The Dow Industrials gained 742 points yesterday. Randomly. The rest of the market was pedestrian.
The trouble for issuers and investors alike is the comparisons. Why is this thing up and that thing down?
There’s a luminous scene in the book Thirteen Moons by Charles Fraser, whose dulcet narrative pleases both the quiet mind and the aloud ear, where frontiersman play cards.
Some toss in Spanish dubloons, others, earrings or knives or nuggets of found gold, and sometimes people like Claire. Read it or hear it. It’s set in the past.
The point is, the parties to the game grasp comparatives. This equals that.
What does your stock equal, public companies? Traders, how do you value something?
Issuers compare themselves among themselves. Why is my stock down and my peers are up? Maybe they’re not your peers. Ever think of that?
United Health Group (UNH) led the Dow Industrials yesterday, though it’s not in Industrials. Laggards like Boeing and Nike, one in Industrials, the other Consumer Discretionary, also jumped.
Even Caterpillar leapt, after declining about 10% the past three months.
Are they peers?
In the sense that they’re in the Dow 30. The principal feature of the big thirty is size. They represent $16 trillion of market cap (about 30% of all US market cap), $500 billion apiece on average.
They are disparate otherwise.
Yet all but four rose (CVX, MSFT, INTC, MRK).
Maybe companies need to redefine what constitutes a peer?
Money buys characteristics like belonging to the Dow Industrials, or having $500 billion of market cap, or less than 2% daily volatility.
Why here, and why now?
Options are resetting – volatility instruments today, new index options tomorrow, full basket Friday, then everything resets Monday. Could it be that the trade for LOW volatility – best found in DJIA stocks – is crowded now?
Derivatives are leverage. Call it what you want, but when you buy something that depends on something else, it’s a form of leverage. What if the thing that brought the Dow 30 all together without respect to sector or story was leverage?
The ProShares UltraPro Dow30 ETF (UDOW) jumped 5.4% yesterday. In a day.
Could it be that leveraged ETFs have got big backers buying baskets of derivatives to close the gaps between, say, the underperforming DJIA (and small caps) and Tech?
Look at the Russell 2000. In five days, the RUT Index is up over 11%. Interest rates? The economy?
Okay.
The Direxion Small Cap Bull ETF was up 5.5% yesterday.
How about a surge in demand for options? The Russell 2000 is 5% of market cap. It. Won’t. Last. Mark it.
The Federal Reserve plays cards too, like those gamblers in Fraser’s Thirteen Moons wearing leather and moccasins in the 1800s.
Sam Goldfarb writing in the WSJ yesterday (subscription required) says $190 trillion of US Treasurys changed hands last year (data from Sifma). That’s a lot of cards, bets. Almost twice the global economy.
And countries everywhere are playing cards with The Fed, tossing in stuff to match what it dishes out. And how? What ratio of euros and devaluing yen and amorphous yuan and stolid francs are equal in a basket?
What’s a knife, a nugget of gold, a dubloon, a girl, worth?
Back to stocks.
This fosters volatility. There are baskets of stocks that average about 2% daily fluctuation (volatility). And there are associated derivatives that expire and renew. And there are rafts of leveraged instruments using the derivatives of the things that fluctuate.
With me still?
Public companies, these factors drive your stock. Almost like an exchange rate. If hedge funds – or Blackrock – trade baskets of stocks for baskets of derivatives for a short time, it’s disruptive to demand and supply, especially into expirations.
And the Dow Jones Industrial Average skyrockets 740 points because there’s surging demand for the derivatives tied to the basket.
And it’s all leveraged. Poof, smoke.
You can control some of what happens by when you report earnings, and how and what you say. Want to know more, ask us.
Traders, it matters to you too. Our decision-support platform EDGE could predict that healthcare had attractive demand/supply divergence (and Industrials, Consumer Discretionary, Real Estate).
UNH? Well, shorting declined 50% in UNH before earnings while Demand stayed spot-on 5.0, a sturdy bull signal.
EDGE always shows the short-term Demand/Supply trends.
In Thirteen Moons, people sorted it out. In currency markets, the consequences of stretching and pulling of values hasn’t yet sorted out. In stocks, it sorts out every month at options-expirations.
But it’s getting weirder, and harder.
And public companies, worry less about how your story compares to your so-called peers and learn instead to love your characteristics. Size, value, growth, volatility, liquidity.
This moment? We’re fine. The next moment? Check the data, and duck.
Traders, the stretchiness of derivatives is a balloon warping the market. Beware. Don’t let it blow up on you.
