Tagged: Fast Trading

Right and Wrong

Cheers!

They got it right, and they got it wrong.  I’ll explain in a moment.

Karen and I took two weeks off from the Market Structure Map and disappeared into the white wilderness.  Steamboat Springs, CO logged the biggest pre-January snow season in nearly 40 years.  Over 200 inches.

I snapped this photo at 10,500 feet atop Sunshine Peak before pointing my skis downhill.

Sunshine Peak, Steamboat Springs ski resort. Courtesy Tim Quast

But there were days when the snow fell in such volume that we resorted to the fireplace and binge-watching Yellowstone.  We’re behind the rest of you but catching up.

I grew up on a cattle ranch. Not one like that with a chopper.

But the battle for survival was similar. We weren’t shooting people and bending interpretations of right and wrong. But I was on hand in the so-called Sagebrush Rebellion when guns bristled everywhere.

My dad would say what Kevin Costner’s character did. Ranching is a hard way to make a living because everything is arrayed against you. The government, the activists, the diseases, the weather. You can do right all day long and still get it wrong.

WSJ columnist James Mackintosh also wrote about right and wrong. Not like Yellowstone, no. He said (subscription required) Wall Street nailed earnings but missed the bear market.

Sellside estimates were within $1 of actual earnings. But the market didn’t do what those numbers should have delivered. Right, and wrong.

If earnings won’t tell you what stocks will do, what’s the point?

That question is the existential one for the investor-relations profession.  In the TV show Yellowstone, the existential question for the Duttons is how to beat impossible odds.

So, IR people, is the market for us or against us?

What John Dutton learns is you have to have influence.  There’s more and I don’t want to give it away.

But it’s the ONE THING the IR profession has never realized. We go right on doing the same things leading to the same inevitable outcome, which is that story doesn’t set price.

Why not? Because the stock market’s purpose isn’t to help your story manifest in your share-price. 

As in any market, the purpose is found in the principal activity. It’s still true that cattle ranching reflects its principal activity: raising bovines to supply a grocery market (you don’t have to like it but it’s true).

A Christmas tree farm raises Christmas trees.

The stock market sets prices.

We’ll come to it in a future Market Structure Map, but those 1,600 pages of proposed new SEC rules you’ve heard about?  They contain nothing that helps you, issuers, see your story better reflected in your shares.

No, they have everything to do with setting prices.  And who sets prices? 

Stock exchanges. Fast Traders. That’s who the market serves. 

How and why?  They learned the Yellowstone lesson. They have people everywhere. They lobby for influence.  They shape rules to help themselves.

We never have.  As a profession, we can do everything right and get it wrong.

I’ll let you ponder that.

Now, a word on the market in 2023 since this is the first Market Structure Map of the new year. Turns out 2022 was a top-ten worst for returns since 1926, with the S&P 500 down 19%.

There are only four periods since 1926 when stocks have posted back-to-back declines:  1929-32, 1939-41, 1973-74, and 2000-02. The losses for those periods were about 86%, 21%, 40%, and 46%. All those periods were recessionary.

S&P 500 losses of about 37% during the so-called Great Financial Crisis came all in a year, 2008.

It won’t surprise me if we notch the first back-to-back losing years since 2001-02 on a total-return basis. 

Why? Because stocks had a top-ten bad year on no reason save prices.  What if we get a reason this year?  All those other periods, again, were recessionary.

And here’s the trouble for investors. It’s not just that it takes five, ten, years to get back to level.  You never get back to level.  Stocks go down 40%, but prices of everything you buy go up.

Each time we retrench, governments intervene and expand the supply of money. So you lose 25% or 50% of your savings, but prices never fall 25-50%.  They rise even faster. 

I penned this letter to the WSJ on how the Federal Reserve contributes to this trouble.

The only money avoiding these growing chasms is the short-term money.  The parties setting prices don’t lose.

The stock exchanges don’t write research or provide market-making support.  Fast Traders don’t support customers, research, issuers. They trade their own capital.

It’s a new year. We have a fresh new chance to do something. 

We must first understand how the stock market works. We can’t argue for change without first knowing what’s wrong (we do, and you should have us on your side).

Number two, as a profession, we need to get some political leverage. NIRI, that’s your puzzle to solve in 2023. It’s not just the right thing to do.  It may be our Yellowstone moment.

Where’s the Poo

Geese are flying over Denver now, headed south.  Have you wondered if they poo up there? 

Well, wonder no more.  Karen and I were walking in Denver’s Washington Park to the distant honk of traveling geese.  I felt something carom off my ear and shoulder.

I thought, “Those darned squirrels dropping debris again.”

Winnie the Pooh Illustration 160172765 © Patrick Guenette | Dreamstime.com

That happens sometimes.  They’re usually apologetic.

I looked up.  No tree overhead.

And you know how your mind processes vast data instantly?  A panoply flashed through my brain in about 400 milliseconds, ending with my eyes fixed on the passing geese overhead.

Direct hit.  I had been shat upon, shamelessly.

Perhaps gleefully.  My hair stylist said the swans in England where she lived a year would tap on the door in hopes humans would open up and offer snacks.  Smart birds. I suspect geese are smart too.  Capable of laughing.

Which brings me as usual to the stock market.  Machines, like the human brains that made them, can instantly synthesize reams of data.  Much of what actually occurs in the stock market is just this sort of thing.

I’m not suggesting it’s poo, if you’re wondering where I’m going.  But the market can give us poo when we least expect it.

Good friend Joe Saluzzi of Themis Trading, a seminal voice on market structure, the mechanics of stocks, noted yesterday via Twitter that 65% of trades in the stock market now are odd lots, less than 100 shares.

Joe introduced the world to speed traders on 60 Minutes with Steve Kroft a dozen years ago this month. Kroft described these machines as “robot computers, capable of buying and selling thousands of different securities in the time it takes you to blink an eye.”

That’s 400 milliseconds.

That sort of trading is about 51% of volume in S&P 500 stocks the past five days, below the longer average of 53%.  Lower than in 2010 when the machines had a huge advantage.

What’s changed since then is shorting – about 49% of all trading volume right now – and derivatives, comprising 18% of S&P 500 volume.

Because they’re collectively massive and dwarfing investment, derivatives, shorting and the machines can cause stocks to surge or plunge without warning.

Well, there’s warning if you’re measuring the data. We’ll come to that.

So stocks last week had their best week since June.

Well, not really. It came on a day. The stock market was down till Thursday, then exploded last Friday when derivatives expired.

This Monday, new options traded. Stocks surged again.

Yesterday was Counterparty Tuesday when parties behind expired options from last week and new options trading Monday squared the books.  Happens every month.

Yes, weekly options are now massive. But not scythes slashing through stocks. They’re little lightning raids compounding instability. But they won’t drop the bottom out of the market or light it afire.

Monthly resets can. It’s why you must know the calendar.

They set a course for trillions of dollars from parties buying volatility, counterparties selling it and hedging it and leveraging it, and big funds substituting derivatives for stocks or using them to match indices.

In short, what happened the past three days was a giant tug-of-war between the buyers and sellers of volatility that gave way suddenly, surging stocks like a rope let go.   

And there will be an offsetting reaction. 

When?

Tracing the rate of change in Supply and Demand in the stock market offers signals.  The data suggest the cost for hedging with low volatility stocks like WMT, PEP, KO, SJM, CPB and so on, has risen along with the demand for them.

That means big money wants stable stocks ahead of US elections.  Tech is too volatile, even the biggest stocks. Mega cap Tech stocks are more than twice as volatile on average as the stocks above.

And with Bank of America saying 60/40 equity/bond portfolios are on track for the worst year in a hundred in this article on the magic number for retirement, the hunt for stability rocks derivatives markets. Leading the proverbial tail to wag the dog.

It’s not earnings.

It’s certainly not stock-picking. It’s in a sense a battle for the soul of the stock market. 

The battle this time juiced stocks, eliciting euphoria from pundits.  But what happens to the buyers or sellers of derivatives who lost?  They’re forced to sell assets – the stocks that just went up.

But our Demand gauge for stocks is at a level from which stocks have fallen afterward invariably, in a day or two or as many as twenty.

This time? We’ll see.

These are facts about the stock market that every investor, every public company, should know. We can analyze it in fractions of seconds with machines. And that is not poo. 

Decline and Fall

We’re just back from Rome, where the empire is no more but its imprint enthralls. 

And yes, that’s like the stock market.  We’ll get to it.

Do the Scavi tour under St Peter’s Basilica.  It’s breathtaking and not just because it’s underground.  It’s an archaeological marvel establishing that Christian traditions about the burial of the Apostle Peter have merit.

As with the stock market, there are no absolutes, just high probabilities. But it’s powerful to see the origin, replete with excavated walls and crypts and stairs and mosaics and plaques, of the largest church in the world.

At the Colosseum in Rome (photo courtesy Tim and Karen Quast) Oct 2022.

And at the colosseum (see us at right) there was merchandise, and seating sections, and concessions, and sophistication rivaling anything we’ve got today in the NFL.  Moving Nero’s statue, which the builders did after draining Nero’s private lake, would challenge our modern machinery. They did it with 24 elephants.

In the Pantheon you walk the same multi-colored marble floor that Marcus Agrippa did, a convex design with subtle drains that wick away rain falling through the open oculus. How many floors exist after 2,000 years open to the air? This one’s perfect still.

Rome was built to last but didn’t. 

The stock market that used to be on the corner of Broad and Wall streets in New York is now on servers in Mahwah, NJ, connected to the Nasdaq’s servers in Carteret, and CBOE and IEX and other servers in Secaucus.

That alone should be telling. The market isn’t in the city that talks about it.

The broadcasting about the stock market – endless chatter about Sellside upgrades and downgrades and whether a stock trading at ten times earnings is a good buy – continues apace from downtown New York.

But the stock market is on fiberoptic cable in New Jersey.

Speaking of disconnects, analysts decided this week that expectations for Ford and GM should be cut.  After the stocks are down 46%.  How is that helpful?

And it’s the essence of the disconnect. The market’s anachronistic trappings are way behind the times. The empire of the Buyside and Sellside long ago became hunks of broken marble strewn amid a remnant of pillars along The Forum.

So to speak.

Patterns show Active and Passive money left Ford and GM back in February.  What continued were the machines, and derivatives. And nine months later, the Sellside cuts ratings and price targets.

Hm.

One cannot help but think of the Federal Reserve.  We’ve had two quarters of declining GDP but there’s no recession.  Way behind. Living in the past.

Rome dissolved into its excesses.  So did the Buyside and Sellside, leaving the looting to the Goths, Visigoths and Vandals.  The Fast Traders (no offense, computerized market machinery).

Declines and falls are products of losing touch with reality. 

The stock market isn’t motivated by the Buyside and Sellside. It’s motivated by spreads and models.  And the machines making the money are happy that we all just continue watching the hand.

The trappings, the marketing materials, the talking heads, the lavish show, haven’t kept up.  Like Rome.

I relished modern-day Rome.  It’s full of delightful people who will patiently help you say things like dopo di te (after you, per favore), and a presto (see you soon!).  The pastas are addictive (cacio a pepe, amatriciana, and up north in Tuscany, pici). The cobbled streets are a storybook. The Lazio wine from Habemus is delectable.

Leaving, I felt an ache.  It’s just so…fabulous. 

And there’s your upshot, investors and public companies. The stock market today is a riveting confabulation of marvelous machinery. It’s just not what it was.

Like yesterday. Future were down steeply before the open.  I told users of our decision-support platform EDGE that you can’t believe the futures. They’re not market reality.

The DJIA at one point was up nearly 400 points.  It finished flat because most of the market didn’t keep pace, and the computerized machinery in New Jersey that really is the stock market knew the money pegging average prices would have to be a lot lower.

And so the market gave up its gains. It was a whole Roman Empire in a day, rising, flourishing, declining, falling.

So, what are we supposed to do?  First, enjoy the stories and traditions but don’t confuse them with reality. We need to be alert and informed members of the equity-market community, not a bunch of tourists.

We can’t succeed as investors, traders and public companies without a solid grounding in reality. Know how the darned thing works.

Now if you’ll excuse me, I need to go eat some salad.  For a change.

Constant Change

The SEC wants to save the little guy. Again. 

A number of you alert readers sent me this story (WSJ registration required but there are similar versions) about the Gensler SEC weighing changes to how trades from retail brokerages are handled.

For those new to market structure, the SEC has a long history of adding complexity to the stock market in the name of helping retail money that ends up instead aiding computerized traders and stock exchanges.

Would that we had less noise and more substance! But we need to first understand the problem. It’s that the stock market is full of tiny trades, and not that retail traders are getting hurt.

Meanwhile, this photo is not of market structure.  Normally in early June – for the bulk of my adult life – I’d be at the NIRI Annual Conference circulating with colleagues.

Photo by Tim and Karen Quast, Jackson Hole, June 2022.

I’d have to count to know for sure, but for most of the past 27 years I’ve been there.  We took a break and this year we’re in Jackson Hole, WY, and other spots in a big loop through WY and MT seeing the west (I’m writing Tuesday night in Billings).

We were in Yellowstone much of Monday covering more than ten miles afoot, riveted by the constancy of change in nature.  Some of it is predictable, like Old Faithful and the Grand Geyser (footage here).

A lot of it isn’t.  And you can’t manage it or direct it.

The point?

Stuff constantly changes.  It’s the most inerrant feature of nature. Change is integral to human nature, which animates the stock market.

Regulators are possessed of that same nature yet want to cast the market like pewter.  Create a model and force every free-moving thing to conform.

It’s most certainly not that SEC chair Gary Gensler is smarter than millions of self-interested participants.  No, regulators want to make a mark, the same as anybody else. 

Pharaohs in Egypt hoped for immortality through pyramids.  Carnegie built libraries.  You can go to Newport and see the edifices of the rich, built to last long beyond the builders.

As ever, I have a point about the stock market. The preceding SEC administration under Jay Clayton revamped the rules, too.

I discussed their final proposed rule, Regulation National Market System II – which I called Reg Nemesis II (see what I wrote about Reg Nemesis I here) – with SEC head of Trading and Markets Brett Redfearn, who described it to the NIRI board at our request.

That rule considered many of the same things Gensler is weighing including redefining the meaning of “round lot,” currently 100 shares regardless of price, to reduce market-fragmentation that harms investors of all kinds.

After all that work, the expended taxpayer resources, the studies and lawsuits and machination, it’s set aside because the new SEC wants to build its own pyramids.   

Okay, Quast, you’ve convinced me everybody wants an ovation. Your point?

The problem is the stock market is stuffed full of tiny trades that devolve purpose from investment to chasing pennies and generating data to sell.

Which in turn is the consequence of rules. I’ve explained before that the SEC’s paramount objective is 100 shares of everything to buy and sell, all the time.

Which is impossible.

I know. I trade.  Trades fragment more at exchanges than in broker-operated markets called dark pools.  Routinely I buy in a chunk in a dark pool and then watch my trades get splintered into 5, 7, 34, 61, shares at exchanges (especially the NYSE).

The exchanges pay traders to set the bid and offer, which snap at my order like piranhas, chopping it into pieces and pricing the market with it.

In Yellowstone, nature takes its course. It’s a marvel, cinematic artistry that takes one’s breath away.  It cannot be and does not need to be directed by humans. We observe it and love it, and it changes.  Some stuff like the Grand Geyser and Old Faithful, follow a clock.  A lot of things don’t.

The same is true of human commerce. The more the few machinate interaction into exceptions and directives and objectives, the less it works.  It should in large part follow its own course, with a clear boardwalk for traipsing through the geysers.

Put another way, rather than merchandising retail trades to build pyramids, we should insist on a single set of standards, no exceptions.  And let the game be played.

There are too many complex rules, too many exceptions.  That’s the real problem.  And so the market lacks the elegance of chance, the beauty of organic and constant change.

The Big Story

Here we go again. 

Twitter fans of Fast Trading are claiming these firms help markets and especially the little guy. Now, before you check out, what’s the Big Market Story of 2021?

Retail trading. Right?  Meme stocks. The rise of the Reddit Mob.

Illustration 209856483 © Hafakot | Dreamstime.com

Editorial Note: And the rise of the #EDGEMob, the success of our trading decision-support platform, Market Structure EDGE, winner of the 2021 Benzinga Global Fintech Award for Best Day Trading Software.  EDGE helps retail traders win by seeing Supply and Demand, the very thing Fast Traders obfuscate daily.

Okay, back to our story.

Fast Trading is computerized speculation.  What most call “market-making.” In the sense that these firms buy stuff wholesale – orders from retail traders – and sell it retail (in the stock market and often back to retail traders via dark pools in bits), that’s true.

But it’s not market-making like Goldman Sachs providing research coverage on hundreds of stocks and committing to buy and sell them.

Fast Traders don’t have customers, don’t write research, don’t most times even commit to both buying and selling. They aim to own nothing at day’s end.  They profit on how prices change. Ironically, they create volatility to vacuum it away through tiny spreads.

Money for nothing.

So, these people on Twitter were saying Citadel and Jane Street and Two Sigma and G1X (unit of Susquehanna that buys retail flow) have better execution-quality than stock-exchange IEX.

That’s like saying sprinters have faster 100-meter times than marathoners.  Well, no kidding. They’re doing different things.  IEX is trying to increase trade-size so we can buy something meaningful. Fast Traders are after the opposite. Tiny spreads, tiny trades.

If you’re getting a headache, let me bring it all around.

“Execution Quality” is part of Reg NMS, the regulatory structure of the stock market. It’s benchmarked by thin gaps between prices, in effect. That is, a spread of a penny is no good. A spread of a tenth of a penny, awesome.

Yet Reg NMS prohibits quoting prices in increments of less than a penny, so there’s an element of irony here.  Quote sub-penny? Illegal. Trade sub-penny? The goal!

At any rate, the SEC determined that it could validate how great the market it had created worked by metering whether brokers executed trades near the best overall prices.

Well, that seems good.

Except the best price is determined by the brokers who are being measured on delivering best prices. That’s like saying, “Whoever you see in the mirror gets to judge you.”

I’m talkin’ ‘bout the man in the mirror. He’s gonna have to change his—sorry, digression. Thank you, Michael Jackson, for that awesome song.

Why use data from firms with no customers – Fast Traders serve none in the sense that Goldman Sachs or IEX do – to determine if there is market quality?

And would someone explain who benefits from a narrow spread?  Anyone? Anyone?

The parties buying and selling stuff but not wanting to own it.  That’s who.

The stock market is supposed to help investors, who want to own stuff.  Yet the rules give kudos to trading firms exploiting retail money, clouding supply and demand, and owning nothing.

That’s how retail money chased herds of buffalo off cliffs in AMC, GME and others. Market regulation crowns highwaymen champions for “narrowing the spread” while meanwhile no one knows what the hell is going on.

Well, we do.  We’re not confused at all.

But what reached a climax in 2021 besides retail trading was confusion. Public companies, do you know why your stock went up or down? Investors and traders, did the market make sense to you?

Stocks fell. Pandemic fears. Stocks zoomed. Fears were easing. Wash, rinse, repeat.

We found it entertaining, as we watched Supply and Demand and saw the market move largely in synchrony with that beat.

Low spreads don’t help public companies or traders. They help regulators justify market structure, market operators make money selling data, Fast Traders make money buying low and selling high in tenths of pennies.

All while saying the market exists for investors and public companies.

Good one, that.

Will it change in 2022?  No.

So, will you?

Traders, if you don’t know Supply and Demand, you’re kidding yourself.

And public companies, I’m not sure what else to say that I haven’t said in 17 years. We can be the people who answer an ever quieter phone, the setters of dwindling meetings as money goes quantitative, data goes quantitative.

Or we can understand Supply and Demand in the stock market.  Ask, and we’ll show you.

Two choices in 2022. Happy New Year! 

Big Strategy

Let’s have a show of hands. 

How many of you think investors woke up, several pounds heavier, the day after Thanksgiving, and opened a browser up to news out of South Africa, and said, “Shazam! Omicron!” And dumped their equities?

Second question, how many of you say that on Monday, Dec 6, investors said, “Screw it, this omicron thing is crap. Buy!” And stocks soared?

If we had a poll on our polls, I’d bet not 30% would have raised hands on either question.

So, why did the headlines say that?  And a step further, if we don’t believe humans knee-jerked the market around the past week, why suppose humans are doing it other times?

Quast, where are you going with this? What do you want us to say? 

I’d like us to come to terms as investors and public companies with the presence of automated trading strategies capable of acting

Illustration 22077880 © Skypixel | Dreamstime.com

independently.  Not as a side show, a reaction.  As valid as Ben Graham’s Intelligent Investor. Ron Baron picking stocks.

Blackrock runs over a thousand funds, the bulk of which follow mathematical models having little directly to do with earnings multiples.  Blackrock, Vanguard, State Street and Fidelity run $20 trillion of assets, most of it passive.

Yet many believe investment models follow the market, and the market is priced by rational thought. 

Why would one think stocks are priced by rational thought?  Give me data to support that view. They trade more? They own more?

Neither of those is true. My long-only investors twenty years ago were generally buy-and-hold.  Are your top 20 core Active holders in and out all the time?  Course not.

The stock market today is 100% electronic, close to 95% algorithmic, and nearly all prices are products of software. So it’s the opposite then. Buy-and-hold investors are accepting prices set by others.

A week ago Olin Corp. (OLN), the world’s largest chlorine company and owner of the Winchester arms brand, was trading near $65. Last Friday it touched $51, and now it’s back to $58. It dropped 22%, a spread of 28% from best to worst.

Anything to do with the fundamentals of Olin’s business? Active money never changed its mind, valuing OLN about $61 since early November (that’s as measurable as any other behavioral factor behind price and volume, by the way. We call it Rational Price.).

It’s volatility, Tim. Noise. 

If we’re willing to characterize a 20% change in price over a week as noise, we’re saying the stock market is a steaming pile of pooh.  A real market wouldn’t do that.

But what if it’s not pooh?  Suppose it’s a strategy that performs best when demand and supply alike both fall?

Then that strategy deserves the same level of treatment in what drives shareholder value as company fundamentals. 

Do you see where I’m going?  The hubris of business news is its fruitless pursuit of human reason as the explanation for everything happening in the stock market.  And it’s the hubris of investor relations too.

Do you know Exchange Traded Funds have created and redeemed nearly $6 trillion of shares in 2021, in US equities alone (data from the Investment Company Institute)?  Nothing to do with corporate fundamentals. All about supply and demand for equities.

Bank of America said last month flows to equities globally have topped $1.1 trillion, crushing all previous records by more than 200%. Most of that money is going to model-driven funds (and 60% to US equities).

Intermediating equity flows all the time, everywhere, are high-speed trading firms like Citadel Securities, Virtu, Hudson River Trading, Two Sigma, Infinium, Optiv, GTS, Quantlab, Tower Research, Jane Street, DE Shaw, DRW Trading and a handful of others.

They follow real methods, with actual tactics and strategies.  ModernIR models show these trading schemes were 54% of trading volume the past week in S&P 500 stocks. Derivatives, a key market for Fast Traders, traced to 18% of equity volume.  About 19% was Passive models like Blackrock’s ETFs.

That leaves about 9% from Active money, your core long-only investors. 

So, what drove the stock market up and down? On a probability basis alone, it’s the 54%. 

It’s not the same everywhere, but the principle applies. For NVS Nov 18-Dec 6, 38% was Passive, just 31% Fast Trading – those machines.  For TSLA, 57% was Fast Trading, 17% from Passives.

For the record, OLN was 54% Fast Trading, 19% Passive, in step with the S&P 500.

Moral of the story?  No view of the market should ever exclude the 54%. Nor should it be seen as noise. It’s a strategy. The difference is it’s driven by Price as an end, not financial returns as an end. (If you want to know your company’s behavioral mix, ask us.)

And it’s the most successful investment strategy in the market.  That should concern you. But that’s a whole other story about the way stocks trade.

On the Skids

If electoral processes lack the drama to satisfy you, check the stock market.

Intraday volatility has been averaging 4%. The pandemic has so desensitized us to gyrations that what once was appalling (volatility over 2%) is now a Sunday T-shirt.

Who cares?

Public companies, your market-cap can change 4% any given day. And a lot more, as we saw this week.  And traders, how or when you buy or sell can be the difference between gains and losses.

So why are prices unstable?

For one, trade-size is tiny.  In 1995, data show orders averaged 1,600 shares. Today it’s 130 shares, a 92% drop.

The exchanges shout, “There’s more to market quality!”

Shoulder past that obfuscating rhetoric. Tiny trades foster volatility because the price changes more often.

You follow?  If the price was $50 per share for 1,600 shares 25 years ago, and today it’s $50 for 130 shares, then $50.02 for 130 shares, then $49.98 for 130 shares, then $50.10 for 130 shares – and so on – the point isn’t whether the prices are pennies apart.

The point is those chasing pennies love this market and so become vast in it. But they’re not investors.  About 54% of current volume comes from that group (really, they want hundredths of pennies now).

Anything wrong with that?

Public companies, it demolishes the link between your story and your stock. You look to the market for what investors think. Instead it’s an arbitrage gauge. I cannot imagine a more impactful fact.

Traders, you can’t trust prices – the very thing you trade. (You should trade Sentiment.)

But wait, there’s more.

How often do you use a credit or debit card?  Parts of the world are going cashless, economies shifting to invisible reliance on a “middle man,” somebody always between the buying or selling.

I’m not knocking the merits of digital exchange. I’m reading Modern Monetary Theory economist Stephanie Kelton’s book, The Deficit Myth.  We can talk about credit and currency-creation another time when we have less stuff stewing our collective insides.

We’re talking about volatility. Why stocks like ETSY and BYND were halted on wild swings this week despite trading hundreds of millions of dollars of stock daily.

Sure, there were headlines. But why massive moves instead of, say, 2%?

The stock market shares characteristics with the global payments system.  Remember the 2008 financial crisis? What worried Ben Bernanke, Tim Geithner and Hank Paulson to grayness was a possibility the plumbing behind electronic transactions might run dry.

Well, about 45% of US stock volume is borrowed. It’s a payments system. A cashless society. Parties chasing pennies don’t want to own things, and avoid that by borrowing. Covering borrowing by day’s end makes you Flat, it’s called.

And there are derivatives. Think of these as shares on a layaway plan.  Stuff people plan to buy on time but might not.

Step forward to Monday, Nov 9. Dow up 1700 points to start. It’s a massive “rotation trade,” we’re told, from stay-at-home stocks to the open-up trade.

No, it was a temporary failure of the market’s payments system. Shorting plunged, dropping about 4% in a day, a staggering move across more than $30 trillion of market-cap. Derivatives trades declined 5% as “layaways” vanished.  That’s implied money.

Bernanke, Geithner and Paulson would have quailed.

Think of it this way. Traders after pennies want prices to change rapidly, but they don’t want to own anything. They borrow stock and buy and sell on layaway.  They’re more than 50% of volume, and borrowing is 45%, derivatives about 13%.

There’s crossover – but suppose that’s 108% of volume – everything, plus more.

That’s the grease under the skids of the world’s greatest equity market.

Lower it by 10% – the drop in short volume and derivatives trades. The market can’t function properly. Metal meets metal, screeching. Tumult ensues.

These payment seizures are routine, and behind the caroming behavior of markets. It’s not rational – but it’s measurable.  And what IS rational can be sorted out, your success measures amid the screaming skids of a tenuous market structure.

Your board and exec team need to know the success measures and the facts of market function, both. They count on you, investor-relations professionals. You can’t just talk story and ESG. It’s utterly inaccurate. We can help.

Traders, without market structure analytics, you’re trading like cavemen. Let us help.

By the way, the data do NOT show a repudiation of Tech. It’s not possible. Tech sprinkled through three sectors is 50% of market-cap. Passive money must have it.

No need for all of us to be on the skids.  Use data.  We have it.

-Tim Quast

Dark Edges

The stock market’s glowing core can’t hide the dark edges – rather like this photo I snapped of the Yampa River in downtown Steamboat springs at twilight.

Speaking of which, summer tinkled its departure bell up high.  We saw the first yellowing aspen leaves last week, and the temperature before sunrise on the far side of Rabbit Ears Pass was 30 degrees, leaving a frosty sheen on the late-summer grass.

The last hour yesterday in stocks sent a chill too. Nothing shouts market structure like lost mojo in a snap.  I listened to pundits trying to figure out why.  Maybe a delay in stimulus.  Inflation. Blah blah.  I didn’t hear anyone blame Kamala Harris.

It’s not that we know everything.  Nobody does.  I do think our focus on the mechanics, the machinery, the rules, puts us closer to the engines running things than most observers.

And machines are running the market.  Machines shift from things that have risen to things that have fallen, taking care to choose chunks of both that have liquidity for movement. Then all the talking heads try to explain the moves in rational terms.

But it’s math. Ebbs and flows (Jim Simons, the man who solved the market at Renaissance Technologies, saw the market that way).

Passives have been out of Consumer Staples. Monday they rushed back and blue chips surged. The Nasdaq, laden with Tech, is struggling. It’s been up for a long time. Everybody is overweight and nobody has adjusted weightings in months. We can see it.

By the way, MSCI rebalances hit this week (tomorrow on the ModernIR Planning Calendar).

This is market structure. It’s morphed into a glowing core of central tendencies, such as 22% of all market capitalization now rests on FB, AAPL, AMZN, NFLX, GOOG, MSFT, AMD, TSLA and SHOP.

That’s the glowing core.  When they glow less, the dark edges grow.

Then there’s money.  Dough. Bucks. Specifically, the US dollar and its relationship to other global currencies. When the dollar falls, commodities surge. It’s tipped into the darkness the past month, marking one of its steepest modern dives.  Gold hit a record, silver surged, producer prices dependent on raw commodities exploded.

Then the dollar stopped diving. It’s up more than 1% in the last five days. And wham! Dark edges groped equities late yesterday. Gold plunged. Silver pirouetted off a 15% cliff.

August is traditionally when big currency-changes occur. Aug last year (massive move for the dollar versus the Chinese Renminbi Aug 5, 2019). Aug 2015. Aug 2018. Currencies rattle prices because currencies underpin, define, denominate, prices.

Back up to Feb 2020.  The dollar moved up sharply in late February, hitting the market Monday, Feb 24, as new options traded.  Pandemic!

Options expire next week.  The equivalent day is Aug 24, when new options will trade. Nobody knows when the dark edges will become cloying hands reaching for our investment returns or equity values.

In fact, Market Structure Sentiment™, our algorithm predictively metering the ebb and flow of different trading behaviors, peaked July 28 at 7.7 of 10.0, a strong read.  Strong reads create arcs but say roughly five trading days out, give or take, stocks fall.

They didn’t. Until yesterday anyway. They just arced.  The behavior giving equities lift since late July in patterns was Fast Trading, machines chasing relative prices in fractions of seconds – which are more than 53% of total volume.

Then Market Structure Sentiment bottomed Aug 7 at 5.3, which in turn suggests the dark edges will recede in something like five trading days.  Could be eight. Might be three.

Except we didn’t have dark edges until all at once at 3pm ET yesterday.

Maybe it lasts, maybe it doesn’t. But there’s a vital lesson for public companies and investors about the way the market works.  The shorter the timeframe of the money setting prices, the more statistically probable it becomes that the market suddenly and without warning dives into the dark.

It’s because prices for most stocks are predicated only on the most recent preceding prices.  Not some analyst’s expectation, not a multiple of future earnings, not hopes for an economic recovery in 2021.

Prices reflect preceding prices. If those stall, the whole market can dissolve into what traders call crumbling quotes.  The pandemic nature of short-term behavior hasn’t faded at the edges. It’s right there, looming.  We see it in patterns.

If something ripples here in August, it’ll be the dark edges, or the dollar. Not the 2021 economy.

The Daytraders

 

A year ago, Karen and I were flying to Fiji, 24 hours of travel from Denver to LA, to Auckland, to Nadi.

We took a ferry out of Denarau Island into Nadi Bay and north toward the Mamanuca Islands, all the way past the castaway home for television’s Survivor Fiji to our South Pacific gem, Tokoriki.

It’s not that I wish now to be a world away.  We can ride bikes past this gem, Catamount Lake, any crisp Steamboat morning (while the fruited plain radiates, it’s 45 degrees most days at 630a in northern Colorado).

It’s the shocking difference a year makes. Everybody’s trading. Instead of going to Fiji or whatever.

Schwab and Ameritrade have a combined 26 million accounts. Fidelity has 13 million in its brokerage unit. E*Trade, over 5 million.  Robinhood, the newest, has 13 million users.

Public companies wonder what impact these traders have on stock prices.  The old guard, the professional investors, seem to be praying daily that retail daytraders fail.

In some sense, the Dave Portnoy era (if you don’t know Barstool Sports and Davey Daytrader – perhaps our generation’s most adroit marketer – you must be a hermetic) has pulled the veil off the industry. It appears the pros know less than they led us to believe.

The pros say just wait.  The wheels are going to come off the retail wagon in a cacophony of sproinging springs and snapping spokes.

Of course, as Hedgeye’s Keith McCullough notes, if the wagon splinters, we’re all in the smithereens because there’s just one stock market.

We wrote in our widely read June 10 post, Squid Ink, about what happens to the millions of online retail trades.  They’re sold to what we call Fast Traders, machines that trade everything, everywhere, at the same time and thus can see what to buy or sell, what to trade long or short.

How does this flow that Citadel Securities, the biggest buyer of retail trades, says is now about 25% of market volume, affect the stock market, public companies and investors?

Two vital points about market structure here.  First, market-makers like Citadel Securities enjoy an exemption from rules governing stock-shorting.  Second, Fast Traders run trading models that predict in fleeting spaces how prices will behave.

Put these two factors together and you have the reason why stocks like TSLA can double in two weeks without respect to business fundamentals – or even the limitations of share supply.

If three million accounts at Robinhood want fractional exposure to TSLA, the problem for Fast Traders to solve is merely price and supply.  If you go to the grocery store and they don’t have shishito peppers, you go home without shishitos.

If you’re a retail trader wanting TSLA, you will get TSLA, and the price will rise, whether any shares exist or not.  Fast Traders will simply manufacture them – the market-maker SEC exemption on shorting.

The market-maker will cover before the market closes in 99% of cases.  So the market-maker isn’t short the stock anymore.  But maybe TSLA will have 25% more shareholdings than shares outstanding permit.

Worse, it’s impossible to understand supply and demand. If market-makers could only sell existing shares – back to shishito peppers – TSLA would skyrocket to $5,000 and plunge to $500.  Frankly, so would much of the market.

Which is worse?  Fake shares or fake prices?  Ponder it.

And machines will continuously calculate the supply or demand of shares of a stock versus others, and versus the exchange-traded derivatives including puts, calls and index futures (oh, and now Exchange Traded Funds which like prestidigitated shares have no supply limitations), to determine whether to lift prices.

As we said in Squid Ink, we believe Fast Traders buying order flow from retail brokers can see the supply in the pipeline.

Combine these features. Fast Traders see supply and demand. They relentlessly calculate how prices are likely to rise or fall. They manufacture shares to smooth out imbalances under SEC market-making exemptions.

And the market becomes this mechanism.

Risks? We’ve declaimed them for years.  The market will show a relentless capacity to rise, until something goes wrong. And then there won’t be enough stock to sell to meet redemptions, and prices will collapse. We’ve had tastes of it.  There will be more.

But it’s not the fault of the daytraders.

Rotation

There’s a story going around about an epochal rotation from momentum (growth) to value in stocks. It may be a hoax.

I’ll explain in a bit. First the facts. It began Monday when without warning the iShares Edge MSCI USA Value Factor ETF (VLUE) veered dramatically up and away from the iShares Edge MSCI USA Momentum Factor ETF (MTUM).

CNBC said of Monday trading, “Data compiled by Bespoke Investment Group showed this was momentum’s worst daily performance relative to value since its inception in early 2013.”

The story added, “The worst performing stocks of 2019 outperformed on Monday while the year’s biggest advancers lagged, according to SentimenTrader. This year’s worst performers rose 3.5% on Monday while 2019’s biggest advancers slid 1.4%, the research firm said.”

A tweet from SentimenTrader called it “the biggest 1-day momentum shift since 2009.”

It appeared to continue yesterday. We think one stock caused it all.

Our view reflects a theorem we’ve posited before about the unintended consequences of a market crammed full of Exchange Traded Funds, substitutes for stocks that depend for prices on the prices of stocks they’re supposed to track.

To be fair, the data the past week are curious. We sent a note to clients Monday before the open. Excerpt:

“Maybe all the data is about to let loose. It’s just. Strange.  Fast Trading leading. ETFs more volatile than stocks. Spreads evaporating. Sentiment stuck in neutral. More sectors sold than bought….Stocks should rise. But it’s a weird stretch ahead of options-expirations Sep 18-20.  It feels like the market is traversing a causeway.”

That stuff put together could mean rotation, I suppose.

But if there was a massive asset shift from growth to value, we’d see it in behavioral change. We don’t. The only behavior increasing in September so far is Fast Trading – machines exploiting how prices change.

What if it was AT&T and Elliott Management causing it?

If you missed the news, T learned last weekend that Activist investor Elliott Management had acquired a $3.2 billion stake in the communications behemoth and saw a future valuation near $60.  On that word, T surged Monday to a 52-week high.

T is the largest component of the MSCI index the value ETF VLUE tracks, making up about 10% of its value.  ETFs, as I said above, have been more volatile than stocks.

Compare the components of MTUM and VLUE and they’re shades apart. Where T is paired with VLUE, CMCSA ties to MTUM, as does DIS.  MRK is momentum, PFE is value. CSCO momentum, INTC, IBM value. PYPL, V, MA momentum, BAC, C, value.

Look at the market. What stuff did well, which did poorly?

The outlier is T. It’s a colossus among miniatures. It trades 100,000 times daily, a billion dollars of volume, and it’s been 50% short for months, with volatility 50% less than the broad market, and Passive Investment over 20% greater in T than the broad market.

T blasted above $38 Monday on a spectacular lightning bolt of…Fast Trading. The same behavior leading the whole market.  Not investment. No asset-shift.

What if machines, which cannot comprehend what they read like humans can, despite advances in machine-learning, artificial intelligence (no learning or intelligence is possible without human inputs – we’re in this business and we know), improperly “learned” a shift from growth to value solely from T – and spread it like a virus?

Humans may be caught up in the machine frenzy, concluding you gotta be in value now, not realizing there’s almost no difference between growth and value in the subject stocks.

Compare the top ten “holdings” of each ETF. Easy to find. Holdings, by the way, may not reflect what these ETFs own at a given time. Prospectuses offer wide leeway.

But let’s give them the benefit of the doubt. What’s the difference between MRK and PFE? V, MA, and PYPL and C, BAC and, what, GM and DIS?

Stock pickers know the difference, sure.  Machines don’t. Sponsors of ETFs wanting good collateral don’t.  Except, of course, that cheap collateral is better than expensive collateral, because it’s more likely to produce a return.

Such as: All the worst-performing stocks jumped. All the best-performing stocks didn’t.

What if this epochal rotation is nothing more than news of Elliott’s stake in T pushing a domino forward, which dropped onto some algorithm, that tugged a string, which plucked a harp note that caused fast-trading algorithms to buy value and sell momentum?

This is a risk with ETFs. You can’t trust signs of rotation.

We have the data to keep you from being fooled by machine-learning.