We pray thee the fairest St Paddy’s spirits!
We wrote in last Tuesday’s email before market (read it at our website if you missed it) that a 1,000-point bounce could be in store. We’re up 800 points since. Sure, it’s a lucky guess, but our reasons reflected what we saw in the data: institutional trading wanting to act with more aggression and less prudence.
The data don’t indicate that this run is quite over. But here are factors to weigh and share around with your fellow executives and IR professionals that’ll help you keep your cool quotient intact: Volatility derivatives expire tomorrow, and the whole rest of monthly futures contracts lapse by Friday March 20. Since US taxpayer money has made whole many holders of counterparty swaps, having traveled from the Federal Reserve and the Treasury Department to AIG and various prime brokers ranging from Deutsche Bank to Goldman Sachs, there’s reason for pension funds to lock forward contracts and let the money ride in equities for a few more days.
But we’re almost certain that gains will be locked before month- and quarter-end. Then logically, we see a return to short-term divergences and languishing equity values. Why? There are zero value drivers in the markets except the ebb and flow of institutional capital, and no amount of political rhetoric and Keynesian drum-beating will alter the fact that spending and consumption are inferior to savings and investment.
So then, how do these “quant bounces," or mathematical surges, occur in the markets? It’s not as complicated as you might think. One analogy: if you merge onto the freeway in your car, you come up to highway speed less because the road allows it than because you’re fitting in with behavior around you. In other words, if institutional risk managers determine that the least risky short-term vehicle is equities instead of credit instruments or commodities or currencies (it’s all about relative value, not absolute value), then the whole equity water level rises regardless of fundamentals because all the money merges at highway speed.
In practical terms, allocations to equities are ratcheted up and money spreads via algorithms across the equity spectrum. The moment it starts to exit one place, it exits everywhere else too, and sets off in pursuit of a different asset class with better near-term risk characteristics.
This is what we’ve experienced over the past week. It’s a classic example of what we describe as price-setting for risk-management reasons, rather than for rational or speculative purposes. Rational investment remains spotty. Speculation remains quite high, frankly. The good news is that the well-run business buttressed by the well-crafted message can stand apart from the crowd in markets like these.
Absent those blessings, you can increase your IR cool quotient by comprehending how quant bounces differ from actual institutional investment.
Margaret E. Wyrwas - Knight Capital Group, Inc. (Nasdaq: NITE)
Senior Managing Director, Corporate Communications & Investor Relations
Equity Analysis™ subscriber since March 2007
"In global markets driven by automation, changing market structure regulation and dynamic investment objectives, today's investor relations professionals require new data points in order to remain relevant and add value in their company's quest to reduce its cost of capital."
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