September 25, 2013

Rebalancing Act

You can see what investors are doing. When indexes are rebalancing, NASCAR ensues. No, not a bunch of noise and southern accents. A race.

On Sep 17 with kickoff of the Federal Reserve’s meeting last week, the top price-setting authority behind the S&P 500, using behavioral analytics, was indexes/ETFs. It was tepid but picking up speed when the Fed said Sep 18 it would keep money easy.

On Sep 19, indexes/ETFs dropped sharply as price-setters and risk-hedging surged into the lead as European money pegged to expiring index futures adjusted to the Fed surprise.

On Friday Sep 20 the lead changed again. Indexes/ETFs raced forward, posting a strong edge over other major market behaviors. No surprise. S&P and Nasdaq quarterly index-rebalancing played out, concluding at the same time as “quad-witching,” that point four times annually when stock and index options and futures expire (but a whole lot more derivatives expire then too).

The brand-new series of monthly derivatives began trading Sep 23, ranging from futures on ETFs to options on your stock. The market was down Sep 20 and again Monday, but not by a chasm. Anecdotally, we thus know passive and active investors shifted away from monthly hedges to something shorter-term, like ETF futures.

It’s a way to steer into the curve of the upcoming debt-ceiling debate. The strength of sentiment, which even when the DJIA was off 185 points Sep 20 remained well over neutral, means investors right now think the debt ceiling issue will resolve. But they’re not plowing big money into insurance policies that may be mispriced. They’ve shortened their horizons.

We know these details both marketwide and in specific construction for each client.

Regularly I hear: “What do I do with market-structure knowledge?”

What do you do with an income statement? A weather or traffic report? How about GPS?

“These inform my decisions,” you say.

Exactly. It’s information about the business, the day, road conditions. The specific purpose of each isn’t to drive some action.

The IR industry has an unusual distinction. It’s the only one I know where many participants seem happy being ignorant about what’s going on. We’d never run a business without understanding who’s consuming our product, how it’s distributed or whether it’s properly priced.

Is that information nice to know or essential? Quarterly calls aren’t essential. The SEC doesn’t require them. When earnings calls first roared to popularity, at least 50% of market volume was bottom-up investing. Today it’s about 15%. How come we’re spending the same effort as before but little on understanding the other 85%?

Hats off to you, adopters of Market Structure Analytics. You’re leading your profession.

If you say, “It’s noise,” you misunderstand institutional behavior. Would you ignore 85% of what comprises your revenue? You’d at minimum quantify, track and measure it.

There’s in IR a devotion to the word “actionable.” Stop worrying about what to do. Focus first on understanding what’s going on. Then we can move to actions. If not even a hundred public companies would support a petition to shorten 13F reporting periods, the c-suite has catching up to do. IR pros, that’s your challenge.

You say, “Back to GPS. The action I take with GPS is driving from point A to point B.”

I drove from Tyler, Texas, to New York City during spring break of my senior collegiate year, in my 1982 Datsun 310. I did not have GPS. We all drive whether we have GPS or not.

The reason you use GPS is because it’s better than a map and better than guessing. So how about your equity market? If you don’t know market structure, you’re guessing at what’s going on.

Today the listing exchanges charging you tens of thousands of dollars for hosting about 20% of your trading (substantially less than what’s in dark pools, which charge you nothing) cannot tell you what’s responsible for your volume. And a lot of IROs and executives are content with that. Why is that okay?

We should redefine baseline expectations in this profession. We can know exactly what investors are doing, which would seem essential if you’re a public company. And that’s no balancing act.

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