January 19, 2022

Uneven Market

My advice?

When the market gets tough, go sailing.  Heck, go sailing when stocks are soaring.  I recommend it.

If you missed the Market Structure Map, we were on hiatus the past two weeks whilst undulating via catamaran over azure seas along the Sir Francis Drake Channel, sailing the whole of the British Virgin Islands from Jost Van Dyke to Anegada.

This photo below is in The Bight where lies the famous Willy T at anchor, off Norman Island.  You can get used to bare feet, tides, the absence of time save the rising and setting sun.

Photo courtesy Tim Quast

I had time to read Raj Rajaratnam’s new book, Uneven Justice, mostly on the long flights there and back.  I lived for a year in Sri Lanka during college, from whence he hails.

You colleagues long in the capital markets will remember the 2009 arrest of the Galleon hedge-fund founder for insider trading. 

The book is repetitive, has some copy-editing shortcomings. But it’s a remarkable read and I recommend it.  If you like the HBO show Billions, you’ll appreciate the sordid conniving by the attorney for the Southern District of New York, Preet Bharara.

I’ve long thought insider-trading was a mushy “crime.” You may disagree. I think Rajaratnam does a creditable job establishing that he committed no insider trading, whatever one thinks of it.

(I understand the stock market and here’s my issue: All high-frequency traders are armed with material nonpublic information called proprietary data, from which they generate ALL their profits.  And investment, public and private, is a continuous pursuit of what others don’t know, or overlook. To criminalize subjective aspects while permitting the vast sea of the rest is nonsensical and cognitively dissonant.)

This isn’t a book review.  Read it and draw your own conclusions.  But Raj Rajaratnam’s jury could not comprehend how the stock market worked. 

Heck, the attorneys didn’t understand it! The judge didn’t understand it. 

Try explaining to a jury of moms and pops (I can’t tell you how many times I’ve gotten the blink-blink explaining a continuous auction market) how a hedge fund works, the buyside, the sellside, what drives trading decisions, interaction with investor relations departments and corporate execs, the bets and gambles on beats and misses at earnings, the relentless thrum of information everywhere.

The defense team presented vast reams of data illustrating how Galleon developed its investment ideas, all of which traced back to colossal volumes of trading records. The firm managed about $8 billion of assets but traded over $170 BILLION in a year.

The government took issue with 0.01% of trades that by Galleon’s math resulted in a loss. But the prosecution simply said, “This Wall Street billionaire who caused the Financial Crisis is a cheat, and these wiretap snippets prove it.”

Again, draw your own conclusions.  But it resonated with me because there’s a pervasive propensity in the stock market to choose the easy snippet over grasping how it works.

Take for instance the market’s struggle since Jan 5, when we left for Tortola and the trade winds.  The easy explanation is we caused it.  I mean, it coincided, right?

I’m joking but you get the point.

The prevailing trope is Tech stocks are falling as investors wrestle with when the Fed will hike rates.

Years of trailing data show no clear correlation between interest rates and how Tech performs. It’s not difficult analysis.  Check the ten-year data for XLK. Compare to your favorite measure for interest rates, such as DXY or GLD.

There IS, however, correlation between periods of strong gains for Tech, and subsequent pullbacks.  There are just three of those for Tech the past decade:  latter 2018 (spilling into 2019), the Pandemic (spring 2020), and late 2021 (spilling into 2022).

These data suggest that save for Pandemics, investors in retirement accounts get overweight equities and especially Tech, and they recalibrate, especially in the fourth quarter.

Consequences rise as Tech gets bigger and bigger and bigger. Recalibrations rumble through how Fast Traders set 60% of prices and how derivatives underpin 20% of market cap, and how Short Volume (the supply chain), surges or stalls.

And then it starts over.  At some point, it won’t, sure. But the cause will be larger than hypothetical interest-rate hand-wringing.

And public companies, it’s measurable. Take AAPL, world’s biggest stock. Between Oct 1, 2018 and Jan 29, 2019, AAPL was never a 10.0 on our ten-point Demand scale.  Between Feb 28-Apr 15, 2020, it was not a 10.0.

And now? AAPL last had ceiling-rattling 10.0 Demand Dec 16. It’s now a 2.6 and bottomed. Right on schedule.

These are the facts, and the math. Headlines are not. Keep that in mind as earnings kick off. You can do what you’ve always done, the easy course. Or you can be armed with facts and details.  We have them.

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