January 25, 2023

Halted Auction

The NYSE opening auction failed yesterday.

Prices gyrated and trading halted in swaths of large caps including XOM, WMT, UL, T, VZ, RTX, MCD, PRU, UNP, MO and many more – trillions in market cap.

It was, to quote comedian Jeff Foxworthy, pandelirium. Especially among the market-structure crowd on Twitter.  The wreckage to prices, trades, data…whew.

Proposed new SEC rules would sharply increase the number of auctions at exchanges. These retail auctions will last just 300-400 milliseconds, but it means one venue out of about 50 will have to get it right.

Big risk.

And it’s not retail or stock-pickers I’m thinking about but Passive money. Vanguard says 80% of its $8 trillion in assets are passive. 

It’s a bellwether. Blackrock and State Street aren’t far off that number across their combined $15T under management. Over half of Fidelity’s assets now track models. The big banks like UBS and Morgan Stanley and JP Morgan, another $12T or so, are using target-date and asset-allocation models.

That money moves in vast ranks.  It’s measurable. You can see it daily in your data if you know what to watch, like we do.  Image #1 here is what we see when Passive money in the S&P 500 rushes back to Tech and lifts the market.

Image 1. Image courtesy ModernIR.com. SP500 pattern data Dec 2-30, 2022.

Here’s the thing. All of it depends on reliable historical quote and trade data. Because it’s executed by algorithms.

The stock market is 98% algorithmic, 100% electronic. The software executing rapid-fire small trades needs clean data to calculate prices and sizes and do its work.

The average S&P 500 stock (all save UL above are in it) trades 45,000 times per day, in 105-share increments, about $730mm of stock daily on average, and price moves 2.5% between high and low daily, and 49% of the volume is short (borrowed).

You can’t have hiccups.

And it’s exceedingly difficult for stock-pickers, who are 10% of daily volume in the S&P 500, to set price.  Most of the time, they’re subsumed in the 75% of volume coming from either Passive Investment – all that model-driven money – or Fast Traders who set prices.

The Designated Market Makers on the NYSE floor are Fast Traders. Most of the prices at the rest of the stock exchanges are set by Fast Traders incentivized to bid or offer at the “top of the book.”

I had a trade yesterday execute at the NYSE in an RLP, a retail liquidity program. A Fast Trader “crossed the spread” to give me a tenth of a penny more per share, and was paid three cents a hundred shares by the NYSE to do it.

Okay, Quast.  My head is spinning. What’s the point? 

If you’re publicly traded, this is your market.  Should someone at every public company know how it works?  Seems so, since the executive team and the Board are fiduciaries to shareholders.

And equally important, WHAT WE DO for the executive team should reflect the facts. 

Let me give you an example.  And it applies to both investors and public companies.  To the latter first, let’s suppose you’re the CFO at 3M Co.  Before you report earnings, you should expect your investor-relations team to tell you what the money has been doing behind price and volume.

Not what your holders are asking, or what the sellside is saying.  Those are known knowns, as they say about battlefields.

The known unknowns include what all the money is actually doing.  Let’s remedy that. Image #2 shows the 30-day Supply/Demand balance in MMM. Deteriorating Demand, Supply high and nearly 60% of trading volume.

Image 2. Courtesy marketstructureedge.com, 30-Day Supply-Demand view, MMM.

That alone, no matter what the story is, says price will fall. Put VALUE messages where machines read them, in the heading and subheading and CEO quote. 

The last image (#3) does what the CFO asks. It shows what the money has been doing the two weeks before earnings. Summarizing the data, price is down 5%, Passive money is up 11% (so it’s a seller), shorting is up, Active Investment is down, Risk Mgmt bets are up.

Image 3. Courtesy ModernIR.com. 2-wk comparison, MMM.

But stock-pickers – Active Investment – are not sellers. There’s again a chance to attract VALUE money.  The message should reflect it.  Key words should reinforce it.

Then MMM should measure what happens in the week after results and the week after that. What changes?  Report it to execs, to the Board of Directors.

This is core investor-relations today. Because the stock market is electronic and algorithmic and most of the money isn’t rational.  You can’t fix shareholder-value with fundamentals because it’s not how something like $40 trillion of assets looks at equities.  And it’s not how the stock market works.

And investors? If you see falling Demand and rising Supply ahead of earnings, cut your exposure. You can come back later at a better price.

The market is complex and fragile, and issuers need a better handle on its rules and mechanics. So do traders and investors. Right now, the intermediaries are making all the rules. That’s how Citadel made $16 billion last year.

I’m happy for Citadel!  But the rest of us need a say too, and a fair and level playing field.

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