August 30, 2017

Harvey Market Structure

We’ve said many prayers for friends, family and colleagues in Texas and Louisiana and will continue in the wake of Harvey. There’s a lesson from it about stocks today too.

Is paying attention to the weather forecast important?  The weather guessers were eerily accurate and I think most would agree that had Harvey hit without warning, outcomes would be factors more harrowing despite current widespread devastation.

The point of the forecasts was to prepare for outcomes, not to alter the path of the storm. Would that the latter were possible but it’s beyond our control. (Could we have lined up all the portable fans in Texas on a giant power strip fronting the gulf and blown that thing back to sea? No).

Just one thing drives me batty talking to public-company executives about market structure. It’s when they say: “If I can’t change it, why do I care about it?”

If we only measure what we can change, why do we track storms? Why mark birthdays?

In all matters human, measuring is the essential task underpinning correct conclusions, awareness, planning for the future, and separating what’s in our control from what’s not.

I’ll give you another comparative:  The solar eclipse on Aug 21.  Thanks to a rare preserved Mayan book called the Dresden Codex kept in Germany, it’s now been historically proven that Mayans could predict solar eclipses.

Their records written hundreds of years ago projected one July 11, 1991, long after they themselves were gone. Sure enough. It’s impressive that people who didn’t know the sun is 400 times larger than the moon or that the moon is 400 times nearer – creating a perfect match periodically – could do it.

But we can infer from archaeological records that they and others like the Aztecs may have used superior knowledge to dupe the less-informed.

More simplistically, a lack of understanding can produce incorrect conclusions. The fearful masses believed when the sun began to fade that the gods were angry. The rulers likely reinforced the idea to retain power.

If you don’t know an eclipse or a hurricane is coming in your shares, you conclude that a version of the angry gods explanation is behind a fall:  It must be something happening today, some news, misunderstanding of story, miscommunication by the IR team.

That’s generally untrue. Like hurricanes and eclipses, the stock market today is mathematical.  Human beings can push buttons to buy or sell things but trades are either “marketable,” or wanting to be the best buy or sell price, or “nonmarketable” and willing to wait for price to arrive.

Any order that is marketable must be automated, rules say. Automated trades are math. The market is riven with mathematical automated trades for all sorts of things and those trades, unless interdicted by something that changes, will perform in predictable ways, thanks to rules – like the ones that permit us to predict hurricanes and eclipses.

Without knowledge of those rules – market structure – you can be duped. And you are routinely duped by high-frequency traders who claim publicly to be “providing liquidity” when we observe with models all the time that they do the opposite, pushing prices higher when there are buyers and lower (and shorting stocks) when there are sellers.

If you’re routinely checking the weather forecast for your stock, you’re less likely to be duped. That’s Market Structure 101.

You may be dismayed to learn that most of your volume is driven by something other than your company’s fundamentals (unless you have lousy fundamentals, and indexes and ETFs don’t know and so value you the same as superior peers).  But you won’t be fooled again, to borrow as I’m wont to do, a song title.

The good news about market structure versus mother nature is that we can change market structure when enough of us understand that rules have been written to benefit intermediaries at the expense of investors and companies.  Knowing and seeing must come first – which requires measuring, just like satellites that tracked Harvey.

With nature, all we can do is prepare. But preparation in all things including market structure always beats its absence.

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