June 12, 2019

Russelling Stocks

We’re back!

At the NIRI Annual Conference last week in Phoenix (where foliage defied fiery environs) we launched an ad campaign for investor-relations professionals that graced the escalator wall into the hall, and the ModernIR booth hummed.

I had the honor of co-vice-chairing, and my market structure panel with hedge-fund legend Lee Cooperman, market commentator Joe Saluzzi, and SEC head of Trading and Markets Brett Redfearn kicked off the conference Monday June 3rd.

Due to an inadvertent clerical error, I was also named a NIRI volunteer of the year (here with NIRI CEO Gary LaBranche and board chair Ron Parham) along with TopBuild’s Tabitha Zane.  And I met NIRI co-founder Dick Morrill who at 97 can still deliver a ringing speech.

Post-conference, Karen and I bolted briefly to our mountain home, Steamboat Springs, where frost dusted the grass twice the last week and Sand Mountain jutted white-capped above a voluptuous carpet of grasses and blooms.

Meanwhile back in the stock market, with trade fears gripping the world – US stocks zoomed at the best rate in 13 months, posting six straight days of gains, a 2019 record, beating even the heady January start.

Against this backdrop loom big index rebalances. The Russell indices have been morphing toward July 1 reconstitution in phases that persist through the next three Fridays. On June 21, S&P quarterly rebalances will join the jammed queue, as will stock and index options and futures expirations June 19-21.

And expiring June 28 when the Russell finalizes are monthly CBOE futures contracts created to help indexers true up benchmark-tracking on the month’s last trading day.

Russell says $9 trillion of assets are pegged to its US equity indexes.  For perspective, the Russell 1000 is 95% of US market cap, the Russell 2000 most of the remaining 5%, as there are only 3,450 public companies.

What’s at stake with rebalances is thus more than pegged assets. It’s all the assets.

Passive assets are now over 50% of managed money, Exchange Traded Funds alone drive more than 50% of volume. The effects of these events are massive not due to susurrations in construction but in the capacity for price-changes to ripple through intertwined asset classes and the entirety of equity capitalization.

It’s like being in Group One on a United Airlines flight.  The fewer the airlines, the bigger the audience, the longer the line.

When the money wanting to queue up beside a benchmark was an eclectic conclave outside Palm Springs, rebalances were no big deal. Now passives are Los Angeles and rebalances are a Friday afternoon rush hour.

Put together the trillions tied to Russell and S&P indexes, the trillions in equity-linked swaps benchmarked to broad measures, the hundreds of trillions tied to expiring currency and interest rate swaps, the ETF market-makers trying to price ETFs and stocks driving $125 billion of daily trading volume, the Active “closet indexers” mimicking models, the Fast Traders with vast machine-computing power trying to game all the spreads. It’s keying the tumblers on the locks to the chains constraining the Kraken.

It’s not a myth. It’s already happening. Stocks imploded when the Communication Services sector was yanked like a rib from the torso of Tech and Consumer Discretionary stocks last September. It happened repeatedly through October, November and December 2018 as sector and market-cap ETFs washed like tides over stocks.

It happened in January, March, May, this year.

And it just happened again. What was it? Strafing waves of short-term passive shifts.

Lead market behavior in June so far? Risk Mgmt – continuous recalibration of derivatives bets.  Followed by Fast Trading – machines changing prices. Followed by Passive Investment (which tied to Risk Mgmt is ETFs, far and away the biggest combined influencer).

All these behaviors are 30%-43% higher than Active Investment as influencers. Defined as percentages of trading volume the past five days, Active is 11.6%, Passive, 26.9%, Fats Trading 41.4%, Risk Mgmt 20.1%.

What’s rustling the thickets of equity volatility, introducing unpredictability into stocks across the board, are vast benchmarked behaviors and their trading remoras.

The longer everyone persists in trying to assign rational motivation to moves, the more dangerous the market becomes. This isn’t complicated: The elephant in the room is the money watching prices – passive, speculative, hedged.  If observers are looking elsewhere, we’ll sooner or later get caught off-guard.

Let’s not.  Instead, be aware. Know the calendar.  Listen for Russelling stocks.

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