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Dec 17, 2019

The 2010s in review: A decade of market structure upheaval

The Flash Crash laid the groundwork for huge flows into passive funds

Earlier this month I was at the NIRI Senior Roundtable in Santa Barbara, which members must have a decade in the profession to join. Investor relations practitioners qualifying now would have been on the job less than a year when the Flash Crash hit.  

Remember that? On May 6, 2010 at 2.32 pm Eastern Time, the stock market came unhinged. For 36 minutes stocks screamed groundward and the Dow Jones Industrial Average dropped 999 points. Accenture traded for a penny. Then the entire mechanism convulsed its way back to the surface with a giant heaving gasp.   

I’m mixing metaphors but you get the point. For the next several months, regulatory bodies, commissions, Congressional committees and caucuses gathered in summits and panels festooned with nameplates and titles and machinated over the market’s mechanical hubris. 

And here we are a decade later. What’s changed?  Well, the exchanges were prodded to install automatic girders for every stock to prohibit hysterical market concavity. Short-selling rules were amended. So-called ‘stub quotes’ that caused Accenture to trade at a cent (you could set a bid to buy for a penny and an offer to sell for $100,000 so as to make markets in between) were outlawed.

And the SEC decided it should study the stock market and ordered the construction of the Midas data system, which today shows 50 percent of all trades are for less than 100 shares. But I digress.  

No, the biggie in the wake of the Flash Crash – profoundly altering our profession – is the rout of assets from stock-picking funds, what IR folks colloquially call long-onlys. 

The trend didn’t start in 2010 but it accelerated then. I think fear did it in part: people stopped trusting the stock market. To the wary degree they still did, they decided models were better than humans. 

Earlier roots of the trend are found in 2007, before the financial crisis and because Regulation National Market System – every IR person needs a basic grasp on Reg NMS governing how stocks trade today – connected all markets and forced trades toward the midpoint. What money tracks that mean? Passive money.  

It’s tectonic. After all, for 50 years, IR has been a marketing job. I know some recoil at the idea we’re selling stuff, but we are – we gumshoe across the fruited plain and around the globe differentiating our businesses from others as good places to put money. Meanwhile the money en masse over the past decade has stopped listening. It’s become factor-driven, indexed, benchmarked. It’s going to ETFs in a wave not seen since tulip bulbs in 17th century Holland.  

It remains poorly appreciated that market structure – the behavior of money behind price and volume – is causal. The market is the laboratory transforming ingredients called stocks into recipes for products called investments. The whole of the capital markets has spent much of its time studying the ingredients but little on how the lab works. In a sense, IR has got to pull on a lab coat in the next decade. 

Before we get back to the future, though, let’s finish our retrospective. The best news is that after scaring the daylights out of everybody in 2010, the market found its groove, an unremitting resilience. We had some wacky stuff in 2012, the year of the glitch, like the Facebook debut debacle and the BATS IPO, a failed Goldman Sachs options algo, the collapse of Knight Securities. 

But in the main, we steadied and then soared. And the market is now majority-owned by passive investment. Who’d have thought in 2010 that so large a shift could come? But it’s here – so the future for all of us is data. Tracking, trending, measuring and reporting on passive money and its direct and indirect consequences: 86 percent of all trading volume is something other than stock-picking as we conclude 2019. 

We’ll become as good at that as we’ve been at telling the corporate story. The future is bright for us in IR because that’s a strategic oversight role, not just a tactical messaging function. We’re chief intelligence officers now. 

And the next decade holds high probability for a bear market. We don’t know how it’ll handle funneling the trillions of dollars of assets in ETFs through trades half the size they were in 2010.   

Our profession will squarely occupy the turret overlooking that scene. Let’s be ready.    

Tim Quast is president and founder of ModernIR