October 4, 2023


Former SEC chair Mary Jo White once said in a speech, “The stock market exists for investors and issuers, and their interests must be paramount.”

It’s a view widely intoned by regulators and on Capitol Hill where there is now no speaker in the House of Representatives.

Photo 27745777 | Derivatives © Alain Lacroix | Dreamstime.com

So why did the SEC approve leveraged Exchange Traded Funds? 

Fair disclosure, I trade instruments like SPXL, SPXU, SDS, SH and so on periodically. I think they are great ideas if you want a stock market full of one-day arbitrage trades.

Which leads us back to the central point.

That regulators claim the stock market is a vehicle for investors to find enterprising growth organizations needing capital while at the same time permitting every form of derivative imaginable is cognitively dissonant.


Because if you can make 3% in a day versus the average annualized return in equities, adjusted for taxes, commissions and inflation, of about 5% (not counting the return-debilitating effects of volatility), which would you do? Buy and hold, or trade?  

It affects the behavior of investors.

An example: MRK routinely has a hundred shares at the bid. MRK has $260 billion of market cap. At the same time, there are thousands of shares at the bid for SPXU, the ProShares Ultrashort S&P 500 ETF trying for three times the negative return of the S&P 500. For SH, the Proshares -1x Short ETF, there are millions of shares at the bid.

Under US national-market rules, stocks must trade between the best bid to buy and offer to sell. Shares at the bid are efforts to buy. The offer is what’s available to buy.  Mind you, there are undisplayed hunks of shares all over the market both at exchanges and in dark pools.  You can use order types that hide shares below the bid or above the offer.

Market-makers – a fancy name for intermediating brokers buying and selling stocks (the entire market, every transaction, is intermediated by law, so how efficient can it really be when you’re cutting the middlemen in on everything rather than out?) – post shares at the best prices to buy or sell.

Trades are supposed to occur between them. That fact, by the way, assures that firms like Citadel will make billions of dollars getting between the bid and the offer, a shave of a penny at a time.

Quast, do you have a point?

I certainly do.  If the stock market exists for issuers and investors, why are there so many intermediaries? 

Here’s the clincher for you public companies.  Why are there leveraged ETFs?  (Investors, we’ll come to you at the end.) Leveraged, or so-called synthetic, ETFs don’t own your stocks. They rely on futures contracts.

Funds like SPXL, the Direxion Daily S&P 500 Bull 3x ETF, uses baskets of futures to approximate three times the move of the S&P 500 index.  If the index is down 1%, SPXL is down 3%. Or more sometimes.

It’s not that its assets rise like that. Arbs trade it up or down versus the futures basket.

Seems dangerous?

That’s not the point here. I’m not suggesting they’re bad instruments. I trade them at times.  They have tiny spreads. They’re superbly, otherworldly, wildly, liquid.  You can buy and sell mass quantities without moving the price.

But that’s money you’re not getting, public companies. 

Money going to leveraged ETFs – and it’s a lot – is trading…fluff. Volatility, really.  The top 25 ETFs trade a billion shares a day.  More than half of those are leveraged.  Some trade a hundred million shares.

If the SEC is so concerned about short-termism, why do they approve Daily 3x leveraged ETFs built on futures contracts trading 100 million shares daily?

If the stock market exists for long-term investors and the public companies innovating to make society better, why do we have way more derivatives – volatility trades – than  companies?

These are questions public companies and investors should be asking.

And for those who say, “Yeah but over the LONG TERM, stocks follow fundamentals and hew back to good companies,” prove it. 

I can prove it’s not true. 

If stocks followed fundamentals, why do more than half the S&P 500 components have negative returns this year while the benchmark is up? Do half the companies in the S&P 500 have poor fundamentals?

If stocks over the long term followed fundamentals, stock-pickers finding the best fundamentals would over the long term outperform the market. But over 90% of stock-pickers don’t beat the benchmark. Over the long term.

What to conclude? Take the facts objectively. Fundamentals don’t drive the market, in part because it’s stuffed full of investment vehicles having zero to do with fundamentals.

Investors, the answer for you is simple. Know market structure. You can’t beat the benchmark without it.

Share this article:

More posts

dreamstime m 34042495
November 22, 2023

I have never been more profoundly grateful than I am this Thanksgiving 2023.  I wish you the season’s blessings, and gratefulness. Prudence doesn’t hurt either. ...

dreamstime m 31492480
November 15, 2023

One time in your life, attend a Texas A&M Aggies football game.  There’s a lesson.  The lesson isn’t that it’s pretty great to get fired...

PXL 20231029 233549919
November 8, 2023

It’s November and I’m in jeans and flip-flops as I was in Denver in July. It’s 75 degrees. But in Aspen last week for a...

dreamstime l 68281572
October 27, 2023

  There are 1,500 companies reporting results this week, a flood of earnings releases all seeking to differentiate a story, a company. At the same...

dreamstime l 6512338
October 18, 2023

Remember the movie Wag the Dog?  Barry Levinson directs, David Mamet (a genius) writes, Robert DeNiro and Dustin Hoffman act.  It’s about creating a distraction....

dreamstime l 143123931
October 11, 2023

Would one expect stocks to rise and oil to fall amidst a declared war in the Mideast? Our hearts, thoughts and prayers go out to...