February 1, 2017

Open Water

If you want to be creeped out – and who doesn’t? – see the movie “Open Water.” It explains the problem with Board reports in investor-relations too.

American director Chris Kentis based his 2003 film on real events. A couple go scuba-diving and are left behind at sea.  He spent $500,000 making it and earned $55 million at the box office. That’s not the part resembling Board reports, unfortunately.

I don’t want to spoil the movie if you’ve never seen it, but I won’t because it’s a psychological drama depending not on action but implication that takes place in one spot on the sea.  Imagine you went scuba diving miles from shore and surfaced and everyone was gone and the current kept you out?

Now suppose as an investigator later it was your job to measure what happened to the couple. You had at your disposal film of the very spot on the ocean that the couple had occupied. You play back four three-month time-lapse slices of film at high speed.

Nothing. Open water.  It’s all you see. Sky whizzes by, days and nights are nearly indistinguishable, the sea appears as an unmarked surface moving across time.

It’s the wrong measure.  To understand what happened to the scuba divers you’d have to zoom in and watch spare increments.  Then you’d see – wait, there.  Are those specks in the water?  Sure enough, two people.  What are they doing?  Now let’s watch….

And that’s what’s wrong with Board reports.  They don’t measure the stock market the way it works. Executives have long strategic horizons and companies are generally benchmarking progress every quarter and looking at years of stock performance.

But your stock is like scuba divers bobbing on the water and your business is as timeless as the sea by comparison to what sets price. Blink.  Okay, blink again. That’s 350 milliseconds, give or take.  Many stocks trade 500 times in one blink.

No, don’t report to the Board every blink in your trading. But if we’re going to impart understanding – the point of providing information – of how shares change in value over time, the measures must reflect the way the ecosystem for your stock functions.

Your buy-and-hold investors have the same horizons you do.  But that’s not the money setting prices most days. Because it buys, and holds.

About 40% of the volume in your stock aims at horizons of a day or less, and generally just fractions of seconds to catch a penny spread a thousand times. Another 33% moves with the ocean, indexes deploying and removing money metronomically with a model. Another 13% or so pegs opportunity to instruments derived from your shares such as options, futures, forwards and swaps with horizons of days or weeks at most.

So just 14% of your market cap traces directly to your long-term strategy.

You say, “That cannot be true.”

In 2006, half the value of the housing market traced to real estate and the rest reflected rights to homes via mortgage-backed securities, and in some markets it was more than 80%. We know because that’s how much home-values declined.

On May 6, 2010, the Flash Crash, the Dow Jones Industrial Average lost a thousand points, or about 10% of its value, in mere minutes, because the money with tiny horizons disappeared from the market.

On August 24, 2015, some exchange-traded funds diverged by 30% or more from the underlying value of assets because money with horizons far shorter than the business strategy of any of the stocks giving them derivative value left. Briefly.

Those are outliers but lesser manifestations are a thrumming reef of vibrancy every day in your stock. At ModernIR, we measure price-setting in one-day and five-day increments because it’s the only way to see the scuba divers bobbing in the water – or the Activists, the fleeting shift in risk-management behavior reflecting deal-arbitrage, the evaporation of momentum, the abrupt drop in index-investment, the paired behaviors indicative of hedge funds coming or going.

Were we to paint stocks with bold brush strokes, the nuances responsible for price-changes would be as flat and impenetrable as open water. And meaningless to the Board and the management team.

The next time you ready information for the Board, think about the ecosystem, which is frenetic – in stark contrast to business strategy.  If nothing else, make sure they recognize that at any given moment, price depends on the 85% oblivious to strategy.

That might seem frightening, like sharks. Like the sharks it’s but a fact of the stock ecosystem, something to be understood rather than feared (and if you want to learn about the ecosystem, ask us!).

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