Tagged: stock market

For the Birds

Did you know the Caribbean is full of brown boobies? 

The blue-footed brown booby, about the size of a seagull.  We’re just back from sailing St Martin and St Barts, where the critters of both sea and sky delighted.

Unlike the stock market, apparently, which has gone to, um, the birds. 

By the way, best food in the islands?  Grand Case on St Martin. It’s French. Need I say more?  On our boat, we had French food, French wine, French chef.

It’s a wonder we left. I gained five pounds. You can see it in the photo, aboard our catamaran in St Barts (more trip photos if you’re interested).

Tim and Karen Quast aboard Norsegod in St Barts Harbor (courtesy Tim Quast).

Back to stocks, we should have expected cratering markets because fundamentals have deteriorated dramatically.

Oh no, wait. They haven’t. 

Zscaler (ZS), which has been crushing expectations every quarter, is up just 6.7% the past year now after rising over 500% the past five years. It’s down 33% the last six months.

Philip Morris (PM), which is not growing, is down 7% the past five years but up 8% the past six months.

The popular explanations for why these conditions exist have reached such shrieking insanity that I might be forced to return to the sea.  And French food.

First, let’s understand how stocks go up.  Not the “more buyers than sellers” version but the mechanics. 

There is demand.  It can come from investors, traders or counterparties. Active investors buy opportunity, Passive investors buy products – growth, value, etc. Traders chase arbitrage (different prices for the same thing). Counterparties buy or sell to meet or mitigate demand for derivatives like options.

When all converge, prices explode. 

And there are compounding factors. Many investors now prefer Exchange Traded Funds (ETFs), which don’t increase the SUPPLY of stocks, just the DEMAND for them.

And traders buy or sell short-term prices with connection only to previous prices, leading to spiraling short-term gyrations.

And derivatives as both implied demand and supply magnify moves.

Are you with me still? Think this is for the birds?

The Tetris of the stock market, the arranging of these blocks, distorts perceptions of supply and demand and fosters absurd explanations.

And over time, it erodes realized returns.  All the toll-collectors – money managers, ETF sponsors, trading intermediaries, stock exchanges, counterparties – get rich.

As of yesterday, the Nasdaq is up about 6.5% annually since March 2000, before taxes and inflation and without respect to risk premia. Tech stocks move 3.5% intraday daily.

You see? Daily price-moves are more than half the average expected pre-tax returns. That’s because of what happens when all the Tetris blocks start falling.

Here’s how. Active investors stop buying equities. Passive investors slow allocations and see redemptions.  Speculators stop setting prices. ETFs have to redeem shares so compounding demand is suddenly replaced by a vacuum. Implied demand via derivatives vanishes.

And prices implode.

This is how the DJIA drops 800 points in a day.

And we haven’t even talked about short volume.  The SEC permits intermediaries to create stock when no real supply exists to satisfy it. That is, they can short stocks without borrowing.

That works great on the way up as it provides supply to rising prices that would otherwise go unsatisfied. On the way down, we become aware that the implied demand in created stock just doesn’t exist.

So, Tim. What can we do in this market?  

You can’t control it.  We could fix it if we stopped letting shilling Fast Traders set prices and create stock.

If we junked the continuous auction market and returned to periodic auctions of real demand and supply. No real buyers or sellers, no prices.

And stock markets should actually compete by offering separate “stores” that aren’t connected electronically and forced to share prices. As it is, markets are just a system.

Alas, none of this will happen anytime soon.

So.

We can continue as companies, investors and traders fooling ourselves that fundamentals drive markets.  Or we can learn how markets work. The starting point.

Otherwise, we’re like somebody reading the opening line today. “Did he just say ‘boobies’?”

I was talking about birds.

We need to understand the topic. The market (ask us, we’ll help).

Extended Chaos

See this photo?  Winter Carnival in Steamboat Springs. The Old West. Sort of. People ride shovels on snow down main street behind horses.

Courtesy Karen Quast. 2022 Steamboat Winter Carnival.

Now. What the hell is happening in extended-hours trading? Could be a shovel ride.

You might’ve forgotten with the pace of news and markets, but during Q4 2021 earnings, SNAP lost 24% of its value by market-close, then soared 62% in the hour and a half after.

Facebook – Meta Platforms (strange to brand as something nonexistent) – lost $235 billion of market cap after the market closed.

Amazon was down 8% at the close, then rose 18% afterward.  Market cap, $1.5T.

What’s going on?

Let me tell you a story. Settle in.

Once there was a buttonwood tree in New York City and stockbrokers would gather to trade there. In 1792 the brokers formed the NYSE.  To trade securities listed at the NYSE, you had to be a member.

Time passed. It worked. In 1929, the stock market blew up.

The government flexed. The Constitution authorizes no intervention in securities markets, but people were economically panicked.  Congress passed the Securities Acts of 1933 and 1934, taking control. Stuff got complicated.

In 1975, with inflation soaring and a war in Asia ending badly (déjà vu), Congress decided the stock market was a vital national interest and should be a System.

They passed the National Market System amendments to the Securities Acts after finding that new data technology could mean more efficient and effective market operations.

So Congress, pursuing the nebulous “public interest,” decided it must decree fair competition among brokers, exchanges, and other markets.

And they said opportunity should exist for trades to execute without the middleman, the broker-dealer or exchange – rejecting the buttonwood model.

With me still? 

I’m explaining how we ended up with extended-hours trading, and why it bucks like a bronc. We’re not there yet. 

In 1971, the National Association of Securities Dealers launched an automated quotation system. That became the Nasdaq.

In the 1990s, computerized trading systems outside the stock markets – as Congress envisaged – sprang up. No broker-dealers. No middlemen (save the software).

They demolished stock markets, taking more than half of all trading.

They were firms like Island, Brut, Archipelago, Instinet (the oldest, from 1969). They weren’t stock exchanges, weren’t brokers.  They were software companies matching buyers and sellers.

Ingenious, frankly. The exchanges cried foul.

The SEC intervened with a set of rules forcing these so-called Electronic Communications Networks (ECNs) to become broker-dealers.

And extended-hours trading began.

Why?

Because exchanges had to display ECN prices, and ECNs had to become brokers. So exchanges would win the price business, and ECNs would win the size business.

By the way, the exchanges bought the ECNs and incorporated the technology. The Nasdaq runs on vestiges of Brut and Island, the NYSE on Arca – Archipelago.  Instinet is owned by Nomura.

In 2005, the SEC fulfilled the vision of Congress from 1975, imposing Regulation National Market System – Reg NMS. That’s the rule running the stock market today, with its 17 exchanges and about 34 “dark pools,” which are ATS’s.  Latter-day ECNs.

Reg NMS links all markets, removes the differences in listing one place versus another, shares all prices and all data, and mandates trading at the best systemwide price.

But rules preceding Reg NMS for ATS’s didn’t proscribe extended-hours trading.

The irony? Congress wanted to cut out the middleman, the broker and exchange, and instead ALL trading is intermediated. It might be the craziest thing in human history outside emergency powers.

Plus, the rise of Passive Investment means vast sums need reference prices – a set price each day – to comply with the Investment Company Act of 1940 (another rule).  So exchanges persist with a 4p ET close.

But Exchange Traded Funds (ETFs) match off-market in blocks – and the parties running those trades are the same operating dark pools (ATS’s), behind most derivatives.

And there you have it.  Exchanges create prices for “40 Act” funds at 4p ET. And broker-dealers trade stuff other times, getting ever bigger.  Gyrating prices when the Stock Market is closed.

It’s now at times the tail wagging the dog.  It’s incongruous if the aim of the legislation behind Reg NMS is a free, fair, regulated, orderly, connected market.

That’s your answer.

Stocks gallop after the market closes because rules have fostered an arbitrage trade between market hours, and after-hours. The reason for extended-hours chaos is rules bifurcating the stock market into prices for thee but not for me.

The fix? I think it’s wrong for a “market system” to own the price of anything.  Stores for stocks should be no different than grocery stores – stocking what they wish and offering prices and supply.

How do we change it? Fix government powers. The SEC owns the market. Not us.

Starting Point

The starting point for good decisions is understanding what’s going on. 

I find it hard to believe you can know what’s going on when you’re authorizing trillions of dollars of spending.  But I digress.

Illustration 22981930 / Stock Trading © John Takai | Dreamstime.com

Investor relations professionals, when was the last time you called somebody – at an exchange or a broker – to try to find out what’s going on with your stock? I can’t recall when the Nasdaq launched the Market Intelligence Desk but it was roughly 2001.

Twenty years ago.  I was a heavy user until I learned I could dump trade-execution data from my exchange into my own Excel models and see which firms were driving ALL of my volume, and correlate it to what my holders told me.

That was the seed for ModernIR. 

Today, market behaviors and rules are much different than they were in 2001. Active money back then was still the dominant force but computerized speculation was exploding.  What started in the 1990s as the SOES Bandits (pronounced “sews”) – Small Order Execution System (SOES) – was rapidly metastasizing into a market phenomenon.

Regulation National Market System took that phenomenon and stamped it on stocks. What was a sideshow to ensure retail money got good deals now IS the stock market.

Nearly all orders are small.  Block trades are about a tenth of a percent of total trades.  For those struggling with the math, that means about 99.9% (not volume, trades) aren’t blocks.  The trade-size in the stocks comprising the S&P 500 averaged 108 shares the past week.  All-time record low.

Realize, the regulatory minimum for quoting and displaying prices is 100 shares.  Trades below that size occur at prices you don’t even see.  I have a unique perspective on market machinery.  I’ve spent 26 years in the IR profession, a big chunk of that providing data on market behaviors to public companies so they know what’s going on (the starting point for good management).

Now I run a decision-support platform too for active traders that gives them the capacity to understand changing supply/demand trends in stocks – the key to capturing gains and avoiding losses when trading (we say take gains, not chances).  And I trade stocks too.  I know what it means when my NVDA trade for 50 shares executes at the Nasdaq RLP for $201.521.

Yes, a tenth of a penny.  It means my broker, Interactive Brokers, routed my trade to a Retail Liquidity Program at the exchange, where a Fast Trader like Citadel Securities bought it for a tenth of a penny better than the best displayed price, and was paid about $0.015 for doing so.

For those struggling to calculate the ROI – return on investment – when you spend a tenth of a penny to generate one and a half pennies, it’s a 1400% return.  Do that over and over, and it’s real money.  Fast Trading is the least risky and most profitable business in the stock market.  You don’t have to do ANY research and your investment horizon is roughly 400 milliseconds, or the blink of an eye.  Time is risk.

For the record, NVDA trades about 300,000 times per day. Do the math. 

Which leads to today’s Market Structure Map singularity – infinite value.  Trades for less than 100 shares sent immediately for execution – that’s a “market order” – must by law be executed.  The Securities Exchange Commission has mandated (does the SEC have that authority?) a “continuous auction market” wherein everything is always buying or selling in 100-share increments or less.

So algorithms almost always chop trades into pieces smaller than 100 shares that are “marketable” – meant to execute immediately.  And retail traders are browbeaten relentlessly to never, ever, ever enter marketable trades.  Only limit orders. That ensconces information asymmetry – an advantage for machines.  Every time I send a marketable trade for execution, I have to check a box acknowledging that my trade is “at the market.”

That’s the truth.  Algorithms pulverize orders into tiny pieces not to make them look like tiny trades, but because tiny trades are required by law to execute.  Large trades are not.  Limit orders are not.  Those both may or may not match.  But tiny trades will. There’s one more piece to that puzzle – the market-making exemption from short-locate rules.  For more on that, go to the youtube channel for sister company EDGE and watch my presentation on meme stocks at The Money Show.

Moral of the story:  The entire structure of the stock market is tilted toward the people and the machines who actually know what’s going on, and away from those who don’t.

Now.  What do you know about the stock market, investor-relations professionals?  You are head of marketing for the stock.  Got that?  Do you know how the stock market works?

If you don’t, you need us.  We know exactly how it works, and exactly what’s going on, all the time.  You should have that information in your IR arsenal. 

Nothing is more important. It’s the starting point.

Data to Know

What should you know about your stock, public companies? 

Well, what do you know about your business that you can rattle off to some inquiring investor while checking the soccer schedule for your twelve-year-old, replying to an email from the CFO, and listening to an earnings call from a competitor?

Simultaneously.

That’s because you know it cold, investor-relations professionals.  What should you know cold about your stock?

While you think about that, let me set the stage. Is it retail money? The Wall Street Journal’s Caitlin McCabe wrote (subscription required) that $28 billion poured to stocks from retail traders in June, sourcing that measure from an outfit called VandaTrack.

If size matters, Exchange Traded Fund (ETF) data from the Investment Company Institute through May is averaging $547 billion monthly, 20 times June retail flows. Alas, no article about that.

You all who tuned to our Meme Stocks presentation last week (send me a note and I’ll share it) know retail money unwittingly depends on two market rules to work.

Illustration 91904354 / Stock Market © Ojogabonitoo | Dreamstime.com

This is good stuff to know but not what I mean. Can you answer these questions?

  • How many times per day does your stock trade?
  • How many shares at a time?
  • How much money per trade?
  • What’s the dollar-volume (trading volume translated into money)?
  • How much of that volume comes from borrowed stock every day?
  • What kind of money is responsible?
  • What’s the supply/demand trend?
  • What are stock pickers paying to buy shares and are they influencing your price?

Now, why should you know those things?  Better, why shouldn’t you know if you can? You might know the story cold. But without these data, you don’t know the basics about the market that determines shareholder value.

Maybe we don’t want to know, Tim.

You don’t want to know how your stock trades?

No, I don’t want to know that what I’m doing doesn’t matter.

What are we, Italians in the age of Galileo? What difference does it make what sets price?  The point is we ought to know. Otherwise, we’ve got no proof that the market serves our best interests.

We spend billions of dollars complying with disclosure rules. Aren’t we owed some proof those dollars matter?

Yes.  We are.  But it starts with us.  The evidence of the absence of fundamentals in the behavior of stocks is everywhere.  Not only are Blackrock, Vanguard and State Street the largest voting block for public companies and principally passive investors, but the majority of trading volume is executed by intermediaries who are not investors at all.

Stocks with no reason to go up, do.  And stock with no reason to go down, do.  Broad measures are not behaving like the stocks comprising them.  Over the whole market last week, just two sectors had more than a single net buying day:  Utilities and Energy. Yet both were down (0.9%, 1.3% respectively). Somehow the S&P 500 rose 1.7%.

You’d think public companies would want to know why the stock market has become a useless barometer.

Let me give you two examples for the questions I asked.  Public companies, you should be tracking these data at least weekly to understand changing supply/demand conditions for your shares.  And what kind of money is driving shareholder-value.

I won’t tell you which companies they are, but I’ll tweet the answer tomorrow by noon ET (follow @_TimQuast).  These are all 5-day averages by the way:

Stock A: 

  • Trades/day:  55,700
  • Shares/trade: 319
  • $/Trade: $4,370
  • Dollar volume:  $243 million
  • Short volume percent: 51%
  • Behaviors:  Active 9% of volume; Passive, 36%; Fast Trading, 32%; Risk Mgmt, 23% (Active=stock pickers; Passive=indexes, ETFs, quants; Fast Trading=speculators, intermediaries; Risk Mgmt=trades tied to derivatives)
  • Trend: Overbought, signal predicts a decline a week out
  • Active money is paying:  $11.60, last in May 2021, Engagement is 94%

Stock B:

  • Trades/day:  67,400
  • Shares/trade: 89
  • $/Trade: $11,000
  • Dollar volume:  $743 million
  • Short volume: 47%
  • Behaviors:  Active, 8% of volume; Passive, 24%; Fast Trading 49%; Risk Mgmt, 19%
  • Trend: Overbought, signal predicts declines a week out
  • Active money is paying:  $121, last in June 2021, Engagement is 81%

The two stocks have gone opposite directions in 2021.  The problem isn’t story for either one. Both have engaged investors. Active money is 8-9%.

The difference is Passive money. Leverage with derivatives.

Would that be helpful to boards and executive teams?  Send this Market Structure Map to them.  Ask if they’d like to know how the stock trades.

Everybody else in the stock market – traders, investors, risk managers, exchanges, brokers – is using quantitative data.  Will we catch up or stay stuck in the 1990s?

We can help.

440 Market

How durable is the US stock market?

It sounds like we’re talking about shoes.  Can I wear these hiking? Are they waterproof?

No, it’s a legitimate question, a fair comparison.  Public companies, your capacity to raise capital, incentivize your executives, and deliver returns to shareholders in large part depends on the stock market’s ability to reflect what you’re doing as a business.

And investors, how do you know you can trust the market?

Trust is the bedrock of commerce.  The founders of our republic thought you couldn’t have confidence in transactions involving the exchange of time for money, or goods for money, if the value of the money wasn’t constant.  It was thought back then essential to assure the people that their money would not be misused or devalued.

In the same sense, I think it’s right to expect assurances about the market.  Our retirement accounts are there, by the trillions.

I think pooling public capital and trusting its deployment to smart, seasoned people is a bedrock capitalist principle. People and money are the pillars of productivity – labor and capital.

Agreed?

We can generally concur that prudent deployment of capital is good. Putting money in the hands of smart, experienced people is a winning idea.

We agree, I expect, about the need for a system of uniform justice.  If a dispute arises about the way money has been handled, you’re owed recourse, redress, due process.

Right?

Then there’s the probity, the integrity, of the capital markets.  It’s as important to know you won’t be jobbed by the commercial market for your public investments as it is to have clear, speedy and reliable jurisprudence.

But the big question hangs there.  Do we have that kind of stock market?

To that point, I’m speaking to my dear investor-relations family, the NIRI Rocky Mountain Chapter, tomorrow as part of a program on macroeconomics and market structure. Guess which piece I’ve got? Come join us!  It won’t be boring.

It’s always been important to understand things.  Money.  Government.  Economics. Markets.  The harder these become to comprehend, the more we should ask why.

I understand the stock market.

Reminds me of a line about bitcoin I saw on Twitter, and I think I’ve shared it before so apologies: I’ve never understood bitcoin. On the other hand, I’ve never understood paper money either.

Rather than valuation metrics I see the stock market as machinery.  I grew up on a cattle ranch where the motto was “hundreds are nice, but we need thousands.”  We fixed everything, welded everything, patched everything.  We paid attention to the machinery because we owned it no matter how old it was, and our livelihood depended on it.

My point is it’s not valuation that necessarily determines the health of a market. It’s the machinery creating the valuation. 

Country singer Eric Church laid down a tune for the ages in 2016, Record Year. One of the best songs ever.  The following year, 2017, was a record for ETFs, which saw almost $500 billion of inflows, data show.

And between then and now, trillions of dollars more have followed, leaving the allure of superior Active returns for the durable machinery of Passive crowd-following.

Not surprisingly, Active Investment is down almost 40% as a percentage of daily US trading volume since 2017.

The weird thing, so is Passive Investment.

As market volume has risen from about $250 billion daily in 2017 to $625 billion so far in Jan 2021, investment of both kinds is down almost 75%.  And speculation and derivatives – substitutes for stocks – are up more than 50%.

Wow, right?

I think it means Passive money isn’t adjusting to rising valuations, leaving itself dangerously out over the skis, as we Alpine folks say on steep slopes.

I don’t think the machinery is about to collapse. But. Let me tell you one more story.

We had a gorgeous John Deere 440 that came with the ranch. It was old. And orange, and easy to drive and full of superfast hydraulics for the blade, the backhoe. Fine machinery.  And it left us too often with a slipped track supine in the river with the busted metal heavy on the fast-flowing river-bottom. Or on hillsides. And in ditches.

Love. Hate.  Like the stock market.

The stock market is sleek and lovely. But the hydraulics are hot and we’re crawling the tracklayer through fast waters. I’m concerned that Passive money isn’t keeping up, that the market is reliant on things that don’t last.

It’s not fear.  It’s prudence that leads me to keep an eye on the tracks and not the trading multiples.  And we have that data for you.

Don’t forget to join us at the NIRI Rocky Mountain session today!

Fearless

How does the stock market work?

That’s what somebody was asking at the online forum for my professional association, NIRI.

By the way, the NIRI Annual Conference is underway.  I enjoyed yesterday’s sessions and seeing the faces of my colleagues in the virtual happy hour.  We’ve got two more days.  Come on! We’ll never have another 2020 Covid-19 Pandemic Annual Conference.

So, I’m not knocking the question. The discussion forum is a candid venue where we talk about everything but material nonpublic information.

Investors and traders, how do you think the stock market works?

My profession exists because there are companies with stock trading publicly. Otherwise, there’s no reason to have an investor-relations department, the liaison to Wall Street. IR people better know how the stock market works.

So it gets better. The question that followed was:  What is IR?

Is that infrared? No, “IR” is investor relations. Liaison to Wall Street. Chief intelligence officer. The department that understands the stock market.

So, why is my profession asking how the stock market works? And why, since we’ve been a profession for over a half-century, are we asking ourselves what our job is?

I think it’s because we’re uncertain. Fearful. Grasping for purpose.

We shouldn’t be. The IR job is knowing the story, governance, key drivers in the industry and sector, and how stock-market mechanics affect shareholder value. Internal politics. External rules. Communications best practices.  We are communicators, data analysts.

That’s it.

So how does the stock market work? Section 502 of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, which became law in May that year, required the SEC to give Congress an answer.

It did, in this 100-page report released in Aug 2020. The government always takes longer to describe things than the private sector.  No profit motive, you know. But still. Do we think the SEC is making stuff up?

They’re not. I’m a market-structure expert. The SEC presents an exceptionally accurate dissection of how the stock market works, the effects of algorithms, the inherent risks in automated markets.

Did you get that, IR people?  The SEC understands the market. Traders do. Investors do. Shouldn’t we?  It’s the whole reason for our jobs.

If you’re offended, apologies. It’s time for our profession to be a little more David, a little less Saul.  A little more huck the stone at Goliath, a little less cower in the tents.  I studied theology, so if my analogy baffles, see the book of I Samuel in the bible, roughly the 17th chapter.

It’s literature for atheists and believers alike. It’s about knowing what you’re doing, fearlessly.

Here’s the stock market in 120 words, boiled down from 100 SEC pages:

There is a bid to buy, an offer to sell. These are set in motion each trading day by computers. The computers reside in New Jersey. Half the daily volume comes from these computers, which want to own nothing and make every trade. The equations computers use are algorithms that buy or sell in response to the availability of shares, and almost half of all volume is short, or borrowed. Stock exchanges pay computerized traders to set prices. About 40% of volume is Passive or model-based investment, and trades tied to derivatives like options. About 10% is buy-and-hold money. The interplay of these behaviors around rules governing stock quotes, trades and data determines shareholder value. And it’s all measurable.  

If you want to see these ideas visually, here they are.  IR people, it’s a mantra.

What do you tell your executives?  They need to hear these 120 words twice per month. Once a week would be better.  Visually. What part of your board report reflects these facts?

“I don’t describe the stock market.”

Oh? Stop fearing. We’ll help. What do those 120 words above look like through the lens of your stock? Ask. We’ll show you.

Let’s stop wondering how the stock market works and what IR is. IR is the gatekeeper between shareholder value and business execution.  Math. Physics. A slung stone. A board slide.

Let’s be IR. Fearless.

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.

Volatile Liquid

There’s a beer in this for you.  A glass of rosé from Provence if you prefer.

What’s the most liquid stock in the US market?

I’m writing this after the virtual happy hour for the NIRI Big I Conference (it’s a strong event, and you can catch Day Two and our wrap-up today that I’ll take part in), which of course makes one think of beverages. Liquid. Virtual drinks are no match for the real thing, nor is false liquidity in stocks.

Let’s lay the groundwork.  Stock exchanges describe market quality as low spreads.  Spreads have never been tighter, they say, and costs for trading were never lower.

Heck, you can trade for free. That’s about as inexpensive as it gets. So, is a low-cost, low-spread stock market a quality and liquid place?

Depends what you mean.  The market doesn’t fail often. Yes, we’ve recorded nearly 13,000 volatility halts since Mar 9.  Remember all the marketwide pauses that month? Still, it didn’t quit operating.

The Nasdaq just corrected – dropped 10% – in three days. And rebounded as fast. It highlights the importance of the definition of “quality.”

Which leads back to liquidity, and by extension, volatility. All three words ending in “y” are related.

Let’s begin with what liquidity is not.  Volume. Liquidity, bluntly, is the amount of a thing that will trade before the price changes. Put an offer on a house.  What’s the spread between the price you’d pay, and the last that somebody else paid?

I’ve just debunked the idea that low spreads reflect quality.  For the seller, a high spread is a reflection of quality.

Low spreads help parties with short horizons.  If my investment horizon is 250 milliseconds, a spread of a penny is wildly attractive. How many pennies can I make, in how many different issues, every quarter-second?

But if my horizon is more than a day, a wider spread reflects higher quality.  How come stock exchanges don’t mention that?

Let’s go one step further. To me, the measures we traditionally look to for guidance about market quality need revamping. For instance, beta, a measure of volatility, has the same flaws as our current economic measures of inflation.  Beta measures how a stock moves from close to close in relation to the market.

Terrible measure of market quality.  WMT, for instance has a beta score of 0.19, 20% of the volatility of the market. Yet its intraday volatility the past 20 days is 2.9%. The S&P 500 is 2.7% volatile over the same time (intraday high and low).

WHEN an investor buys during the day could in theory be nearly 3% different from somebody else’s price.  And WMT, contradicting beta, is not a fifth as volatile as the market but 7% more volatile.

The truth is low spreads PROMOTE frequent price-changes, which is the definition of volatility. The parties driving low trading spreads are ensuring volatility. Creating it.  And telling us it signals market quality.

They mean well. But good intentions pave roads to oblivion.

(Editorial note: Inflation isn’t the rate at which prices increase. It’s whether you can buy things.  All over the economy, people now buy on credit. Debt has exploded. That’s the evidence of inflation. Not the Fed’s equivalent of beta.)

And liquidity isn’t volume. That’s confusing busy with productive. Volume is stuff changing hands. Liquidity is how MUCH of it changes hands.  The most liquid stock in the market is AMZN (not counting BRK.A, a unique equity), at $70,000 per trade.

The mean component of the S&P 500 trades about $17,000 at a time.  But here’s the kicker. Just 50 companies, 10% of the index, trade MORE than $17,000 per trade. That’s the list from AMZN to DPZ. Everybody else trades less.

Including now, AAPL. It used to be in the top ten. Now it’s 146th post-split, trading about $12,000 per transaction on average.  TSLA was top five but post-split is now 49th at $17,600, well behind 32nd-ranked MSFT at $20,100.

Splits don’t foster liquidity. They breed volume. And price-changes. Volatility. We’re not anti-split. We’re anti-volatility, which increases risk for investors and the cost of capital for companies.

Why does the market promote one at the expense of the other? It’s a question owed an answer. All investors, every public company, should know liquidity. We have the data.

Moon Rules

We spent last week in Summit County, famous for Breckenridge and Keystone. With windows open and the sun set, the temperature at 9,000 feet drops fast, great for sleeping.

It’s not great for staying awake reading a Kindle but I worked through some exciting pages of Artemis, the new novel by Andy Weir, who wrote The Martian, made into a Ridley Scott movie starring Matt Damon.

And yes, Artemis got me thinking about market structure. Not because of the profanity, the ripping pace, the clever characters, the exotic settings.  It’s a book set on the moon, where scientific rules matter.

Weir’s genius is the application of science to clever storylines. On the moon, if you want to commit a crime to save the community, you better understand how to blend acetylene and oxygen in zero atmosphere. Fail to follow or understand the rules, you die.

It’s not life and death in the stock market but rules play the same supreme role in dictating outcomes. If as public companies you think your story will determine the outcome for your stock, the rules will humble you.  How much of your trading volume comes from Active Investment? You can and should know – and it’s not what you’d think. But that’s not the point of being public, is it.  So don’t be afraid.

If you’re an investor and you think fundamentals will pace you to superior results, think again. The amount of money choosing company financials has plunged, while funds indexing to markets has mushroomed. Rules helping models will eat your lunch.

What rules? Start with Regulation National Market System. It creates a marketplace that forces revenue-sharing among intermediaries. Professional sports like basketball in the USA also operate with rules that shift focus from playing the sport to managing salary cap (Denver just traded three Nuggets for that reason).

If you don’t know this, you’ll have a false understanding of what drives the sport. The “haves” must distribute funds to the “have nots.” Some owners in money-losing markets might choose to skimp on salary to scrape mandated distributions from teams making bank (I wonder what the NBA Cavaliers will do now?).

Right now, stock market sentiment reflecting not the opinions of humans but the ebb and flow of money and the way machines price stocks (the rules, in other words) is topping again as it did about June 12. Options expire today through Friday.  So, no matter what you expect as earnings commence, the market will have a propensity to decline ahead.

It’s like the rules on the moon.  In one-sixth of earth’s gravity, harsh sun, no atmosphere, success depends on knowing how stuff works. Investors and public companies, welcome to the moon. You can’t treat it like earth. Rules determine outcomes. If your actions don’t account for the rules that govern how markets function, outcomes will reflect it.

But it’s fun on the moon once you know what you’re doing. It’s fun knowing when the market is topped, and bottomed, on rules. It’s fun doing investor-relations when you know what all the money is doing.  So, come on up to zero atmosphere! It’s not scary.

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.