December 28, 2016

The Math

“Making investment decisions by looking solely at the fundamentals of individual companies is no longer a viable investment philosophy.”

So said Steve Eisman, made famous in Michael Lewis’s book The Big Short, upon shutting down his new investment fund in 2014.  Actor Steve Carrell portrayed Eisman as Mark Baum in last year’s hit movie from the book.

Michael Burry, the quirky medical doctor running Scion Capital in the book and the movie (played by Christian Bale), first earned street credibility via posts about stocks on Silicon Investor, the online discussion forum huge before the dot-com bubble burst.

But in the ten years after Regulation National Market System transformed the stock market in 2005 from a vibrant human enterprise into a wide-area data network, 98% of all active stock-pickers failed to beat the S&P 500, proving Mr. Eisman correct.  You can’t pick stocks on merits alone now.

That’s contrary to the legacy objective of the investor-relations profession, which is to stand the company’s story apart from the rest.

As with finding the root of the mortgage-industry rot, today the market is all about data.  Everything is.  Google Analytics examines internet traffic patterns.  ZipRecruiter is analytics for hiring. Betterment is analytics for personal investing.  HomeAdvisor and Angie’s List are analytics for home-repair. Pandora is analytics for music you like.

Pick your poison. Everything is data. So why, ten years after Reg NMS, is the IR profession calling someone to ask, “How come my stock is down today?” All trades pricing the market under Reg NMS must by law be automated.

If you’re calling somebody to ask about your stock, I’m sorry but you’re doing IR like a caveman. And, paraphrasing Steve Eisman, running the IR department solely by telling the story to investors is no longer a viable industry philosophy.

Why? Because it begins with the flawed premise that the money buying and selling your shares is motivated by fundamentals alone.  For the past decade – the span of Reg NMS – trillions have departed active stock-picking portfolios and shifted to indexes and Exchange-Traded Funds, because tracking a benchmark is a better path to returns.

Take yesterday.  All you had to do was buy technology and materials stocks.  Today it might be something else. The most widely traded stock on the planet is SPY, the S&P 500 ETF.  It traded $7 billion of volume yesterday, ten times BAC, the most active stock.

Here’s another. XLU, the Utilities ETF, was among the 25 most actively traded issues yet the sector barely budged, up 0.04%. Why active then? ETFs fuel arbitrage.  Profiting on price-differences. It’s not where prices close but how they change intraday.

Best trade yesterday?  NUGT, the leveraged gold ETF, was up 7.5% even though gold has been a bust the past month.  The S&P 500 took the whole year to gain 10% and then only on the Trump Bump. Between Dec 30 and Oct 31, the S&P 500 eked out 2% appreciation. You could triple that in a day with NUGT so why invest long-term?

“Boy, Quast,” you say. “It’s the holiday season! What are you, The Grinch?”

Not at all! The opposite in fact. I’m on a quest to make IR central to public companies again. We invented Market Structure Analytics, data for the IR profession to address the demise of IR as Storyteller.  The future for our profession isn’t a command of fundamentals but knowledge of market form and function.

Let me be blunt. Anybody can tell the story. Only IR professionals dedicate themselves to knowing how the market works – and that’s job security, a transferrable skill set.

The way IR shifts back from a rotational role to vital standalone profession is through knowledge of the stock market. If you want to be a biologist, study and understand biology. If you want to be a biology reporter, you just need to know some biologists (no offense to biology reporters).

Which will the IR profession be in 2017?

Having threshed trading data for 15 years now through the regulatory and behavioral transformation of the equity market, I feel a tad like those guys in The Big Short who studied mortgage numbers and concluded it was irrefutable: It was going to blow up.

These data are irrefutable: Over 80% of your volume most days is driven by something much shorter-term than your business strategy.  Ergo, if all you tell your Board and management is how your strategy influences the stock, you’ll at some point be in trouble.

This is the lesson of 2016.  Make 2017 the year IR transforms how the people in the boardrooms of America understand the stock market. That is an invigorating challenge that will breathe value into our profession. The math doesn’t lie.

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