, what issue am I talking about?  I continue to hear executives and investor-relations officers say, “I don’t see why short-term trading matters when we’re focused on long-term investors.”

I hear some of you groaning.  “Quast,” you moan. “We don’t want to keep hearing the same stuff.”  I get that. If you already know the answer, you can cut out of the Market Structure Map early today.  Catch you next week.

The rest of you, if you’ve got a tickling there in the back of your head like a sneeze forming in the nose that you really don’t want the CFO to ask you why market structure matters, then let’s talk about houses.

Big money tracks residential real estate – houses. Just this week we had or will have reports on new home sales, the Federal Home Financing Administration’s housing index, the Case-Shiller Home Price Index, mortgage applications, and pending home sales. Decisions about construction, banking, credit-extension and more depend on these data.  They’re part of certain GDP components.

Now suppose it was unclear who was buying and selling houses, whether the sales were cash or financed, how much of the volume of new and existing home-sales were simply transactions between brokers trying to pump up volumes (suppose it were half!), whether mortgage applications were real or indications of interest that wouldn’t materialize, and 35% of all home-sales were in the dark with nothing more known about them save the net number.

We’d be outraged.  This condition could imperil not only the economy but the global payments system backed by government policies and the Federal Reserve. Nobody would know the actual supply or demand of houses, or whether prices were real or a figment of intermediary imaginations. The real money would leave. The sector would be a casino.

You see where I’m going. We depend on the equity market to provide some proxy on the economy and the movement of investment capital.  Yet 85% of it isn’t fundamental. It’s intermediation, asset-allocation, risk-hedging, things that can change in a heartbeat.  It’s such a big deal that The Fed and Congress are concerned.  And public companies aren’t?

Suppose you sold widgets through dealers. What if you had no idea who consumed the widgets or how they were used?  How would you market to customers? What metrics would you use to form future investment and hiring plans? How would you tell your widget story to investors, if you were a publicly traded widget-maker?  “We have no idea who buys them, but we’re really happy with volumes.”

That would be crazy.  So why isn’t it in the equity market?

The average public company’s net ownership change in a given quarter is about 3/63 of the volume for the quarter. Or if you prefer, a central tendency of 1/21, which is not statistically significant. Which consumers are driving the 20/21 of volume you’re not seeing in ownership data?

We’d never stand for this condition in any other market, period. So why is it okay in the $23 trillion stock market, upon which hinges almost everything of importance in the USA, from our individual net worth to the stability of the financial system?

That’s more than a curiosity. Knowing (and we do and can know, actually) should be of paramount importance and spearheaded by IROs and public companies. We don’t want to be the shrugging observers here.

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