September 4, 2013

Street Level

“My CEO doesn’t get market structure.”

I’ve heard that more than a time or two! IROs wanting executives to grasp market complexity in order to see share-behavior in an accurate and contemporary fashion run into the buzz saw of The CNBC Mindset.

I’m not criticizing CNBC or CEOs. But some perspective is in order. In my Denver neighborhood, we’ve had a summer-long municipal effort to improve storm drainage. Streets are barricaded for blocks around and getting to our house is a circuitous adventure. The infrastructure is a mess (we hope this plan works!).

What’s market infrastructure like? On CNBC, everything is headlines and earnings. Fast money. Technicals. Stocks are supposed to be simple things – some multiple of discounted cash-flows minus the cost of capital should render fair value. Right?

That’s how it used to be. Simple, like our streets. Follow your GPS to our house right now, and you’ll be navigating awhile, because the tool won’t show you the truth at street-level.

There are $15 trillion of assets at companies in the US running mutual funds, ETFs, and other funds. About 28% are in equities. There are more than one MILLION global indexes, if you add the 830,000 or so that S&P/Dow Jones calculates at least once daily to MSCI’s 100,000, Russell’s 50,000, and Nasdaq’s 21,000-ish. A million slices of the global economy to which you can benchmark a trade or investment for a second or more.

There are 4,300 brokers regulated by FINRA, and every trade must past through one. Yet just 200 execute trades across 17 billion monthly shares in our models, and 30 drive 90% of volume. Vast uniformity yet continuously shifting arbitrage. Convergence and divergence.

About 40% of the typical US stock’s volume comes from borrowed shares. We see megacaps with 55% of all daily volume borrowed – rented shares, short shares. Your top holders lend securities to large broker-dealers who sublet them through margin accounts for daily use. Renting is cheaper than owning. And ownership won’t hold answers.

Most stocks have intraday volatility around 2% — the spread between high and low prices. That’s a great deal more than the basis points of daily movement you see in closing prices.

The average trade-size is under 200 shares. Building a position as an investor most times can’t consume more than 10% of daily volume or every predatory trader will know and arbitrage it. You’ve got two weeks or less to finish lest the environment, risk strategies, costs, require recalibration.

This is the market at street-level. Every investor who buys or sells your shares must navigate the maze, jostling and competing with what races through it, whether you trade 20,000 or 20 million shares. Every such step affects behaviors around, and will be altered in turn by them. You could move as easily today on random, basket-driven statistical arbitrage between indexes and ETFs as on fundamental investment.

Your CEO maybe doesn’t care about any of that. But it’s the product market IR manages and your consumers – investors – use. I lunched with a client recently who had 380 one-on-ones with investors last year. However many you hosted – that’s part of the IR job – market structure tells you which to call tomorrow, so relationships bear fruit.

It’s easy to spend IR time and money driving fruitlessly and figuratively around where street and map don’t match. But it’s not smart business. That’s something any CEO will get.

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