October 8, 2014

Casting About

I remember the day my elementary school friend pierced his ear. By accident.

We were nine-year-olds fishing eastern Oregon’s Burnt River on my dad’s cattle ranch. Young John gave his line a mighty cast. We awaited the expected kerplunk in the water.  Nothing.  Assuming he’d caught a branch in the trees behind us, he yanked the line and let out a yelp. He’d caught himself. The hook had punched right through his earlobe. I admit, I laughed.

The old way for getting answers to moves in your shares also involves a casting process. If your stock moves up or down sharply, you cast about.

Early in the IR chair I did it too. If the CEO rang and said, “Quast, what the heck’s going on?  Why are we down three percent?” I would react by calling others, who would cast about for reasons. The exchange or my market intelligence sources would say variously, “We’re hearing rumors there’s a seven-digit seller,” or “UBS is big on the sellside so we think it’s retail,” or “you broke through your 20-day and 50-day moving averages and the quants are pressuring shares,” or “Smithers on the sellside at Gaujem & Flippitt has got a bearish sector note out today.”

Some or all of it could be causal, and some or all is irrelevant. There’s no statistical link. What if your stock is down today because of something occurring last week?

If it rains today in your city, it’s unlikely that anybody is ringing weatherpersons and saying, “Hey, what’s going on?  What’re you hearing to explain this rain?” Meteorologists have models that while imperfect provide generally accurate predictive views of tomorrow’s weather.  We check forecasts before we travel, right?  Last week Karen and I were glad to know flying into Dallas that the bad weather would hit Thursday and not Friday.

In business, sometimes we cast about for explanations to missed numbers. More often, management knows if revenues are flattening and expenses are rising and can prepare for narrowing margins. Financial models help us predict what’s ahead.  Heck, Mayan oligarchs were predicting solar eclipses, using mathematical models to look like gods and fool the unwashed masses.

Rooting in the news detritus for meaning doesn’t reflect what institutions are doing. There are 800 investment-company fund sponsors holding nearly $7 trillion of US equities at the end of 2013, the Investment Company Institute says. Annual asset-weighted turnover in equity-fund assets was 41%, substantially less than the 61% average from 1980-2013 and dropped to 29% in 2013.

Speaking of markets, quick aside: If you’re in Denver tomorrow, attend the NIRI luncheon, where the NYSE’s Rich Barry – yes, the one and the same – and I will hold an old-fashioned revival on stock-market structure and why we’re at an inflection point.

Anyway, indexed money dominates now. At the end of 2013, 370 index funds managed $1.7 trillion in equity investments. Nearly half of all equity inflows went to index funds in 2013, and 82% were benchmarked to the S&P 500 or other equity indices. Passive money “pegs the benchmark.” Outsized effects on your shares can reflect efforts to outperform an index, but the cause is the index.

Now add ETFs, which must post positions every day (creating big volume). These also have $1.7 trillion of assets at the end of 2013.  Combined, indexes and ETFs hold nearly half the investment-company equity assets. This money relentlessly changes (your buy-and-hold investors do not). It means that almost all the time, your price fluctuates for reasons unrelated to what you’ll find while casting about. Those are not the right answers.

That’s frankly good news!  Your shares are not reacting to the miscast fishing line of youth, a random tug.  This is the 21st century. IR professionals can apply measures to market behavior that reflect the facts behind structure and institutional assets.

At ModernIR, we measure the central tendency in trading data for indexes/ETFs and can know every day whether it’s setting price. That’s a better mousetrap – or fishing pole.

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