You wonder what’s going to happen next.
I mean, look around. The South Carolina women ran ruthlessly through everyone, capping a 38-0 season with the NCAA basketball championship.
Right before a total eclipse not of the heart but of the sun.
Then UConn trammeled the competition like a doormat to take home Championship #2 in a row in the men’s wildly busted bracket.
Right after an eclipse.
There was an earthquake in Taiwan unrelated to government spending on semiconductor chips. So far as we know. Then another one next-door to all the data centers running the US stock market in New Jersey.
Talk about signs and wonders.
Our response? Leave. We headed directly to the Caribbean where all you have to worry about are hurricanes but those are out of season. If you need us, try White Bay or Foxy’s on Jost Van Dyke, where we might find Kenny Chesney somewhere in the sun.
Meanwhile, after a surreal spate of calm market seas – volatility quite literally vanished, dropping to 0.4% in SPY – we’re back to proper spreads. SPY is moving 1%, the underlying basket of S&P 500 stocks is jostling up and down daily about 2%, and the paltry momentum to be found is still moving 3%.
We call that relationship the 1-2-3 rule. It’s how the market works. Trackers like SPY become the benchmark, the mean, beta. They don’t move much. The basket of stocks that keeps shrinking is where arbitragers make the spread that keeps the skids of the market greased.
I’ll explain. Stay with me.
And all the big measures need a spartan sprinkling of “alpha,” outperformance, to keep them moving up. But just as the Magnificent Seven is now the Fab Four, if that, momentum is getting hard to find.
Like alpha. As I’ve written before, Marc Rowan says there’s no alpha in public equities, only beta. So be beta, public companies. Stop shooting for the impossible and take the probable instead. It’s so much easier.
What I mean by arbitragers making the spread is they need stocks to move more than ETFs or there’s no profit in intermediation. The SEC gives them the spread.
What I mean by the shrinking basket is what Jamie Dimon wrote in this year’s shareholder letter. He says the number of public companies peaked at 7,400 in 1998 and it’s now 4,300. I use that data in a slide all the time on Rethinking Earnings.
If you want to see the deck, drop me a note. Everybody on the planet has my email address, I believe, thanks to data breaches, and also widespread availability.
But that figure includes a bunch of tiny stocks with 0.1% of market cap. The real number is about 3,500. Back out what’s too illiquid for institutions, and you’re down to 2,500. But if you want the ones that consistently reflect the benchmark – meaning they move 2% or less – that’s 800 at most. The S&P 500 is 88% of market cap. Eighty percent of anything really IS that thing.
And that’s what I mean by the shrinking basket.
It’s worth noting that Mr. Dimon decried the collapse of public companies. He said we should have more of them, not fewer. Agreed! We’d have more investor-relations jobs, more ModernIR clients!
We should be focusing on that. But I digress.
In some ways, the biggest sign and wonder of all is the durability of the US stock market against these appalling odds – worse than South Carolina running the tables, UConn repeating, the clouds parting over Dallas at the exact moment of totality.
The stock market depends on every single little thing going right all the time. But to ensure that it does, it depends on arbitrage vehicles such as Exchange Traded Funds and zero-days-to-expiration (0DTE) options.
What happened when volatility dropped below 0.5% is somebody stopped trading. And the market clanked to its worst day in a year.
It works the other way too: Move more than 2%, which almost never happens because there’s then no arbitrage trade, and somebodies will quit and the market can go kaput.
This is how the stock market actually works. And it’s a wonder, I’ll say again.
So, the central question is what causes volatility or its absence?
Public companies, your earnings releases are relentless and repeating volatility sources (to reduce volatility, rethink that process – we can help). By extension, economic data points do the same to the broad market now.
When everyone sells volatility, it migrates near zero and the market tumbles. Everybody is on the wrong side of the boat. And when everybody goes overboard, order is restored. Economies are supposed to work the same way and don’t because governments interfere.
I digress.
And there’s your irony. Signs and wonders don’t demolish the market. Little things do. God’s still, small voice. A rumor of a plague. A blip in inflation. A hiccup in an auction. A change in policy.
So don’t study the sky for what’s next. Check the sidewalk for gum. And with that, we’ll see you in a couple weeks. Assuming we come back. Bon voyage!
