Analyst Day

Why do you hold an Analyst Day? 

Traders and investors, these are what Joel Elconin on Benzinga Premarket Prep this past Monday called “the dog and pony show.”

For the investor-relations profession, the liaison to Wall Street, it’s a big deal, ton of work. We choreograph, prepare, script, rehearse, plan. We’re laying out Management’s strategic vision.

And it’s successful if…what?  The stock jumps?

Analyst Days: Productive, or just busy? Illustration 130957015 © Turqutvali | Dreamstime.com

Before Regulation National Market System in 2007 transformed the stock market into the pursuit of average prices, triggering an avalanche of assets into index funds and ETFs, you could say that.

Even more so before decimalization in 2001 transformed “the spread,” the difference between the prices to buy and sell, into the pursuit of pennies. It’s now devolved to tenths of pennies in microseconds.

The point is, a good Analyst Day meant investors bought the stock. Same with earnings. News. 

Let me take a moment here.  In addition to ModernIR, the planet’s IR market-structure experts and the biggest provider of serious data for serious IR professionals at US-listed companies, Karen and I run a trading decision-support platform called Market Structure EDGE.

Using data from that platform, I bought 200 shares of a known Consumer Discretionary stock this week using an algorithm from my online firm, Interactive Brokers. The order was split into three trades for 188 shares, 4 shares, and 8 shares, all executed at BATS, owned by CBOE, the last trade at a half-penny spread.

Why is this germane to an Analyst Day?  Stick with me, and you’ll see.

Would you go to a store looking for carrots and buy 10 of them at one, then drive to another for 2, and a third for 4?  Idiocy. Confusing busy with productive. So, why is that okay in a market worth $50 trillion of FIDUCIARY assets?

The stock I bought is a household name.  Ranks 463rd by dollars/trade among the 3,000 largest stocks traded in the US market, which are 99.9% of market capitalization. It’s among the 500 most liquid stocks.

Your Analyst Day is a massive target.  And over 90% of volume in the market has a purpose other than investment in mind. My trade in three pieces meant the purpose for the other side was to profit by splitting an order into tiny parts. That’s not investment. It’s arbitrage.

Investor-relations people, you are the market maestros. Your executives and Board count on you to know what matters.  Did it occur to you that your Analyst Day is a giant plume of smoke attracting miscreants? Does your executive team understand that your Analyst Day could produce a vast plume of arbitrage, and not what they expect?  If not, why not?

Look, you say. I run an Analyst Day. Are you saying I shouldn’t?

I’m saying that whether you do or not should be data-driven.  And evaluating the outcome should be data-driven too.  As should be the planning and preparation.

As should the understanding from internal audiences that at least 70% of the volume around it will be profiteers chasing your smoke plume, just like they gamed me for about 2.5 cents.

It’s not the 2.5 cents that matters. It’s the not knowing supply or demand. It’s the absence of connection between price and reality. 

By the way, Rockwell Medical is the current least liquid stock in the National Market System. You can trade $250 of it at a time on average, without rocking the price.  Most liquid? AMZN, at $65,000 per trade (price $3,275, trades 190,000 times per day, 18 shares at a time).

IR does not derive its value from telling the story. Its value lies in serving as trusted advisor for navigating the equity market.  Making the best use of shareholder resources. Understanding the money driving price and volume. You are not a storyteller.  You are the Chief Market Intelligence Officer. 

Think of the gonzo state of things.  I know what revenue every customer generates in our businesses, and what the trends are, the engagement is, the use of our data, what people click or don’t.  Yet too many public companies are spewing information to the market with NO IDEA what creates volume, why they’re traded, what sets price.

Is that wise?

So, what SHOULD we be doing?  The same thing we do in every other business discipline.  Use software and analytics that power your capacity to understand what drives returns. Do you understand what creates your price and volume?

Back to the Analyst Day. Don’t hold one because tradition says so. Do it if you benefit from it!  If your investors are fully engaged, you’re wasting their time and yours. That’s measurable.  You should know it well beforehand.

If they aren’t, set a goal and measure market reactions.  Realize that arbitragers will game your smoke plume.  That’s measurable too. Know what Active stock-pickers pay.  Know when Passives wax and wane. Know what’s happening with derivatives, and why.

Everything is measurable. But not with 1995 tools. Don’t do things just because you always have. Do them because they count.

That’s the IR profession’s opportunity, the same as it is everywhere else.

Bare Windows

It’s window-dressing. 

That saying suggests effort to make something appear better than it is.  And it’s a hallmark of stocks in today’s Relative Value era where the principal way we determine the worth of things is by comparing them to other things (true of stocks, and houses, art, cars, bonds, etc.).

ModernIR clients know we talk about “window dressing” at the ends of months and quarters.  It gets short shrift in the news but the PATTERNS of money that we observe cast long shadows over headlines.

Every month, managers who send investors performance statements want stuff to look as good as it can.  Things get bought and sold.  Then the headline-writers root around for some reason, like the Fed chair testifying to Congress.

Even bigger is the money tracking benchmarks. Every month, every quarter, that money needs to get square with its targets.  If Tech is supposed to be 24% of my holdings, and at quarter-end it’s 27%, I’m selling Tech, and especially things that have just gone up, like SNAP.

So SNAP drops 7%.  What did your stock do yesterday?  There’s a reason, and it’s measurable in behavioral patterns. Market structure.

The reason yesterday in particular was so tough is because it was T+2, trade date plus two more days, to quarter-end. If you need to settle a trade, effect a change of ownership, and it’s a big basket you’re working through, you’ll do it three days from quarter-end to make sure all positions settle in time.

With tens of trillions of dollars benchmarked to indexes around the globe, it’s startling to me how little attention is paid to basic mechanics of the market, such as when index money recalibrates (different from periodic rebalances by index creators).

And realize this.  In the last month, half the S&P 500 corrected – dropped more than 10%. About 90% of the Russell 2000 did.  No wonder small caps were up sharply Monday.  Most indexes were underweight those. But they’re less than 10% of overall market cap (closer to 5% than 10%). Truing up is a one-day trade.

Tech is a different story. Five stocks are almost 25% of the S&P 500 (AAPL, AMZN, GOOG, FB, MSFT).  And technology stocks woven through Consumer Discretionary and Communication Services stretch the effects of Tech north of 40%, approaching half the $50 trillion of US market cap.

The wonder is we don’t take it on the chin more often. I think the reason is derivatives. There’s a tendency to rely on substitutes rather than go through the hassle of buying and selling stocks.

As I’ve explained before, this is both the beauty and ugliness of Exchange Traded Funds (ETFs). They’re substitutes. They take the place of stocks, relieving the market of the…unpleasantness of moving real assets.  ETFs are just bits of digital paper that can be manufactured and destroyed at whim.

Remember, ETFs were created by commodity traders who thought, “Wouldn’t it be cool if we didn’t have to get out the forklift and move all that stuff in the commodity warehouse? What if we could just trade warehouse RECEIPTS instead of dragging a pallet of copper around?”

This time the forklifts are out.  It’s been coming since April.  See the image here? That’s Broad Sentiment, our 10-point index of waxing and waning demand for S&P 500 stocks, year-to-date in 2021, vs SPY, the S&P 500 ETF.  SPY is just 2.8% above its high point when Sentiment lost its mojo in April.

Broad Sentiment, courtesy MarketstructureEDGE.com

From Mar 2020 to Apr 2021, we had a momentum market juiced by time and money. There were surfeits of both during the pandemic. People gambled. Money gushed. Stocks zoomed.

But as with all drugs, the effect wears off.  Sentiment peaked in March. Strong stocks notwithstanding, we’ve been coming off a drug-induced high since then.

And the twitches have begun. You see it first in derivatives.  Every expirations period since April has bumped – before, during or right after.  I’ve circled them on the image. It means the cold shakes could come next.  Not saying they will. All analogies break down.

Back to window-dressing.  When it gets hard to dress up the room no matter what curtains you hang, it means something.  Here we are, on the doorstep of Q4 2021.  It’s possible the market, or a benchmark or two, might’ve turned negative for the third calendar quarter yesterday (I’m writing before the market closes).

The RISK can be seen by observing movement in Passive money.  Because it’s the biggest thing in the market.  The windows are bare this time. If we were smart, we’d take a good look around.

But that’s probably too optimistic.  Governments and central banks will try again to slap on the coverings, dress it up, make it look better than it is.

Resistance and Support

Bucket-list seeing Colorado aspens in autumn. It will remind you that the planet is a living canvas and that everything is going to be okay.

Colorado aspens at Muddy Pass summit. Karen Quast

Now, what about the stock market?  I said last week in the Market Structure Map:

“Predictions? I bet we rebound next week. BUT if Monday is bad, the bottom could fall out of stocks.  And you should always know what’s coming, companies, investors and traders. It’s just data.”

Well son of a gun.

New options traded Monday and the market took a vicious thwap to the noggin. Why? No, not Chinese real estate.  Or this thing, or that thing.  There was a buffet of options spread out for consumption and the crowd that showed up to feast was sparse like a pandemic trade show.

That’s weak implied demand. So stocks fell. Again, read last week’s blog. About 20% of market capitalization ties to rights to buy or sell that reset monthly.  If demand drops even a half-percent it can rock equities.

Who’s using those?  Hedge funds.  Traders.  Funds substituting derivatives for equities (permissible up to about 10% of assets).

Shouldn’t we wonder WHY fewer guests came to the options banquet? Yes, but in advance! If you’re casting about AFTER it happens, you’re making it up, like resistance and support. We talked for three weeks about the big risk into Monday.

The point isn’t being right. The point is correct data.  

What’s more, investors didn’t sell. Active Investment was down about 17% marketwide Monday. And the last-hour recovery that clawed back 30% from the lows came on quant money and machines.

I was talking with the investor-relations officer for a Nasdaq-traded Consumer Discretionary company.  I said, “What do you do for answers about why your stock moves differently from your peers?”

She said, “I call the Nasdaq.  The guy there tells me what our levels of resistance and support are.”

There are over $63 trillion in worldwide regulated (following standardized government guidelines like the Investment Company Act of 1940) investment funds, says the Investment Company Institute in its 2021 Factbook.

None of that money makes decisions using levels of support or resistance. So why would that be the explanation, if the job of the investor-relations officer is to help the board and executive team understand what drives shareholder value and how to succeed in the public equity markets?

Just askin’.

To be fair, this IR officer is now a client. It’s telling though, isn’t it, that for many in the investor-relations profession a telephone is the chief source of data. And the data provider says, “You broke through your support levels.”

Uh huh.

It’s true machines will calculate how to price bids and offers by sifting the surrounding data.  From that data come levels of support and resistance. The trouble is those machines don’t want to own anything.

Our friend in Consumer Discretionary saw shareholder value plummet 23% from the end of August to September options-expirations. Principal cause, Derivatives.  Active and Passive Investment patterns shrank over that time.

It had nothing to do with story.  In fact, that company’s Engagement score – quantitative measure of influence from Active stock-pickers – is 91%. Superb.  At this moment, the stock is exactly in line with what stock-pickers are willing to pay. That’s measurable.

And it wasn’t levels of support or resistance. Yes, over that time the machines manufacturing most prices averaged 55% of the stock’s volume and owned no shares at day’s end (and 60% of volume was short to boot – borrowed or manufactured).

To me, support and resistance are like the daytime temperature. Today’s high and low temperatures reflect seasons and weather-fronts, not support and resistance.  The seasons and weather-fronts of the stock market are patterns of changing behavior.

Last week, the S&P 500 saw a 1% drop in demand for derivatives – we call that a 1% decline in Risk Mgmt – when options-expirations should have driven an increase in demand.

Against falling demand (Sentiment) and rising supply (Short Volume) marketwide, we thought, “The market could take a Mike Tyson to the chin.”

Indexes reweighted too, and Passive investment was down 5% in the S&P 500.  Suggests weaker flows to Tech since that’s where all the market cap is.

What now? The Fed meets at 2p ET today.  Our 10-point index of short-term supply and demand called Broad Sentiment is 4.4, and 4.0 is a bottom. Probably stocks recover.

If the bottom turns to mush, people will be saying, “The market’s next level of support is…”

And that won’t be it. The data say we’ve been in a long slowdown from momentum since April. The consequences can show up all at once.  I doubt it’s right here, right now. But it’s possible. 

Just Data

If stocks rise when VIX options expire, is it good or bad?

It’s data. That, we know.  If you’d never considered a relationship between stocks and options, welcome to market structure.  It’s something every public company, investor, trader, should grasp. At least in big brush strokes.

So here goes.

“Market structure” is the mechanics of the stock market. The behavior of money behind price and volume, we say. You’ll hear the phrase from people like SEC chair Gary Gensler and Virtu CEO Doug Cifu. Those guys understand the stock market.

By the way, if you missed our piece on Payment for Order Flow, an arcane element of market structure that now plays a central role for prices marketwide, read it here.

So, options-expirations.  Here’s the calendar.  Options are expiring all the time but the juggernaut are the monthly ones.  VIX options expired yesterday. That’s the so-called “Fear Gauge,” and we’ve written before about it.  It’s the implied volatility of the S&P 500.

It’s a lousy risk meter.  By the time it moves it’s too late. Its gyrations are consequences, not predictors. ModernIR (and sister company EDGE for trading decision-support) has much better predictive tools.

The VIX is really about volatility as an asset class (and it’s trillions of dollars now, not just VIX but volatility instruments).  You can buy things that you hope rise, short things you think might fall – or trade the gaps between, which in some ways is the least risky thing because it’s always in the middle.

In any case, the assets backing volatility are the same things that rise or fall. Stocks.  So a jump in demand for volatility hedges can cause stocks to rise. 

Yesterday stocks rose with VIX resets. 

And when it falls, it can mean the opposite. As it did August 18 when the VIX last lapsed and renewed.  A big pattern of Passive buying preceded it.  Then wham! Down day with the VIX reset.

Then growth stocks, momentum stocks, Big Tech, the FAANGs, etc., shot up.  That’s because money reduced its exposure to volatility hedges and increased its bets on “risk,” or things that might rise.

So.

Did that just stop?  No, it stopped last week.  What’s more it’s apparent in the data. 

Let me explain. Backing up, from Aug 6-17 – right before August expirations – there is a MASSIVE pattern of Passive money.  After that pattern, the market shot up. Except for one day, Aug 18. VIX expirations.

It indicates that ETFs took in large quantities of stocks, then created ETF shares and sold them to investors, which drove the market up. And the money spent on hedges was shifted to chasing call-options in “risk-on” stocks.

And yes. We can see that in any stock, sector, industry, peer group.

Back to the present, index-rebalances are slated for this Friday, quarterlies for, among others, big S&P Dow Jones benchmarks.  There are three MILLION global indexes now.

The data suggest those rebalances finished between Aug 26-Sep 10. Money didn’t wait to be front-run Friday. There’s another massive Passive pattern during that time.  The image here shows both patterns, the one in August, and this September version (through Sep 14, right before VIX expirations).

We can infer, albeit not with absolute certainty, that the trade from August has reversed.  ETFs are shedding stocks and removing growth-portfolio ETF shares.  Hedges are going back on.

Does that mean the market is about to tip over like so many have been predicting?

Rarely does a market implode when everybody is expecting it. In fact, name a time when that was true. Sure, somebody always manages to make the right call. But it’s a tiny minority.

Whatever happens, it’s going to surprise people. Either the pullback will be much worse than expected, or all the hedges that are going on as we proceed into September expirations will blunt the downside and reverse it when new options trade next week.

By the way, market woe sometimes comes on new options.  Sep 24, 2015.  Feb 24, 2020.  I could list a litany. Those are dates when new options traded. If nobody shows up for new options, the 18% of market cap that rests on rights but not obligations to do something in the future – derivatives – stuff can tumble.

Hedging in the SPX is about 19% of market cap right now.  ETF flows are down about 5% the last week versus the week before.  Our ten-point scale of Broad Sentiment has fallen from a peak Sep 7 of 6.1 to 5.1 Sep 14, still trending down. Any read over 5.0 is positive. It’s about to go negative.

Predictions? I bet we rebound next week. BUT if Monday is bad, the bottom could fall out of stocks.  And you should always know what’s coming, companies, investors and traders. It’s just data.

 

Growth vs Value

Are you Value or Growth?  

Depends what we mean, I know. S&P Dow Jones says it distinguishes Value with “ratios of book value, earnings and sales to price.”

It matters because Growth is terrorizing Value.  According to data from the investment arm of AllianceBernstein, Growth stocks outperformed Value stocks by 92% between 2015-2020.  Morningstar says it’s the biggest maw on record, topping the 1999 chasm.

If you’re in the Growth group, you’re loving it.  But realize.  By S&P Dow Jones’s measures, anybody could be a Value or Growth stock at any time.  It’s all in the metrics.

The larger question is why the difference?  AllianceBernstein notes that the traditional explanation is earnings growth plus dividends paid.  That is, if your stock is up 50% more than a peer’s, it should be because your earnings and dividends are 50% better.

If that were the case, everybody would be a great stock-picker. All you’d need do is buy stocks with the best earnings growth. 

Well, turns out fundamentals accounted for just ten percentage points of the difference.  The remaining 82% of the spread, as the image here from AllianceBernstein shows, was multiple-expansion.  Paying more for the same thing.

Courtesy AllianceBernstein LP. https://www.alliancebernstein.com/corporate/en/insights/investment-insights/whats-behind-the-value-growth-performance-gap.html

Put differently, 90% of the time Growth stocks outperform Value stocks for no known reason. No wonder stock-picking is hard.

Take Vertex (VRTX) and Fortinet (FTNT), among the two very best and worst stocks of the past year.  I don’t know fundamentally what separates them. One is Tech, the other Healthcare.

I do know that running supply/demand math on the two, there’s a staggering behavioral difference.  FTNT spent 61 days the past year at 10.0 on our ten-point scale measuring demand called Market Structure Sentiment.  It pegged the speedometer 24% of the time.

VRTX spent five days at 10.0.  Two percent of the time.  You need momentum in today’s stock market or you become a Value stock.

We recently shared data with a client who wondered why there was a 20-point spread to the price of a top peer.  We ran the data.  Engagement scores were about the same – 85% to 83%, advantage to our client. Can’t say it’s story then.

But the peer had a 20% advantage in time spent at 10.0.  The behavioral patterns were momentum-style. Our client’s, GARP/Value style.

Okay, Quast.  Suppose I stipulate to the validity of your measure of supply and demand, whatever it is.  Doesn’t answer the question. Why do some stocks become momentum, propelling Growth to a giant advantage over Value?

I think it’s three things. I can offer at least some data, empirical or circumstantial, to support each.

Let’s call the first Herd Behavior.  The explosion of Exchange Traded Funds concentrates herd behavior by using stocks as continuously stepped-up collateral for ETF shares.  I’ll translate.  ETFs don’t invest in stocks, per se.  ETFs trade baskets of ETF shares for baskets of stocks (cash too but let’s keep it simple here). As the stocks go up in value, ETF sponsors can trade them out for ETF shares. Say those ETF shares are value funds.

The supply of Value ETF shares shrinks because there’s less interest in Value.  Then the ETF sponsor asks for the same stocks back to create more Growth ETF shares.

But the taxes are washed out via this process. And more ETF shares are created.  And ETFs pay no commissions on these transactions. They sidestep taxes and commissions and keep gains.  It’s wholly up to traders and market-makers to see that ETF shares track the benchmark or basket.

The point? It leads to herd behavior. The process repeats. Demand for the same stuff is unremitting.  We see it in creation/redemption data for ETFs from the Investment Company Institute. ETF creations and redemptions average over $500 billion monthly. Same stuff, over and over. Herd behavior.

Second, there’s Amplification.  Fast Traders, firms like Infinium, GTS, Tower Research, Hudson River Trading, Quantlab, Jane Street, Two Sigma, Citadel Securities and others amplify price-moves.  Momentum derives from faster price-changes, and Fast Traders feed it.

Third is Leverage with derivatives or borrowing.  Almost 19% of trading volume in the S&P 500 ties to puts, calls and other forms of taking or managing risk with derivatives. Or it can be borrowed money. Or 2-3x levered ETFs. The greater the pool of money using leverage, the larger the probability of outsized moves.

Summarizing, Growth beats Value because of herd behavior, amplification of price-changes, and leverage.

By the way, we can measure these factors behind your price and volume – anybody in the US national market system.

Does that mean the Growth advantage is permanent?  Well, until it isn’t. Economist Herb Stein (Ben’s dad) famously said, “If something cannot last forever, it will stop.”

And it will. I don’t know when. I do know that the turn will prompt the collapse of leverage and the vanishing of amplification. Then Growth stocks will become Value stocks.

And we’ll start again.

Gensler’s Gambit

Suddenly it’s September.  Statistically, the worst month for stocks.

Illustration 172906555 © Corneliakarl | Dreamstime.com

It’s then no surprise that SEC Chair Gary Gensler would start hucking Molotovs at market structure.  If you’re gonna do it, why not when stocks might be rocky? Gives you air cover.

For those who missed it, Gensler told Barron’s the SEC could consider banning what’s called Payment for Order Flow (PFOF).  I’ll explain.

You might also have seen that new stock exchange MEMX (Members Exchange) has asked the SEC to let stocks quoting with a one-cent spread to trade in half-cents.

What do these things mean to you, traders and investors and public companies? 

I’m glad you asked!

First, let’s understand the current rules. PFOF exists because of rules. Ironic, right? SEC rules require all stocks to trade at a single best price marketwide.  What’s more, brokers who execute the trades are required to meet “Best Execution” standards that, simplified, are a percentage of time at the best prices to buy or sell.

Well. Retail trades are small. Prices constantly change. It’s a pain trying to comply with SEC rules when handling gobs of tiny trades.

So firms like Robinhood sell their orders to others with sophisticated systems for complying with the rules. Regulators keep making exceptions to accommodate the vital role these so-called “market-making” firms play in the SEC’s grand scheme for a continuous auction where everything exists in 100-share increments.

We’ll get to what it all means.  Now, half-pennies?  Not what meets the eye.  Regulation National Market System prohibits QUOTES in sub-penny increments for stocks with prices above $1. That’s the Sub-Penny Rule.

But stocks TRADE all the time in sub-pennies.  Of my last ten trades using decision-support from our sister company (vote for us in the Benzinga Fintech Awards!) Market Structure EDGE, five were in tenths of pennies.

Examples of that, I bought 75 shares and then 25 shares of AAPL (there aren’t 100 shares at a single venue at the market’s best price – yup, truth), both at half-penny spreads.  I sold FB for a two-tenths spread.  But brokers, not exchanges, matched these.

The doozy is this: I bought NVDA at a six-tenths penny spread through the Nasdaq’s “Retail Liquidity Program” where a high-speed trader like Virtu sold it to my broker, Interactive Brokers, at a price a scooch (say three-tenths) better than the best offer and was also paid about three-tenths of a penny by the Nasdaq for doing it.

All this fits together. Don’t worry if you’re feeling confused. I’ll sort it out for you.

MEMX wants a piece of the half-penny business brokers are getting. It could double MEMX’s market-share. It’s not virtuous.

Now let’s understand PFOF. The SEC wanted a perfect Shangri-La for the little guy. Where anybody can buy or sell 100 shares of everything.

Except that’s impossible.

Brokers said, “We can’t do it. You’ll have to permit us to create shares for instances when there are no real sellers for buyers, and vice versa.”

The SEC agreed. Thus, market-makers like Citadel Securities are exempt from Reg SHO Rule 203b(2) mandating that stocks must be located before they can be shorted.

That’s another story.

Since there was no incentive for market-makers to buy and sell, the SEC gave them a guaranteed spread, permitting broker-operated Alternative Trading Systems called dark pools (where my trades matched) to execute trades BETWEEN the best bid and offer.

Volume shifted off exchanges to dark pools. Conceding, the SEC approved Retail Liquidity Programs letting exchanges pay for trades that originate with retail investors.

And they allowed exchanges to pay traders incentives called “rebates” to set the best bid to buy and offer to sell. I’m hitting only high points.  Now 85% of trades are midpoints at exchanges too.

But this gave rise to PFOF. Enterprising firms realized that if exchanges would pay them for trades, they could buy trades too. And execute them at fractions of pennies of profits both directions.

And brokers like Schwab, E*Trade, Ameritrade, Fidelity, Robinhood, realized they had this…thing.  Retail flow. By selling it, they offloaded compliance. And they could now give trades away to boot to foster more of them.

Gary Gensler is threatening to chop the legs off this stool the SEC created.

Look. I don’t like this market because it’s not free. But the problem isn’t PFOF by itself. It’s a contrived, rules-driven market that promotes arbitraging time and price as an end unto itself.  And now $50 trillion of market cap dances, pirouettes, on tiny split-penny trades.

Kick a leg out and it’ll be a disaster.  Re-think Reg NMS, and disconnect markets, and stop paying traders to change prices, and we could bring back lumpier and committed investment. Right now, we have exactly what the rules encourage.

I have low expectations.  And this is why you need Market Structure Analytics, traders and public companies. We understand it all. 

Where’s It Going?

Where’s what going?

Time? Hm.

Money?  Well. Yes.

It abounds and yet it doesn’t go far.  Why that’s the case is another story (I can explain if you like but it usually clears a room at a cocktail party).

First, if you were spammed last week with the MSM, apologies! It was inadvertently set on full-auto.  And one other note, our sister company Market Structure EDGE  is up for several Benzinga Fintech Awards.  As in American politics, you may vote early and often (just kidding!). No, you can vote daily though till about Oct 22, 2021.  We hope you’ll help! Click here, and turn it into a daily calendar reminder.

Today we’re asking where the money gushing at US stocks and bonds like a ruptured fire hydrant is going. Morningstar says it’s $800 billion into US securities the last twelve months through July.

That’s minus a $300 billion drop in actively managed equity assets. Stock-pickers are getting pounded like a beach in a hurricane. Public companies, you realize it?

That’s not the point of this piece. But investor-relations professionals, realize the money you talk to isn’t buying. It’s selling.  There are exceptions and you should know them.  But don’t build your IR program around “targeting more investors.” Build it on the inflows (your characteristics), not the outflows.  If you want to know more, ask us.

So where did the $800 billion go? 

About $300 billion went to taxable bond funds.  Not for income. Appreciation. Bonds keep going up (yields down, prices up). They’re behaving like equities – buy appreciation, not income.

The rest, about $500 billion, went to US equities.  We’re going to look at that. 

$500 billion seems like a lot.  Ross Perot thought a billion here, billion there, pretty soon you’re talking real money. For you who are too young to know it, Google that.

But today $500 billion ain’t what it was. And frankly, five hundred billion deutschemarks wasn’t much in the Weimar Republic either.  The problem wasn’t inflation. The problem was what causes inflation: too much money.

Ah, but Weimar didn’t have derivatives. Silly fools.

For perspective, more than $500 billion of Exchange Traded Funds (ETF) are created and redeemed in US equities every month.  Stocks trade more than $500 billion daily in the US stock market.

And the money supply as measured by the Federal Reserve’s “M2” metric reflecting the total volume of money held by the public, increased by $5 trillion from Feb 2020 to July 2021.  That’s a 32% increase. About like stocks (SPY up 33% TTM).

Wait. The stock market is up the same as the money supply? 

Yup.

Did everybody sell stocks at higher prices?

No. Everybody bought stocks at higher prices.

Okay, so where did the stock come from to buy, if nobody sold?

Maybe enough holders sold stocks to people paying 33% more to account for the difference. Good luck with that math. You can root it out if you want.

But it’s not necessary.  We already know the answer. The money went into derivatives. 

The word “derivative” sounds fancy and opaque and mysterious. It’s not.  It’s a substitute for an asset.  You can buy a Renoir painting. You can buy a Renoir print for a lot less. You can buy a stock. You can buy an option on that stock for a lot less.

Suppose you want to buy the stocks in the S&P 500 but you don’t want the trouble and expense of buying 500 of them (a Renoir). You can buy a swap (a print, No. 347 of 3,900), pay a bank to give you the returns on the index (minus the fee).

Or you can buy SPY, the S&P 500 ETF.  You think you’re getting a Renoir.  All those stocks. No, you’re getting a print somebody ran on an inkjet printer.  It looks the same but it’s not, and it’s not worth the stocks beneath it.

Image courtesy ModernIR, Aug 25, 2021.

See this image?  There is demand.  There is supply. The former greatly exceeds the latter like we’ve seen the last year during a Covid Pandemic (chew on that one for a bit), so excess demand shunts off to a SUBSTITUTE. Derivatives. ETFs, options, futures.

That’s what’s going on. That’s where the money went. Look at GME and AMC yesterday. Explosive gains on no news. Why? Banks squared derivatives books yesterday after the August expirations period. Demand for prints (options), not paintings (stock), vastly exceeded supply.

So banks bought the underlying paintings called GME and AMC – and sold traders ten times as many prints. Options. Derivatives. It’s implied demand. The stocks shot up.

Bad? Well, not good. The point isn’t doom. The point is understanding where the money is going. Every trader, investor, public company, should understand it. 

It’s all measurable if you stop thinking about the market like it’s 1995. It’s just math. About 18% of the market is in derivatives.  But about 75% of prices are transient things with no substance.  Prints, not paintings.

Public companies, know what part of your market is Renoir, what part is just a print.  Traders, do the same.

We have that data.  Everybody should always know where the money is going.

Suddenly

Things are getting worrisome. 

It’s not just our spectacular collapse in Afghanistan less than a month before the 20-year anniversary of Nine Eleven.  That’s bad, yes.  Inexcusable.

Illustration 179312099 / Ernest Hemingway © Lukaves | Dreamstime.com

It’s not the spasmodic gaps in supply chains everywhere – including in the stock market. 

It’s not bond yields diving as inflation spikes, which makes sense like accelerating toward a stop sign.

It’s not the cavalier treatment of the people’s money (do you know we spent $750 million of US taxpayer dollars on the Kabul embassy, the world’s largest, then left the keys on the desk?).

It’s all of it.  Stuff’s jacked up, and it should bother us.

Karen and I went to a concert at Strings, the performing arts venue in Steamboat Springs.  If you want to feel better about yourself, go to the state fair.  Or an Asleep at the Wheel concert in Steamboat.

People are showing up with walkers, oxygen tanks, doddering uncertainly up the walkway.  I’m joking!  Mostly.  You get the point. (Lord, I apologize for my poor taste.)

And Asleep at the Wheel is awesome. I grew up on Hotrod Lincoln and The House of Blue Lights.

Anyway, covid mania continues so the hall serves no food or drink inside.  We’re dependent on food trucks outside for snacks.

None showed up.

There was a big bike ride this past weekend, three thousand gravel riders.  The food trucks were there. But there’s not enough staff working to cover more than one base. We and the oldsters were out of luck for tacos and cheesesteak.

But we were told they’d be there, and they weren’t. That kind of thing happened in Sri Lanka when I lived there for a year in college. But not in the World’s Superpower.

It gets worse.

The bartenders were shaking their heads. They couldn’t restock beforehand because the supplier was closed.  No staff.  A major liquor store – the biggest in the region with normally 3-4 registers running simultaneously – had to close because they had no staff to run the shop.

If you can’t stock your bar, you’re in trouble of collapsing as an empire. I say that in the barest jest only.

Back to the stock market.  The supply chain for stocks is borrowed shares. I’ve explained it before.  Dodd Frank basically booted big brokers from the warehouse business for equities.

Used to be, if you were Fidelity you called Credit Suisse and said, “I need a million shares of PFE.”

Credit Suisse would say, “We’ve got 500,000. We’ll call Merrill.”

And the wholesale desk there, the erstwhile Herzog Heine Geduld, would round the other half up.

Not so in 2021.  The banks now are laden to creaking with “Tier One Capital” comprised mostly of US Treasuries.  You’re the government and you need a market for debt, you just change the rules and require banks to own them, and slash interest rates so fixed income funds need ten times more than before.

Elementary, Watson.

What’s more, the stock market is a continuous auction. Everything is constantly for sale in 100-share increments. 

Except there aren’t 100 shares of everything always available. Certainly not 100,000 shares. So the SEC requires – they mandate it – brokers to short stock, create it in effect, to keep the whole continuous auction working.

Well, it’s getting wobbly.  There are sudden surges and swales in short volume now.  And the average trade size in the S&P 500 is 104 shares. Lowest on record.  Almost half that – 44% currently – is borrowed. In effect, the supply chain in the stock market is about 60 shares.

Depending on that tenuous thread is about 75% of three MILLION global index products.  Thousands of ETFs.  And $50 TRILLION of market cap.

The 1926 Ernest Hemingway book The Sun Also Rises has an exchange between two characters.  One asks the other how he went broke.

“Gradually,” he said. “Then suddenly.”

Afghanistan’s sudden collapse was 20 years in the making.  The same thing is happening around us in a variety of ways, products of crises fomenting in our midst that we ignore or excuse.

So what do we do about it?

The societal question is tough.  The market question is simple: Understand the problem, engage on a solution.

Public companies, it’s you and your shareholders sitting at the head of this welling risk.  We owe it to them to understand what’s going on. Know the risk of fragility in your shares’ supply chain. That’s a start. We have that data.

Solving the whole problem will require a well-informed, prepared constituency that cares.  Or all at once it’s going to implode. Not hyperbole. A basic observation.

Starting Point

The starting point for good decisions is understanding what’s going on. 

I find it hard to believe you can know what’s going on when you’re authorizing trillions of dollars of spending.  But I digress.

Illustration 22981930 / Stock Trading © John Takai | Dreamstime.com

Investor relations professionals, when was the last time you called somebody – at an exchange or a broker – to try to find out what’s going on with your stock? I can’t recall when the Nasdaq launched the Market Intelligence Desk but it was roughly 2001.

Twenty years ago.  I was a heavy user until I learned I could dump trade-execution data from my exchange into my own Excel models and see which firms were driving ALL of my volume, and correlate it to what my holders told me.

That was the seed for ModernIR. 

Today, market behaviors and rules are much different than they were in 2001. Active money back then was still the dominant force but computerized speculation was exploding.  What started in the 1990s as the SOES Bandits (pronounced “sews”) – Small Order Execution System (SOES) – was rapidly metastasizing into a market phenomenon.

Regulation National Market System took that phenomenon and stamped it on stocks. What was a sideshow to ensure retail money got good deals now IS the stock market.

Nearly all orders are small.  Block trades are about a tenth of a percent of total trades.  For those struggling with the math, that means about 99.9% (not volume, trades) aren’t blocks.  The trade-size in the stocks comprising the S&P 500 averaged 108 shares the past week.  All-time record low.

Realize, the regulatory minimum for quoting and displaying prices is 100 shares.  Trades below that size occur at prices you don’t even see.  I have a unique perspective on market machinery.  I’ve spent 26 years in the IR profession, a big chunk of that providing data on market behaviors to public companies so they know what’s going on (the starting point for good management).

Now I run a decision-support platform too for active traders that gives them the capacity to understand changing supply/demand trends in stocks – the key to capturing gains and avoiding losses when trading (we say take gains, not chances).  And I trade stocks too.  I know what it means when my NVDA trade for 50 shares executes at the Nasdaq RLP for $201.521.

Yes, a tenth of a penny.  It means my broker, Interactive Brokers, routed my trade to a Retail Liquidity Program at the exchange, where a Fast Trader like Citadel Securities bought it for a tenth of a penny better than the best displayed price, and was paid about $0.015 for doing so.

For those struggling to calculate the ROI – return on investment – when you spend a tenth of a penny to generate one and a half pennies, it’s a 1400% return.  Do that over and over, and it’s real money.  Fast Trading is the least risky and most profitable business in the stock market.  You don’t have to do ANY research and your investment horizon is roughly 400 milliseconds, or the blink of an eye.  Time is risk.

For the record, NVDA trades about 300,000 times per day. Do the math. 

Which leads to today’s Market Structure Map singularity – infinite value.  Trades for less than 100 shares sent immediately for execution – that’s a “market order” – must by law be executed.  The Securities Exchange Commission has mandated (does the SEC have that authority?) a “continuous auction market” wherein everything is always buying or selling in 100-share increments or less.

So algorithms almost always chop trades into pieces smaller than 100 shares that are “marketable” – meant to execute immediately.  And retail traders are browbeaten relentlessly to never, ever, ever enter marketable trades.  Only limit orders. That ensconces information asymmetry – an advantage for machines.  Every time I send a marketable trade for execution, I have to check a box acknowledging that my trade is “at the market.”

That’s the truth.  Algorithms pulverize orders into tiny pieces not to make them look like tiny trades, but because tiny trades are required by law to execute.  Large trades are not.  Limit orders are not.  Those both may or may not match.  But tiny trades will. There’s one more piece to that puzzle – the market-making exemption from short-locate rules.  For more on that, go to the youtube channel for sister company EDGE and watch my presentation on meme stocks at The Money Show.

Moral of the story:  The entire structure of the stock market is tilted toward the people and the machines who actually know what’s going on, and away from those who don’t.

Now.  What do you know about the stock market, investor-relations professionals?  You are head of marketing for the stock.  Got that?  Do you know how the stock market works?

If you don’t, you need us.  We know exactly how it works, and exactly what’s going on, all the time.  You should have that information in your IR arsenal. 

Nothing is more important. It’s the starting point.

Passive Pitfalls

We’re back!  We relished upstate New York and Canandaigua Lake. 

If you’ve never been to Letchworth and Watkins Glen parks, put them on your list.  See photo here from the former, the Upper Falls there. Alert reader Deb Pawlowski of Kei Advisors, a local resident, said in pragmatic investor-relations fashion, “Beautiful area, isn’t it?”

Boy, indeed.

Letchworth State Park – Tim Quast

And it was month-end.  Companies were demolishing earnings expectations, a thousand of them reporting last week, sixteen hundred more this week.  Most big ones pile-driving views and guidance saw shares fall.

But how can that be?  Aren’t markets a reflection of expectations?

Tim.  Come on.  You buy the rumor, sell the news.

If that’s how you’re describing the market to your executive team and board…um, you’re doing IR like a caveman.  Rubrics and platitudes ought not populate our market commentary in this profession.

Use data.  Everybody else does (except certain medical-science organizations, but let’s just step lightly past that one for now).

Last week across the components of the S&P 500, Active Investment was up 0.0%. Unchanged.  Passive Investment – indexes, Exchange Traded Funds, quants, the money following a road map – fell 7%.  The use of derivatives, which should be UP during month-end when indexes use futures and options (quarterly options and monthly futures expired Jul 30) to true up tracking instead fell 2%.

No biggie? Au contraire.  A combined 9% drop in those behaviors is colossal. In fact, Passive money saw the steepest drop Jul 30 since Aug 3, 2020.

I’ll come back to what that means in a moment. 

Finishing out the Four Big Behaviors behind price and volume, the only thing up last week besides short volume, which rose to 45% Friday from a 20-day average of 44% of S&P 500 volume, was Fast Trading. Machines with an investment horizon of a day or less. Up 4%.

Think about all the economic data dominating business news.  The Purchasing Managers Index came in at 55 versus expectations of 56. Jobless claims unexpectedly jumped above 400,000.  Inflation came in hotter than expected at a seasonally adjusted 5.4%, annualized. Egads!

As Ronald Dacey in the Netflix series Startup would say, “You feel me?”

I’m just saying data abounds and so do reactions to it. Yet we talk about the stock market like it’s got no measurable demographics or trends driving it.

Well, of course it does!  Why is there not a single report Monday – except mine on Benzinga’s “Market Structure Monday” segment on the Premarket Prep Show – driven by data?

By the way, on Monday Aug 2, Passive Investment surged more than 14%. New month, new money into models.  The reason the market didn’t goose into the rafters was because it filled the giant Friday Passive hole I just described.

Broad Market Sentiment at Aug 2 is 5.4 on our 10-point market-structure scale of waxing and waning demand. That’s exactly what it’s averaged for more than ten years.  The market is not a daily barometer of reactions to data.  But it IS a reflection of what money is observably doing.

And what it’s observably doing to the tune of about 90% of all market volume is not picking stocks. The money follows models.  The money speculates. The money transfers risk. Because time is risk. The riskiest of all market propositions is buying and holding, because it leaves all the price-setting to stuff that’s much more capricious.

The least risky thing to do in the stock market is trade stuff for fractions of seconds, because your money is almost never exposed to downside risk. This is how Virtu famously disclosed in its S-1 that it made money in 1289 of 1290 days.  Stock pickers just want to be right 51% of the time.

What’s the lesson? Everything is measurable and trends manifest precisely the way money behaves.  It’s darned well time that boards and executive teams – and investors – understand the market as it is today.

Oh, and why is the Jul 30 drop in Passive money, the biggest in a year, a big deal? Because the market corrected in September 2020. The so-called FAANG stocks (FB, AAPL, AMZN, NFLX, GOOG/L) fell 35% in three days.

There is Cause. Then a delay. Then the Effect.  There is DEMAND and SUPPLY.  If DEMAND declines and SUPPLY rises, stocks fall.  In fact, those conditions uniformly produce falling prices in any market.

We measure it. Sentiment is demand. Short Volume is supply. 

So. The stock market is at 5.4. Right at the average. But if the supply/demand trends don’t improve, the market is going to correct.  Can’t say when. But the data will give us a causal indication.

If you want to know, use our analytics. We’ll show you everything!