Did A Market Strand Snap?

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Source: Tim Quast,Managing Director, ModernNetworks IR LLC

If the three-strand cord that constitutes your price and volume braids rational investment, speculation and risk-management, which one just snapped?   Anyone? Anyone?  

To refresh, we at ModernIR say most buying and selling in the markets comes from those three sources.  There are real, rational investors deploying capital and taking profits, and portfolio managers adjusting their asset balances and associated hedges to manage risk.  Around those, speculators engage in various trading tactics. We believe at least 95% of volume for a given issue ties to one of these threads. Sometimes human traders drive it and other times computers do. The machines dominate today.  

Did humans or machines blow a fuse Monday June 22?  Well, last Thursday the 18th the Wall Street Journal’s European Markets update at 1:30 pm Eastern Time read: “Financial stocks fueled a broad advance in Europe after data revived optimism on the economy…” Today at 6:00 am ET, the Wall Street Journal’s Asian Markets update said: “Asian share markets closed broadly lower Tuesday, with major indexes posting their biggest one-day losses in weeks on concerns over the global economic recovery.”

Sounds like a one-eighty doesn’t it? It’s not impossible for rational investors to hold a diametrically opposite viewpoint Tuesday than they had the preceding Thursday.  But in truth, schizophrenia strikes the thoughtful purveyors of investment wealth only rarely.  What else has been happening?  Options expirations, certainly.  Decelerating equity volumes, except for big ETFs.  Some big announcements about consolidation among major commodities producers. 

So, speculation must be our answer? We’ve described here before how short-term movement of share prices up and down like pistons across global equity markets is often statistical arbitrage (see link below) chasing timing, liquidity and information gaps between different market centers. But trading data indicate a slowdown in high-frequency trading and other forms of speculation.  

So that leaves risk-management.  No one can know the inner workings of the markets, and this despite efforts by masses of keenly intelligent and skilled beings basically since the advent of human history.  Nonetheless, fictional detective Sherlock Holmes said about sleuthing that once you eliminate the impossible, what remains – no matter how implausible – is your answer. We’ve not isolated the impossible, true.  But what’s plausible is this: if a strand snapped Monday, it’s the risk-management one. 

What might that mean, and how can you be cool in the IR chair? It means stocks retreat and buyers get picky again. If your stock suffers declines and your bosses and Board members are pacing outside your office, educate them.  Explain that investment drives price but a third of the time, with speculators chasing rainbows and portfolio managers modulating risk, behind the balance.  

Here’s the clincher: that means two-thirds of the time, it’s somebody else’s fault. We say that with a twinkle – but human nature being ever so predictable, it’s nice not being at fault.  If you have the power to show execs that selling decisions aren’t about you but are due to portfolio risks, well, that’s valuable. And when you use it to set internal expectations and measure external outreach, it is power indeed.  

So be cool, and watch out for snapping strands.   

Have a good week,

Tim Quast

Managing Director

ModernNetworks IR LLC
Quantum Global Statistical Arbitrage

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