August 22, 2012

Bourbon Street Market

The equity market is like Bourbon Street.

No, we don’t mean the stock market is home to “Big Daddy’s World Famous Love Acts.” We mean it’s a bit off, a party, somewhat wanton, full of folks in disguise doing things they wouldn’t do anywhere else. Fantastical.

I interviewed Joe Saluzzi at the NIRI Southwest Regional Conference last week in New Orleans. Joe and co-founder Sal Arnuk at Themis Trading are the reason we all know about “high frequency trading.” Their white paper on toxic equity trading went viral in 2008, and the rest is history.

We sat down Charlie-Rose-style at the Hotel Monteleone and talked candidly about Joe’s new book, “Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street Are Destroying Investor Confidence.”

If you haven’t done so, buy it for yourself (I have it on my Kindle) and get a copy for your CFO or CEO. Everybody who at some time utters the word “equity” should read it.

If you’re in the IR chair, executives expect you to deliver a story to investors that advances shareholder value. You want a market that supports those efforts by helping risk-taking capital connect to the opportunity in your shares. Most executives generally conclude that it’s working. Stocks seem to be trading comparably to historical S&P 500 earnings multiples.

So why would Joe and Sal argue that markets are broken?

Because high-frequency trading is what everybody must engage in to navigate them. All the money, whether buying shares to hold for years or persisting along an investment horizon running from 9:30am-4pm Eastern Time, must move at high speed from place to place. Most of the money is shuffling shares or hedging the risk involved in doing so. By our measures, more than 85% of it.

The folks continuing to do IR like cavemen often say, “Our top shareholders don’t change much.” And then: “So we don’t watch the stock.”

Really? What if you saw your car go by on the street, driven by someone unknown, but you’re certain the car’s in the garage? It either is or isn’t. Right?

So if your shareholders don’t change, who’s setting your stock price? You can’t have it both ways – “our shareholders are properly valuing our shares,” and “our shareholders don’t change.” Your stock price is set by parties buying and selling shares right now, for whatever time horizon. Not by those holding them and doing nothing.

So who’s driving the car? Or put another way, what’s setting your stock price?

It may well be top holders trading around positions each day for returns in an unreliable market more apt to move on the dollar or the euro than on earnings. And if so, they’re speculating.

You can and should know the behavior setting your stock price. The markets run on math, and math – the fabric of the universe – can be measured.

Not everybody likes math. We’d rather be on Bourbon Street than machinating metrics, but reading, writing and arithmetic are essentials in the IR chair. Math right now is coolest. And it’s contemporary.

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