Tagged: Market Structure

What We Do

We’re about to decamp for Switzerland for the month of July.  It’s an example of time and experience changing what we do. 

We’re blessed to have the freedom and means to do it.  But that’s not the point.

The Pandemic and observation – seeing our aging relatives, aging friends, no longer able to do what they’d want, right at the point they’ve got the time and money to do it – have prompted us to seize the day.

Illustration 121184273 © Noree Saisalam | Dreamstime.com

We won’t always be able to ride bikes from Montreux to Zurich.  But we can now.  So we’re doing it now.

Which gets to the question I hear most from investor-relations people.  They’re intellectually interested in “market structure,” the way the market works.

After all, we’re the professionals (a line critical to the great Denzel Washington movie, “Man on Fire”).  We’re supposed to know how the stock market works.

And so often I hear, “What do I do with it?”

If you were to learn through God or some miracle of science (oxymoron purposeful) that you had ten years to live, what would you do?  Keep on doing what you’ve always done?

Here’s what the data show irrefutably about the stock market.  And for backdrop, I think we’ve written more about market form and function than anybody in the USA, right here on this page.  About 800 words per week, nearly every week, since 2006.

I’ve testified to Congress (in writing) about how to improve the market for issuers and investors.  Been on CNBC talking about market structure.  Done it in our profession for two decades.

And I summed up the Essentials last week. Three things every public company should be doing.

If you’re a smallcap, go big or go home. You can’t stay small. If you’re a public company, you should understand the cadence and rhythm of the stock market – its context, let’s call it – and don’t put out earnings, important news, during its violent thunderstorms (options-expirations, rebalances).

And your principal job now is using data to help your executive team and Board of Directors make good decisions about deploying shareholder capital. 

It’s not telling the story to a diminishing audience.

Look, I don’t mean people aren’t showing up at Non-deal Road Shows, sellside conferences. I mean stock-pickers are an endangered species that doesn’t set prices.

I don’t know a profession less data-driven than ours. We do a bunch of things out of tradition, not data demonstrate returns.

Many a time I’ve sat in meetings with IR people who argued that “we’ve got a pretty good sense of what’s going on.”  And they don’t even know what Reg NMS is. 

Would you run a business that way – got a pretty good sense of what’s going on? How the can a professional pursuit like IR, which has a certification program?

You could be the Zoom Video Communications (ZM) investor-relations team talking to investors in 2020 – by web meeting – and think you’re just killing it. And that was before anyone had heard of ZM.

And you could be the ZM IR team now, a ubiquitous brand name and a massively larger business, talking to investors and the 30-odd sellside analysts covering the stock, and it trades below where it did in Mar 2020.

Because telling the story to this crowd doesn’t create shareholder value.

Asset allocation – the earmarking of money to parts and groups and slices of the market according to a model – and speculation, furious trading, and leverage with derivatives, create and dispel shareholder value.

You can measure your Engagement with stock-pickers quantitatively (we do it) but they don’t set prices more than about 10% of the time.

At this moment, it’s a great time for ZM to call on holders. Because the Supply/Demand balance – every public company should know that balance (and you can, just ask) – is favorable.

What you do with it is you ground your company in reality and make the most of an equity market that’s not driven anymore by stock-pickers.

How much money do you spend on targeting, tracking interaction with the buyside and sellside, keeping up with what your peers are doing? About $50,000 annually?

And how do you tie that to shareholder value with data? 

You can’t. It doesn’t.  You CAN use data to help your company make the most of the market.  Just not that data. 

What we come to understand about life should affect how we participate in it.  And it’s all about what we do with the time we’re given.

The same applies to the IR profession, or any endeavor for that matter. Knowledge should change what we do and how we do it.

Investor-relations is the data-driven mission to maximize listing in public equity markets, which starts with understanding the stock market.

And with that, we’re off to Switzerland.

Elasticity

CNBC is running a second-by-second countdown to the Federal Reserve decision on rates today.

Seems like a market too dependent on the few. Risk disperses through decentralization.  We’re counting on a central bank to disperse risk.  Hm.  Whatever the Fed does today, from 50 basis points to a hundred, we know risk is concentrated.

In what?

Illustration 164670867 © Adonis1969 | Dreamstime.com

I’ll come to that. First, every public company should have reliable, accurate market intelligence on what’s driving – or harming – shareholder-value.  With just 5% of trading volume manifesting as ownership-changes, you need quantitative market analytics.

We have them.  You may need them in coming months as much or more than at anytime you’ve occupied the chair, investor-relations professionals. Send me an email and ask about our special deal through Dec 31.

So, where is risk?  It’s been transferred from every part of the economy, from all assets, into our currency, thanks to the central bank’s effort to be on both sides of the Supply/Demand teeter-totter simultaneously.

And since our currency denominates risk assets and all economic interaction including trading time for money, and trading money for good and services, we didn’t transfer it anyplace.  It’s a grenade, pin pulled and hucked, that bounces right back.

The Panic of 1873 collapsed proliferating railroads and the banks and investors backing them. Investors started selling the railroad bonds they owned and pretty soon there were too many bonds around and nobody wanted them.

But it didn’t spread to other parts of the economy. It didn’t threaten the currency, which by 1880 had gained BACK all the lost purchasing power resulting from the Civil War and paper banknotes.

Imagine getting some purchasing power back. Wow.

Anyway, in 2022, people are selling off bonds. But they’re not railroad bonds. They’re government bonds. And the Federal Reserve, which hasn’t started selling its giant trove yet, will follow suit.

The yield, which moves inversely to price, on the five-year US Treasury, for instance, is up from about 70bp last summer to 3.6%. It reflects plunging demand for bonds.

The banks that sold railroad bonds in 1873, and the railroad companies that used the proceeds to lay rails, and the investors who owned the paper backing transportation capital-spending went broke.

Of course nobody bailed them out. The destruction of speculation and overbuilding is a necessary part of any healthy economy.  Otherwise you end up with assets that don’t produce returns.

That’s what happened during the Pandemic.  Assets that were not producing returns were kept afloat by the Fed, which issued bonds to create currency to keep stuff alive through payroll protection plans.

Then the Fed took the unprecedented step of just sending everybody checks (the Treasury did it but that money came from nothing – poof, just like the metaverse), shifting from keeping the supply side going, to juicing the demand side of the teeter-totter.

So you have unproductive assets getting money, and unproductive people getting paid.  And consuming stuff, and trading stocks, and buying bitcoin, blah blah.

At some point, that process stops.

I’m not knocking emergency efforts. But the government gave no thought to having to undo what was done. Elastic money was the Great Elixir that would “promote growth.” The truth might be closer to setting one’s house afire to stay warm.

Leading into 1873, the banks and the builders and the bond-buyers were seeing big future demand for rails.  Instead, there was an economic slowdown, and people had to sell bonds to raise money.

It’s not 1873, because that was only railroads.  I don’t know what will happen here.  But the whole world depends on the dollar.  It’s the only reserve currency. We transferred the entire perceived – which proved wrong – effects of the Pandemic to it.

Bailing stuff out is bad because it compounds until it comes around and what was just a little jab that didn’t land in a boxing match is now a Mike Tyson upper cut.

And who bails out the dollar?

In 1913, the Federal Reserve was created to give money the elasticity to absorb panics. It absorbed WWI. That collapse in output coupled with the explosion of money sent us galloping into the Roaring Twenties.

And the equal and offsetting reaction was the 1930s.

Human nature tends to do things until they blow up. We may have exhausted the elasticity of modern monetary policy. And the snapback could be intense.

Be prepared. We’ve got data for navigating turbulence.

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.

Understanding

How do I attract more investors? 

It’s the key question from investor-relations people, the liaison to Wall Street for public companies. The answer, though, isn’t what you think.

And I have to share.  Come in closer, I need to keep my voice down.

I am cracking up over these ex-sellsiders at the IR profession’s online community, who are now investor-relations people, asking how to attract more sellside coverage.

Well, didn’t you used to do that job?  Why are you asking other IR people how to get what you gave?

Anyway, back to my normal voice, for you investors and traders wondering what the hell I’m talking about, let me explain.  There’s the buyside.  That’s investors who buy stocks. Retail investors, you’re generally excluded because you’re a wild and fragmented audience.

(Also, we IR people have a professional association and an online community where we discuss stuff. That’s what I’m talking about, for you folks in other professions.)

The IR job revolves around the buyside and the sellside.  Investors. And stock-research analysts at firms ranging from Goldman Sachs to JMP Securities who cover stocks – write research and make buy/sell recommendations.

The sellside created the stock market. The Nasdaq was the National Association of Securities Dealers – brokers – who devised an automated quotation system.  NASD-AQ.  Nasdaq.

And 24 brokers agreed in 1792 to give each other preference on buy and sell orders. That agreement laid the foundation for the NYSE.

Today, the buyside does its own research.  Hedge funds like Millennium and Point72 buy every conceivable form of data from social-network sentiment to satellite images of parking lots at factories and shipments at ports, and God only knows what else.

They know more about you, public companies, than you do.

And way more than sellside analysts.  The sellside is so yesterday (but Top Gun: Maverick, a reprise from 36 years ago when I was in college, is very much today, very awesome. We saw it, loved it.).

Sure, stocks move on upgrades and downgrades, but that’s mostly machines doing latency arbitrage – trading at different prices in different places but way faster than you can blink.

For the sellside, the result has been a great rout, a diaspora, a scattering.  Demand for their views has collapsed, even though you see analysts all day on CNBC.

So they want IR jobs.  As I’ve said before, when I started in the profession in the 1990s, we wanted to be Mary Meeker and Henry Blodget, making the big bucks. Internet analysts.

Now the Meekers and Blodgets want to be us.  Well, Henry Blodget launched Business Insider, reinventing himself.  Mary Meeker is a venture capitalist.  The point is, the sellside is a dead end.

Tim, you haven’t answered the question. 

I know it.  I’m keeping you waiting.

I was providing an overview of ModernIR Market Structure Analytics to a new investor-relations guy.

He said, “How do these analytics help me attract more investors?”

I said, “You can’t. Not the way you think.”

I said, “The trouble is, unless or until someone – say, you – shows the Board and the executive team what the money is doing today, they will expect you to attract more investors. But Active money is on the same growth trajectory as payphones.”

Now, you CAN attract investors. But you do that with your CHARACTERISTICS, not your story. You do it principally with capital-allocation.

Tim, I don’t get it.  I just go talk to investors, and they buy our stock, and our price goes up.

Would that it were!

See the image here?  In 1995, more than 80% of market volume traced to stock-picking. And over 90% of institutional assets were actively managed. Easy to tell the story.

Copyright Modern Networks IR, LLC, 2022. Image from ModernIR product demo. Data courtesy ModernIR market-structure models.

Now, Active assets are nearing 40%, and falling. One category dominates: Passive Large Cap Blend, approaching 40% of assets. Trading volume is 90% something besides story.

Public companies can’t tell the corporate story to a shrinking audience and get a higher stock price. They CAN determine how to get in front of the money – which is Passive Large Cap Blend. 

If your market cap is under $5 billion, the probability you can become a large cap stock is about 1%. Every investor-relations officer should tell that to every c-suite, every boardroom.

It’s not to discourage you, but to get you focused on what matters. Your story, public companies, doesn’t determine your value.  Your characteristics do.

If 40% of the money is Passive Large Cap Blend, you have at least a 40% chance of being in front of it by achieving those CHARACTERISTICS.  That’s way better than 1%. Go big, or go home.

You want market cap? Go where the money is, by becoming what it wants. We always know where it’s going. If you want to more fully understand what I’m saying here, hit reply (or ask for a Demo through the ModernIR website at upper right).

Snapped

SNAP broke yesterday. I’ll explain two reasons why.

Yes, the company blew the quarter. Dramatic swings in guidance don’t instill joy.

But the losses occurred before anybody talked about them.  SNAP closed Monday at $22.47 and opened Tuesday for trading at $14.49 and closed at $12.79.

It lost 36% when most couldn’t trade it and shed just $1.30 during official market hours.

Illustration 135866583 © Jm10 | Dreamstime.com

How is that fair?

Regulations are meant to promote a free, fair and open stock market. I think premarket trading should be prohibited because it’s not a level playing field.

Who’s using it? Big institutions with direct access to brokers who operate the markets running around the clock. Hedge funds could dump shares through a prime broker, which instantly sells via so-called dark pools.

And the hedge funds could buy puts – and leverage them – on a whole basket including the stock they dumped, peers, ETFs, indices.  All outside market hours.

Something unfair also happens DURING market hours. I’ll explain with my own experience as a retail trader using our decision-support platform, Market Structure EDGE.

It’s not that my trade was unfair.  I understand market structure, including how to use volatility, trade-size, liquidity and stock orders to best effect.  I made money on the trade.

But it’s instructive for public companies, traders, investors.

I sold 50 shares of NXST. Small trade, with a reasonable return. I pay a modest commission at Interactive Brokers to observe how trades execute.

Most times I buy and sell 100 or fewer shares, often 95 or 99. The average trade-size in the market is less than 100 shares so I don’t want to be an outlier. And you’re looking for blocks? Forget it. The market is algorithmic.

And I know the rules require a market order, one accepting the best offer to sell, to execute immediately at the best price if it’s 100 or fewer shares.

Stay with me – there’s a vital point.

NXST trades about $7,300 at a time (a little under 50 shares), the reason for my trade-size. And it’s 2.1% volatile daily. Since it was up 2% during the day, I knew it was at the top of the daily statistical probability, good time to sell.

I checked the bid/ask spread – the gap between the best bid to buy and offer to sell.  Bid was $176.01, offer was $176.25. A spread of $0.25. That’s big for a liquid stock.

So I used a marketable limit order – I picked a spot between them, aiming to the lower side to improve the chance it filled: $176.05. I was wanting to leave.

The trade sat there for a bit, and then filled.  I checked. It split into two pieces, 45 shares at “Island,” which is Instinet, the oldest Electronic Communications Network, now owned by Nomura. I paid a commission of $0.19.

And the other piece, five shares, also executed at Instinet at the same price.  And I paid $1.02 in commission. For five shares!

What the hell happened? 

This is how the ecosystem works.  And this rapid action can smash swaths of shareholder value, foster wild and violent market swings – especially during options-expirations (yesterday was Counterparty Tuesday, when banks square monthly derivatives books, and it was a tug-of-war) – and, sometimes, work masterfully.

It’s market structure.

My broker sent the trade to Instinet, determining by pinging that undisplayed shares there would fill it.

And one or more Fast Traders hit and cancelled to take a piece of it, permitting my broker to charge me two commissions, one on five shares, another on 45 shares.

And now my one trade became ammo for two. The going rate at stock exchanges for a trade that sets the best offer is around $0.25 per hundred shares – the exact spread in NXST.

Yes, that’s right. Exchanges PAY traders to set prices. I traded 50 shares, but since the order split, it could become the best national offer two places simultaneously, generating that high frequency trader about $0.15.

What’s more, my order originated as a retail trade, qualifying for Retail Liquidity Programs at stock exchanges that pay an additional $0.03.

So my intermediary, Interactive Brokers, made $1.21. Some high-frequency trader probably made another $0.18 for breaking the trade up and buying and selling it at the same price two places. Zero risk for an $0.18 return.

Do that 100,000 times, it’s big, risk-free money.

It didn’t cost me much. But suppose it was 500,000 shares or five million?  Every trade navigates this maze, public companies and investors, getting picked and pecked.

Not only do costs mount for moving any order of size but the market BECOMES this maze. Its purpose disappears into the machination of pennies. Oftentimes it’s tenths of pennies in liquid stocks.

And you’re telling your story, spending on ESG reports, a total approaching $10 billion for public companies complying with rules to inform investors.

And the market is the mass pursuit of pennies.  Yes, there are investors. But everybody endures this withering barrage that inflates on the way up, deflates on the way down.

And it’s wrong that the mechanics of the market devolve its form into the intermediated death of a thousand cuts. Is anyone going to do anything about it?

Experience

“The market structure is a disaster.”

That’s what Lee Cooperman said in a CNBC conversation yesterday with “Overtime” host Scott Wapner.

What he thinks is wrong is the amount of trading occurring off the exchanges in so-called dark pools and the amount of shorting and short-term trading by machines.

I’m paraphrasing.

Mr. Cooperman, who was on my market-structure plenary panel at the 2019 NIRI Annual Conference, decries the end of the “uptick rule” in 2007. It required those shorting stocks to do so only on an uptick.

To be fair to regulators, there’s a rule. Stocks triggering trading halts (down 10% in five minutes) can for a set time be shorted only at prices above the national best bid to buy. It’s called Reg SHO Rule 201.

But market-makers are exempt and can continue creating stock to fill orders. It’s like, say, printing money.

Mr. Cooperman has educated himself on how the market works. It’s remarkable to me how few big investors and public companies (outside our client base!) know even basic market structure – its rules and behaviors.

Case in point.  A new corporate client insisted its surveillance team – from an unnamed stock exchange – was correct that a big holder had sold six million shares in a few days.

Our team patiently explained that it wasn’t mathematically possible (the exchange should have known too).  It would have been twice the percentage of daily trading than market structure permits.  That’s measurable.

Nor did the patterns of behavior – you can hide what you own but not what you trade, because all trades not cancelled (95% are cancelled) are reported to the tape – support it.

But they’re a client, and learning market structure, and using the data!

The point though is that the physics of the stock market are so warped by rules that it can’t function as a barometer for what you might think is happening.  That includes telling us the rational value of stuff.

You’d expect it would be plain crazy that the stock market can’t be trusted to tell you what investors think of your shares and the underlying business.  Right?

Well, consider the economy.  It’s the same way.

Illustration 91904938 © Tupungato | Dreamstime.com

The Federal Reserve has determined that it has a “mandate” to stabilize prices.  How then can businesses and consumers make correct decisions about supply or demand?

This is how we get radical bubbles in houses, cryptocurrencies, bonds, equities, that deflate violently.

Human nature feeds on experience. That is, we learn the difference between good and bad judgement by exercising both.  When we make mistakes, there are consequences that teach us the risk in continuing that behavior.

That’s what failure in the economy is supposed to do, too.

Instead, the Federal Reserve tries to equalize supply and demand and bail out failure.  

Did you know there’s no “dual mandate?”  Congress, which has no Constitutional authority to do so, directed the Fed toward three goals, not mandates: maximum employment, moderate long-term interest rates and stable prices.

By my count, that’s three. The Fed wholly ignores moderate rates. We haven’t had a Fed Funds rate over 6% since 2001.  Prices are not stable at all. They continually rise. Employment? We can’t fill jobs.

From 1800-1900 when the great wealth of our society formed (since then we’ve fostered vast debt), prices fell about 50%.  The opposite of what’s occurring now. 

Imagine if your money bought 50% more, so you didn’t have to keep earning more.  You could retire without fear, knowing you wouldn’t “run out of money.”

Back to market structure.

The catastrophe in Technology stocks that has the Nasdaq at 11,700 (that means it’s returned just 6% per annum since 2000, before taxes and inflation, and that matters if you want to retire this year) is due not to collapsing fundamentals but collapsing prices.

How do prices collapse?  There’s only one way.  Excess demand becomes excess supply.  Excess is always artificial, as in the economy.

People think they’re paying proper prices because arbitragers stabilize supply and demand, like the Fed tries to do. That’s how Exchange Traded Funds are priced – solely by arbitrage, not assets. And ETFs permit vastly more money to chase the same goods.

It’s what happened to housing before 2008.  Derivatives inflated the boom from excess money for loans.

ETFs permit trillions – ICI data show over $7 trillion in domestic ETFs alone that are creating and redeeming $700 BILLION of shares every month so far in 2022 – to chase stocks without changing their prices.

And the Federal Reserve does the same thing to our economy.  So at some point, prices will collapse, after all the inflation.

That’s not gloom and doom. It’s an observable, mathematical fact.  We just don’t know when.

It would behoove us all to understand that the Federal Reserve is as big a disaster as market structure.

We can navigate both. In the market, no investor, trader or public company should try doing it without GPS – Market Structure Analytics (or EDGE).

The economy?  We COULD take control of it back, too.

Weird

This is weird. 

I’m traveling to an actual business meeting, by aircraft, and I intend to wear a suit.

Illustration 155967106 / Dune © Rolffimages | Dreamstime.com

There are many things in our society that I had considered weird but these two were not among them.  It’s pretty weird seeing Will Smith slap Chris Rock, who took it with aplomb while the Hollywood audience weirdly applauded.

But that’s not what I was thinking about.

Currently among the weirdest – by no means alone – is the divide between what people think is true about the stock market and what actually is. 

Which I suppose makes it somewhat less weird that my suit-wearing face-to-face is with American manufacturing firms in Atlanta at the MAPI conference. That’s the Manufacturers Alliance for Productivity and Innovation.

I’ve been invited to talk about how Passive Investment profoundly shifts the center of gravity for the investor-relations profession, liaison to Wall Street.

Glad to see these companies caring about their stock market.

And it’s not ESG causing the big shift.  Without offense to those advocating the hot ESG zeitgeist gusting globally, it’s yet another way for public companies to do qualitative work turning them into quantitative trading products.

You may not like that characterization. Well, scores are quantitative measures. Score something, and somebody will trade that score against another – exactly the way sports athletes are, or wine-rankings are, or restaurants on Open Table are.

Long-only investment is qualitative, like writing an essay.

Well, get this.  Active Investment is almost 50% higher in SPY, the S&P 500 ETF, than it is on average in stocks actually comprising the S&P 500.

Public companies, it means stock-pickers invest more in SPY than in the fundamentals of individual stocks. That is a statistical and irrefutable fact.

The problem isn’t you. The problem is the market. 

SPY has a 50-day average of 1.2 million trades per day, and over $53 billion of daily dollar flow. TSLA alone comes remotely in range at $25 billion, half SPY’s colossus. AAPL is a distant third at $15 billion.

Public companies continue to do ever more to ostensibly satisfy what investors want.  And they’re buying SPY.

If the SEC persists in implementing regulations with no precedent legislation – which will mark a first in American history – soon you’ll face mandatory climate disclosures.

So, from the Securities Act of 1933 implementing reporting rules for public companies, through 2022, the amount of information issuers are required to disgorge has become a sandstorm right out of the movie Dune. 

And investors are just buying SPY.

That should exercise you, public companies.  You bust your behinds delivering financial results, blowing sums of Congressional proportion populating the fruited plain with data.

And investors just buy a derivative, an ETF with no intrinsic value or story or results.

Years ago we studied the SPY data, measuring creations and redemptions and trading volume in the world’s largest ETF. We found that 96% of it was arbitrage – aligning SPY with the basket of 500 stocks it tracks.

But because the amount of Active Investment is significantly greater in SPY than the average one of those 500 stocks, we know stock-pickers well outside the S&P 500 are simply using it as a proxy for bottom-up investing too.

So, what should we do as a capital-markets constituency? 

The first rule of holes is when you’re in one, stop digging.  If we want to dig something in, how about our heels?  The entire contingent of public companies should rise up and tell regulators to pound sand.

That you will no longer comply with any further disclosures until the SEC makes markets more hospitable to the investors we work our fingers to the bone to court.

Because it’s not working. 

Why?

The SEC has overridden the stated purpose of the law that created it – notwithstanding that Congress had no Constitutional authority to regulate financial markets in the first place because the states never delegated it by amendment to federal government – which is to foster free, fair and unimpeded capital markets.

Instead the SEC decreed that the purpose of the market would be a continuous auction. Creating prices. And so investors are forced to own things with enough prices to permit them to get in and out.

For stupidity, it’s right up there with Will Smith slapping Chris Rock.

But we’ve got ourselves to blame. Public companies have not cared enough about the market to even pay attention to how it works. So we have a market that sets vast numbers of prices but impairs investment.

If you want to know how the stock market works, use our Market Structure Analytics for a year.  See what really happens. Then you can fight back. Maybe you’ll be moved to storm the regulatory Bastille and bring an end to this aristocratic crap.

That would be weirdly and wildly and wonderfully beautiful.

Rise and Fall

The stock market last week posted its best day since 2020 and gave it back.

Why?

And why does your stock rise while another falls, and how do stocks trade today?

I’m glad you asked!

A week ago on Feb 23, the market moved clear of February derivatives-expirations.  Stocks surged. Then index futures expired Feb 28. Stocks swooned (the event isn’t neat but spills over the vessel either side).

The mechanics of those moves are forms of arbitrage. There are two parties to both, and at least one hedges exposure, compounding both market volume and volatility.

Tim, it’s Ukraine, you say.

Has your investment plan changed?

In my adult life, never have TV images of invading forces been other than Americans.

Hm.

All money tracking a benchmark or model depends to some degree on futures contracts. Using futures, passive money transfers responsibility for holding the right components in the right amounts at month-end to banks.

Banks like Goldman Sachs in turn mitigate exposure by buying, selling, shorting, stocks.

That tumult just happened.

Ukraine? The Federal Reserve? War? Inflation? Earnings?

Illustration 67216931 © Thelightwriter | Dreamstime.com

Risk and uncertainty affect markets, yes. But gyrations aren’t the juking and jiving of investors. It’s hedging and arbitrage.

(Editorial note: For more on that topic, here’s a list from The Map).

What you get from your stock exchange daily, public companies, is the same wherever you’re listed. It’s peer, sector, industry, performance; broad measures, market commentary, the dollar, gold, oil. Now maybe crypto. When appropriate, stuff on wars and rumors of wars.

Same that I received as an investor-relations officer in 2001.  Why no change? No reason. No one cares.

Anyway, it’s only possible for your stock to behave the same as your peers if the characteristics are the same. Liquidity, supply, demand, behavior.

CEOs think, “My stock’s down, my peer is up, investors are buying them, not me.”

The math says no. The stock market is like every market. There are supply-chain disruptions. Demand fluctuations.

The average trade-size in S&P 500 components last week was 98 shares – less than the regulatory minimum bid or offer of 100 shares, lowest we’ve marked. So prices are unseen till afterward.

If a market order – a trade without a price – is 100 or fewer shares, the law of the stock market says it must be filled. Now.

So. Either the broker receiving the trade can automatically route it away to somebody else, or they’ve got to buy or sell the stock.

Don’t ponder the risk implications. Your head will explode. Stay with me here.

It gets to why the stock market does things you don’t expect, why your stock doesn’t trade as you suppose.

That trade I just described? It’s filled even if no actual buyer or seller exists (part of the reason you can’t track what sets your price with settlement data. Doesn’t work anymore.).

It’s the law. Market-makers are exempt from locating shares to short.

The machines, the algorithms, are programmed to know this fact. They change the price.

Tim, I don’t get it. What are you saying?

That it’s most times not about you. And you should know what it IS.

Your CEO asks, “How come our stock was down and so-and-so, our closest peer, was up? What investor is buying them and not us?”

Statistically, 90% of the time it’s supply/demand or liquidity differences and not some investor picking your peer.

Last week in the S&P 500, the average stock traded 60,000 times daily, up 50% from long-term averages.  Intraday volatility – spread between high and low – was 3.6%.  Average dollars/trade was $17,000 and index stocks traded $1 billion daily.

The median is about $9,000/trade. To be in the top thousand marketwide, where 95% of the money is, you’ve got to trade $4,200 at a time.

Back up 200 days and it was $5,000.

You got that, IR people? It speaks to what investors can BUY. Or sell. What are your stock’s liquidity characteristics?

The best three S&P 500 stocks the past five days:

ETSY the last five days: 130,000 trades/day, $9,000/trade, dollars/day, $1.2 billion. Computerized speculation led gains, and Demand was bottomed, Supply was extreme and created a short-squeeze.

ENPH:  66,000 trades/day, $8,000/trade, dollars/day was $530 million. Computerized trading led ENPH too. Demand was bottomed, Supply was on trend.

MOS: 90,000 trades/day, $6,000/trade, dollars/day, $530 million. Active Investment was the lead behavior, and Demand rose while Supply fell.

Wouldn’t you want to know this stuff? We have more, including all the trends.

Why isn’t every public company measuring these data? Dunno. Mystery.

But. We’re going to democratize it. All public companies can and should know these data, and we’ll open that door.  Stay tuned.  

Cliffside

I took a screenshot yesterday at 2:22pm, on Feb 22, 2022. 

Sign from God? Turning point? Hogwash?

Those are better than most proffered reasons for the stock market’s moves.

Lately it’s been delivering pain. Blame goes to Ukraine, where the Gross Domestic Product of about $155 billion is 40% of Apple’s 2021 revenue. Way under Denver’s $200 billion GDP. A tenth of Russia’s.

Illustration 45324873 © Iqoncept | Dreamstime.com

Ukraine is not destabilizing global stocks. Numbers help us understand things.  The numbers don’t add up, without offense, for Ukraine.

So, why are stocks falling? Answering why is like explaining what causes earthquakes: We understand they’re products of mathematical facts insinuated into our dirt.

Well, mathematical facts shape equity markets too, and the construction emanates from the USA and its 40% share of the total global equity market.

Anybody remember the Flash CrashFlash orders?  Books were written. Investigations convened.  Congressional hearings held.  MSM’s good friend Joe Saluzzi was on CBS 60 Minutes describing how the stock market works.

We seem to have forgotten. 

Now the Department of Justice is probing short-selling.  The SEC is investigating block trades.

For God’s sake.

The block market that should be investigated is the off-market one where Exchange Traded Funds are created in huge, swapped block trades of stock without competition, taxes, or commissions. The SEC is fine with that. Approved it.

The short-selling needing investigating is the market-maker exemption from short-locate rules that powers the stock market.  Academic studies claiming clouds of short-selling around big declines lack comprehension of how the stock market works.

The SEC knows how it works. I doubt the DOJ does. 

Everybody wants to find that volatility springs from nefarious intent. Greedy people. Cheats.

No, it’s the rules. The SEC publishes data on cancelled trades – legal spoofing.  That’s the MIDAS system, built for the SEC by a high-frequency trader.

People have gone to jail for what’s a fundamental fact of market function. The truth is, most orders are cancelled.  How can you parse what’s legal or not when the market is stuffed with behaviors that if separated by label or exemption move from illegal to legal?

Something should be wrong, or not.  Don’t lie. Don’t steal. Don’t cheat.  The Ten Commandments are simple.

When you say, “Don’t cheat – unless you’re a market-maker,” your stock market is already a disaster in the making.  People won’t understand why prices go up or down.

Here’s some math.  The average trade-size in the stock market – shares trading hands at a time – is down more than 50% since 2016.  It dropped 10% just in the past 200 days in the S&P 500.

The average S&P 500 stock trades 100 shares at a time, data ModernIR tracks show. That’s exactly the regulatory minimum for quoting a bid or offer.

Meanwhile, the number of trades daily is up more than 20% from a 200-day average of 40,000 trades daily per S&P 500 component to nearly 50,000 in the last five trading days.

Oh, and roughly 48% of all stock volume the last five days was SHORT (vs about 45% 200-day average).

And the DOJ is investigating short-selling.

Combine stocks and ETFs and 90% of trades are cancelled. Over 90% of all short-selling is sanctioned, exempted market-making – firms making stock up out of thin air to keep all those 100-share trades happening.

The DOJ is searching for a private-sector speck while a beam protrudes from the all-seeing government eye.

Do we want a stock market that gives you 100 shares that might not exist? Or a stock market that reflects reality?  People don’t even know.  You can’t have both.  The SEC simply hasn’t explained to anybody this Hobson’s Choice.

The principal stock buyers and sellers embed their computers in every tradable market on the planet, and all the machines share instant information. They’re 50% of volume. That’s why equities rise and fall in relative global uniformity (not perfectly – there are always asymmetries to exploit).

Machines identify breakdowns in supply and demand and magnify them. Stock exchange IEX made famous by Michael Lewis’s book Flash Boys calls it “crumbling quotes.”  The stock market becomes like California cliffsides.  It…dissolves.

Investigations are wasted time.  Constant scrutiny of headlines and fundamentals for meaning behind the market’s moves is mostly pointless.

I’m not saying nothing matters. But the central tendency, the principal answer, is market structure.

I could also say math signals gains next, and also says stocks are down because momentum died in Jun/Jul 2021. Another story.

There’s just one thing wrong with the stock market.  Its singular purpose is the perpetuation of continuous activity.  When activity hiccups, the market crumbles like a California cliffside.

The rest is confusing busy with productive.

And that’s why if you’re a trader or public company in the stock market, and you don’t spend SOME time understanding how it works, you’re on that cliffside.

Uneven Market

My advice?

When the market gets tough, go sailing.  Heck, go sailing when stocks are soaring.  I recommend it.

If you missed the Market Structure Map, we were on hiatus the past two weeks whilst undulating via catamaran over azure seas along the Sir Francis Drake Channel, sailing the whole of the British Virgin Islands from Jost Van Dyke to Anegada.

This photo below is in The Bight where lies the famous Willy T at anchor, off Norman Island.  You can get used to bare feet, tides, the absence of time save the rising and setting sun.

Photo courtesy Tim Quast

I had time to read Raj Rajaratnam’s new book, Uneven Justice, mostly on the long flights there and back.  I lived for a year in Sri Lanka during college, from whence he hails.

You colleagues long in the capital markets will remember the 2009 arrest of the Galleon hedge-fund founder for insider trading. 

The book is repetitive, has some copy-editing shortcomings. But it’s a remarkable read and I recommend it.  If you like the HBO show Billions, you’ll appreciate the sordid conniving by the attorney for the Southern District of New York, Preet Bharara.

I’ve long thought insider-trading was a mushy “crime.” You may disagree. I think Rajaratnam does a creditable job establishing that he committed no insider trading, whatever one thinks of it.

(I understand the stock market and here’s my issue: All high-frequency traders are armed with material nonpublic information called proprietary data, from which they generate ALL their profits.  And investment, public and private, is a continuous pursuit of what others don’t know, or overlook. To criminalize subjective aspects while permitting the vast sea of the rest is nonsensical and cognitively dissonant.)

This isn’t a book review.  Read it and draw your own conclusions.  But Raj Rajaratnam’s jury could not comprehend how the stock market worked. 

Heck, the attorneys didn’t understand it! The judge didn’t understand it. 

Try explaining to a jury of moms and pops (I can’t tell you how many times I’ve gotten the blink-blink explaining a continuous auction market) how a hedge fund works, the buyside, the sellside, what drives trading decisions, interaction with investor relations departments and corporate execs, the bets and gambles on beats and misses at earnings, the relentless thrum of information everywhere.

The defense team presented vast reams of data illustrating how Galleon developed its investment ideas, all of which traced back to colossal volumes of trading records. The firm managed about $8 billion of assets but traded over $170 BILLION in a year.

The government took issue with 0.01% of trades that by Galleon’s math resulted in a loss. But the prosecution simply said, “This Wall Street billionaire who caused the Financial Crisis is a cheat, and these wiretap snippets prove it.”

Again, draw your own conclusions.  But it resonated with me because there’s a pervasive propensity in the stock market to choose the easy snippet over grasping how it works.

Take for instance the market’s struggle since Jan 5, when we left for Tortola and the trade winds.  The easy explanation is we caused it.  I mean, it coincided, right?

I’m joking but you get the point.

The prevailing trope is Tech stocks are falling as investors wrestle with when the Fed will hike rates.

Years of trailing data show no clear correlation between interest rates and how Tech performs. It’s not difficult analysis.  Check the ten-year data for XLK. Compare to your favorite measure for interest rates, such as DXY or GLD.

There IS, however, correlation between periods of strong gains for Tech, and subsequent pullbacks.  There are just three of those for Tech the past decade:  latter 2018 (spilling into 2019), the Pandemic (spring 2020), and late 2021 (spilling into 2022).

These data suggest that save for Pandemics, investors in retirement accounts get overweight equities and especially Tech, and they recalibrate, especially in the fourth quarter.

Consequences rise as Tech gets bigger and bigger and bigger. Recalibrations rumble through how Fast Traders set 60% of prices and how derivatives underpin 20% of market cap, and how Short Volume (the supply chain), surges or stalls.

And then it starts over.  At some point, it won’t, sure. But the cause will be larger than hypothetical interest-rate hand-wringing.

And public companies, it’s measurable. Take AAPL, world’s biggest stock. Between Oct 1, 2018 and Jan 29, 2019, AAPL was never a 10.0 on our ten-point Demand scale.  Between Feb 28-Apr 15, 2020, it was not a 10.0.

And now? AAPL last had ceiling-rattling 10.0 Demand Dec 16. It’s now a 2.6 and bottomed. Right on schedule.

These are the facts, and the math. Headlines are not. Keep that in mind as earnings kick off. You can do what you’ve always done, the easy course. Or you can be armed with facts and details.  We have them.