What is volatility? I might as well ask: ‘What is the color blue?’ There are lots of ways of describing blue and it means different things to different people. The same is true of volatility. For IROs, the word used most to describe volatility might be ‘scary’. ‘A big part of IR is having an answer ready when your CEO calls and says, Why is the stock down?,’ points out Brian Matt, vice president of institutional targeting at CapitalBridge.
To begin my hunt, I go where volatility seems to live: the stock market. This tack is immediately validated by Richard Nadeau, senior vice president at the Toronto Stock Exchange (TSX). ‘Issuers are getting more interested in how their stocks trade, and stock exchanges are increasingly becoming a source for just that kind of information,’ he confirms.
Nadeau probably has more experience of volatility than some of his US counterparts. The Canadian market has a lot of mining and resource stocks, which tend to swing around a lot. Plus, compared with the US, Canada is a land of small and medium-sized enterprises, and that small-cap bias brings more volatility.
But wait. I still don’t know what volatility is. I track down Frank Hatheway, NASDAQ’s chief economist. He tells me there are two main ‘flavors’ of volatility: long term and short term. The former is typically driven by ‘big picture causes’, like movements in the global markets. ‘Then there’s short-term volatility – maybe less important, but more likely to occupy an IR professional’s time,’ Hatheway says.
The two types are measured in different ways, and they’re caused by different things. So far so good. But now Hatheway utters one of those classic economist’s statements that remind me why I should have stayed awake in economics class: ‘If you do a good job on the macro-side, it helps out on the micro-side.’
Simpler than it sounds
It turns out it’s not very complicated. Hatheway means the better a company communicates with analysts and investors, explaining where its profits come from, what its risk factors are, and so on, the less volatility will affect the stock.
And when short-term spikes result from uncertainty about the nearterm outlook, analysts and investors will already have confidence in management so they’ll feel comfortable picking up the phone to call the IRO before selling the stock. I think I’m getting the hang of this volatility thing.
Then Hatheway trips me up again. I always thought volume and volatility went together, so with massive amounts of money sloshing around the market, surely volatility is high in 2007? Not at all. The accepted measure of market-wide volatility is the Chicago Board Options Exchange’s Volatility Index, or VIX, which shows the market’s expectations for near-term volatility by tracking S&P 500 option prices. And the VIX, it turns out, has fallen steadily since early 2002 and hit a nearrecord low in December 2006.
Contrary to my first impulse, high liquidity is one reason why volatility is low. When investors want out of a stock, there are likely to be others with cash in hand waiting to get in.
Meanwhile, fast money, often from hedge funds, can help ‘smooth out some of the lumps,’ adds David Mason, senior vice president at the Equicom Group, a Canadian IR consultancy recently acquired by TSX Group. Even those mysterious ‘dark pools’ that make up a ‘third market’ can help here: big blocks of stock can find natural buyers without stirring up the wider market.
Besides, today’s easy trading means investors around the world can readily trade in stocks listed just about anywhere, adding to the liquidity available for any given equity story. In the US, a stable macro-economic policy over the last decade has also helped. Other factors include: stable interest rates, Bush the First’s favorable tax policy and Bush the Second’s pro-business and pro-investor outlook, which is likely to survive the 2008 presidential election. ‘In terms of both fiscal and monetary policy, things have been good for a long time,’ Hatheway confirms.
Good IR will out
While overall market volatility is a big component of any given stock’s volatility, IROs also need to think about causes closer to home. The traditional measure of a stock’s volatility is its beta compared with the S&P 500. So if your stock tends to go up 1.5 percent on a day the S&P 500 goes up 1 percent, you have a beta of 1.5.
A more useful measure compares your stock to others in your sector. If your stock typically moves 2.5 percent on a day when your peers change 2 percent, then you’ve got a volatile stock.
The question then is what to do about it. Mason, like Hatheway, basically says good IR will out: ‘If a company is consistent in telling its story, the whole volatility issue will take care of itself. Say what you’re going to do, then do it, and investors will come.’
Matt says you could also look at market quality, or how well the market for your shares is being made. If you’re listed on NASDAQ, how many market-makers do you have? If you’re on the NYSE and not very liquid, is your specialist doing a good job of ‘putting the market together’?
Sometimes traders might complain that your specialist isn’t doing a good job, or there aren’t enough market-makers. ‘Your goal is to have sufficient liquidity so buyers and sellers can come together,’ explains Matt.
Unfounded fears
I’m hearing a lot about ‘market quality’. It’s a key issue for exchanges as they vie for listings and their share of trading in those shares, and evidently low volatility is one of its key indicators. So in early June I follow its trail to the webcast of NYSE Euronext’s first analyst day as a combined company, and its new president and co-chief operating officer, Duncan Niederauer, is talking about changes since the introduction of the hybrid market several months ago. With trades taking 300 milliseconds instead of nine seconds and with less intervention by specialists on the exchange floor, it had been feared volatility would rise sharply.
Those fears were largely unfounded, as Niederauer reveals. ‘As we’ve gotten faster, the percentage of auto-executed volume has gone up dramatically,’ he explains. ‘Spreads, both quoted and effective, have come down a little. The only thing that goes against the grain of market quality is that volatility has ticked up slightly. It’s only marginally above pre-hybrid levels, but I would hope to see it come down if some of the things I’m working on come out as they should.’ His plans include luring trading back to the exchange with features like daily and even hourly crossing sessions.
Trading metrics
IROs may also be reassured by new enhancements to NYSEnet, the exchange’s intranet for listed companies: OpenBook shows the specialists’ limit order book, which traders use to assess market conditions, and VolumeTrac shows each broker’s intraday activity, divided up by buy and sell volume. While these don’t track volatility per se, they’re great new windows on market quality.
Similarly, NASDAQ is ramping up the information IROs get from its market intelligence desk with the launch of its own stock surveillance service, Pinpoint Intelligence, and Nadeau promises the TSX will continue to add more data to TSXConnect, its joint venture with Thomson Financial.
Which brings me neatly back to my initial question: what is volatility? And the answer? Oh, go ask your stock exchange.
