Can stocks fall if nobody sells?
For a sneak peek at my thesis, here’s my segment with Brian Sullivan and Kelly Evans on CNBC Power Lunch Monday Apr 28.
You may be thinking: Is it a trick question? There’s a buyer for every seller.
I hate to break it to you but prices can change without buyers or sellers. Take your house. It doesn’t lose value because people sell houses. Value falls when people don’t buy houses.
Derivatives are implied demand. The term “Derivative” merely means that the instrument is derived from, predicated on, something else. So options are derived from stocks and ETFs and indexes.
If you buy options, you’re hoping to either sell it for a profit, or use it to acquire shares at a beneficial price (perhaps so you can turn around and sell the shares). If you sell them, you’re hoping to keep the income generated from the option without having to give up the underlying shares.
For big index funds, options offer an inexpensive and liquid way to fill in potholes in the portfolio. This stock is way up, that one way down – buy puts and calls to square positions to what the fund’s prospectus purports.
That happens with monthly and month-end expirations. The latter expires today. More on that in a moment.
In effect, options give holders the right to future prices. And market-makers add the activity in the options market to Demand and Supply in the equity market.
Then suddenly something – say, tariffs – casts a cloud over future prices. And options devalue rapidly. Not because traders sold options. Values just reset. And the market-makers trading everything reactively drop prices of underlying stocks.
Or yank prices higher violently, as happened April 9.
Now, you might say, “What difference does it make, Tim, if the market declined and recovered on derivatives or selling by investors?”
Because the latter is fear. The former is MARKET STRUCTURE. If nobody really sold, people aren’t nearly so concerned as the market’s behavior seems to signal.
A word on tariffs: A criticism is that tariffs are taxes and therefore bad for consumers. Well, we’re already taxed. Are those bad?
Paul Harvey, who passed away in 2009 after a 50-year radio broadcasting career, used to say, “Corporations don’t pay taxes. People pay taxes.” Complaining that tariffs will be passed along to consumers while ignoring that all taxes are passed along to consumers is incongruous.
For that matter, inflation, which some say tariffs will foster, is a tax. John Maynard Keynes, the father of government deficit spending, said in 1919: By a continuing process of inflation, Governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.
Keynes thought governments caused inflation. So did Milton Friedman. Are they wrong?
Back to stocks, they declined in March even as the supply of ETFs increased. The Investment Company Institute says sponsors created and redeemed $1 trillion of ETF shares in the month (most recent data). Creations – ETF shares to sell to investors – outpaced redemptions, or ETFs shares returned to ETF sponsors in trade for a basket of stocks, by $90 billion ($572 billion of creations, minus $482 billion of redemptions).
Not chump change.
Ninety billion dollars of monthly inflows is over $1 trillion annualized. Even Blackrock didn’t do that in 2024 with its record $641 billion haul. Yet the S&P 500 declined from about 5,840 to 5,590 in March.
How’d it happen? Looking at the quantitative data for SPY as a proxy, Active money rose 5.2%, Short Volume rose 19.4%, price of SPY declined 5.9%. It means hedge funds shorted the market with ETFs.
By the way, Passive money declined 4% in March. Most of the money today follows models. Flows slowed but there was no selling in models.
That’s the money you need, public companies. You want 20-25% of your daily volume coming from Passives. Have a strategy for it. Not telling the story. Crafting a product.
Summarizing, the April tumult was derivatives that plunged in value and then revalued as traders and machines scooped up cheapened rights.
In March, some part of the trillion dollars of ETF creations was for shorting the market. That’s speculation, not fear. It’s market structure.
And into this construct, two thousand companies this week including at least a third of the S&P 500 report results, furiously differentiating themselves.
Why? Money buys products. There is safety in the herd. Do your best to stay in it, public companies. Draw attention, and the hyenas will circle. You need a plan and predictive analytics for this market.
And investors and companies alike: Month-end options expire today. These contracts were set roughly April 1. SPY is down just 1.5% since March 31. But volatility has nearly doubled. Passive Investment is down 22% in April vs March. Derivatives are down 8%.
That COULD mean trouble. And Demand (flows of money) peaked yesterday. Supply (short volume) is nearly 52% in S&P 500 stocks. Same as it was March 31.
Investors (join our live Demo Thursday!), you need a plan, a strategy too. Because it’s not what you think. That’s the real risk.
