Tagged: Trading

Halted Auction

The NYSE opening auction failed yesterday.

Prices gyrated and trading halted in swaths of large caps including XOM, WMT, UL, T, VZ, RTX, MCD, PRU, UNP, MO and many more – trillions in market cap.

It was, to quote comedian Jeff Foxworthy, pandelirium. Especially among the market-structure crowd on Twitter.  The wreckage to prices, trades, data…whew.

Proposed new SEC rules would sharply increase the number of auctions at exchanges. These retail auctions will last just 300-400 milliseconds, but it means one venue out of about 50 will have to get it right.

Big risk.

And it’s not retail or stock-pickers I’m thinking about but Passive money. Vanguard says 80% of its $8 trillion in assets are passive. 

It’s a bellwether. Blackrock and State Street aren’t far off that number across their combined $15T under management. Over half of Fidelity’s assets now track models. The big banks like UBS and Morgan Stanley and JP Morgan, another $12T or so, are using target-date and asset-allocation models.

That money moves in vast ranks.  It’s measurable. You can see it daily in your data if you know what to watch, like we do.  Image #1 here is what we see when Passive money in the S&P 500 rushes back to Tech and lifts the market.

Image 1. Image courtesy ModernIR.com. SP500 pattern data Dec 2-30, 2022.

Here’s the thing. All of it depends on reliable historical quote and trade data. Because it’s executed by algorithms.

The stock market is 98% algorithmic, 100% electronic. The software executing rapid-fire small trades needs clean data to calculate prices and sizes and do its work.

The average S&P 500 stock (all save UL above are in it) trades 45,000 times per day, in 105-share increments, about $730mm of stock daily on average, and price moves 2.5% between high and low daily, and 49% of the volume is short (borrowed).

You can’t have hiccups.

And it’s exceedingly difficult for stock-pickers, who are 10% of daily volume in the S&P 500, to set price.  Most of the time, they’re subsumed in the 75% of volume coming from either Passive Investment – all that model-driven money – or Fast Traders who set prices.

The Designated Market Makers on the NYSE floor are Fast Traders. Most of the prices at the rest of the stock exchanges are set by Fast Traders incentivized to bid or offer at the “top of the book.”

I had a trade yesterday execute yesterday at the NYSE in an RLP, a retail liquidity program. A Fast Trader “crossed the spread” to give me a tenth of a penny more per share, and was paid three cents a hundred shares by the NYSE to do it.

Okay, Quast.  My head is spinning. What’s the point? 

If you’re publicly traded, this is your market.  Should someone at every public company know how it works?  Seems so, since the executive team and the Board are fiduciaries to shareholders.

And equally important, WHAT WE DO for the executive team should reflect the facts. 

Let me give you an example.  And it applies to both investors and public companies.  To the latter first, let’s suppose you’re the CFO at 3M Co.  Before you report earnings, you should expect your investor-relations team to tell you what the money has been doing behind price and volume.

Not what your holders are asking, or what the sellside is saying.  Those are known knowns, as they say about battlefields.

The known unknowns include what all the money is actually doing.  Let’s remedy that. Image #2 shows the 30-day Supply/Demand balance in MMM. Deteriorating Demand, Supply high and nearly 60% of trading volume.

Image 2. Courtesy marketstructureedge.com, 30-Day Supply-Demand view, MMM.

That alone, no matter what the story is, says price will fall. Put VALUE messages where machines read them, in the heading and subheading and CEO quote. 

The last image (#3) does what the CFO asks. It shows what the money has been doing the two weeks before earnings. Summarizing the data, price is down 5%, Passive money is up 11% (so it’s a seller), shorting is up, Active Investment is down, Risk Mgmt bets are up.

Image 3. Courtesy ModernIR.com. 2-wk comparison, MMM.

But stock-pickers – Active Investment – are not sellers. There’s again a chance to attract VALUE money.  The message should reflect it.  Key words should reinforce it.

Then MMM should measure what happens in the week after results and the week after that. What changes?  Report it to execs, to the Board of Directors.

This is core investor-relations today. Because the stock market is electronic and algorithmic and most of the money isn’t rational.  You can’t fix shareholder-value with fundamentals because it’s not how something like $40 trillion of assets looks at equities.  And it’s not how the stock market works.

And investors? If you see falling Demand and rising Supply ahead of earnings, cut your exposure. You can come back later at a better price.

The market is complex and fragile, and issuers need a better handle on its rules and mechanics. So do traders and investors. Right now, the intermediaries are making all the rules. That’s how Citadel made $16 billion last year.

I’m happy for Citadel!  But the rest of us need a say too, and a fair and level playing field.

The Winners

There was a country hit 30 years ago called Nobody Wins.

Why drag out a 1993 song by Radney Foster?  Well, it popped into my head reading the SEC’s proposed new regulations for the US stock market.

Oh, but somebody wins here.

Photo 126390367 / Sec © Grey82 | Dreamstime.com

If you missed last week’s first chapter, Origins, read it.  I promised this week to describe who wins in the 1,650 pages of new regulations the SEC thinks the stock market needs.

At Amazon is a book called “How to Play Chess: A Beginner’s Guide to Learning the Chess Game, Pieces, Board, Rules, & Strategies.” It says you’ll master chess. It’s got 498 reviews and gets 4.5 stars. It’s 49 pages.

If you can master chess in 49 pages, you’d think the stock market, which the SEC has opened to 100 million Main Street folks by permitting free trading (no commissions!), must be simple. After all, the SEC wouldn’t just let beginners in. Right?

Regulation National Market System, which regulates the stock market’s quotes, prices data and access (to all three) is 520 pages.  Probably a good idea to know what it says.

After all, the US stock market is home to about $45 trillion of invested assets, over 3,500 public companies, over 2,000 Exchange Traded Funds, hundreds of closed-end funds, scads of preferred and other classes. A combined 10,000 securities.

It’s roughly 70% of total global market-capitalization.  If you’re an investor, this market supports your retirement plans.

But wait, there’s more.

The SEC’s Market Data Infrastructure Plan is 900 pages.  You should probably know what’s in that too. With it, the Clayton SEC regime aimed to end the exchange data monopoly. Exchanges sued and blocked parts of it (not the definitions, though).

The stock market and the exchange business are all about data.

The NYSE is a tiny part of Intercontinental Exchange (NYSE: ICE), which is in the data business.  ICE had $9.2 billion of revenue in 2021, $4.1 billion of income, a 44% margin.

According to ICE’s 2021 10K, 71% of its revenue is data, analytics and network services.  Listings are 13%.

The Nasdaq had 2021 revenue of $3.4 billion after deducting $2.2 billion of rebates paid to traders to set prices, and earned $1.2 billion, a 35% margin.

Here’s the irony. The whole of SEC market regulation is about narrow margins. LOW SPREADS. Remember those two words. 

Nasdaq segment-reporting shows 2021 revenue of $1.1 billion from market data, index-licensing and analytics. 

Do the math. Without that byproduct from operating markets and paying traders to set prices, the Nasdaq made $100 million.

That’s still a lot of money. But it’s a 3% margin, not much different than running a grocery store. Grocery stores are low-margin stock markets matching producers of goods with consumers of them.

The stock market is a grocery store for public companies trying to find investors for their shares.  And this grocery store has margins of 35-44%. 

At whose expense?

The intermediaries using the platform such as Citadel, Virtu (30% margin in 2021), Hudson River Trading, Quantlab, Two Sigma, Infinium, GTS, SIG, Tower Research, IMC, Flow Traders, Optiver, make billions of dollars as middlemen.

Jane Street traded $17 trillion of stock in 2020 and made $8 billion, give or take. It’s got 2,000 employees. Bank of America just reported net income of $7.1 billion. It’s got 220,000 employees.

Anybody seeing a trend? 

The SEC has now proposed 1,650 more pages, bringing the total near 3,000, not counting the thousands more pages of rule-filings emanating from the exchanges every year.

And they’re principally focused on shrinking spreads. A penny is too wide. We need tenths of pennies in quotes now, or the little guy is getting screwed.

We’re told.

By the way, you’ll hear a term over and over and over from regulators and exchanges:  Execution Quality.  It’s supposedly what defines the stock market as “good.”

No, it’s what makes money for intermediaries and ensures what the SEC wants: That somebody keeps posting quotes and trades in this absurdly complicated environment.

When you see the term, know it’s obfuscation.

Let me cut out the intermediating verbiage. The SEC sees that we have a bifurcated market where half the trades, roughly, are occurring off-exchange in dark pools, but the exchanges provide the prices, quotes and small spreads. And the exchanges make scads selling resulting DATA.

The SEC also sees that the data advantage held by the exchanges is unfair, but the exchanges sue when the SEC tries to fix it.  And meanwhile as trading OFF exchange nears 50%, the VALUE of the data the exchanges sell is threatened, and so is the necessary tense alliance between the SEC and exchanges.

So the SEC has, with 1,650 pages, struck a deal. We’ll push more trading and quotes and prices back to you, exchanges, so you get more of the spread. But charge less for trades and ensure that the continuous auction market doesn’t break down.

Execution quality.

The winners are the SEC and the exchanges. 

I can promise you this, investors, traders and public companies, parties for which the stock market exists: Trading in tenths of pennies at stock exchanges is bad.

The smaller the spread, the shorter the investment horizon.

And that’s what these latest 1,650 pages promote. Smaller spreads, tinier trades, more data.  Bigger margins for intermediaries. For the purposes I described.

It’ll be called Execution Quality. It means the middlemen are merchandising you.

And you lose.

Do you care? Does anyone anymore?  You issuers, you are the biggest losers. You’ve lost your audience, your capital-formation mechanism.

And if you let the parties running your market make 40 cents of every dollar, you probably deserve it.

Origins

I counted the times “issuer” appears in the SEC’s four new market-structure proposals.   

Investors and traders (and issuers), should you care?

Without issuers, there’s nothing to trade. These rules could push issuers onto the endangered species list.  You can read and comment

Photo 108381110 / Austin © Sean Pavone | Dreamstime.com

on the proposals here, and you should do both. At minimum, read the fact sheets here.

The word “issuer” never appears beneficially. I’ll explain.

We’re back from Austin TX and marking Karen’s mom’s 80th birthday. Friends and family turned out in droves.  We kids (using the term loosely) served 16 bottles of prosecco, white wine and red wine, plus all the trappings including over 80 Italian cream cupcakes.  The oldsters can party.

In the retirement facility where mom resides is a man named Walter Bradley.  He was a professor for 40 years at Colorado School of Mines, Baylor and Texas A&M. He’s got a PhD in polymer sciences. We talked to him, know who he is.

Turns out, everything is made of chemicals and proteins, inanimate or not.  How these compounds combine is what makes plastics. And humans. 

Walter Bradley is a Christian.  He pioneered a school of scientific thought on the origin of life called Intelligent Design.

Stay with me.  As ever, I’ve got a market-structure lesson. 

Ben Stein made a documentary called “Expelled: No Intelligence Allowed.” Walter Bradley is in it.

Whether you believe in God or don’t, how life happened here is a persistent mystery.  Delve into the science – not the ideologies and philosophies predominating on both sides – and you find convergence of opinion:

Nobody knows for sure.

You’d think the science was settled. There’s evolution with the answers. Ah, but no. Giant, whistling holes. Science can’t obviate God.

Dr. Bradley says the Second Law of Thermodynamics disproves a natural origin to life. The principle, called Entropy (that’s what I’d call my rock band), holds that all things move from a state of order to a state of disorder, like kids’ bedrooms.

Life depends on a precise combination of proteins and chemical reactions, which can only arise from the opposite: Moving from disorder to order. It doesn’t occur in nature.

Nobody in science disputes that, believers and atheists alike.

As Ben Stein’s documentary says, the probability that the right string of proteins combines randomly to foster cellular replication is so monstrously unlikely as to accrue gaggles of zeros.  It’s all the same as impossible.

But it happened.

Which brings us back to the word “issuer.” 

It’s in these SEC documents 24 times by my count.  Just six mean “public companies.”

Three times on page 397 (472 total) of the filing called Disclosure of Order Execution Information – do we need almost 500 pages on that? – we’re told issuers are hurt by “financial frictions.”

Says the SEC: “Financial frictions may have an adverse impact on capital formation. In particular, higher transaction costs may hinder customers’ trading activity that would support efficient adjustment of prices and, as a result, may limit prices’ ability to reflect fundamental values. Less efficient prices may result in some issuers experiencing a cost of capital that is higher than if their prices fully reflected underlying values…”

That’s demonstrably false. Like claiming things naturally move from disorder to order.

Trillions of dollars are raised and deployed in private investments without any stock exchanges or “financial friction.” It proves irrefutably that “fundamental values” do not depend on trading.

But that’s still not the point. 

The market started with issuers. It’s the origin of species, so to speak, for stocks.  There were first, before brokers, which in turn created the exchanges that now compete with them, shares of companies. Without them, there is no stock market.

In a 399-page proposal called The Order Competition Rule, the term “issuers” appears three times in reference to the Securities and Exchange Act’s prohibition on discrimination against issuers and unfair allocation of dues and fees.

Well.

There are three big exchange groups: The NYSE, with 19.4% of volume across five platforms, most of that at the NYSE floor, and NYSE Arca, its derivatives market.

There is the Nasdaq, with 16.9% on three (not one) platforms.

There’s CBOE, with 12.6% at four platforms.

Do the math. A majority of trading happens somewhere else. You companies listed at the NYSE and Nasdaq, over 80% of your trading occurs where you’re not listed. At no cost.

What are you paying for, then? You pay exchanges to trade your stock. But they’re not. 

Issuers, your fees are too high. What are you going to do about it? The SEC is violating the law. Will you defend yourselves?

Trading firms like Citadel are getting rich a tenth of a penny at a time, at your expense. Exchanges are financial behemoths. And there are half the number of public companies there were when the Nasdaq started. Half the investor-relations jobs.

And these 1,600 pages of new rules compound the divide.

Origins matter. The SEC has forgotten that the stock market originated with issuers.  And cannot exist without them.  Issuers, are you going to buy the myth, or the science?

Next time, we’ll talk about who benefits from these new rules – somebody does! – and what they mean to investors and traders.

Market Palio

Maybe we should have a horse race to decide our elections. 

In Siena, the whole region gathers July 2 and August 16 annually, thronging the Piazza del Campo (the city square you see behind our beverages in the photo here, shot Sep 26) for The Palio, pounding equine competitions involving the city’s contrade, the 17 districts of Siena.

View of the Piazza del Campo from the best bar seat in the square (photo Tim Quast Sep 26, 2022).

After Siena succumbed in a 150-year war with Florence (talk about endurance), competition turned inward. The city’s uniquely designated districts redirected their energies to competitive horsemanship instead of Florentine raids.

Each year, horsemen from ten of the contrade race each other, three furious laps around the square. The other seven automatically qualify for the next race, with three others added by lottery.

I’ll skip the finer details but it’s full of intrigue, chicanery, sordid deals, massive sums spent on jockeys, who may conspire and cheat, and tears and cheers and meals and wine.

In short, it’s just like politics. 

But in The Palio, while victory is everything, it really means nothing. It’s just Sienese culture.  That seems like a much better outcome than modern politics.

The stock market lately too has felt like The Palio.  A drumming, entertaining, heartbreaking, chaotic mess pelting around turns and slamming into walls, with little logic or purpose.

Can we make sense of it?  Of course. But not logically.  It’s the Palio of Siena.  It only makes sense if you understand the underlying story and purpose.

Public companies and investors, your best friend amid the churning dirt of the market’s Palio is market structure. It’ll help you make sense of what seems to be random disorder.

The best-performing S&P 500 stock year-to-date is OXY, up about 88%.  Ranked second is ENPH, up about 55%.  Both are energy stocks, one the old-fashioned kind with a D rating for planet-friendliness, whatever that means.  The other is a clean-energy stock.

Active money is 9% of OXY’s daily volume, 10% of ENPH’s. Both perform well financially but not more so than other Energy stocks. But both are darlings of Passive money, receiving outsized allocations. Over 40% of trading volume in both traces to Exchange Traded Funds.

It’s like the two stocks were the winning horses in The Palio (where the horse wins, even without a rider).

It’s a lesson about the stock market. There’s still a lot of clinging to the notion that you own “good companies.”  As defined by what?  OXY and ENPH are good companies as defined by the amount of volume from ETFs.

If that’s the money driving the stock market, then they’re both good companies.

And it illustrates the importance of understanding what kind of money creates good companies.  And it may not be revenue and profits.  It may be Demand vs Supply.

OXY has spent 130 of 183 days since Jan 4 at 5.0 or higher Demand on the ten-point scale we use to measure buying and selling by investors and traders, called Market Structure Sentiment.  ENPH has spent 118 days at or over 5.0. 

The more time stocks spend over 5.0, the better they do. There’s no direct connection to financial results.  It’s about whether there’s greater Demand for the stock from any purpose or time-horizon.

Did anyone pick OXY and ENPH as the 1-2 ranked S&P 500 stocks for 2022 when the year began?  I don’t know.  Not based on financial performance. Those winners would have come from the Tech sector. Which has been brutalized.

The math is clear.  Winners in the stock market are not determined by financial performance but by Supply/Demand balances. Strong demand, constrained Supply, prices rise.  It’s a much better predictor of winners than is the bottom line.

For better or worse.

In that sense, the stock market is The Palio. It’ a horse race built around culture, where “culture” is market structure.

We tell users of Market Structure EDGE to always know the Supply/Demand balance of stocks they like, and to buy divergences.

And for public companies, the Supply/Demand balance is critical to predicting what stocks will do at any time, but especially into earnings.  After all, Supply and Demand are measuring every input – fundamental, quantitative, long/short, global macro, hedged, high-frequency, leveraged, you name it.

So how do you win the stock market’s Palio?  It’s a lottery.  You can improve your chances of a shot at victory by first being BIG.  Get into the Russell 1000 and do it with M&A if you must. You’ll be where 95% of the money and the market cap is.

And then it depends on your contrada, your segment of the stock market.  Then you hang on till the three laps are done. The good news is we can measure your odds of winning.

Why Yass Wins

I get a kick out of Jeff Yass and not just because he’s a libertarian. 

And when did “libertarian” became a bad word? We used to love liberty.

Anyway, Jeff Yass started Susquehanna International Group in Bala Cynwyd, PA.  He’s roughly Number 184 on the Forbes richest list. 

SIG, as the firm is called, says it “thrives at the intersection of trading, quantitative research, and technology.”

By the way, this photo is the ModernIR client services team dining at Mountain Standard during our retreat in Vail this week.  Thank you, Arrabelle, for taking good care of us!

ModernIR client services team at Aug 2022 Vail retreat dining at Mountain Standard. Great job, team! Photo courtesy Tim Quast

In 2020 SIG traded about 25% of all options volume in the USA, the equivalent of 1.8 TRILLION shares of stock.

SIG’s website says, “As one of the largest proprietary trading firms in the world, we trade our own capital at our own risk.”

Mr. Yass traffics in probabilities. It’s arbitrage – buying and selling the same things at different prices. All short-term trading is arbitrage.  It’s 53% of US market volume, our metrics show.

Mr. Yass makes billions trading imbalances in the options market. But he invests in private companies like Bytedance and TikTok.

If you’re an expert on market mechanics, why would you invest in some other market?  Because Mr. Yass – and I’m surmising here – understands market mechanics. 

They don’t work long-term.  Short-term trading returns crush long-term buy-and-hold results.

It’s math. Mr. Yass arbitrages public equities and invests in private businesses, where he can get away from his own arbitrage.

Interjection:  This photo is the group that hiked the Berrypicker trail to the Eagle’s Nest at 10,400 feet, an elevation gain of 2,300 feet. No small feat!

Intrepid ModernIR team hiking 2,300 feet up from Vail Village to the Eagle’s Nest, Aug 23, 2022. Photo courtesy Tim Quast

The founders of another proprietary trading firm, Jane Street, came out of SIG.  In 2020, Jane Street traded $17 trillion of stocks, keeping about $7 billion in earnings. The math suggests Jane Street makes gobs of tiny, profitable trades.

Jane Street says, “We are a global liquidity provider and trading firm, using sophisticated quantitative analysis and a deep understanding of market mechanics to help keep prices consistent and reliable.”

Some still describe SIG’s and Jane Street’s trading as “noise.” It’s the same kind that Citadel, Virtu, Hudson River Trading, Tower Research, Infinium, GTS, Two Sigma, Quantlab, Optiver, and so on, do.

It’s not noise. It’s quantitative investment.  It dominates the stock market and it’s got nothing to do with corporate fundamentals.  The richest investors now are these quants.

Unless investors are making money, they will leave the stock market.  This is what happened to a great many stock-pickers the past 20 years.

By and large, profits in the stock market come from arbitrage – different prices for the same things. You can disagree. The facts won’t change.

And the majority of stock-pickers don’t outperform passive funds. If you can’t beat your competition, you go out of business.

Everything we write here is meant to make public companies and investors more intelligent participants in the market that has made Citadel and SIG and Jane Street wildly wealthy. 

Investor-relations professionals, you need to sit at the intersection of quantitative data and market mechanics and technology, too. Because that’s what THE MONEY is doing.

It’s easier than calling stock-pickers and trying to generate shareholder value.  That doesn’t work. That’s Sisyphus.

Yes, we do it still. But it should be 30% of your time, not 95%.    

Here’s what does work.  Ahead of earnings, know the last time stock-pickers bought, and what they paid. That’s measurable. Know what percentage of your trading volume they drive.  Give those data points to the c-suite and the board.

Why? Because otherwise they won’t understand the stock market. (One study shows retail investors understand cryptocurrencies better than stocks, a disaster for public companies.)

If Demand is falling into earnings and Supply is rising, make the subheading in your earnings release a VALUE message – “bolstered our balance sheet in the quarter.”

Machines will read it.  Your Supply/Demand balance says your stock will fall, so tee up the money that buys dips. Value money.

And after earnings, report what kind of money set price, and how patterns changed, and if Active money bought and changed its percentage of trading volume.

IR in a quantitative market should know when to emphasize value or growth or other characteristics in external communication. And IR should provide regular, cadenced data on what drives or hurts shareholder-value that reflects how the market works.

The market is quantitative because the mechanics and rules of the market are mathematical.

Just a fact.

If we could be coldly analytical, we’d stop wasting time and money on things that don’t matter. We’d own the data. It starts with understanding who’s making money in the stock market, and why.  Ask Mr. Yass what he does. 

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.