Tagged: Short Volume

The Trouble

I don’t own cryptocurrencies or NFTs or other digital assets. Let me just offer that first.

But anybody, in any market, including the US stock market, should understand the risk of manufactured traffic.

I’ll explain.

You all know about the collapse at FTX, wunderkind Sam Bankman-Fried’s (he’s called SBF and I’m not sure it’s good to be known as an acronym) trading platform for content creators.

Photo 227837967 / Ftx © Zhanna Hapanovich | Dreamstime.com

I get how and why he wound up using his proprietary trading unit, Alameda Research, to support the exchange’s currency, a token called FTT. I don’t know if its fraud or foolishness. In any case, it’s unethical.

The reason I can wrap my head around at least some of what occurred is because of what’s happened in the US equity market, and how it works. 

Take Pipeline Trading. I wrote about it in 2011.  It’s gone away.

Reason? It was fined for trading against customer orders (editorial note: You can in fact know now if your shares trade at dark pools here at Finra, and from our partner for institutional analytics, PointFocal).

The fine didn’t bankrupt Pipeline but it led to a loss in confidence.  The market didn’t offer the liquidity it purported to have. Orders dried up, the market shut down.

Let me explain further.  At FTX, the hullabaloo is not just that it’s collapsed and gone bankrupt but that SBF’s proprietary trading unit might have been trading against customer orders, with customer funds held in the firm’s own tokens.

Not good.

For the record, many broker-dealers over the years have been fined in the US market by regulators for trading against customer orders. I wrote about it a long time back.

The problem isn’t that brokers take the other side of orders. It becomes a problem if customers don’t know it.  They think there’s more demand for their goods than really exists.

It’s like building a mall and leasing space to retailers. And nobody shows up.  You’ll do anything to drive traffic.

SBF wanted to establish FTX as global leader in digital assets. He needed a lot of customer interaction. And there was. So long as everything from NFTs to cryptocurrencies boomed.  Big traffic played a role in FTX’s $32 billion valuation.

But when a bear market developed in the metaverse, trading diminished, we can surmise.  Suppose customers were quitting or wondering if they needed to pull out of the mall.

I’m leaving out big details but follow me.

Enter Alameda Research.  What if we just…goose the market a little by demonstrating there’s a lot of liquidity, a lot of action here?

Reminder: This is what Pipeline Trading did. But not with customer assets.

We’re led to believe thus far that Alameda Research, the proprietary trader, may have used customer FTT tokens to prop up the market for digital assets at FTX.

Reminds one of the Federal Reserve using fake money to prop up the economy. Cough, cough. I digress.

The trouble is relying on stuff that doesn’t exist. There wasn’t enough customer demand for digital assets at FTX. That demand was coming from SBF.

And the market unraveled, and the tokenized medium of exchange at FTX collapsed.

The US stock market doesn’t use a token. So that’s good news. But it cannot function without proprietary traders taking the other side of customer orders.

You understand that, right? It’s not dissimilar to what was happening at Pipeline Trading except it’s sanctioned in the stock market.

Here’s what I mean.  Over half the volume in the stock market would not exist, save that it comes from proprietary traders, the equivalent of SBF’s Alameda Research. Exchanges are permitted under rules to pay them to buy and sell. They prop up the market.

Rather than using customer assets like SBF did, these same brokers are permitted by the SEC to create stock to use to trade against customer orders. 

I’ve explained it repeatedly but maybe this context will get the point across better.

No market of any kind can continuously offer buying and selling without some form of artifice and trickery. Physics don’t function that way. There isn’t always, at every split-second, a buyer and seller meeting. 

Without these two kinds of it in the stock market we’d have to go back to holding periodic auctions that line up supply and demand like a cattle auction.  Ranchers bring cattle. Buyers from Swift Amour and JBS show up and bid for the cattle.

You can’t manufacture cattle to fill cattle orders. But you can manufacture stock to fill stock orders because it’s electronic. Maybe every electronic market is subject to this risk, from cryptocurrencies to central-bank debt auctions.

Worth pondering.

I’m not saying the stock market will blow up like SBF. I’m saying it shares some DNA.  And every participant in it, from traders to investors to public companies, should understand that half the market’s volume just props up supply and demand.

It works out fine 99% of the time.

Short Story

Are traders shorting your stock?

There’s a good article in IR Magazine by independent board director Rosalind Kainyah on what she expects from the company’s IR team.  One data point: Comparative shorting for the company and peers.

The trouble is most Boards and c-suites think only about Short Interest. It’s a 1974 measure created by the Federal Reserve to track the use of margin accounts.  It’s not an SEC metric, let alone one suited to a market that’s 100% electronic, 97% algorithmic.

After the USA left the gold standard in 1971, financial-asset volatility exploded. The Fed feared it wasn’t accurately tracking the money supply. So it created Regulation T requiring a 50% margin in eligible accounts.

Short Interest reports twice per month were born. The measure hasn’t changed in 48 years.

Short Volume is a 2010 measure reflecting the SEC’s passage of a modified uptick rule called Regulation SHO Rule 201.  It defines certain restrictions on shorting stocks and it’s part of Regulation National Market System governing the stock market now.

What’s more, Short Interest is a consequence of Short Volume (there must first be shorted shares before there can be Short Interest). Why meter the consequence if you can measure the cause?

So that’s what we assess – in everything – at ModernIR, applying proprietary smoothing techniques reflecting market rules.  We’ve been tracking that data since Finra implemented regulations for brokers about reporting it.

We call Short Volume “Supply,” because it’s the stock market’s supply chain. That is, most large orders to buy or sell are in part or in whole facilitated by borrowed stock.

(EDITORIAL NOTE: The SEC wants a “continuous auction market” and so exempts market-makers from having to locate shares to short. If you want to know more, Google “SEC market-maker short exemption” and click “Key Points About Regulation SHO – SEC.gov”.)

Source: Market Structure EDGE Broad Sentiment data, Sep 20, 2022

When Demand is rising and Supply is falling, stocks rise. That condition manifested briefly when the market hit 2022 highs to end March, and again from June option-expirations to August options-expirations (SEE FIRST IMAGE).

The reverse punctuated the 2022 low for stocks into June options-expirations. That was a record high for Supply.

Until now. 

Currently, 52% of S&P 500 volume is short, borrowed. That means a minority, 48%, is stocks the buyers and sellers own.

Take a good look at the image.  Demand is decent, over 5.0 (baseline for rising prices). But the supply chain is overloaded.

Your Board and c-suite would no doubt like to know the Supply/Demand balance in your stock, your peers, your sector, industry. 

Speaking of adding value, the client-services team at ModernIR hosted a panel on using market-structure data in IR. Thank you, Clay Bilby, IR head at Palo Alto Networks (PANW), and Matt Garvie, VP IR at US Xpress (USX), for sharing your approaches.

While that panel was unfolding, I was in New York to present at the IR Workshop for the American Gas Association, and I focused on using data to engage the c-suite and Board. You can see a condensed version of my slides here.

Data is king. 

Back to the Short story, VIX options expire today with the whole market shorted, and Jay Powell hiking rates 75 basis points or more.

The market might rise, even so.

I’m not saying it’ll happen! But there will be effort by the parties who are NOT short to move the market in a way that mitigates risk.  It won’t surprise me.

The central tendency though is that a market with topping Demand well shy of historical tops that’s simultaneously the shortest on record will fall. 

We could take a drubbing.

It will be essential to watch the supply chain, Short Volume.

Unless and until those levels recede in a sustained and meaningful way, the bias of the market will be down.

And it doesn’t matter what the news is. Market Structure tells you what everyone thinks – longs, shorts, global macro, asset allocators, stock pickers, risk managers, all of it.

Everything occurring in the stock market rolls up into Demand, and Supply.

That same data in your stock will tell you ahead of results what’s likely to happen, no matter if you beat or miss.  It will tell you if investors buy your stock on non-deal roadshows. It’ll tell you who to call this week among your holders.

If the stock market rallies today, tomorrow, Friday, know it’s quicksand unless Short Volume comes down. Without a supply-chain change, the market will be lower a week from now than it is today.

Maybe a lot lower. That’s the short story.

Photo courtesy Tim Quast, Sep 19, 2022.

PS – And this second image is the view up 8th Avenue from W 43rd in New York City Monday Sep 19 from the 38th floor of the Westin. That tallest building is the latest Billionaires Row addition on West 57th. The penthouse is yours for $250 million.

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.

Most Important

The most important thing this week is gratefulness. 

We at ModernIR wish you and yours everywhere happiness and joy as those of us here in the USA mark a long and free tenure with Thanksgiving tomorrow.

Karen and I saw the Old South Meeting House in Boston, and the Exchange Building in Charleston last week.  For history buffs, it’s a remarkable juxtaposition.  The former gave root to the Boston Tea Party, the latter anchored South Carolina’s revolutionary role.

Mel Gibson’s character in The Patriot is based on Francis Marion, for whom a square and a hotel and much more are named in town.

Charleston, SC. Photo Tim Quast.

And on June 28, 1776, brave souls bivouacked at Fort Moultrie in Charleston Bay behind palmetto logs (why South Carolina is the Palmetto state) took shells lobbed from British warships that stuck in the soft wood and pried them out and fired them back, sinking two and disabling two more, and the Brits withdrew, the first defeat in a long war.

And the battle of Cowpens in Jan 1781 stopped the British in the south, cementing an American victory at Yorktown.

We walked miles and marveled at history on quaint sidewalks under live oaks. Also, we consumed unseemly amounts of grits, seafood and charming southern hospitality. We arrived concave and left convex.  Stay at the Zero George and dine there.

So, what’s most important to investor-relations officers, and traders, as we reflect this late November 2021?  While in Boston, I had opportunity to join a panel about alternative data for the Boston Securities Traders Association.

I told them I could summarize my twenty years of market structure with three words: Continuous auction market. At my advancing age, I think it’s the most important thing to grasp, because it gives rise to everything else.

I’ll explain.

In a continuous auction market, buying and selling are uninterrupted. It’s not really possible. At the grocery store, a continuous auction market would suggest the store never runs out of anything, even with no time for re-stocking. At least, in a declared amount.

Had you thought about that, IR folks and traders?  There isn’t a continuous stream of stock for sale. That condition is manufactured.

The SEC declared the stock market would never run out of at least 100 shares of everything.  Why? So the little guy’s trade would always get executed.  Consequences? It’s like that scene near the end of Full Metal Jacket where they huck a bunch of smoke grenades to go find the sniper.

The stock market is a confusing smoke cloud.  Let me give you some stats, and then I’ll explain what they mean. First, 70% of market volume in the S&P 500 is either Fast Trading, machines changing prices, or equity trades tied to derivatives.

So only 30% is investment. Yet over 40% of market volume is short – manufactured stock intended to ensure that 100 shares of everything is always for sale. So what’s fake is larger than what’s real.

Plus, 80% of all orders don’t become trades, according to data from the SEC.  And 60% of trades are less than 100 shares (odd lots).  The stock market is mist, a fine spray of form over substance.

What does this mean for all of us?  You can’t tell the Board and the executive team that investors are setting your price, IR people. Yes, it happens. But it’s infrequent. Most of your volume is the pursuit of something other than investment, principally price as an end unto itself (TSLA trades a MILLION times per day and moves 5.5% from high to low daily, on average).

And traders, it means technical signals work poorly.  They don’t account for how many prices are false, how much volume isn’t investment.

Thankfully, there’s a solution. If you understand the PURPOSE of the stock market – to create a continuous auction – then you can understand its behaviors and sort one from the other to see actual supply and demand.

Public companies, there is no other way to delineate Controllables from Non-Controllables. We can help. We’ve done the time, the thinking, the work, so you don’t have to.

And traders, you can trade supply and demand, rather than price.  Vastly more stable, less capricious, duplicitous, cunning.

I’m grateful to know that. And I’m grateful for rich and rewarding time on this planet. All of us have travails, trials. It’s part of life. But it’s vital to consider what’s most important. 

Happy Thanksgiving.

The Missing Wall

If your house was missing a wall, would you worry whether the front door was locked?

Well, the stock market is missing a wall. 

And yes, the image here is not a missing wall but the walls you can ski at Steamboat.

To our story, investors and public companies need to understand what it means to have a market with a gaping maw in its structure.  Imagine if you went around the house before bedtime shutting off lights, closing windows, locking the front door.

And a wall was missing.

That’s funny like The Truman Show.  Yet glaring structural flaws are no laughing matter.  For investor relations, the profession linking Wall Street to public companies, the job is keeping the house in order.

The lights and windows represent things long done to promote differentiators.  Earnings calls.  Non-deal roadshows (that means visiting holders without pitching a stock or debt offering). Analyst days.  Investor-targeting. Perception studies. On it goes.

You’d be surprised at the work and effort directed at these missions, you who are not in the profession.  We have an entire body of knowledge around the discipline of investor-communication, internally and externally.  Sums spent on tools and services and regulatory compliance and listing fees and so on total billions of dollars annually.

Keeping the house up is a full-time job. But the house is missing a wall. And too often the profession acts like everything is fine.

Evidence of it splashed again through the stock market yesterday. Rocket Companies (NYSE:RKT) slammed into at least three trading-volatility halts en route to a 71% gain.

It’s a great company.  CEO Jay Farner – I heard him on Squawk Box via Sirius Radio last Friday after results as I was descending from the Eisenhower Tunnel to Silverthorne off the Continental Divide – is so impressive. The cynosure of a prepared spokesperson.

And they’re a rocket, no doubt. RKT had $17 billion of revenue and $9 billion of net income, a 53% margin. Who knew selling loans was a more profitable business than selling data?

But.

That’s not what juiced RKT.  Sure, it was up Feb 26, up again Mar 1. But Active investment – the money focused on fundamentals – was 6.8% of RKT volume Mar 1.  So 93.2% of it was something else.

What’s more, Short Volume exploded at the very time rumors surged across the media that we had another Gamestop (GME) here, another “short squeeze,” now in RKT.

I’ll explain everything, so stay with me.

On Feb 19, Short Volume, the percentage of daily trading representing borrowed stock, was 29% of RKT volume.  By Feb 26 as the stock began to jump, it was 55%.

This is the draft you feel, public companies. This is the missing wall leaving you utterly exposed to what’s outside your control, no matter how much you spend, no matter the windows and doors you lock.

Investors, we’ll get to the meaning for you too.

There is only one way for a stock to rise.  Somebody sells stock at a higher price.  Not what you expected?  You thought I’d say, “Somebody must be willing to pay more.”

Yes. That’s true.  But suppose no owners want to sell, because they believe a mortgage company growing more than 100% year over year with 53% margins is a stock to hold.  And suppose the shorts don’t react.

Where does stock come from then?

Answer: That explosion in Short Volume we saw before the stock skyrocketed.

Somebody SHORTED the stock to make it available for sale at a higher price.  Sound cognitively dissonant?  It’s not. It’s called a “market-making exemption.”

We’ve written about it often before.  Read what we wrote on GME.

Truth is, most of the time when investors buy stock, somebody shorts it first and buys it back for the buyer.  At any moment, this can happen to any of you, public companies. And it doesn’t require high short interest – that 1975 measure still in use like a Soviet relic.

No, it can happen on belief. It can happen on nothing more than a machine-driven updraft.  And it could as easily be a downdraft.  What’s to stop market-makers from creating stock to SELL instead of buy? Correct. Nothing.

No matter what your story, your fundamentals, Fast Traders sitting in the middle can create shares out of whole cloth, because regulators have given them leeway to do so, and your stock can behave in unimaginable ways.

Public companies, if you directed 10% of what you spend on story and compliance to targeting Congress for a solution, we might shore up structure.

A solution starts with understanding the problem. And we do.  We can help you (and your board and c-suite).

Investors, your turn.  Market structure is to me the most important trading factor because it trumps everything else.  If you were modeling RKT market structure, you’d have seen the entry point Feb 22.

How many more situations like these will it take before we start looking at the missing wall? 

Sailing Away

Sailing takes me away to where I’ve always heard it could be just a dream and the wind to carry me.

Christopher Cross said it (youngsters look it up). In this pandemic we said, “That boy might have it figured out.”

TQ and KQ sailing

So, with two negative Covid tests in hand, we’re currently near 17 degrees North, 62 degrees West readying our 70-foot catamaran for a float with friends.  Chef, bar, crew, trade winds blowing our hair around, azure waters, sunrise, sunset. We’ll catch you after, Feb 8.

And in between, let’s have a look at the market.  The big buzz is GME, Reddit now dominating chatter with WallStreetBets (y’all can look that up too), the stock streaking, a push-pull among longs and shorts, and Andrew Left from Citron cannonballing into the discourse and an pool empty.

It may be a sideshow.  GME is up because Fast Trading, the parties changing bids and offers – shill bids, I call it – and buying retail volume surged from 38% of GME trading to over 57%.

At the same time, Short Volume, daily trading that’s borrowed, plunged from 47% to 34%. The funny thing is it happened AFTER the news, not before it.

The Reddit WSB crew has the sort of solidarity I wish we’d direct at being free. Nobody says to them the words “allow,” or “mandate,” and I love that.

But.

In a free stock market, your actions as traders are known before you make them.

That is, plow millions of limit orders into the market from retail brokerage accounts, and the firms like Citadel Securities buying them know before they hit the market.  They will feed the fire, blowing on the conflagration until it runs out of fuel.

And BBBY is up 50% in two weeks.  But it’s not the same, looking at market structure (the behavior of money behind price and volume in context of rules). Quantitative money plowing into BBBY to begin the year ignited the surge.

Could the actions of machines be misunderstood by humans?  Of course. Already the pattern powering GME has reverted to the mean.  In BBBY, Short Volume is up already on surging Fast Trading, the same machines we just talked about.

All but impossible is beating trading machines. They know more, move faster.

However, they are, paradoxically, unaware of market structure beyond fractions of seconds into the future.

Humans have the advantage of knowing what’s days out.  And on Fri Jan 29, the largest futures contract in the market comes due.  It’s designed to erase tracking errors. This is a much bigger deal than GME and BBBY but not as much fun.

Tracking errors are the trouble for Passive investors, not whether they’re “beating the benchmark,” the goal for Active stock-pickers.

A tracking error occurs when the performance of a fund veers from its benchmark.  The aim is generally less than 2%.  Yet S&P 500 components are 2.5% volatile daily, the difference between highest and lowest average daily prices. For those counting, daily average exceeds monthly target).

It’s why Passives try to get the reference price at market-close. But the market would destabilize if all the money wanting that last price jammed into so fleeting a time.  It would be like all the fans in Raymond James Stadium pre-pandemic – capacity 65,618 – trying to exit at the same time.

Congrats, Tom Brady. We old folks relish your indomitable way.

Like Brady’s achievements, everybody leaving RJ Stadium at once is impossible in the real world.

So funds use accounting entries in the form of baskets of futures and options.  ModernIR sees the effects.  The standard deviation between stocks and ETFs in 2019 was about 31%.  The difference reflects the BASKET used by the ETF versus ALL the stocks. To track that ETF, investors need the same mix.

Well, it’s not possible for everyone in the market to have the same quantity of shares of the components. So investors pay banks for options and futures to compensate for those tracking errors.  The more errors, the higher the demand for true-up derivatives.

In 2020, the average weekly spread rose to 71%, effectively doubling.  In the last eight weeks since the election it’s up to 126%.

The paradoxical consequence is that increasing volatility in benchmark-tracking is creating the illusion of higher demand for stocks, because options and futures are implied DEMAND. 

And so we’re

sailing away. You guys hold the fort. Keep your heads down.  We’ll catch you after the last Antigua sunset.

Deal Art

The Federal Reserve’s balance sheet is 185 times leveraged, and DoorDash’s market cap is $50 billion.  I’m sure it’ll all work out.

Image courtesy Amazon and Showtime.

In some ways the Fed is easier to understand than DoorDash. It’s got $7.2 trillion of liabilities and $39 billion of capital.  Who needs capital when you can create money? The Fed is the intermediary between our insatiable consumption and the finite time we all offer in trade for money.

Speaking of money, DoorDash raised over $2.4 billion of private equity before becoming (NYSE:DASH).  For grins, recall that INTC’s 1971 IPO raised $6.8 million.  Thanks to the Fed’s approach to money, it would be worth at least seven times more today.

Really, it says the 1971 dollar is about $0.14 now.  I suspect it’s less still, because humans find ingenious ways to offset the hourglass erosion of buying power running out like sand.  (And INTC’s split-adjusted IPO price would be $0.02 per share rather than the $23.50 at which they then were offered.)

I’m delighted for those Palo Alto entrepreneurs at DASH who early on both wrote the code and delivered the food. And the movie Layer Cake declared that the art of the deal is being a good middleman.  DASH is a whale of a fine intermediary.

As is Airbnb.  The rental impresario is worth $75 billion. Not bad for sitting in the middle.  ABNB is already in six Exchange Traded Funds despite debuting publicly just Dec 10.

Funny, both these intermediary plays are most heavily traded by…intermediaries.  Both in early trading show 70% of volume from Fast Traders, machines intermediating market prices.  More than 50% of daily volume in each thus far is borrowed too.  That is, it’s not owned, but loaned.

ABNB is trading over 22 million shares daily, over 330,000 daily trades, and 54% of volume is borrowed. DASH is averaging 110,000 trades, 9.4 million shares of volume.  And through yesterday, 57% of those shares, about 5.4 million daily, were a bit like the money the Fed creates – electronically borrowed from nowhere.

How? High-speed traders constructing the market’s digital trusses and girders daily like Legos get leeway as so-called market-makers to trade things that might not exist in the moment, if the moment demands it for the sake of stability.

Do you follow?  When the Fed buys our mortgages, it manufactures money. It’s an accounting entry.  Trade banks $200 billion of electronic bucks residing in excess reserves for the mortgages the banks want to sell, which in turn become digital assets on the Fed’s balance sheet. The country didn’t raise that cash by borrowing or taxing.

Pretty cool huh?  Wish you could do that?  Don’t try. It’s fraud for the rest of us.

Anyway, traders can do the same thing, earning latitude to make liquidity from stock marked “borrowed,” so long as the books are squared in 35 days.

And here’s the kicker.  ETFs are intermediary vehicles too.  Man, this art of the deal thing – being a good middle…person – is everywhere.

ETFs take in assets like ABNB shares, and issue an equal value of, say, BUYZ, the Franklin Disruptive Opportunities ETF.  They manage the ABNB shares for themselves (tax-free too). And you buy BUYZ in your brokerage account instead.

Got that?  ETFs don’t manage any money for you. Unlike index funds.  They sell you a substitute, an intermediary vehicle, called ETFs.

Franklin used to be an Active manager. Key folks there told me a couple years ago that unremitting redemptions from active funds had forced them into the ETF business.

One of them told me, paraphrasing, it’s a lot easier running ETFs. We don’t have to keep customer accounts or pick stocks.

You need to understand the machinery of the markets, folks. And the Grand Unified Theory of Intermediation that’s everywhere in our financial markets nowadays.

It’s the art of the deal.  And reason not to expect rational things from the stock market.

If 70% of the volume in ABNB and DASH is resulting thus far from machines borrowing and trading it, and not wanting to own it, valuations reflect the art of the deal, intermediation. Not prospects (which may be great, but the market isn’t the barometer).

Same thing with ETFs.  The art of the deal is exchanging them for stocks.

The Fed? The more it buys, the more valuable debt becomes (and the less our money is worth). So that’s working too.  Cough, cough.

Here’s your lesson, investors and investor-relations folks. You cannot control these things. But ignore them at your peril (we always know the facts I shared about DASH and ABNB). All deals with intermediaries need three parties to be happy, not two.  And one always wants to leave.

In Control

What can you control?

Courtesy IEX

It’s a question largely abandoned in the modern era under the assumption humans can control everything.  Arrogance often precedes experience-induced humility.

But we’re talking specifically about the stock market.  Public companies. Share-performance.  Investor relations. What’s within your sphere of influence?

There’s a big difference between your capacity to drive shareholder value rationally in a quantitative market – and the value you provide internally to your board and executive team about what depends on story, and what turns on the product, your shares.

I’ll talk in practical terms about it Thursday at the NIRI Chicago 2020 IR Workshop, the first virtual edition. Join us for the event! I’m on about 1:30pm ET Thursday the 24th.

Market structure plays a key role.  Supply and demand affect stocks the same way they do products in any market. Yet the supply of product – shares – is almost never a consideration for public companies and investor-relations professionals, who suppose that telling the story to more investors will create volume and drive the price up.

Our friends at IEX here explain the difference between volume and liquidity (and we described liquidity and volatility last week). The more parties between the sources of supply and demand, the more volume compounds (especially with derivatives, leverage via borrowing, Exchange Traded Funds).

But volume doesn’t create more supply of the product.  This by the way is how stocks soar and lurch today (we touched on it last week).

SHOP, the big Canadian e-commerce company, saw shares plummet about 30% in a week on a share-offering. The stock then skyrocketed yesterday.  Shares were trading near $1,140 to start September, fell to $850 after the news, and were near $960 yesterday.

Rational thought?

No, supply and demand. SHOP is the 7th most liquid stock in the US market (a reason why we cluster it with close cousins the FAANGs). In fact, supply is so tight in SHOP that it depends on borrowed stock.

Most times stocks with high short volume – borrowed shares – underperform the market.  Shorting adds supply to the market.  If demand falls, short volume weighs on price.

Short volume is at a basic level rented inventory. Traders who deal shares in fractions of seconds rent stocks to sell to others, profiting on the differences in price.  At some point before the close they buy it back and return it, aiming to make more getting between buyers and sellers – see the IEX video – than they spend renting stocks and covering that borrowing.

In SHOP, the demand has been so great that even high shorting isn’t dragging the price down. They’re an outlier, and edge case (and that data clearly indicate they can afford to continue issuing stock, by the way). There’s more to be made trading SHOP every day than the cost of constantly covering borrowed shares.

Disrupt that supply chain with a stock offering and the whole SHOP market for shares shudders.

That’s why it’s essential for investor-relations professionals to help executives and boards understand what’s controllable.  If your market capitalization is less than roughly $4 billion, you’re outside where 95% of the money plays, which is in the Russell 1000.

You can either get bigger and get into the top thousand, come up with something that makes you a screaming growth play that’ll compound your trading and limited liquidity into $4 billion of market cap – or set realistic internal expectations for your team.

Data can help you make a difference with your liquidity. Use it to time your outreach to investors. Aiming to attract buyers when it’s 62% short – unless you’re SHOP – is wasting time. Wait till liquidity improves.

I’ll use a great example to kick off the Chicago discussion tomorrow. And if you’re on hand live and we have the data, I’ll tell you your liquidity ranking.

Bottom line, IR should be captaining liquidity. You’re the chief intelligence officer. Supply and demand determine your price. Know your liquidity.  Ask us, and we’ll help.

The Little Short

In Michael Lewis’s The Big Short, a collection of eccentrics finds a flaw in real estate securities and shorts them.  The movie is great, the book even better.

Somebody will write a book about the 2020 stock market (anyone?) flaw.

The flaw? Depends who you ask. Writing for Barron’s, Ben Levisohn notes ZM is worth more in the market on $660 million of sales for the quarter than is IBM on $18 billion.

TSLA is up a thousand percent the last year, sales are up 3%. NVDA is trading at a hundred times quarterly revenue. AAPL is up 160% on 6% sales growth.

I know a lot about fundamental valuation after 25 years in investor relations. But 20 of those years were consumed with market structure, which our models show mechanically overwhelms fundamentals.

Why is market structure irrational?

Because most of the money in the market since Reg NMS isn’t rational. And still investor-relations professionals drag me to a whiteboard and sketch out how the performance of the stock – if it’s up – can be justified by prospects, or if it’s down is defying financials.

Market structure, rules governing how stocks trade, is agnostic about WHY stocks trade. The flaw is process has replaced purpose. Money inured to risk and reality can do anything. Just like government money from the Federal Reserve.

And yet that’s not what I’m talking about today.  The market is the Little Short.  Nobody is short stocks. I use the term “nobody” loosely.

Let me give you some history.

First, ignore short interest. It’s not a useful metric because it was created in 1975 before electronic markets, ETFs, Reg NMS, Fast Traders, exchange-traded derivatives, blah, blah. It’s like medieval costumes in Tom Cruise’s redux of Top Gun. It doesn’t fit.

After the financial crisis, rules for banks changed. The government figured out it could force banks to own its debt as “Tier 1 Capital,” and the Fed could drive down interest rates so they’d have to keep buying more.

Voila! Create a market for your own overspending. The Basel Accords do the same thing.

Anyway, so big banks stopped carrying equity inventories because they couldn’t do both.  Meanwhile the SEC gave market-makers exemptions from limitations on shorting.

Presto, Fast Traders started shorting to provide securities to the market. And that became the new “inventory.” Ten years later, short volume – borrowed stock – averages 45% of trading volume.

It was over 48% this spring.  And then it imploded in latter August, currently standing at 42.6%. The FAANGs, the giant stocks rocketing the major measures into the stratosphere, show even more short paucity at just 39%.

Realize that the market was trading $500 billion of stock before August, about 12 billion shares daily. So what’s the point? Short volume is inventory today, not mainly bets on declining stocks. It’s the supply that keeps demand from destabilizing prices, in effect. A drop from 48% to 43% is a 10% swoon, a cranial blow to inventory.

Higher short volume restrains prices because it increases the available supply. If demand slows, then excess supply weighs on prices, and stocks decline. We’ve been measuring this feature of market structure for a decade. It’s well over 80% correlated.

So the absence of inventory has the opposite impact on prices. They rise.  If the whole market lacks inventory, stocks soar. And the lowest inventory right now is in the FAANGs, which are leading the stampeding bulls.

Thinking about prices as rational things is wholly flawed. It’s not how the market works, from supply-chain, to routing, to quotes, prices, execution.

We thought temporal tumult in behaviors two weeks ago would derail this market. It didn’t. Or hasn’t yet. The big drop in shorting followed, suggesting those patterns included largescale short-covering by market-makers for ETFs.

When the market does finally reverse – and it will, and it’s going to be a freak show of a fall too, on market structure – low short volume will foster seismic volatility. Then shorting will explode, exacerbating the swoon as supply mushrooms and prices implode.

The good news is we can measure these data, and the behaviors responsible, and the impact on price. There’s no need to ever wonder if your stock, public companies, or your portfolio, traders, is about to step on a land mine.  We’re just waiting now to see how the Little Short plays out.

Liquidity

Want a big ranch out west?

Apparently you don’t. The Wall Street Journal last month ran a feature (subscription required) on the mushrooming supply of leviathan cattle operations from Colorado to Idaho, legacy assets of the rich left to heirs from the era of Ted Turner and John Malone.

A dearth of demand is saddling inheritors with big operating expenses and falling prices.  Cross Mountain Ranch near Steamboat Springs, CO is 220,000 acres with an 11,000 square-foot house that costs a million dollars annually to run. It can be yours for a paltry $70 million, $320 an acre (I wonder if that price holds for a thousand?).

What have cattle ranches got to do with the stock market?  Look at your holders, public companies.  What’s the concentration among the largest?

The same thing that happened to ranches is occurring in stocks.  The vast wealth reflected in share-ownership came considerably from generations now passing on inheritance or taking required minimum distributions. The youngsters, at least so far, aren’t stockowners. They’re buying coffee, cannabis and café food.

Juxtapose that with what we’ve been saying about liquidity in stocks, and as the WSJ wrote today.

Liquidity to us is how much of something can be bought or sold before the price changes.  Those landed dynasties of western dirt are discovering people eschew large land masses and monolithic homesteads.

In stocks, the same is true.  Back up five years to Sep 4, 2014. The 200-day (all measures 200-day averages) trade size was 248 shares and dollars/trade was $17,140. Short volume was about 42%, the average Russell 1000 stock traded about $230 million of stock daily. And intraday volatility, the difference between highest and lowest daily prices, was about 2.2%.

Five years later? Average trade-size is 167 shares, down 33%.  Dollars/trade is down 26% to $12,760. Shorting is nearly 47% daily. Dollars/day is down 17% to $170 million. Volatility is up 32% to 2.9% daily.

But market-capitalization has increased by some 40%.  It’s as though the stock market has become a giant ranch in Colorado teetering over millennials loitering in a coffee shop. No offense, millennials.

Every investor and public company should understand these liquidity characteristics because they increase risk for raising capital or making stock investments.

Why is liquidity evaporating like perspiration out of an Under Armor shirt?

Rules and behaviors. Rules force brokers – every dollar in and out of stocks passes through at least one – into uniform behavior, which decreases the number capable of complying. Picture a grocery store near dinnertime with just three checkout lanes open.

In turn, concentration means more machination by brokers to hide orders. They break them into smaller pieces to hide footsteps – and machines become more sophisticated at interrupting trades in ever smaller increments to reveal what’s behind them.

And all the liquidity measures shrink. We see it in the data. A blue bar of Active Investment rarely manifests without an array of orange bars swarming to change prices, Fast Traders who have detected the difference in the data where human influence drives machine behavior.

What can you do, public companies and investors?  Prepare for bigger and unexpected gyrations (volatility erodes investment returns and increases equity cost of capital).

Examples: HRB reported results before Labor Day. The quarter is fundamentally inconsequential for a company in the tax-preparation business. Yet the stock plunged. Drivers?  Shares were 71% short and dominated by machines setting prices and over 21% of trading tied to short derivatives bets.

Those structural facts cost holders 10% of market cap.

Same with ULTA. While business conditions might warrant caution, they didn’t promote a 30% reduction in equity value.  Market structure did it – 58% short, 55% of total volume from machines knowing nothing about ULTA and paying no heed to the call.

We have the data. Market structure is our sole focus. No public company or investor should be unaware of liquidity factors in stocks and what they predict.

Put another way, all of us on the acreage of equities better understand now that vast tracts of value are tied up by large holders who don’t determine the price of your stocks anymore than your grandfather’s capacity to buy 100,000 acres will price your big Wyoming ranch now.

What does is supply and demand. And liquidity is thin all over.  Data can guard against missteps.