New year, new opportunities
09 January 2018
David Lewis of FIS reviews how technology shaped and influenced the securities financing market and dominated short interest in 2017
Image: Shutterstock
The New Year period is always one of renewal, putting the trials and successes of the previous year behind you, resetting all your counters to zero and looking forward to new opportunities. The securities finance industry, like many other industries and indeed individual companies, like FIS, is also going through a period of change and renewal as it adapts to the challenges and opportunities ahead. But what of other industries and markets? Can part of our industry help us understand what is going on in terms of renewal and change in the world economy?
While there are clearly changes afoot that are individually significant, such as the second Markets in Financial Instruments Directive and the Securities Financing Transactions Regulation, regulatory changes in Germany on dividend taxation and others, there are also the broader, more sweeping changes in the industry. As a technology provider, we are working on ideas for introducing artificial intelligence (AI) into our service workflows, moving more clients into our managed services offerings and developing single sign-on applications from which you can monitor and manage your global business as well as undertake almost any transaction type from that single place. In the Astec Analytics division specifically, we are working on ever-faster data and analytics, as well as feeding data into clients’ systems, such as Apex SF, to deliver the market data needed to underpin automated trading–the early introduction of AI into the trader’s workflow. While we can all recognise the way our industry is moving and why, is it just a reflection of a wider global movement toward more automation and technology as more traditional, more physical processes and businesses decline or something else?
Technology has always had an impact on the physical world. For example, the use of satellite communications by radio wave all but obsoleting copper wire connections laid under oceans, and of course, email replaced letters. The effects of this transition are increasingly visible now, such as with major internet retailers replacing bricks and mortar stores, and thus changing our high streets and habits of social interaction beyond recognition; and not always for the better. If this change is irreversible, it could be expected that the more physical industries, from coal and iron production to high-street stores, will trend into decline and be wholly replaced by high-tech companies with global reach and scalability, unconstrained by physical boundaries. Even currencies may cease to be a hurdle as cryptocurrencies rise. Is this reflected in the overall market sentiment toward the future though?
Looking at market sentiment toward technology stocks compared with more traditional industries, it might be expected that older, arguably less efficient and profitable industries that are commonly more susceptible to economic booms and busts would be more heavily shorted than the new, vibrant technology operators. Looking at the market valuations, it could certainly be argued that this could well be the case. Figure one shows the closing prices of the S&P 500 and Dow Jones Industrial Average (DJIA) compared with the Nasdaq Technology 100 over the past five years. As an index, the technology group has risen some 186 percent over the period, versus 86 percent for both the S&P and DJIA. While both the more traditional groupings have displayed significant gains over the past five years, the technologists have made much greater strides.
However, looking at the average levels of utilisation (the proportion of shares physically available to borrow, that have already been borrowed), the story may be a little different than expected. Figure two shows the unweighted average utilisation for the top 30 stocks of the Nasdaq Technology 100 compared to the utilisation levels for the DJIA, again over the past five years.
As the graph shows, borrowing demand, taken as a proxy for short interest, for the technology stocks is consistently higher than it is for the more traditional industries. It should be acknowledged, of course, that there is some crossover. For example, Apple is a member of both indices. Both profiles have trended downwards through 2016 and 2017, suggesting the overall market sentiment to increasing values is improving, but the significant difference between the two levels cannot be ignored. This could be explained by the risk appetite of investors.
Technology stocks may well offer significant returns when things go well. Many financial observers like to quote how rich an investor would be now if they had bought and held onto Apple shares at the IPO, but to believe that investor could really have expected that company to now be worth over $900 billion is not reasonable. Therein lies the risk–many technology firms have yet to turn a profit and some may never do so. By contrast, it could be argued that the more traditional firms may offer less upside, but also less downside risk. Short sellers are targeting those technology stocks with outlandish multiples and shaky futures, dragging up the average demand levels.
On these indicators, it could be inferred that although the older industries could be in long-term decline, their time does not appear to be coming any time soon. New technologies bring new and exciting opportunities, but not all of them will fly and they will only really supplant the more traditional industries over the longer term. Some of this is due to inertia and even apathy, but change is coming and through some lenses, it could well be argued that the securities finance industry is, indeed, a reasonable reflection of the outside world.
Figure one: Index closing prices 2012 to 2017
Figure two: Utilisation 2012 to 2017
While there are clearly changes afoot that are individually significant, such as the second Markets in Financial Instruments Directive and the Securities Financing Transactions Regulation, regulatory changes in Germany on dividend taxation and others, there are also the broader, more sweeping changes in the industry. As a technology provider, we are working on ideas for introducing artificial intelligence (AI) into our service workflows, moving more clients into our managed services offerings and developing single sign-on applications from which you can monitor and manage your global business as well as undertake almost any transaction type from that single place. In the Astec Analytics division specifically, we are working on ever-faster data and analytics, as well as feeding data into clients’ systems, such as Apex SF, to deliver the market data needed to underpin automated trading–the early introduction of AI into the trader’s workflow. While we can all recognise the way our industry is moving and why, is it just a reflection of a wider global movement toward more automation and technology as more traditional, more physical processes and businesses decline or something else?
Technology has always had an impact on the physical world. For example, the use of satellite communications by radio wave all but obsoleting copper wire connections laid under oceans, and of course, email replaced letters. The effects of this transition are increasingly visible now, such as with major internet retailers replacing bricks and mortar stores, and thus changing our high streets and habits of social interaction beyond recognition; and not always for the better. If this change is irreversible, it could be expected that the more physical industries, from coal and iron production to high-street stores, will trend into decline and be wholly replaced by high-tech companies with global reach and scalability, unconstrained by physical boundaries. Even currencies may cease to be a hurdle as cryptocurrencies rise. Is this reflected in the overall market sentiment toward the future though?
Looking at market sentiment toward technology stocks compared with more traditional industries, it might be expected that older, arguably less efficient and profitable industries that are commonly more susceptible to economic booms and busts would be more heavily shorted than the new, vibrant technology operators. Looking at the market valuations, it could certainly be argued that this could well be the case. Figure one shows the closing prices of the S&P 500 and Dow Jones Industrial Average (DJIA) compared with the Nasdaq Technology 100 over the past five years. As an index, the technology group has risen some 186 percent over the period, versus 86 percent for both the S&P and DJIA. While both the more traditional groupings have displayed significant gains over the past five years, the technologists have made much greater strides.
However, looking at the average levels of utilisation (the proportion of shares physically available to borrow, that have already been borrowed), the story may be a little different than expected. Figure two shows the unweighted average utilisation for the top 30 stocks of the Nasdaq Technology 100 compared to the utilisation levels for the DJIA, again over the past five years.
As the graph shows, borrowing demand, taken as a proxy for short interest, for the technology stocks is consistently higher than it is for the more traditional industries. It should be acknowledged, of course, that there is some crossover. For example, Apple is a member of both indices. Both profiles have trended downwards through 2016 and 2017, suggesting the overall market sentiment to increasing values is improving, but the significant difference between the two levels cannot be ignored. This could be explained by the risk appetite of investors.
Technology stocks may well offer significant returns when things go well. Many financial observers like to quote how rich an investor would be now if they had bought and held onto Apple shares at the IPO, but to believe that investor could really have expected that company to now be worth over $900 billion is not reasonable. Therein lies the risk–many technology firms have yet to turn a profit and some may never do so. By contrast, it could be argued that the more traditional firms may offer less upside, but also less downside risk. Short sellers are targeting those technology stocks with outlandish multiples and shaky futures, dragging up the average demand levels.
On these indicators, it could be inferred that although the older industries could be in long-term decline, their time does not appear to be coming any time soon. New technologies bring new and exciting opportunities, but not all of them will fly and they will only really supplant the more traditional industries over the longer term. Some of this is due to inertia and even apathy, but change is coming and through some lenses, it could well be argued that the securities finance industry is, indeed, a reasonable reflection of the outside world.
Figure one: Index closing prices 2012 to 2017
Figure two: Utilisation 2012 to 2017
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