Tagged: Trading

Experience

“The market structure is a disaster.”

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

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

I’m paraphrasing.

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

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

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

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

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

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

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

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

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

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

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

Illustration 91904938 © Tupungato | Dreamstime.com

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

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

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

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

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

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

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

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

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

Back to market structure.

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

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

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

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

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

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

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

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

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

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

Human Nature

Science and the stock market both aim for outcomes data don’t support.

I’m going to take you on a short but intense journey, with ground rules. I’ll ask that you check politics at the door.  Keep an open mind.

I’ll take Science first.  Suppose it was a business plan.  You craft an objective, and the path to achieving it.  It’s something I know after roughly 30 years in business.

Science said it aimed to flatten the Covid curve. That we could create a vaccine that would immunize us all, and we’d be free.

Now pelting toward two years of Covid, a great bulk of the population is vaccinated, many boosted too, and Covid abounds.

I’m vaccinated but not boosted and I had it.  Karen and I heard CNBC’s Jim Cramer, perhaps the World’s Most Vaccinated Person, Friday, and looked at each other and said, “He’s got Covid.”

Sure enough.

Here’s the point. Science has known for decades that coronavirus vaccines don’t work because the viruses constantly mutate.

I think mRNA research will be a boon for treating pathologies from cancer to respiratory disease. But Science did what science shouldn’t do.  It gambled.  Dismissed known data, central tendencies, facts. Proclaimed it would eradicate the virus.

You’d expect that from inveterate optimists like entrepreneurs, cowboys riding the bull that’s never been ridden, politicians, the Cinderella team playing the reigning champs.

That’s hope.  Hope isn’t a strategy.

Religion is in the hope business.  Science is supposed to be in the data business.  If we’re objective, stripped of politics, zeitgeist, predilections – shall I say hope – we have to say Science failed.  We didn’t conquer Covid. Our immune systems did.

Can we admit we were wrong?

Yeah, but vaccines lower severity.

That’s an assumption. A hope. And it wasn’t the objective.

Let’s shift to the stock market.  Regulation National Market System is 524 pages dictating a mathematical continuous auction market that works only with pervasive mandatory intermediation and a market-maker exemption from short-locate rules.

It is by design not rational but mathematical.  Yet everywhere, in everything we hear, read, see, is a thesis that the stock market is a constant rational barometer.

The stock market was declining because the Fed was tapering.  Then on the day the Federal Reserve met, stocks soared. Oh no wait, markets like rising rates because it means the economy is better.

Then stocks plunged. It’s Omicron.  Then stocks soared. Omicron fears have faded.

For God’s sake.

The problem is the explanation, nothing else. We know how the market works. It’s spelled out in regulations.  If you want a summary, read the SEC’s Gamestop Memo.

Options expired last week, while the Federal Reserve was meeting. You should expect bets. Indexes rebalanced Friday and demand was down.  So with new options trading Monday, the market fell.

Then Counterparties squared books yesterday, and one would naturally expect a big surge in demand for options at much better prices.  Stocks surged.

VIX volatility hedges expire today. If money sees a need for volatility hedges, stocks will rise.  If not, they’ll fall.  But that’s not humans reacting to Omicron. It’s programmed.

Weather forecasts are predicated on expert capacity to measure and observe weather patterns.  It’s data science.

The stock market is data science. 

If we have vast data science on weather, coronaviruses, the stock market, why would we hope rather than know? 

It happened to Copernicus too.  The sun is the center. No, shut up or die.

Science thought so much of itself that it believed it could do what they say can’t be done.  Save that for Smokey and the Bandit.

What happened?  Human nature. No matter how much one claims to be objective, there is confirmation bias, a belief – hope? – in one’s desired outcome.

Is the investor-relations profession able to let go its predilections, its hope, and shift to objective data science on what drives shareholder value?

What matters is the whole picture. Do you know if Story, Characteristics and capital allocation mesh, or contradict each other? If you’re a long or short trade?

Math. Measurable.

Illustration 131408341 © Zybr78 | Dreamstime.com

It’s of no help to your executive team and Board to paint an unrealistic picture that says Story drives value when the data tell us the opposite. Who cares what drives price? So long as we understand it.  That should be the view.

Humorously, there is hope.  Hope is like faith, a belief in things unseen, in outcomes no data yet validate. There’s hope we’ll come around to reality.  We can help you get there.

And with that, we hope your reality for the Holiday Season 2021 is blissful, joyful, thankful. Merry Christmas! We’ll see you on the far side. 

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 Inferiors

One of the penalties of refusing to participate in politics is that you end up being governed by your inferiors.

So, purportedly, said Plato. That’s our sole word on current elections.

Illustration 209532110 / Plato © Naci Yavuz | Dreamstime.com

Now let me tell you how my order to buy 50 shares was internalized by my broker, but my limit order to sell it split into two trades at Instinet, and what that’s got to do with the Federal Reserve and public companies.

Sounds like a whodunnit, right? 

Let me explain. I trade stocks because of our trading decision-support platform, Market Structure EDGE. It’s a capstone for my long market-structure career: I know now what should matter to public companies, what should matter to traders, how it ALL works.

Continuing, the Fed today probably outlines plans to “taper.” Realize, the Fed has been buying US mortgages at the same time nobody can build houses because there isn’t any paint, no appliances, you can’t find glass, wood went through the roof (so to speak).

So the Fed inflated the value of real estate.  Why?  Because it prompts people to spend money. To the government, economic growth is spending.  Mix surging balance sheets with gobs of Covid cash, and it’s like taking the paddles and telling everybody, “Clear!” and hitting the economy with high voltage.

The Fed has concluded the heartbeat is back and it’s putting away the paddles. Its balance sheet, though, says tapering is a ways off.

What’s that got to do with my trade? The Fed is intermediating our buying and selling to make it act and look like more.

But it’s not more.  And the economy rather than looking like an elite athlete – trimmed, toned, fit – is instead just off the gurney.

Put another way, the economy reflects multiple-expansion, a favorite Wall Street explanation for why stocks go up. It means everybody is paying more for the same thing.

We should have let it get tough, trim, fit. Ah well.

Did you see the Wall Street Journal article (subscription required) this week on payment for order flow in stocks and options?  I’m happy market structure is getting more airplay.  It will in the end be what gets discussed when everyone asks what happened.

Everything is intermediated. The Fed buys mortgages. Traders by trades.

I bought 50 shares of a tech stock at the market. That is, I entered the order and said, “I’ll take the best price available for 50 shares.”

I know my 50 shares is less than the minimum 100-share bid so it MUST be filled at the best price.  I also know the stock I bought trades about $16,000 at a time, and my order for 50 shares is just under that.

I’m stacking the deck in my favor by understanding market structure (I also know the stock has screaming Demand, falling Supply, a combo lifting prices, as in the economy, so I’m adding to my advantage, like a high-speed trader).

I had to confirm repeatedly that I understood I’d NOT entered a “limit” order, a trade with a specified price.

Brokers don’t want us traders using market orders because they can’t sell them. So my own broker sold me shares. That’s internalizing the trade, matching it in-house.

I sold via limit order because I was in a meeting. My broker sold it to somebody like Citadel, which split it into two trades at Island (Instinet, owned by Nomura) and took a penny both times. Then price rose almost a dollar more.

Wholesalers see all the flow, everywhere. They buy limit orders only on high odds of rising prices, making a spread, and buying and selling several times over to make more than the $0.08 they paid for my trade. I know it, and expect it.

But the purpose of the market, public companies – you listening to me? – becomes this intermediation. It’s over half of all volume. You think investors are doing it.

And this is the problem with the Fed. It manipulates the capacity to spend, and the value of assets, and manipulation becomes the purpose of the economy.

Markets cease to be free. Outcomes stop serving as barometers of supply and demand.

Actually, we see supply and demand in stocks (ask us). Too many public companies still don’t want to believe the data and instead go on doing pointless stuff. I don’t get that.  Why would we want our executives to be ignorant?

Apply that to the economy (maybe to Plato’s observation).  Let’s be honest. Rising debt and rising prices are clanging claxons of folly, like my 50 shares becoming two trades. They’re not harbingers of halcyon days.

Why be public for arbitrage? Why trade to be gamed?

We should face facts both places. The sooner, the better.  Elsewise we’re governed by our inferiors.

Clear the Room

Winter is coming.

But autumn is mighty fine this year in the Rockies, as my weekend photo from Yampa Street in Steamboat Springs shows.

Winter follows fall and summer. Other things are less predictable, such as economic outcomes and if your Analyst Day will do what you hope (read from last week).

Here, two of my favorite things – monetary policy, market structure – dovetail.

Steamboat Springs. Photo by Tim Quast.

If you want to clear the room at a cocktail party, start talking about either one.  In fact, if you’re trapped talking to somebody you’d rather not, wanting a way out, say, “What’s your view of the fiat-currency construct?”  or “What do you think of Payment for Order Flow?”

I’ve told you before about the daily noon ET CNBC segment Karen calls the “What Do You Think of THIS Stock?” show.  Guests yammer about stocks.

Some weeks ago the host said, “What do you think of Payment for Order Flow?”

Silence.  Some throat-clearing.

Nobody understands it!  These are market professionals. Decades of experience. They don’t know how it works.

Not our topic. But so I don’t leave you hanging, PFOF is as usual with the stock market an obfuscating way to describe something simple.  Retail brokers sell a product called people’s stock trades so those people can trade stocks for free.

This is why you’re brow-beaten to use limit orders at your online brokerage.  Don’t you dare put in a market order! Dangerous!  Not true. Fast Traders, firms wanting to own nothing by day’s end and driving 53% of market volume, eschew limit orders.

They know how the market works. Brokers want you to use limit orders because those get sold. Most market orders don’t.

Pfizer wants everybody to be vaccinated and retail brokers want every trade to be a limit order, because both get paid. Same thing, no difference.

Now, back to the point.  If you tell your corporate story to a thousand investors, why doesn’t your price go up?  Similarly, why can’t we just print, like, ten trillion dollars and hand it out on the street corner and make the economy boom?

Simple. Goods and services require two things:  people and money. Labor and capital. Hand out money and nobody wants a job. Labor becomes scarce and expensive.

And if you hand out money, you’re devaluing the currency.  Money doesn’t go as far as it used to.  You need more to make the same stuff.

The irony is that handing out money destroys the economy.  You can’t make stuff, deliver it, ship it, pack it, load it, unload it, move it – and finally you can’t even buy it because you can’t afford it.

Got it?

The best thing we could do for the economy is put everything on sale.  Not drive prices up and evacuate products from shelves.  But that requires the OPPOSITE action so don’t expect it.

What does market structure have in common with monetary policy?

Too many public companies think you just tell the story to more investors and the stock price goes up.  We’re executing on the business plan. The trouble is too few know.

Wrong.  That’s a controllable, sure.  But it’s not the way the market works. AMC Theaters is a value story.  It was a herculean growth stock in early 2021 and along with Gamestop powered the Russell 2000 Value Index to crushing returns.

I was looking at data for a large-cap value stock yesterday.  The Exchange Traded Fund with the biggest exposure is a momentum growth ETF. It’s humorous to me reading the company’s capital-allocation strategy – balance-sheet flexibility with a focus on returning capital to shareholders – and looking at the 211 ETFs that own it.  It’s even in 2x leveraged bull ETFs (well, the call-options are, anyway).

Your story is a factor.  But vastly outpacing it are your CHARACTERISTICS and the kind of money creating supply, and demand. If you trade $1,500 at a time, and AMZN trades $65,000 at a time, which thing will Blackrock own, and which thing will get traded and arbitraged against options and futures?

Your CFO needs to know that, investor-relations people. And we have that data.

That large-cap I mentioned? We overlaid patterns of Active and Passive money.  Active money figured out by May 2021 that this value company was a growth stock and chased it. They were closet indexers, the Active money. PASSIVE patterns dwarf them.

And when Passive money stopped in September, the stock dropped like a rock.

It wasn’t story. It was supply and demand.

Same with the economy. Flood it with cash, and it’s hard to get that cat back in the bag once you’ve let it out.  You cannot reverse easy monetary policy without harsh consequences, and you can’t shift from momentum to value without deflation.

The good news is when you understand what’s actually going on, you can manage the controllables and measure the non-controllables. Both matter.  Ask us, and we’ll show you.

Analyst Day

Why do you hold an Analyst Day? 

Traders and investors, these are what Joel Elconin on Benzinga Premarket Prep this past Monday called “the dog and pony show.”

For the investor-relations profession, the liaison to Wall Street, it’s a big deal, ton of work. We choreograph, prepare, script, rehearse, plan. We’re laying out Management’s strategic vision.

And it’s successful if…what?  The stock jumps?

Analyst Days: Productive, or just busy? Illustration 130957015 © Turqutvali | Dreamstime.com

Before Regulation National Market System in 2007 transformed the stock market into the pursuit of average prices, triggering an avalanche of assets into index funds and ETFs, you could say that.

Even more so before decimalization in 2001 transformed “the spread,” the difference between the prices to buy and sell, into the pursuit of pennies. It’s now devolved to tenths of pennies in microseconds.

The point is, a good Analyst Day meant investors bought the stock. Same with earnings. News. 

Let me take a moment here.  In addition to ModernIR, the planet’s IR market-structure experts and the biggest provider of serious data for serious IR professionals at US-listed companies, Karen and I run a trading decision-support platform called Market Structure EDGE.

Using data from that platform, I bought 200 shares of a known Consumer Discretionary stock this week using an algorithm from my online firm, Interactive Brokers. The order was split into three trades for 188 shares, 4 shares, and 8 shares, all executed at BATS, owned by CBOE, the last trade at a half-penny spread.

Why is this germane to an Analyst Day?  Stick with me, and you’ll see.

Would you go to a store looking for carrots and buy 10 of them at one, then drive to another for 2, and a third for 4?  Idiocy. Confusing busy with productive. So, why is that okay in a market worth $50 trillion of FIDUCIARY assets?

The stock I bought is a household name.  Ranks 463rd by dollars/trade among the 3,000 largest stocks traded in the US market, which are 99.9% of market capitalization. It’s among the 500 most liquid stocks.

Your Analyst Day is a massive target.  And over 90% of volume in the market has a purpose other than investment in mind. My trade in three pieces meant the purpose for the other side was to profit by splitting an order into tiny parts. That’s not investment. It’s arbitrage.

Investor-relations people, you are the market maestros. Your executives and Board count on you to know what matters.  Did it occur to you that your Analyst Day is a giant plume of smoke attracting miscreants? Does your executive team understand that your Analyst Day could produce a vast plume of arbitrage, and not what they expect?  If not, why not?

Look, you say. I run an Analyst Day. Are you saying I shouldn’t?

I’m saying that whether you do or not should be data-driven.  And evaluating the outcome should be data-driven too.  As should be the planning and preparation.

As should the understanding from internal audiences that at least 70% of the volume around it will be profiteers chasing your smoke plume, just like they gamed me for about 2.5 cents.

It’s not the 2.5 cents that matters. It’s the not knowing supply or demand. It’s the absence of connection between price and reality. 

By the way, Rockwell Medical is the current least liquid stock in the National Market System. You can trade $250 of it at a time on average, without rocking the price.  Most liquid? AMZN, at $65,000 per trade (price $3,275, trades 190,000 times per day, 18 shares at a time).

IR does not derive its value from telling the story. Its value lies in serving as trusted advisor for navigating the equity market.  Making the best use of shareholder resources. Understanding the money driving price and volume. You are not a storyteller.  You are the Chief Market Intelligence Officer. 

Think of the gonzo state of things.  I know what revenue every customer generates in our businesses, and what the trends are, the engagement is, the use of our data, what people click or don’t.  Yet too many public companies are spewing information to the market with NO IDEA what creates volume, why they’re traded, what sets price.

Is that wise?

So, what SHOULD we be doing?  The same thing we do in every other business discipline.  Use software and analytics that power your capacity to understand what drives returns. Do you understand what creates your price and volume?

Back to the Analyst Day. Don’t hold one because tradition says so. Do it if you benefit from it!  If your investors are fully engaged, you’re wasting their time and yours. That’s measurable.  You should know it well beforehand.

If they aren’t, set a goal and measure market reactions.  Realize that arbitragers will game your smoke plume.  That’s measurable too. Know what Active stock-pickers pay.  Know when Passives wax and wane. Know what’s happening with derivatives, and why.

Everything is measurable. But not with 1995 tools. Don’t do things just because you always have. Do them because they count.

That’s the IR profession’s opportunity, the same as it is everywhere else.

Growth vs Value

Are you Value or Growth?  

Depends what we mean, I know. S&P Dow Jones says it distinguishes Value with “ratios of book value, earnings and sales to price.”

It matters because Growth is terrorizing Value.  According to data from the investment arm of AllianceBernstein, Growth stocks outperformed Value stocks by 92% between 2015-2020.  Morningstar says it’s the biggest maw on record, topping the 1999 chasm.

If you’re in the Growth group, you’re loving it.  But realize.  By S&P Dow Jones’s measures, anybody could be a Value or Growth stock at any time.  It’s all in the metrics.

The larger question is why the difference?  AllianceBernstein notes that the traditional explanation is earnings growth plus dividends paid.  That is, if your stock is up 50% more than a peer’s, it should be because your earnings and dividends are 50% better.

If that were the case, everybody would be a great stock-picker. All you’d need do is buy stocks with the best earnings growth. 

Well, turns out fundamentals accounted for just ten percentage points of the difference.  The remaining 82% of the spread, as the image here from AllianceBernstein shows, was multiple-expansion.  Paying more for the same thing.

Courtesy AllianceBernstein LP. https://www.alliancebernstein.com/corporate/en/insights/investment-insights/whats-behind-the-value-growth-performance-gap.html

Put differently, 90% of the time Growth stocks outperform Value stocks for no known reason. No wonder stock-picking is hard.

Take Vertex (VRTX) and Fortinet (FTNT), among the two very best and worst stocks of the past year.  I don’t know fundamentally what separates them. One is Tech, the other Healthcare.

I do know that running supply/demand math on the two, there’s a staggering behavioral difference.  FTNT spent 61 days the past year at 10.0 on our ten-point scale measuring demand called Market Structure Sentiment.  It pegged the speedometer 24% of the time.

VRTX spent five days at 10.0.  Two percent of the time.  You need momentum in today’s stock market or you become a Value stock.

We recently shared data with a client who wondered why there was a 20-point spread to the price of a top peer.  We ran the data.  Engagement scores were about the same – 85% to 83%, advantage to our client. Can’t say it’s story then.

But the peer had a 20% advantage in time spent at 10.0.  The behavioral patterns were momentum-style. Our client’s, GARP/Value style.

Okay, Quast.  Suppose I stipulate to the validity of your measure of supply and demand, whatever it is.  Doesn’t answer the question. Why do some stocks become momentum, propelling Growth to a giant advantage over Value?

I think it’s three things. I can offer at least some data, empirical or circumstantial, to support each.

Let’s call the first Herd Behavior.  The explosion of Exchange Traded Funds concentrates herd behavior by using stocks as continuously stepped-up collateral for ETF shares.  I’ll translate.  ETFs don’t invest in stocks, per se.  ETFs trade baskets of ETF shares for baskets of stocks (cash too but let’s keep it simple here). As the stocks go up in value, ETF sponsors can trade them out for ETF shares. Say those ETF shares are value funds.

The supply of Value ETF shares shrinks because there’s less interest in Value.  Then the ETF sponsor asks for the same stocks back to create more Growth ETF shares.

But the taxes are washed out via this process. And more ETF shares are created.  And ETFs pay no commissions on these transactions. They sidestep taxes and commissions and keep gains.  It’s wholly up to traders and market-makers to see that ETF shares track the benchmark or basket.

The point? It leads to herd behavior. The process repeats. Demand for the same stuff is unremitting.  We see it in creation/redemption data for ETFs from the Investment Company Institute. ETF creations and redemptions average over $500 billion monthly. Same stuff, over and over. Herd behavior.

Second, there’s Amplification.  Fast Traders, firms like Infinium, GTS, Tower Research, Hudson River Trading, Quantlab, Jane Street, Two Sigma, Citadel Securities and others amplify price-moves.  Momentum derives from faster price-changes, and Fast Traders feed it.

Third is Leverage with derivatives or borrowing.  Almost 19% of trading volume in the S&P 500 ties to puts, calls and other forms of taking or managing risk with derivatives. Or it can be borrowed money. Or 2-3x levered ETFs. The greater the pool of money using leverage, the larger the probability of outsized moves.

Summarizing, Growth beats Value because of herd behavior, amplification of price-changes, and leverage.

By the way, we can measure these factors behind your price and volume – anybody in the US national market system.

Does that mean the Growth advantage is permanent?  Well, until it isn’t. Economist Herb Stein (Ben’s dad) famously said, “If something cannot last forever, it will stop.”

And it will. I don’t know when. I do know that the turn will prompt the collapse of leverage and the vanishing of amplification. Then Growth stocks will become Value stocks.

And we’ll start again.

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!

Rewards of Risk

Investor relations involves risk.  And that’s good. 

Don’t you mean investing involves risk, Tim? And why is it good?

Well, yes, investing is a risky endeavor. But I mean the role of “investor relations,” the liaison to Wall Street at public companies, requires taking risk.

It’s not a “yes” job.  You’ll need the courage and occasional temerity to tell your executive team and board what each needs to understand about the equity market – and occasionally what not to do.

Time would fail me to tell you about all the times I’ve had conversations with IR folks who say, “I’m not sure my Board is willing to….” Pick your thing.

In my case, it happens when I explain that 10% of trading volume is rational stock-picking.

Some recoil in horror.  What am I going to do if the executives know 90% of our trading volume is something we can’t control?

If they don’t know, you’ll face unrealistic expectations.  Considered that possibility?  If your board and executive team don’t know how the stock market works, is that a good thing or a bad thing?

We’re still getting to what’s good about risk.

It’s our job to know how the stock market works and to be able to articulate what’s controllable and what’s not. Take the so-called meme stocks like AMC.  I credit AMC leadership for raising capital while the market embraces the stock.  They didn’t make the rules that permit crazy trading. They’re adapting.

And do you know how a stock with 450 million shares outstanding can trade 650 million in a day?  Yes, Fast Trading, in part.  Machines moving the same shares over and over.

But the big reason reaches back to the basics of how today’s stock market works under contemporary rules.  All shares must pass through a broker-dealer. All stocks must trade between the best bid to buy and offer to sell.  And all brokers who are registered to trade stocks must make a minimum bid and offer, both, of 100 shares.

Well, what if there aren’t 100 shares available?  There are no appliances available to install tomorrow in your house.  The electrical market is running out of GFCI outlets. Sherwin Williams is running out of paint.  You may not be able to get a load of lumber.

Yet somehow, magically, there is always 100 shares of your stock for sale. 

It’s not magic. It’s rules.  Rules require brokers and stock exchanges to connect to each other electronically. If they’re registered and not using “Unlisted Trading Privileges” to bid or offer rather than do both, brokers must commit to 100 shares each direction.

Well, it’s impossible. There aren’t 100 shares of everything available at every moment without artificial intervention.

So the SEC let’s brokers create shares under Rule 203(b)(2), the market-maker short-locate exemption, in order to assure 100 are always available.  Well, technically they’re shorting it without having to locate it.  Those trades have to be marked short.  And AMC has had short volume of 50-60% of total trading for two weeks running.

Brokers are manufacturing stock. That’s how the meme stocks scream. Brokers are selling buyers shares that don’t exist. If you’re in the IR profession, should you know these things?

So, why is risk good?  Mitch Daniels, President of Purdue University and ever a ready source for well-turned phrases, told graduates last month, “Our faculty has determined that data analysis, as we now call it, should be as universal a part of a Boilermaker education as English composition.”

We IR people are good at English composition. We need to be great at data.  Because, quoting President Daniels, certainty is an illusion. Just like those shares of AMC, and a swath of the whole market.

But leaders offer the capacity to understand the knowns and unknowns and make confident choices and recommendations.

I think data analytics are as vital to the IR job now as knowing Reg FD and Sarbanes-Oxley. The market translates our companies into digital value.  We need to understand it.

Otherwise we’ll be too fearful to lead our execs and boards boldly through the market we’ve got today.  Sure, there’s risk.  But the rewards of bold leadership never go out of style.  And we need that now more than ever.

Something Wicked

When I was a kid I read Ray Bradbury’s novel, Something Wicked this Way Comes, which plays on our latent fear of caricature. It takes the entertaining thing, a traveling carnival, and turns it into 1962-style horror.

Not 2021-style of course. There’s decorum. It stars a couple 13-year-olds after all.

The stock market also plays on our latent fear of caricature.  It’s a carnival at times.  Clowns abound.  As I said last week, companies can blow away expectations and stocks fall 20%.  That’s a horror show.

Courtesy The Guardian

Devilish winds have been teasing the corners of the tent for a time.  We told our Insights Reports recipients Monday about some of those.

The Consolidated Tape Association, responsible for the data used by retail brokers and internet websites like Yahoo! Finance and many others last week lost two hours of market data.  Gone.  Poof.

Fortunately, about 24 hours later they were able to restore from a backup.  But suppose you were using GPS navigation and for two hours Google lost all the maps.

So that was one sideshow, one little shop of horrors.  I don’t recall it happening before.

Twice last week and six times this year so far, exchanges have “declared self-help” against other markets.

It’s something you should understand, investor-relations professionals and traders.  It’s a provision under Regulation National Market System that permits stock exchanges to stop routing trades to a market that’s behaving anomalously, becoming a clown show.

Rules require all “marketable” trades — those wanting to be the best bid to buy or offer to sell — to be automated so they can zip over to wherever the best price resides. And exchanges must accept trades from other exchanges. No exceptions.  It’s like being forced to share your prices, customers, and even your office space with your competitors.

The regulators call this “promoting competition.” Sounds to me like a carnival.

But I digress. Exchanges must by law be connected at high-speed, unless declaring self-help.

An aside, I’ll grant you it’s a strange name for a regulatory term.  Self-help?  Couldn’t they have come up with something else?  Why not Regulatory Reroute? Data Detour?

Anyway, last week the trouble occurred in options markets.  First the BOX options market went down. It’s primarily owned by TMX Group, which runs the Toronto Stock Exchange.

Then last Friday CBOE — Chicago Board Options Exchange, it used to be called — failed and the NYSE American and Arca options markets and the Nasdaq options markets (the Nasdaq is the largest options-market operator) declared self-help. They stopped routing trades there until the issue was fixed.

Now maybe it’s no big deal.  But think about the effect on the algorithms designed to be everywhere at once.  Could it introduce pricing anomalies?

I don’t know.  But Monday the Nasdaq split the proverbial crotch of its jeans and yesterday the so-called “Value Trade” blew a gasket.

I’m not saying they’re related. The market is a complex ecosystem and becoming more so. Errors aren’t necessarily indicative of systemic trouble but they do reflect increasing volumes of data (we get it; we’re in the data business and it happens to us sometimes).

And we’d already been watching wickedness setting up in our index of short-term supply and demand, the ten-point Broad Market Sentiment gauge.  It’s been mired between 5.8-6.1 for two weeks.

When supply and demand are stuck in the straddle, things start, to borrow a line from a great Band of Horses song, splitting at the seams and now the whole thing’s tumbling down.

And here’s a last one:  Exchange Traded Funds (ETFs) have been more volatile than the underlying stocks for five straight weeks, during which time stocks had risen about 5% through last Friday. Since we’ve been measuring that data, it’s never happened before.

Doesn’t mean it’s a signal. It’s just another traveling freak show. Clowns and carnivals. ETFs are elastic and meant to absorb volatility. Stocks are generally of fixed supply while the supply of ETFs fluctuates constantly.  You’d expect stocks most times to thus move more, not less.

I think this feature, and the trouble in options markets, speaks to the mounting concentration of money in SUBSTITUTES for stocks.  It’s like mortgage-backed securities — substitutes for mortgages.  Not saying the same trouble looms.  We’re merely observing the possibility that something wicked this way is coming.

Our exact line Monday at five o’clock a.m. Mountain Time was: “There’s a lot of chaos in the data.”

Son of a gun.

I don’t know if we’re about to see a disaster amongst the trapezes, so to speak, a Flying Wallendas event under the Big Top of our high-flying equity market.  The data tell me the probability still lies some weeks out, because the data show us historically what’s happened when Sentiment hits stasis like it’s done.

But. Something is lurking there in the shadows, shuffling and grunting.

And none of us should be caught out. We have data to keep you ahead of wickedness, public companies and traders. Don’t get stuck at the carnival.