What about the stock market can we believe?
You can’t believe prices. At least, during the day. If you’re a trader, how do you know if the price will move favorably?
Yet prices are the core ingredient of technical signals, and the way we value stocks fundamentally – “it’s trading at 17 times forward earnings.”
I sat in the ModernIR conference room probably seven years ago with a high-frequency trader and a member of the Federal Reserve’s market structure group and we talked for two hours about how the stock market works.
He said, paraphrasing, at the tick-level, correlations reach zero. The minute-by-minute movement of prices and quotes means nothing. He said they learned to trust the models, which were not fooled like the humans by constantly changing prices.
So how could one consistently make money using technical signals?
I digress.
Don’t believe prices. They’re not reliable. Shift to probabilities, and Demand/Supply imbalances.
And you can’t believe premarket signals, either. Have you noticed the disconnect between futures before the stock market opens and where the broad measures finish the day? Futures can be up and the market closes way down, and vice versa.
Of what use are those as signals, then?
It happens because the rules during market hours are not applicable outside market hours. And hedge funds and other big investors can move massive positions through broker-dealers, while small investors can’t.
It raises a question: Is it better to report earnings during market hours when the rules governing prices have volatility girders? It’s an idea we’re examining.
Today, the Federal Reserve Open Market Committee meeting concludes with the press conference by Chair Jay Powell. By definition, “open market” operations means the central bank is buying and selling securities. Should they be doing that? Why or why not? Why doesn’t anyone ask?
James Madison wrote to Congress and President Washington in February 1791 in opposition to legislation for creating a government bank, saying the power in the bill had not been expressly delegated by the Constitution to Congress and could not be rightfully exercised.
And he said the bill favored the institution over the public, adding, “it is in all cases the duty of the Government to dispense its benefits to individuals with as impartial a hand as the public interest will permit.”
Now we all hang on every word from the central bank. Madison was right. Paradoxical.
Let’s get back to what you can believe. Issuers: If your stock falls and your peers rise, the question shouldn’t be WHY you’re up, and they’re down – though we can answer it, because we have all the data on your trading – but what is a “peer?”
You look at a set of companies that do what you do, and suppose investors will treat you the same. Sometimes it’s true. Big passive investors don’t do that, however. The characteristics Blackrock buys are not the ones stock-pickers buy.
Take CRM. They sell software-as-a-service. That’s STORY. Is that how investors with scads of money benchmarking to broad measures see CRM?
No. CRM is a megacap, a group of 113 stocks (at the moment) with more than $100 billion of market cap that comprise more than 75% of market equity. Those are peers.
CRM is also part of the Tech sector, in the Dow Jones Industrials, in the S&P 500. Add it up. CRM is in a basket that’s somewhere between 25% and 88% of market cap.
The key for CRM then is to stay with the herd. Large cap value and growth equities. The problem is that all public companies try to separate themselves from the herd.
This is the orthodoxy of investment. Find differentiated companies with better fundamentals, better market opportunities, better technology. Yet all the money owns the same stuff. I’ve noted before that the top holdings in the world’s largest active and passive mutual funds are the same, and the key difference is the index fund costs a fraction of the active one.
Morningstar data show that a staggering 98% of stock-pickers in large cap growth equities the past 20 years didn’t beat the benchmark (and about 70% of those funds no longer exist).
CRM dutifully differentiated itself in December last year, touting operating results. The stock soared. Seems like a great victory! We differentiated!
Blackrock isn’t buying outliers. It’s buying the herd. Differentiated results that sharply drive prices up or down cause tracking errors for money wanting the benchmark. And those stocks are then removed from baskets that ETFs use to price the benchmark.
We told CRM that over the next two quarters it would give its gains back. Because it was out of the basket. Might be over time, or all at once.
We run a Low Volatility performance model. It very nearly mirrors the S&P 500 but beats that benchmark by holding stocks with less gyration. It’s up more than 17% YTD.
The data illustrate what big money wants. Low volatility, liquid stocks. CRM’s gains came on directional hedge-fund bets. Hedge funds gather all the data and bet which way price will move, using such large scale that they can tip the entire market – outside market hours.
CRM’s 16% move Nov 30-Dec 1, 2023 were driven by a single measurable event (we meter behavioral change): a 13% jump in derivatives trades. Hedge-fund bets forced sellers of volatility to cover. And consequently, all CRM’s Dec 1 gains vanished May 31.
What should CRM have done instead? Ask us, and we’ll explain. Give the market that product it wants.
Investors, returns are paradoxically best achieved, and SUSTAINED, through a low-volatility basket. Public companies, you can best deliver lasting shareholder-value by avoiding what erodes gains – being an outlier.
If you want to know how, ask us. We have a process.
