June 28, 2011

Yin and Yang in Your Stock

Stocks go up and down. Nothing new there.

The dollar dropped for a second straight day today. Stocks are again up, like they were yesterday. The dollar gained ground last Wed-Fri, and stocks fell.

This week marks the end of the month and quarter. We recommend in our IR Calendar that you consider some tactical timing as part of your overall IR strategy. Generally, the last few trading days of a quarter or month aren’t best for releasing good news. But they may be perfect for bad news.

Why? Institutions will be shoring up portfolio returns or managing exposure to market risk. They address risk by offsetting it with something that is inversely correlated. Notice that stocks and the dollar are inversely correlated. Notice that the dollar and other currencies, such as the Euro, are often inversely correlated.

All institutions try to generate yield from assets – managed money – through short-term trading. That’s what we’re seeing now. Money is trying to make up for a lackluster month through aggressive short-term trading. Is that investment? Only if you think any form of buying low and selling high, even in 30 microseconds, is investment. We call that speculation.

Back to macro behavior, markets execute transactions in currencies that are valued relative to other currencies today rather than fixed according to income or net worth of countries. Suppose the value of your house were tied to the value of houses in Greece. In a sense, it is, because the value of the currency in your pocket varies according to the one used in Greece, the Euro.

Now, think about all of these things from an investment standpoint. If the value of your house was a big part of your balance sheet – true for most of us – but it varied according to factors that had little to do with the supply or demand for houses of a kind and location like yours, or the particular distinguishing features of your house, would you be more or less inclined to buy a house?

You’d probably be less likely, right? Now translate these analogies to your IR program and the ends of months and quarters. Our measures show that some 85% of all daily volume is a form of short-term trading for yield, or risk-management activity to balance out exposure across many assets, not just stocks. Investors set the prices of stocks in our client base 20-30 times per year on average, while market prices are changing every day.

Investors are least likely to set prices at the ends of months and quarters, and during options expirations. There are bigger priorities, and 85% of money is moving en masse or chasing minute divergences. It’s not focused on investing in the neighborhood, so to speak.

Suppose you announced good news today. Your stock briefly separates from peers and the market – most times speculators are responsible. In the next two days it’s equalized by macro factors affecting large baskets of securities. This is your house getting valued with Greece, so to speak.

Conversely, if you put out bad news in the last three days of a month or quarter, traders and risk managers might buy your stock the following day or two anyway, simply because it temporarily diverged and now offers hedge or yield characteristics. Plus, who wants to sell a stock and hurt portfolio performance on the last trading day?

In new months, you have a better chance to stand out from the crowd. Why? Stock pickers have a long time to be rewarded – a full month!

These are realities in markets driven by machines and relative value. Turn them to your advantage wherever possible, by understanding them.

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