Any of you Denzel Washington fans?
He starred in a 2010 movie loosely based on real events called Unstoppable, about a runaway freight train (I have Tom Petty’s “Runaway Train” going through my head).
In a way, the market has the appearance of an unstoppable force, a runaway train. On it goes, unexpectedly, and so pundits, chuckling uncomfortably, try to explain why.
Tellingly, however, in the past month, JP Morgan said 80% of market volume is on autopilot, driven by passive and systematic flows. Goldman Sachs held a conference call for issuers on what’s driving stock-prices – focusing on market structure. Jefferies issued a white paper called When the Market Moves the Market (thank you, alert readers, for those!).
We’ve been talking about market structure for almost 15 years (writing here on it since 2006). We’re glad some big names are joining us. You skeptics, if you don’t believe us, will you believe these banks?
Market structure has seized control. Stock pickers say the market always reflects expectations. Well, stocks are at records even as expectations for corporate earnings predict a recession – back-to-back quarterly profit-declines.
There’s more. Last week the S&P 500 rose 0.8%, pushing index gains to 9.3% total since the end of May. But something that may be lost on most: The S&P 500 is up less than 2.5% since last September. The bane of stock-investing is volatility – changing prices.
Hedge funds call that uncompensated risk. The market has given us three straight quarters of stomach-lurching roller coasters of risk. For a 2.5% gain?
We all want stocks to rise! Save shorts and volatility traders. The point is that we should understand WHY the market does what it does. When it’s behaving unexpectedly, we shouldn’t shrug and say, “Huh. Wonder what that’s about?”
It’s akin to what humorist Dave Barry said you can do when your car starts making a funny noise: Turn the radio up.
Let me give you another weird market outtake. We track composite quantitative data on stocks clustered by sector (and soon by industry, and even down to selected peers). That is, we run central tendencies, averages, for stocks comprising industries.
Last week, Consumer Discretionary stocks were best, up 1.5%. The sector SPDR (XLY, the State Street ETF) was up 2% (a spread of 33% by the way). Yet sector stocks had more selling than buying every day but Friday last week.
You know the old investor-relations joke: “Why is our stock down today?”
“Because we had more sellers than buyers.”
Now stocks are UP on more selling than buying.
An aside before I get to the punchline: ETF flows are measured in share creations and redemptions. More money into ETFs? More ETF shares are created. Except there were $50 billion more ETF shares created than redeemed in December last year when the market fell 20%.
The market increasingly cannot be trusted to tell us what’s occurring, because the mechanics of it – market structure – are poorly understood by observers. ETFs act more like currencies than stocks because they replace stocks. They don’t invest in stocks (and they can be created and shorted en masse).
With the rise of ETFs, Fast Trading machines, shorting, derivatives, the way the market runs cannot be seen through the eyes of Benjamin Graham.
Last week as the S&P 500 rose, across the eleven industry groups into which it’s divided there were 28 net selling days, and 27 net buying days (11 sectors, five days each).
How can Consumer Discretionary stocks rise on net selling? How can the market rise on net selling? Statistical samples. ETFs and indexes don’t trade everything. They buy or sell a representative group – say 10 out of a hundred.
So, 90 stocks could be experiencing outflows while the ten on which this benchmark or that index rests for prices today have inflows, and major measures, sector ETFs, say the market is up when it’s the opposite.
Market Structure Sentiment™, our behavioral index, topped on July 12, right into option-expirations today through Friday. On Monday in a flat market belying dyspepsia below the surface, we saw massive behavioral change suggesting ETFs are leaving.
Stay with me. We’re headed unstoppably toward a conclusion.
From Jan 1-May 31 this year, ETFs were less volatile than stocks every week save one. ETFs are elastic, and so should be less volatile. Suddenly in the last six weeks, ETFs are more volatile than stocks, a head-scratcher.
Mechanics would see these as symptoms of failing vehicle-performance. Dave Barry would turn the radio up. None of us wants an Unstoppable train derailing into the depot. We can avoid trouble by measuring data and recognizing when it’s telling us things aren’t working right.
Investors and public companies, do you want to know when you’re on a runaway train?