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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.

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.

Data to Know

What should you know about your stock, public companies? 

Well, what do you know about your business that you can rattle off to some inquiring investor while checking the soccer schedule for your twelve-year-old, replying to an email from the CFO, and listening to an earnings call from a competitor?

Simultaneously.

That’s because you know it cold, investor-relations professionals.  What should you know cold about your stock?

While you think about that, let me set the stage. Is it retail money? The Wall Street Journal’s Caitlin McCabe wrote (subscription required) that $28 billion poured to stocks from retail traders in June, sourcing that measure from an outfit called VandaTrack.

If size matters, Exchange Traded Fund (ETF) data from the Investment Company Institute through May is averaging $547 billion monthly, 20 times June retail flows. Alas, no article about that.

You all who tuned to our Meme Stocks presentation last week (send me a note and I’ll share it) know retail money unwittingly depends on two market rules to work.

Illustration 91904354 / Stock Market © Ojogabonitoo | Dreamstime.com

This is good stuff to know but not what I mean. Can you answer these questions?

  • How many times per day does your stock trade?
  • How many shares at a time?
  • How much money per trade?
  • What’s the dollar-volume (trading volume translated into money)?
  • How much of that volume comes from borrowed stock every day?
  • What kind of money is responsible?
  • What’s the supply/demand trend?
  • What are stock pickers paying to buy shares and are they influencing your price?

Now, why should you know those things?  Better, why shouldn’t you know if you can? You might know the story cold. But without these data, you don’t know the basics about the market that determines shareholder value.

Maybe we don’t want to know, Tim.

You don’t want to know how your stock trades?

No, I don’t want to know that what I’m doing doesn’t matter.

What are we, Italians in the age of Galileo? What difference does it make what sets price?  The point is we ought to know. Otherwise, we’ve got no proof that the market serves our best interests.

We spend billions of dollars complying with disclosure rules. Aren’t we owed some proof those dollars matter?

Yes.  We are.  But it starts with us.  The evidence of the absence of fundamentals in the behavior of stocks is everywhere.  Not only are Blackrock, Vanguard and State Street the largest voting block for public companies and principally passive investors, but the majority of trading volume is executed by intermediaries who are not investors at all.

Stocks with no reason to go up, do.  And stock with no reason to go down, do.  Broad measures are not behaving like the stocks comprising them.  Over the whole market last week, just two sectors had more than a single net buying day:  Utilities and Energy. Yet both were down (0.9%, 1.3% respectively). Somehow the S&P 500 rose 1.7%.

You’d think public companies would want to know why the stock market has become a useless barometer.

Let me give you two examples for the questions I asked.  Public companies, you should be tracking these data at least weekly to understand changing supply/demand conditions for your shares.  And what kind of money is driving shareholder-value.

I won’t tell you which companies they are, but I’ll tweet the answer tomorrow by noon ET (follow @_TimQuast).  These are all 5-day averages by the way:

Stock A: 

  • Trades/day:  55,700
  • Shares/trade: 319
  • $/Trade: $4,370
  • Dollar volume:  $243 million
  • Short volume percent: 51%
  • Behaviors:  Active 9% of volume; Passive, 36%; Fast Trading, 32%; Risk Mgmt, 23% (Active=stock pickers; Passive=indexes, ETFs, quants; Fast Trading=speculators, intermediaries; Risk Mgmt=trades tied to derivatives)
  • Trend: Overbought, signal predicts a decline a week out
  • Active money is paying:  $11.60, last in May 2021, Engagement is 94%

Stock B:

  • Trades/day:  67,400
  • Shares/trade: 89
  • $/Trade: $11,000
  • Dollar volume:  $743 million
  • Short volume: 47%
  • Behaviors:  Active, 8% of volume; Passive, 24%; Fast Trading 49%; Risk Mgmt, 19%
  • Trend: Overbought, signal predicts declines a week out
  • Active money is paying:  $121, last in June 2021, Engagement is 81%

The two stocks have gone opposite directions in 2021.  The problem isn’t story for either one. Both have engaged investors. Active money is 8-9%.

The difference is Passive money. Leverage with derivatives.

Would that be helpful to boards and executive teams?  Send this Market Structure Map to them.  Ask if they’d like to know how the stock trades.

Everybody else in the stock market – traders, investors, risk managers, exchanges, brokers – is using quantitative data.  Will we catch up or stay stuck in the 1990s?

We can help.

Rustling Data

The Russell Reconstitution is so big everybody talks about it.  And yet it’s not. 

The Nasdaq touted its role facilitating this year’s Russell reset, saying, “A record 2.37 billion shares representing $80,898,531,612 were executed in the Closing Cross in 1.97 seconds across Nasdaq-listed securities.”

Impressive, no question.  That’s a lot of stuff to happen in the equivalent of the proper following distance when driving 65 mph (a rule often ignored, I’ve observed).

I’d also note that the Closing Cross is not the “continuous auction market” required by SEC rules but a real auction where buyers meet sellers. Regulators permit these to open and close markets.

The Nasdaq said, “Russell reconstitution day is one of the year’s most highly anticipated and heaviest trading days in the U.S. equity market, as asset managers seek to reconfigure their portfolios to reflect the composition of Russell’s newly-reconstituted U.S. indexes.”

The press release said it was completed successfully and the newly reconstituted index would take effect “Monday, June 29, 2020.”

Somebody forgot to update the template.

But that’s not the point.  What the Nasdaq said is untrue.  The Russell rebalance June 25, 2021 was not “one of the heaviest trading days in the US equity market.”

It was 159th out of 252 trading days over the trailing year, using the S&P 500 ETF SPY as a proxy (we cross-checked the data with our internal volume averages for composite S&P 500 stocks, and against other major-measure ETF proxies).

SPY traded 58 million shares June 25 this year but has averaged over 72 million shares daily the trailing twelve months.

Whoa.

Right?

This is market structure. If a stock exchange doesn’t know, who are you counting on for facts about the stock market?

CNBC June 29, 2021

I snapped the photo here hurriedly of the conference-room TV at ModernIR yesterday with CNBC’s Sara Eisen and former TD Ameritrade Chair Joe Moglia. But look at what they call in video production the lower third, the caption.

That’s what hedge-fund legend Lee Cooperman said in the preceding segment. “Market Structure is totally broken.”  Eisen and Moglia were talking about it.

When I vice-chaired the NIRI Annual Conference in 2019, I moderated the opening plenary session with Lee Cooperman, Joe Saluzzi, co-author of the book “Broken Markets” (you should read it), and Brett Redfearn, head of the SEC’s division of Trading and Markets (now head of capital markets for Coinbase).

The market may not appear broken to you. But you should know that market-structure events occur about 70 times per year. And the Nasdaq ought to know if the Russell Reconstitution is really a heavy trading day. It’s their business.

Just as it’s your business, investor-relations professionals, to know your market. The equity market.

Just the preceding week, June quad-witching owned the Russell Reconstitution like Mark Cavendish sprinting at the Tour de France.  Worse, actually, though few cycling moments match seeing The Manx Missile win his 31st stage after having left the sport.

It was a beatdown.  SPY volume June 16-18 averaged 97 million shares, 67% higher than the Russell rebalance, peaking the 18th at 119 million shares. 

And June 30, 2020, the final trading day of the second calendar quarter last year, SPY traded more than 113 million shares, nearly twice this year’s Russell volumes June 25.

June 30 is today. 

In fact, the last trading day of each month in the trailing twelve averaged 99 million shares of SPY traded.

What do those dates and June 16-18 have in common?  Derivatives.  Each month, there are six big expirations days: The VIX, morning index options, triple- or quad-witching, new options, the true-up day for banks afterward, and last-day futures.

This final one is the ultimate trading day each month featuring the lapsing of a futures contract used to true up index-tracking. The CBOE created it in 2014 for that purpose. Russell resets may be using it instead.

What’s it say that derivatives expirations are 67% more meaningful to volume than an annual index reconstitution for $10 trillion pegged dollars, or that average daily volume in SPY, the world’s largest exchange-traded derivative – all ETFs are derivatives, substitutes for underlying assets – exceeds volume on a rebalance day?

That your executive teams and boards better know. They deserve to know. If you give them anachronistic data unreflective of facts, it’s no help. Imagine if Lee Cooperman is right, and our profession fails our boards and executive teams.

No practice has a higher duty to understand the equity market than the investor-relations profession.  If you’re not certain, ask us for help. We’ll arm you so you need never worry again about fulfilling it.

Blunderbuss

Do stores sell coats in the summer? 

No, they sell bathing suits. They match product to consumer.  Do you, investor-relations professionals?

I’ll tell you what I mean.  First, here’s a tease:  I recorded a panel yesterday with the Nasdaq’s Chris Anselmo and Kissell Research Group’s Dr. Robert Kissell on How New Trading Patterns Affect IR.

It airs at 4p ET June 22 during the 2021 NIRI Annual Virtual Conference.  Root around in the couch cushions of your IR budget and find some coins and join us.  We’ll be taking questions live around the panel.  Sling some heckling if you want!  It’s a great program.

Now, back to matching product to consumer.  The IR outreach strategy for maintaining relationships with investors often resembles a blunderbuss. Unless you went to elementary school when I did and saw pictures of pilgrims sporting guns with barrels shaped like flugelhorns, you probably don’t know what I’m talking about.

You threw some stuff in the barrel and loaded it with powder and ignited it and hoped some of what belched out went in the general direction you were pointing.

Illustration 165213327 © Dennis Cox | Dreamstime.com

If you don’t have anything better I guess it works. But the IR profession shouldn’t be blunderbussing wildly around.

I get it, Tim.  Be targeted in our outreach.

No, I mean sell your product to consumers who’ll buy it.  Your product is your stock.  Your story is a narrative that may or may not match your product.

Huh?

Stay with me.  I’ll explain.  This is vital.   

Think of it this way. REI is an outdoors store.  It’ll sell you cycling stuff and camping gear in the summer, and skiing gear and coats in the winter.  The data analytics they use are pretty simple: The season changes.

In the stock market, the seasons are relentlessly changing but the temperature doesn’t rise and fall in predictable quadrants to tell you if igloos or swimsuits are in. But the BEHAVIORAL DATA wax and wane like many small seasons.

The Russell 2000 value index is up 30% this year. The Russell 2000 growth index has risen just 3.8%.  Is value more appealing than growth?  No, as both Benzinga and the Wall Street Journal reported, GME and AMC rank 1-2 in the index.

The crafters of the indices didn’t suppose that movie theaters in the age of Covid or a business built on selling games that have moved online were growth businesses.

They’re not. But the products are. These are extreme cases but it happens all the time.

CVX, market cap $210 billion, is in both Value and Momentum State Street SPDR (S&P Depositary Receipts) Exchange Traded Funds. It’s got both characteristics AT DIFFERENT TIMES.

AAPL, in 299 ETFs, is used for focus value, dividend strategies, technology 3x bull leveraged exposure, high growth, luxury goods, risk-manager and climate-leadership investing, among a vast array of other reasons.

Look up your own stock and see what characteristics are prompting ETF ownership.  That’s data you can use.  Don’t know what to do? Ask us. We’ll help.

How can ETFs with diametrically opposed objectives use the same stocks? That’s something every investor-relations professional needs to know. ETFs control $6 trillion in the US alone. They’re not pooled investments and they don’t hold custodial accounts like mutual funds.

Should the IR profession understand what the money is doing in the stock market?

Set that aside for now. There’s an immediate lesson to help us stop behaving like blunderbusses.  Stocks constantly change. I think rather than targeting specific investors, you should build a big tent of folks you know.

And you should RECONNECT with them in highly specific, data-driven ways.  If you just call investors you know to follow up, you’re doing IR like a cave man. Stop doing that.

The deck is already stacked against investors focused on story.  They need all our help they can get! I’ve explained it many times.  Rules promote average prices and harm outliers.  Passives want average prices. Stock pickers want outliers.

If we want investors interested in our stories to succeed, use DATA to help them.

Like this. We met with a Financials component yesterday.  The data show a big surge in Passive money in patterns.  You won’t see it in settlement data.  It never leaves the custodian because it the same money moving from indexes to ETFs and back.

But ModernIR can see it in near realtime.

The IR department should be calling core GROWTH names, even though it’s a value story.  That wave of Passive money is going to lift the stock. Growth money buys appreciation. Value money buys opportunity.

You want to move from blunderbuss to data expert in modern markets?  Ask us.  You don’t have to be way behind like the Russell indices.  You can be way ahead, like a modern IRO.

Get rid of that blunderbuss, pilgrim.   

Something Wicked

When I was a kid I read Ray Bradbury’s novel, Something Wicked this Way Comes, which plays on our latent fear of caricature. It takes the entertaining thing, a traveling carnival, and turns it into 1962-style horror.

Not 2021-style of course. There’s decorum. It stars a couple 13-year-olds after all.

The stock market also plays on our latent fear of caricature.  It’s a carnival at times.  Clowns abound.  As I said last week, companies can blow away expectations and stocks fall 20%.  That’s a horror show.

Courtesy The Guardian

Devilish winds have been teasing the corners of the tent for a time.  We told our Insights Reports recipients Monday about some of those.

The Consolidated Tape Association, responsible for the data used by retail brokers and internet websites like Yahoo! Finance and many others last week lost two hours of market data.  Gone.  Poof.

Fortunately, about 24 hours later they were able to restore from a backup.  But suppose you were using GPS navigation and for two hours Google lost all the maps.

So that was one sideshow, one little shop of horrors.  I don’t recall it happening before.

Twice last week and six times this year so far, exchanges have “declared self-help” against other markets.

It’s something you should understand, investor-relations professionals and traders.  It’s a provision under Regulation National Market System that permits stock exchanges to stop routing trades to a market that’s behaving anomalously, becoming a clown show.

Rules require all “marketable” trades — those wanting to be the best bid to buy or offer to sell — to be automated so they can zip over to wherever the best price resides. And exchanges must accept trades from other exchanges. No exceptions.  It’s like being forced to share your prices, customers, and even your office space with your competitors.

The regulators call this “promoting competition.” Sounds to me like a carnival.

But I digress. Exchanges must by law be connected at high-speed, unless declaring self-help.

An aside, I’ll grant you it’s a strange name for a regulatory term.  Self-help?  Couldn’t they have come up with something else?  Why not Regulatory Reroute? Data Detour?

Anyway, last week the trouble occurred in options markets.  First the BOX options market went down. It’s primarily owned by TMX Group, which runs the Toronto Stock Exchange.

Then last Friday CBOE — Chicago Board Options Exchange, it used to be called — failed and the NYSE American and Arca options markets and the Nasdaq options markets (the Nasdaq is the largest options-market operator) declared self-help. They stopped routing trades there until the issue was fixed.

Now maybe it’s no big deal.  But think about the effect on the algorithms designed to be everywhere at once.  Could it introduce pricing anomalies?

I don’t know.  But Monday the Nasdaq split the proverbial crotch of its jeans and yesterday the so-called “Value Trade” blew a gasket.

I’m not saying they’re related. The market is a complex ecosystem and becoming more so. Errors aren’t necessarily indicative of systemic trouble but they do reflect increasing volumes of data (we get it; we’re in the data business and it happens to us sometimes).

And we’d already been watching wickedness setting up in our index of short-term supply and demand, the ten-point Broad Market Sentiment gauge.  It’s been mired between 5.8-6.1 for two weeks.

When supply and demand are stuck in the straddle, things start, to borrow a line from a great Band of Horses song, splitting at the seams and now the whole thing’s tumbling down.

And here’s a last one:  Exchange Traded Funds (ETFs) have been more volatile than the underlying stocks for five straight weeks, during which time stocks had risen about 5% through last Friday. Since we’ve been measuring that data, it’s never happened before.

Doesn’t mean it’s a signal. It’s just another traveling freak show. Clowns and carnivals. ETFs are elastic and meant to absorb volatility. Stocks are generally of fixed supply while the supply of ETFs fluctuates constantly.  You’d expect stocks most times to thus move more, not less.

I think this feature, and the trouble in options markets, speaks to the mounting concentration of money in SUBSTITUTES for stocks.  It’s like mortgage-backed securities — substitutes for mortgages.  Not saying the same trouble looms.  We’re merely observing the possibility that something wicked this way is coming.

Our exact line Monday at five o’clock a.m. Mountain Time was: “There’s a lot of chaos in the data.”

Son of a gun.

I don’t know if we’re about to see a disaster amongst the trapezes, so to speak, a Flying Wallendas event under the Big Top of our high-flying equity market.  The data tell me the probability still lies some weeks out, because the data show us historically what’s happened when Sentiment hits stasis like it’s done.

But. Something is lurking there in the shadows, shuffling and grunting.

And none of us should be caught out. We have data to keep you ahead of wickedness, public companies and traders. Don’t get stuck at the carnival.

Roped Together

This Cinco de Mayo we’re grateful for tequila.

Especially if you’re a Tech investor. Why are companies crushing earnings and revenue being pulverized by an imperious market?

It’s easiest to say expectations for the future have diminished and so market capitalization will too.  That doesn’t reflect how the market works.

In fact, there’s inherent contradiction between that orthodox view of equities and the way money now behaves.  Morningstar shows that more than a third of all institutional assets are in large-cap blend Passive funds.  Total domestic ETF assets have increased by $1.5 trillion in the past year, says the Investment Company Institute.

Well, what’s that money do?  We all understand the idea of following the money.  That is, if you want to understand what’s driving behavior, track where the money goes.

For instance, prices of things consumers buy for both daily and discretionary reasons have risen.  Personal income is up 21%.  That’s following the money. The more there is, the more stuff costs.

Until everything resets.

See the image here.  The Tech sector dwarfs other parts of the S&P 500 at 28%.  Data we track show Passive and Active Investment – combined indexes and ETFs and stock-picking flows – were up about 5% in the sector last week as stocks fell 5%.

That means investors were selling Tech.

No mystery there, you might think. But stocks can fall on the absence of buying as much as the presence of selling. And Tech has come down further since, though the pattern of selling by investment behaviors is receding.

Here’s the point.  The stock market’s value nears $50 trillion.  Tech is about $15 trillion. And it’s even more when you consider that the largest companies – Google, Apple, Amazon, Facebook, Tesla, Microsoft – are spread over three sectors, not one, the big green box on the left of the image.

If 5% of that money leaves during month-end window-dressing it’s destabilizing not just to a handful of stocks but to the sector, the whole market.  The big green box is about $24 trillion.  All of that can oscillate if money shifts to say, Financials (up 2% last week) or Energy (up 5%).

I’ll give you another observation from the data.  This one requires understanding something. ETFs – Exchange Trade Funds – are not fiduciaries. They don’t manage your money.  If you buy Blackrock ETFs, you don’t have an account at Blackrock.

And Blackrock can do what you can’t.  Blackrock can dump its Tech stocks all at once via the “redemption basket” – the garbage to take out – while simultaneously asking for only appreciating stocks in the “creation basket,” the grocery cart from brokers.

So Blackrock could shed its falling Tech stocks for ETF shares and then trade the ETF shares for Financials, Homebuilders, Energy stocks, Real Estate stocks.  It thus avoids the falling stocks and rides the rising ones. 

But that’s a very short-term trade.  There’s not enough stock in those sectors and industries to remotely account for the 52% in the giant swaths of the market populated by Big Tech.

So either the whole market tips over. Or suddenly Tech will look good again. There’s no way to meet the demands of large-cap Passive target-date funds with heavy weightings in equities without Tech.

We told clients this in the Friday Market Desk note out Apr 23:

You recall when those two Bear Stearns mortgage-backed securities funds went under in 2007?  We all went, “Huh. Wonder what happened there.”  Then we followed the Dave Barry Car Mechanic Manual:  When your car starts knocking, turn up the radio.

We didn’t understand that those funds and Bear Stearns and Lehman and the whole housing industry were roped together and pulling each other off El Capitan. I’m not saying we’re roped here.  But it’s possible.  

We’re all roped to Tech.  Tied to its weight.

I also trotted out an old theology term from my college days studying that discipline: Laodicea. I said the market was neither cold nor hot, and it was the kind that could spew us out.  You can look it up in the last book of the bible, Revelation, chapter 3.

I think there’s too much commitment to equities by large-cap diversified Passive target-date (that’s a mouthful) funds for us to fall from El Capitan.  Yet.  There will be a day when the flows stop, and Blackrock can’t trade anything for Tech shares.

That’s when, as the head of campus security back in my collegiate days in tornado country would say, “You go grab little brother Willie off the porch.”

Swapping Volatility

Google chose as motto “don’t be evil.” “Beware derivatives” isn’t a bad motto either.

If you’ve read the MSM long, you know we’ve beaten the drum like Boneshaker (when you hear the sound of the drum, here we come) over the risk in derivatives.

Oh please, Quast.  Can’t we talk about something more interesting, like the molecular structure of Molybdenum?

Do you want to know what’s coming, public companies and investors?  We’ve now been warned twice.  I’ll explain.

Before that, this: Recall that we said the market could take a beating this week because of derivatives. A raft of major banks have reported combined damage in the billions from bad derivatives bets by one hedge fund, Archegos Capital.

And VIX bets hit today.  Volatility bets blew up another fund.  Warning Signal No. 2.

Gunjan Banerji wrote about it yesterday in the WSJ (subscription required), admirably explicating the complexities of variance swaps.  The Infinity Q Diversified Alpha Fund shut down.

Diversified Alpha, a mutual fund marketed as a hedge fund for the masses, had roughly $1.75 billion of assets at last word.  The fund aimed in part at volatility strategies.  It said:

“The Volatility Strategy seeks to profit from the mispricing of volatility related instruments across equities, currencies, bonds, interest rates, and commodities markets. These instruments include options, variance swaps, correlation swaps, and total return swaps. The Strategy invests across a wide range of time horizons and takes long and short positions in the underlying volatility instruments.”

The fund went broke betting on volatility – mispricings.  That’s two in short succession.  Diversified Alpha filed its plea with the SEC Feb 21 to halt redemptions. Right after February expirations. Archegos Capital went belly-up with March expirations.

Much of the money in equities trades mispricings. That’s what ETFs do (ETF vs a basket). It’s what Fast Traders do (one price vs another). It’s what derivatives traders do (stocks vs options).  Those behaviors are roughly 80% of US equity volume.

These disasters you describe, Tim, are isolated to leveraged outfits.

Nope.

Here’s the SAI for the Blackrock Technology Opportunities Fund. I have read a great many SAIs, a reason I’ve in the past highlighted risks, especially for Exchange Traded Funds.

On page 3 is this: Only information that is clearly identified as applicable to the Fund is considered to form a part of the Fund’s SAI.

Then follows a table, with X’s by what applies.  See page 4, the derivatives section. Derivatives for hedges and speculation apply.  Credit default swaps, interest-rate swaps, total return swaps, options on swaps, on it goes.

I’m sure it’s a small part of this fund’s assets, used within rules to true up tracking or remediate some of the unremitting volatility that’s been seeded in all financial instruments by vast artificial quantities of money and low interest rates. But read the SAI on your favorite fund. What’s it say?

By the way, volatility in stocks has plunged by 50% the past couple weeks. Almost like a tide going out ahead of a tsunami. Behind it in other data we track are vast swings in standard deviation between the prices of sector stocks and the ETFs tracking them.

That is, if we compile moves of all sector stocks and the average is a 1.8% decline and the composite average for sector ETFs is 0.1%, standard deviation is 625%.

It suggests to me that ETFs are substituting stuff that moves less than stocks – like swaps or IOUs of some sort, or cash – to get away from the error-inducing volatility in stocks.

But that could blow up derivatives predicated on a statistical equity basket. What the hell is going on?  Exactly.  That’s what I want to know. Something is wrong, and we’re seeing little fissures, seeping steam, wisps of ash.

We’ve long been concerned about these risks. But they’re like the way Ernest Hemingway described how one goes broke (a line I’ve used often): very slowly then all at once.

I’m not wringing my hands. Forewarned is forearmed. Investors and traders, it’s wise to get out of the pool around these things, which we observe in the data, and report.

And for public companies, it’s high time to make sure your executive teams realize risk resides beyond “alternative investments.” It’s everywhere. All around us. 

How central are Morgan Stanley, JP Morgan, Credit Suisse, Deutsche Bank, banks losing on Archegos, to financial markets from IPOs to Treasury Open Market operations?  Derivatives to equity and ETF trading?

It may be the cost of paying ourselves to sit out a Pandemic is the stability of our financial markets. We’re inflating everything including derivatives.  We can survive it.  In fact, it would do us good to roll around in the dirt and develop some resilience.

Whatever happens, we’ve got the data.  We warned EDGE users to be out by last Friday. We can tell you, public companies, if these instruments are large in your price. 

Everybody is swapping volatility. Beware.