Tagged: Passive investment

Troubling Signs

Ahoy!

As you read, we are stopping in Charlotte en route to a 2pm arrival in Sint Maarten in the Caribbean.

Illustration 91269233 © Dharshani Gk Arts | Dreamstime.com

We saw the inflation print at 8.5%, plunging consumer confidence, rising credit risk, the supply-chain morass, and said, “Let’s flee to the sea.”

Okay, not really. We reset this sailing trip that vanished into the Pandemic.  Weirdly, we need no Covid test to see the sand and sea but for us citizens of the Land of the Free, we can’t get back in our OWN COUNTRY without one.

After being shot, boosted and afflicted with Covid in roughly that order.

We the People need to put the little despots in their places, power-seekers lording it over others without respect to math, science or common sense.  Untenable.  Unacceptable.

Back to market structure.  And monetary policy. 

Options expire this Good Friday short week, today and tomorrow. Trading is a tug of war between parties to expiring options and futures on Treasuries, currencies, interest rates, commodities, equities and bonds, and the counterparties with risk and exposure on the other side.

Don’t expect the market to be a barometer on investor-sentiment right now.

And new options trade Monday. Then counterparties square books Tuesday. Volatility derivatives expire Wednesday.

What will be apparent is if risk-taking is resuming.  I think Mon-Tue next week (Apr 18-19) are key.  Look, you can’t peg the day. Could be before, could be after.  But the market will either turn because investors and traders reset swaths of options and futures or we could get clocked.

No middle ground?

Broad Sentiment signals risk.  Might be a couple months away, or not.  Data going back the past decade that we track show that Broad Sentiment with a 90-day rolling read near 5.0 precedes a steep decline.

That’s about where it is.  History warns us.

What about the risk of recession?  Well, of course there’s risk.  Central banks globally exploded the supply of currency and shut down output. Nothing could be more damaging to economies.  Trying to remedy that catastrophe will take a toll.

And the Federal Reserve knows it and knows it must get interest rates back to a level that leaves room to chop them to zero to try to forestall an economic collapse. 

The Fed is motivated to stock up some ammo, not to “normalize rates.” The quickest way to do that is to lift overnight rates and start selling off bonds. If demand for bonds falls, interest rates rise.

That simple. And the Fed is wholly willing to put everything and everyone in jeopardy in order to give itself policy tools. 

I’m not opposed to raising rates. I’m opposed to low rates that devalue savings and purchasing power and encourage debt and consumption.

Impact on equities?  I think we’re seeing it already.  Passive Investment marketwide has fallen from 20.4% of trading volume over the trailing 200 days, to 18.8% now.

Doesn’t seem like much. But a sustained recession in demand from indexes, ETFs and quants will reduce stock prices.  Derivatives demand is down too, from 18% to 17.2%.

Mathematically, that’s an 8% long-term decline in Passive Investment, 4% drop in derivatives demand. Is a 12% reduction in real and implied demand meaningful?  

Absolutely.

So, it’s a matter of the degree of effect, and if or when that trend reverses.  A trend-change across the whole market is unlikely here at April options-expirations. 

How about earnings season?  Only if it’s a barnburner, which is improbable.

I think the best chance is June options-expirations, the next time big money can make meaningful changes to asset-allocations.  In between are Russell rebalances in May.

I’m neither bull nor bear. We’re data analysts. We track the trends.  There are troubling signs here.  Yes, they could dissolve again under the inexorable repetition of There Is No Alternative.

But if not, there’s a rough ride ahead.  So.  You will find us on a boat.  See you Apr 27.

Electric Jellyfish

There are four Pinthouse locations in Austin and Round Rock, TX.

We’ve not been to any of them but we’ve had their scrumptious hazy IPA beer, Electric Jellyfish.  It may be the world’s best.

And the stock market has been an electric jellyfish.

Illustration 234002321 / Electric Jellyfish © Rul Stration | Dreamstime.com

Let me explain, on this Groundhog Day (it’s 2/2/22!).  Jellyfish float on the currents.  They don’t propel themselves with purpose around the sea.  But an electric one probably would, except you’d never know where it was headed.

Substituting, the stock market floats on the currents, and if it was electric, it would propel itself around and you’d never know where it was headed.

Look, I’m joking to some degree!  We all make our living in the stock market.  And as Joe Walsh said, life’s been good to me.  Remember, the name of that album was “But Seriously, Folks….”

And the stock market has measurably predictive characteristics. So do jellyfish from the standpoint that ocean currents will tell you where they’ll go.  Currents drive both.

And it’s hard to fight the current.  Friday Jan 28 and Monday Jan 31 reflected the explosive role of futures contracts in the stock market, which in turn effectuate the epochal role of Passive money in stocks.

One thing leads to another (a good song by The Fixx but maybe the better version of one thing leading to the next is the great country tune by Hardy called “One Beer”).

Passive money follows a model. Fast Traders set the prices. 

Suppose investors are biased toward GROWTH. Those stocks get an outsized allocation in models tracking otherwise statistically predictable benchmarks like the S&P 500.

That in turn drives up the value of associated options contracts.  The notional value of traded put and call options exceeded the value of trading in the underlying stocks in 2021.

And that’s a further input into the value of futures contracts used by index and exchange-traded funds to match benchmarks.  They can transfer the risk of buying or selling stocks to banks through baskets of futures expiring the last monthly trading day.

All of that stuff compounds, driving values artificially high. If that current changes, markets can lose value at stunning speeds.

Jan 28 was the day before options contracts expired. Right before the close, stocks surged – as an electric jellyfish might.  Happened again Jan 31 as Dec-Jan futures contracts true-ups hit, and money reset to contracts lapsing the last day of February.

Last week, trading data we track showed investment declined about 12% in the S&P 500, while trading tied to derivatives that we call Risk Mgmt rose over 3%, Fast Trading 2%.

That’s the effect of futures contracts used by Passives – transferred to banks – and machines sifting the prices of stocks and derivatives and rapidly repricing both.

There’s another electric jellyfish datapoint here.  Short Volume, daily trading on borrowed or created stock, hit 49% of total market volume Monday Jan 31, the highest level we believe we’ve ever recorded in the S&P 500.

In a sense, the stock market went beyond electric jellyfish into the metaverse.  Banks tasked with truing up indexes had to buy gobs of stuff to make index clients whole after a tumultuous January.

That’s the implication.

And because there was very little stock for sale, Short Volume – the supply chain of the stock market – surged to accommodate it.

Market-makers can manufacture stock. They are required to make bids and offers even when no one is buying and selling. They’re exempt from rules requiring others to first locate shares.

We might say that banks prestidigitated stock to fill orders for derivatives.  Just made up shares to back instruments that might not get used.

I’m sure it’ll all work out.  Cough, cough.

And look, it might.  Weird things can occur, without apparent consequences.  But it all compounds.

At some point, all the screwy stuff we humans are doing to escape reality is going to bring us crashing back to earth. So to speak.  Monetary policy is artificial. The stock market is artificial. And now people are spending hundreds of millions of dollars on dirt that doesn’t exist, in the metaverse.

It was a terrific January 2022 for ModernIR as companies of all sizes sought us out for a grounding in the reality of data, a way to track the electric jellyfish.

And we can track it.  We can’t predict when it’ll stop working. We can predict that if you like IPAs, you’ll love Electric Jellyfish.

Passive Pitfalls

We’re back!  We relished upstate New York and Canandaigua Lake. 

If you’ve never been to Letchworth and Watkins Glen parks, put them on your list.  See photo here from the former, the Upper Falls there. Alert reader Deb Pawlowski of Kei Advisors, a local resident, said in pragmatic investor-relations fashion, “Beautiful area, isn’t it?”

Boy, indeed.

Letchworth State Park – Tim Quast

And it was month-end.  Companies were demolishing earnings expectations, a thousand of them reporting last week, sixteen hundred more this week.  Most big ones pile-driving views and guidance saw shares fall.

But how can that be?  Aren’t markets a reflection of expectations?

Tim.  Come on.  You buy the rumor, sell the news.

If that’s how you’re describing the market to your executive team and board…um, you’re doing IR like a caveman.  Rubrics and platitudes ought not populate our market commentary in this profession.

Use data.  Everybody else does (except certain medical-science organizations, but let’s just step lightly past that one for now).

Last week across the components of the S&P 500, Active Investment was up 0.0%. Unchanged.  Passive Investment – indexes, Exchange Traded Funds, quants, the money following a road map – fell 7%.  The use of derivatives, which should be UP during month-end when indexes use futures and options (quarterly options and monthly futures expired Jul 30) to true up tracking instead fell 2%.

No biggie? Au contraire.  A combined 9% drop in those behaviors is colossal. In fact, Passive money saw the steepest drop Jul 30 since Aug 3, 2020.

I’ll come back to what that means in a moment. 

Finishing out the Four Big Behaviors behind price and volume, the only thing up last week besides short volume, which rose to 45% Friday from a 20-day average of 44% of S&P 500 volume, was Fast Trading. Machines with an investment horizon of a day or less. Up 4%.

Think about all the economic data dominating business news.  The Purchasing Managers Index came in at 55 versus expectations of 56. Jobless claims unexpectedly jumped above 400,000.  Inflation came in hotter than expected at a seasonally adjusted 5.4%, annualized. Egads!

As Ronald Dacey in the Netflix series Startup would say, “You feel me?”

I’m just saying data abounds and so do reactions to it. Yet we talk about the stock market like it’s got no measurable demographics or trends driving it.

Well, of course it does!  Why is there not a single report Monday – except mine on Benzinga’s “Market Structure Monday” segment on the Premarket Prep Show – driven by data?

By the way, on Monday Aug 2, Passive Investment surged more than 14%. New month, new money into models.  The reason the market didn’t goose into the rafters was because it filled the giant Friday Passive hole I just described.

Broad Market Sentiment at Aug 2 is 5.4 on our 10-point market-structure scale of waxing and waning demand. That’s exactly what it’s averaged for more than ten years.  The market is not a daily barometer of reactions to data.  But it IS a reflection of what money is observably doing.

And what it’s observably doing to the tune of about 90% of all market volume is not picking stocks. The money follows models.  The money speculates. The money transfers risk. Because time is risk. The riskiest of all market propositions is buying and holding, because it leaves all the price-setting to stuff that’s much more capricious.

The least risky thing to do in the stock market is trade stuff for fractions of seconds, because your money is almost never exposed to downside risk. This is how Virtu famously disclosed in its S-1 that it made money in 1289 of 1290 days.  Stock pickers just want to be right 51% of the time.

What’s the lesson? Everything is measurable and trends manifest precisely the way money behaves.  It’s darned well time that boards and executive teams – and investors – understand the market as it is today.

Oh, and why is the Jul 30 drop in Passive money, the biggest in a year, a big deal? Because the market corrected in September 2020. The so-called FAANG stocks (FB, AAPL, AMZN, NFLX, GOOG/L) fell 35% in three days.

There is Cause. Then a delay. Then the Effect.  There is DEMAND and SUPPLY.  If DEMAND declines and SUPPLY rises, stocks fall.  In fact, those conditions uniformly produce falling prices in any market.

We measure it. Sentiment is demand. Short Volume is supply. 

So. The stock market is at 5.4. Right at the average. But if the supply/demand trends don’t improve, the market is going to correct.  Can’t say when. But the data will give us a causal indication.

If you want to know, use our analytics. We’ll show you everything!

Mean Plus

The stock market is high on tryptophan, hitting records.

Right ahead of Thanksgiving, 2020 looks to deliver the best November in 30 years.  We’re grateful!  You don’t expect it in a pandemic

Courtesy shutterstock

.  You’d think amid a plague we’d find bitcoin trading near $20,000.  Oh, sure enough.  Check.

Where is all the money coming from that’s pounding things to heights right along with real estate, speculative Electric Vehicle stocks from China with no revenue (NYSE:LI), and Elon Musk’s net worth (he is, however, putting people on the space station and recovering first-stage rockets for repeated use by landing them on a barge called “Of Course I Still Love You”)?

Here’s where it gets interesting.

Data from Morningstar, which reports monthly on fund flows, show US equity outflows in October near a monthly record of $46 billion, and over the trailing twelve months (TTM) topping $265 billion.

Active stock-pickers in US stocks have seen outflows of about $270 billion the past twelve months, including $35 billion in October.  The spread in Active versus totals reflects a small net TTM gain for Passive equity funds.

Bonds crushed it, adding over $500 billion TTM taxable and municipal assets.  But the biggie is the swing from Active to Passive across stocks and bonds, in total a $600 billion delta, with about $300 billion into Passive funds and out of Active ones.

Morningstar, always most conservative in gauging Active versus Passive assets, showed the latter overtaking the former in 2019.

Stripping data down, we’ve added a couple billion dollars, net, to US stock funds and hundreds of billions to bond funds, and the stock market is setting records.

You can’t say stocks are soaring on a flood of money. The data don’t support it.  Nor can one say it’s “stock-picking.” Those assets are down another $300 billion the past year, a 12-year-long trend.

So what’s doing it?  Clearly, something else.

To mark Thanksgiving last year, we presented Sentiment data in a piece called Blurry.  As we observed then, stocks have spent the majority of the past half-decade above 5.0 on our 10-point Market Structure Sentiment scale, averaging about 5.4.  That’s a GARP – growth at a reasonable price – market.

And son of a gun, Growth has outperformed Value.

In 2020, stocks have spent 62% of the time over 5.1/10.0 (GARP), and about a third of the time above 6.0/10.0, “Overbought” from a market-structure view.

Demand has exceeded supply. Yet we’ve just seen from Morningstar that money is flat in US equities. The inflows near $300 billion rushed not to stocks but bonds.

One thing so far is sure. Passive money will pay more for stocks than Active money. There are more Passive assets than Active ones now. Any net inflows go to Passive funds.  The average price for all stocks in the S&P 500 was about $127 a year ago. Today it’s about $146, up 15%.

Well, it can’t be stock-picking, can it.  And it’s thus circumstantially evident that Passive Investment is the reason why Growth has beaten Value.

It also explains the market’s relentless propensity to remain over 5.0.  That’s the mean.  Passive money tracks the mean. And, Passive assets are growing – so the outcome is Mean Plus, let’s call it.  A little better than the mean.

ModernIR data show two more factors contributing to these outcomes.  Fast Trading, machines pulverizing trade-size as intermediaries, are 54% of volume the past 200 days.

If your aim running algorithms is changing prices all day and finishing flat, and the market is 5.4/10.0, and Passive money is trying to peg the benchmark, what do you get?

A market that relentlessly rises.

It’s Mean Plus till the next time something like a Pandemic or a currency crisis, or something we haven’t thought of yet, rattles that cage.

Look, all of us want rising markets. It’s great for net worth.  But as we’ve been saying to public companies, you can’t continue to make My Story the principal explanation.  Somewhere in your quarterly board deck there’s got to be more than that.  I’ve just given you some good data.

Energy companies, this is what’s happened to you.  Back up 20 years and you were 15% of the market, even as we imported fuel.  Today amid US energy independence you’re 2.5% of the market.  AAPL is worth more than the whole sector. And AAPL is the most loved of all ETF stocks.

Investors, it’s why market structure matters.  It’s a Mean Plus market for now. We’re grateful this Thanksgiving for it.  But we might say a prayer for protection from its consequences too.

Flying Machines

While France roasts on both the heat of the US women’s soccer strikers and mother nature’s summertime glow, in Steamboat Springs Lake Catamount sits alpine serene, and it was 46 degrees Fahrenheit (about the same read in Celsius in France) on our early bike ride yesterday.

In the USA, we join figurative thankful hands with you across the fruited plain to mark this amazing republic’s 243rd birthday.  Long may the stars and stripes fly.

What’s flying in markets are a bunch of machines.

Joe Saluzzi, one of our marquee panelists at the NIRI Annual Conference last month, spoke to IR Magazine on how the market works and why investor-relations professionals need to educate themselves. As Joe says, much of your volume isn’t investment but trading. It distorts perceptions of real supply and demand.

Why does that matter?  Because your board, your executive team, your investors, see your stock as a barometer of fundamentals. You need to know when that’s true – and when it’s not.  Misunderstanding what the market is doing can lead to big mistakes.

What if your stock declines sharply with results and management believes it has miscommunicated key messages (and blames you)?

Suppose market structure shows Active money bought in the preceding two weeks – because you’ve been talking regularly over the quarter about what you’re trying to do strategically. Then before the call, they stop buying to pay attention to what you say.

The absence of what had been present will be patently apparent to Fast Traders. They will sell and short you.  Whoosh! The flying machines take you down.

Every IRO should understand, and observe, and report internally to the executive team and the board, the starkly apparent data demonstrating these facts. We have that data. For anyone traded in US markets.  Including your peers. And yes, you can see that data.

Story is vital, sure.  But the way we think about the influence of story, fundamentals, strategy, should be predicated on facts, not a perception diverging from reality.

Illustratively, CNBC ran a headline last Saturday reading “80% of the stock market is now on autopilot.”  Referencing a JP Morgan client note, the reporter said about 60% of assets are in passive indexes and Exchange-Traded Funds (ETFs), with another 20% following systematic strategies.

An aside, I think Morningstar is behind the curve on measuring the pervasive and endemic shift to passive in stocks. It’s not just assets under management but the composition of volume.

A WSJ article (registration required) last December describing the “herdlike behavior of computerized trading” also quoted JP Morgan officials estimating that 85% of market volume was something other than Active investing.

Those of you using our analytics know we track the facts with precision. Currently, it’s 87%, with just 13% of market volume the past week from Active investment.

Does it render IR obsolete?  Of course not!  Stop thinking your job consists of talking to investors.

That’s part of the job, sure. But IR is a strategic management function. Your job is to know what all the money is doing, all the time, and communicate important facts about trends and drivers to the board and executives so they’ll have realistic expectations.

And your job is to manage the market for your shares, which includes sorting out what’s controllable and what’s not, and providing important metrics on equity health and drivers around news, earnings, and non-deal road shows – and on a regular basis, proactively, as all good business managers do.

That’s IR today. The market is not full of “noise.” It’s full of flying machines, amazing sensors feeding back vital data to observers like us, who in turn help you take command of the equity-market battlefield as trusted strategic advisor to your executive team.

Ponder that with a cold beer (or a cold Rose from Provence!) and a flag this holiday week.  Happy birthday, USA!

Five Questions

Is less more?

This is the question anyone looking at the stock market as a barometer for rational thought – from stock-pickers to investor-relations professionals – should be asking.

A Wall Street Journal article yesterday, “Passive Investing Gains Even in Turbulent Times,” notes that $203 billion flowed to Exchange Traded Funds (ETFs) between September and January, while $167 billion went to index funds.

Most thought stock-pickers would win assets during volatility. So let’s ask another question. From where did the money come?  Morningstar, the WSJ says, shows $370 billion – the same figure – left stock-picking funds from Sep 2018-Jan 2019.

Here’s a third question: What sets prices for stocks?

If you move money from savings to checking, total value of your bank accounts doesn’t gyrate. Should we be asking why moving money from stock-pickers to indexers would be so violent?

I’ve got one more question for IR practitioners before we get to answers: If stock-pickers are seeing net redemptions – money leaving – what should we expect from them as price-setters in stocks?

Okay, let’s review and answer:

Is less stock-picking worth more?  What sets stock-prices? Where did the money going to ETFs and indexes come from? Why did the market move violently these last months? And finally, what should we expect from stock-pickers as price-setters?

Less is not more.  I’m reminded of a line from a professional poker-player who taught poker to a group of us.  He said, “People who chase straights and flushes borrow money to go home on buses.”

The point is that hoping something will happen isn’t a strategy. Hoping stock-pickers, which have lost trillions to passive investments over the past decade, will set your price more is chasing a flush.

We teach our clients to cultivate a diverse palette of those shrinking Active Investment relationships so an Active force will be present more frequently. We show them how to use data to better match product to consumer, further improving the odds.

But look, IR people: If stock pickers saw $370 billion of outflows, they were selling stocks, not buying them. Less is not more.

Stock prices are set by the best bid to buy or offer to sell. Not your fundamentals, or news or blah, blah, blah. What MOTIVATES somebody to hit the bid or the offer is most often that the price changed.

The investment category benefiting most from changing prices is ETFs, because they depend on an “arbitrage mechanism,” or different prices for the same thing.

(Editorial Note:  I’ll be speaking to the Pittsburgh NIRI chapter the evening of Mar 26 on how ETFs affect stocks.)

ETFs are not pooled investments. Blackrock does not combine funds from investors to buy stocks and hold them in an ETF.  ETFs don’t manage other people’s money.

ETF sponsors receive stocks from a broker as collateral, and the broker creates and sells ETF shares. Only the broker has customer accounts. The ETF’s motivation is to profit on the collateral by washing out its capital gains, leveraging it, selling it, investing it.

I’m trying to help you see the motivation in the market. The longer we persist in thinking things about the market that aren’t buttressed by the data, the greater the future risk of the unexpected.

The money that motivated ETFs to profit from changing prices September to January came from stock-pickers.

The market was violent because ETFs form a layer of derivatives in markets obscuring the real supply and demand of stocks. As stocks declined, the number of shares of ETFs did not – causing a downward cascade.

Then as money shifted out of stocks to ETFs, the supply again did not increase, so more money chased the same goods – and ETFs were a currency reflating underlying assets.

If no money either came into or left the market, and it was tumultuously up and down, we can conclude that the actual withdrawal of money from equities could be epic straight-chasing, everybody borrowing money to go home on buses.

We should expect stock-pickers to drive the market to the degree that they are price-setters. That’s 10-15% of the time. In this market riven with collateralized derivatives, you must know what sets prices.

Stock-pickers, if you know, you won’t chase straights and flushes. IR professionals, you’ll help your board and executive team understand the core drivers behind equity value. It’s your story only sometimes. They should know when it is – and when it’s not.

Much of the time, it’s just because your price changes (which ETFs feed). Ask us! We’ll show you the data behind price and volume.

Impassively Up

A picture is worth a thousand words.

See the picture here, sparing you a thousand words (for a larger view click here). It explains our rising stock market.  Look at the line graphs.  Three move up and down, reflecting normal uncertainty and change. Just one is up like the market.  Passive Investment.

Stock market behaviors

At ModernIR, we see the market behaviorally. There are four big reasons investors and traders buy and sell, not one, so we quantify market volume daily using proprietary trade-execution metrics to see the percentages coming from each and trend them.

Were the market only matching risk-taking firms with risk-seeking capital, valuing the market would be simpler. But 39% of volume trades ticks, gambling on fleeting price-moves. About 12% pairs stocks with derivatives, down from over 13% longer term.

Less than 14% of trading volume ties directly to corporate fundamentals. So rational thought isn’t pushing stocks to records. In a sense that’s good news because most stocks don’t have financial performance justifying the 20% rise for the S&P 500 the past year.

Alert reader Alan Weissberger sent data from the St Louis Federal Reserve (click the “1Y” button at top right) showing falling corporate profits the past year. To be sure, profits don’t always connect to markets or the economy. There were rising corporate profits during the 1970, 1991 and 2001 recessions.

And corporate profits were plunging in 2007 when the Dow posted its second-fastest 1,000-point rise in history (the one from 22,000-23,000 just now is the third fastest, and both trail the quickest, in 1999 when profits were likewise falling).

Now, I’ll qualify: This picture reflects a model. Eugene Fama, the father of the Efficient Market Hypothesis, said models aren’t reality.  If they explained everything then you would need to call them reality.

But the market as we’ve modeled it with machines that bring a taciturn objectivity to the process has been driven by the sort of money that views fundamentals impassively.

You might think it surreal that 36% of volume derives from index and exchange-traded funds and other quantitative investment. Yet it makes logical sense. Blackrock and Vanguard have taken in a combined $600 billion this year says the Wall Street Journal and the two now manage nearly $12 trillion that’s largely inured to sellside analysts and your earnings calls, public companies.

And the number of public companies keeps falling, down a third the past decade. I suspect though no one has offered the math – I will buy a case of our best Colorado beer for the person with the data – that total shares of public companies (all the shares of all the companies minus ETFs and closed-end funds) has also fallen on net, 2007-present.

There you have it.  Money that simply buys equities as an asset class sliced in various ways is doing its job.  But it becomes inflation – more money chasing fewer goods. Wall Street calls it “multiple expansion,” paying more for the same thing (current Shiller PE is the highest in modern history save the dot-com bubble).

And because passive money like Gene Fama’s models doesn’t ask whether prices are correct and merely accepts market prices as they are, there’s no governor, no reasoning, that prompts it to assess its collective behavior. So as other behaviors drop off, passive money becomes the dominant force.

In that vein, look at Risk Mgmt. It reflects counterparties to investors and traders using options, futures, forwards, swaps and other derivatives to protect, substitute for or leverage stock positions. The falling percentage suggests the cost of leverage is rising.

It fits. A handful of banks like Goldman Sachs dominate the business. Goldman’s David Kostin publicly expressed concern about market values. Kostin says the stock market is in the 88th percentile of historical valuations. If banks think downside risk is higher, the cost of insuring against it or profiting on rising markets increases.

Where in the past we worried about exuberance, we should be equally wary of the impassive face of passive investment that doesn’t know it’s approaching a precipice.

I don’t think a bear market is near yet but volatility could be imminent. By our measures the market has not mean-reverted since Sept 1. It suggests target-date and other balanced funds are likely overweight in equities. When it tries to rebalance, we could have severe volatility – precisely because this money behaves passively. Or impassively.

Realistic Expectation

How do you set realistic expectations about your shares for management?

I’ll give you examples.  One of our clients had a cyberattack and disclosed the impact, a material one degrading expected quarterly results.  What to expect?

Shares are up on strong volume.

That’s great but it makes execs scratch their heads. And the reverse can happen.

“The division heads tell their teams that growth will translate into share-price gains,” the investor-relations director told me. “They deliver, and the stock goes down 7%.”

I was having this conversation in Silicon Valley.  In fact, I had it twice the same day.

It illustrates a market transformation affecting investor-relations and investors. Fundamentals cannot be counted on to drive corresponding shareholder value.  Active stock-pickers and IR professionals have been slow to adapt, harming outcomes for both.

I was at the whiteboard in a conference room with another technology IR head, who was comparing revenue and margin drivers for his company and its key peers.

“How do I get these numbers to translate into the share price?” he said.

“You’re making the job harder than it has to be today,” I said. “And you might create unrealistic expectations from management for IR and for the company.”

There’s one more implication (we’ll answer them all before we wrap). Things like stocks behaving unexpectedly shouldn’t be ignored or glossed over.

For example, we found water dripping from the air-handler housing in the basement for the central air-conditioning system at our house. Great timing. July.

We could say, “Huh. That’s not what we were expecting.” And go on about what we’re doing.  But that’s a poor strategy, leaving us open to bigger troubles ahead.

When your stock doesn’t act as you expect, it’s water dripping from your air-handler, telling you, IR folks and investors, you’re missing something vital about the market.

Admit it.  Most of us know the market has got a drippy coil. But we go on with what we’ve been doing. We’d rather ignore the leak in the basement than address it.

For whom is that bigger trouble?  Your management team, IR. And your returns, investors. We should change what we’re doing, and revise expectations.

“I don’t want expectations for our stock,” you say. Would a board hire a CEO candidate who said, ‘Don’t expect anything from me’?

Back to our examples. In the cyberattack, Active money bought the news (bad clarity trumps okay uncertainty) but passive investment drove subsequent gains. The IR head appropriately differentiated the two and set expectations about trends and drivers. That’s good 21st century IR.

In the second example, don’t let the notion that growth will drive appreciation become an unmet expectation. Growth may boost the stock. But the IR Officer can go on the offensive with internal presentations showing how the market works and what role Story plays in setting price.

It’s up to IR to help management understand. If 80% of the time something besides Story sets price, doesn’t everybody internally have a right to know?  Don’t disillusion the team by letting incorrect expectations survive. That’s bigger trouble.

At the whiteboard with our IRO wanting to get the market to value results better, what about doing the opposite? It’s easier, less stressful, data-driven. Let the market tell YOU what it values. If 20% of the market values your numbers, measure when that 20% sets price. (We do that with Rational Price and Engagement metrics.)

Then measure how the rest of the money behaves that doesn’t pay attention to Story, and show your management team its trends and drivers. Now you’ll know when it’s about you, your management team will have data-driven views of what the money is really doing, and you, there in the IR chair, will have wider internal value.  And less stress.

That’s the right kind of realistic expectation.

What’s the market’s leaky coil? Two things.  Passive investment is asset-management, not results-driven stock-selection. Prices expand or contract with the rate of capital inflows and outflows for indexes and ETFs. You don’t control it. It controls you.

And over 50% of daily volume comes from fleeting effort to profit on price-differences or protect and leverage portfolios and trades (often in combo). It prices your stocks without wanting to own them.

And speaking of expectations, options are expiring today through Friday. It’s rarely about you when that’s happening. Set that realistic internal expectation (and stop reporting results the third week of each new quarter).

BEST OF: IR Power

EDITORIAL NOTE: Whew! It’s 11pm here in Orlando (this view just off the patio at Highball & Harvest, The Ritz, Grand Lakes), and NIRI National, the annual confab for investor-relations professionals, has wrapped. The bars at the JW Marriott and Ritz Carlton Grand Lakes are full of IR folks — wait, let me rephrase. Post-conference relationship-building is occurring. We’re all about guidance and message, you know.

This is IR Power. It doesn’t mean what you think in a market where Blackrock, Vanguard, and State Street alone have $11.5 trillion of assets ignoring corporate message and sellside research. I’ll give you our view of NIRI National 2017 (and our fact-finding junket in Key West) next week. For now, IR pros and investors, read this. It’s among our most important posts. Cheers from sultry central FL!

First run:  May 17, 2017

“What’s eye are?  I haven’t seen that acronym.”

So said a friend unfamiliar with this arcane profession at public companies responsible for Wall Street relationships.  IR, for you investors who don’t know, is the role that coordinates earnings calls and builds the shareholder base behind traded shares.

Investor Relations is a vocation in transition because of the passive tide sweeping investment, money that can’t be actively built into a shareholder base. Money in models is deaf to persuasion. The IR job is Story. The market more and more is Structure.

But IR underestimates its power. There’s a paradox unfolding in the capital markets.  I liken it to shopping malls and Amazon.  Used to be, people flocked to department stores where earnest clerks matched people to products.

We still do it, sure. But nowadays seas of cash slosh onto the web and over to Amazon without a concierge. It’s passive shopping.  It’s moved by what we need or want and not by service, save that Amazon is expert at getting your stuff in your hands well and fast.

“You were saying we underestimate our power,” you reply, IR pro. “How?”

You’ve seen the Choice Hotels ad?  A guy with an authoritative voice declares that the Choice people should use four words: “Badda-book, badda-boom.”

The advertisement is humorously stereotyping the consultants, high-powered and high-paid pros who arrive on corporate premises to, buttressed by credibility and prestige, instruct managers on what they must do.

Whether it’s marketing and communications or management like McKinsey & Co., they command psychological currency because of real and perceived credibility, and confident assertion.

Might these people be buffaloing us? There’s probably some of that. But the point is they command respect and value with authority and expertise.

All right, apply that to IR.  Especially now, with the profession in a sort of identity crisis. It’s become the ampersand role.  You’re head of IR &…fill in the blank.  Strategy.  Corporate Development.  Treasury.  Financial Planning & Analysis.  Communications.

The ampersand isn’t causing the crisis. It’s the money.  Bloomberg reporters following the passive craze say indexes and Exchange Traded Funds (ETFs) may surpass active stock funds soon for assets under management.

They already crush stock-pickers as price-setters.  Passive investment is nearly twice as likely to set your price every day as your story.  Buy and hold money buys and holds. Your story isn’t changing daily.  But prices are. Sentiment is. Macro factors are. Risk is.  These and more breed relentless shifting in passive behavior, especially ETFs.

And here’s the IR powerplay.  You are the authoritative voice, the badda-book badda-boom on capital markets internally. With the behavior of money changing, you’re in the best position to be the expert on its evolution. To lead.

If you were the management consultant, you would lay out a plan and benchmarks for organizational transformation. If you were the widget product manager, you’d be providing executives regular data on the widget market and its drivers. You wouldn’t wait for the CEO to say, “Can you pull data together on what’s happening with widgets?”

Sometimes IR people pride themselves on how management never asks about the stock.  If you’re the expert, silence is not your friend. Get out in front of this transformation and lead it.  Don’t let them watch the stock, but help them consistently measure it.

What set of vital facts about passive investment should your management team understand? If you don’t have answers, insist on the resources needed to get them.

Don’t be timid. Don’t wait for management to say, “We want you to study and report back.” It’s too late then. You’ve moved from the expert to the analyst.

Instead, set the pace. See it as a chance to learn to use analytics to describe the market.  Make it a mission to wield your IR power as this passive theme changes our profession.

And we’ll catch you in two weeks!  We’re off to ride the tides on the Belizean reef, a weeklong Corona commercial catamaraning the islands.  We’ll report back.

As we leave, Market Sentiment has again bottomed so stocks rose with Monday’s MSCI rebalances and probably rise through expirations Wed-Fri before mean-reverting again. How many mean-reversions can a bull market handle?

IR Power

“What’s eye are?  I haven’t seen that acronym.”

So said a friend unfamiliar with this arcane profession at public companies responsible for Wall Street relationships.  IR, for you investors who don’t know, is the role that coordinates earnings calls and builds the shareholder base behind traded shares.

Investor Relations is a vocation in transition because of the passive tide sweeping investment, money that can’t be actively built into a shareholder base. Money in models is deaf to persuasion. The IR job is Story. The market more and more is Structure.

But IR underestimates its power. There’s a paradox unfolding in the capital markets.  I liken it to shopping malls and Amazon.  Used to be, people flocked to department stores where earnest clerks matched people to products.

We still do it, sure. But nowadays seas of cash slosh onto the web and over to Amazon without a concierge. It’s passive shopping.  It’s moved by what we need or want and not by service, save that Amazon is expert at getting your stuff in your hands well and fast.

“You were saying we underestimate our power,” you reply, IR pro. “How?”

You’ve seen the Choice Hotels ad?  A guy with an authoritative voice declares that the Choice people should use four words: “Badda-book, badda-boom.”

The advertisement is humorously stereotyping the consultants, high-powered and high-paid pros who arrive on corporate premises to, buttressed by credibility and prestige, instruct managers on what they must do.

Whether it’s marketing and communications or management like McKinsey & Co., they command psychological currency because of real and perceived credibility, and confident assertion.

Might these people be buffaloing us? There’s probably some of that. But the point is they command respect and value with authority and expertise.

All right, apply that to IR.  Especially now, with the profession in a sort of identity crisis. It’s become the ampersand role.  You’re head of IR &…fill in the blank.  Strategy.  Corporate Development.  Treasury.  Financial Planning & Analysis.  Communications.

The ampersand isn’t causing the crisis. It’s the money.  Bloomberg reporters following the passive craze say indexes and Exchange Traded Funds (ETFs) may surpass active stock funds soon for assets under management.

They already crush stock-pickers as price-setters.  Passive investment is nearly twice as likely to set your price every day as your story.  Buy and hold money buys and holds. Your story isn’t changing daily.  But prices are. Sentiment is. Macro factors are. Risk is.  These and more breed relentless shifting in passive behavior, especially ETFs.

And here’s the IR powerplay.  You are the authoritative voice, the badda-book badda-boom on capital markets internally. With the behavior of money changing, you’re in the best position to be the expert on its evolution. To lead.

If you were the management consultant, you would lay out a plan and benchmarks for organizational transformation. If you were the widget product manager, you’d be providing executives regular data on the widget market and its drivers. You wouldn’t wait for the CEO to say, “Can you pull data together on what’s happening with widgets?”

Sometimes IR people pride themselves on how management never asks about the stock.  If you’re the expert, silence is not your friend. Get out in front of this transformation and lead it.  Don’t let them watch the stock, but help them consistently measure it.

What set of vital facts about passive investment should your management team understand? If you don’t have answers, insist on the resources needed to get them.

Don’t be timid. Don’t wait for management to say, “We want you to study and report back.” It’s too late then. You’ve moved from the expert to the analyst.

Instead, set the pace. See it as a chance to learn to use analytics to describe the market.  Make it a mission to wield your IR power as this passive theme changes our profession.

And we’ll catch you in two weeks!  We’re off to ride the tides on the Belizean reef, a weeklong Corona commercial catamaraning the islands.  We’ll report back.

As we leave, Market Sentiment has again bottomed so stocks rose with Monday’s MSCI rebalances and probably rise through expirations Wed-Fri before mean-reverting again. How many mean-reversions can a bull market handle?