On Monday evening, we brought you some excerpts from a truly amusing new note from Wells Fargo entitled “Passive Is The New QE: The Buy-Side Is On A Seller’s Strike.”
In that piece we tied together what we’ve variously described as the “wave paradox” with the bank’s contention that passive flows have effectively served as the equity market equivalent of QE, thus forcing active managers to participate in what’s become a perpetual motion machine that drives stocks inexorably higher.
Well, as a brief follow up to that post, and in an effort to build on the notion that active managers are starting to adapt to this new reality not only by going on what Wells describes as a “seller’s strike” but also by picking off “dumb” passive flows in an opportunistic fashion, we wanted to highlight the following set of bullet points from the same note.
This, ladies and gentlemen, is how passive is affecting intra-day volumes and liquidity and also how active is adapting by using the passive bid to dodge the machines intraday. Again, we hope you’re happy with yourselves (oh, and do note how this may be causing buyback activity to dominate flows are certain other times during the session)…
Via Wells Fargo
Anecdotally, daily Passive equity flows appear to be further driving intra-day equity volume towards the end of the day.
Passive Equity investors have become daily investors and are daily liquidity takers. They need to invest their inflows same day and traders are often given the closing prices as their benchmark because NAV is struck off the closing prices.
If you follow the logic, Passive investors are becoming price setters not price takers (with increasing daily flows). Their objective function is to find liquidity as they promise the closing NAV to all new investors (somewhat price indiscriminate). In general, liquidity demands usually come with a cost and hence, we would expect prices to be pressured higher as these investors take liquidity.
Some believe that the Passive dynamics (receiving inflows midday or early afternoon and needing to be done by the close) continue to skew equity market volume toward the last few hours of the day.
The behavior of Active equity players seems to be adapting to this new liquidity supply / demand dynamic. Conversations suggest the Active investors by many accounts are waiting until later in the day to transact due to greater liquidity and potentially lower transaction costs.
In addition, we hear things like…
- The market only goes higher so I’ll have higher strikes when selling.
- I don’t want to leave a footprint across the day for some High Frequency sniffing algo.
A by-product to the evolving dynamic of Passive flows is less liquidity at the start of the day and potentially more exaggerated stock movements. In theory, this should only cause more volatility in early trading and it should not be expected to cause a directional move.
However, in the morning, Corporate Buybacks are likely becoming a larger component to the market and at times may be placing a firm bid into the market.