Market Structure Edge founder and CEO Tim Quast was a guest on Benzinga’s weekly Pre-Market Prep program and shared insights into recent market trends and acquisitions.
Why Did We Believe the Acquisition Deal for Microsoft (NASDAQ: MSFT) of Speech Technology Company, Nuance Communications (NASDAQ: NUAN) was Imminent?
People started to bet on a deal that Microsoft would pursue something. How did we know that? Because short volume, that is the percentage of daily trading volume coming from borrowed stock, dropped to what we call our deal threshold level at about 30%.
It’s important to understand that about half of all market volume, around 45% of it, comes from borrowed stock. So, when you see a bunch of volume out there, half of that volume isn’t coming from owners, it’s people furnishing borrowed stock. So, when that level drops to near 30% you can conclude two things. Number one, the cost to borrow that stock has risen and machines just go around the market scooping up cheap stuff to borrow and furnish to the market because they just want to inter-mediate the intraday volatility, which by the way in the S&P 500 is 300 basis points every day. People don’t understand how much movement there is. So machines will inter-mediate that and go long and short based on how average prices are behaving. But when the cost rises you get excluded from a basket. And if there are deal arbs walking around and talking to people who actually are thinking (and who hold Microsoft) those owners may not want to loan their securities out. So the levels decline and we can look at what happened to Nuance as well and we will see a move.
For about two weeks people thought Microsoft was going to do a big deal, so we wanted to be long on Microsoft not short. That whole attitude pervaded the market and showed up in this steep drop from the normal levels of shorting for Microsoft to a level that was very abnormally low and right at that 30% threshold.
Follow the Shorts on Nuance
Look at Nuance. Nuance was well over 50% short and then 73% short and then it imploded. (Nuance Communications NUAN). It dropped from 73% short all the way down to 30% and there is your deal threshold level. So there was confirmation from the deal arbs that probably Nuance was the target and that arrived on April 6, so it wasn’t very long ago, but long enough ago to tell you that all the deal arbs had shifted from short Nuance on its fundamentals to long Nuance on its M&A attributes.
The Tech Sector is Outperforming
We talked about how tech would perform and Early in April, I said tech is going to be the place to be again, no matter how much you hear this discussion about the re-open trade and the shift back to value and the stocks that have done well. There are always outliers and exceptions, and clearly, Zoom hasn’t done well, but Microsoft sure has. Look at how well Microsoft has done and it comes back to the construction of the market and what the money does today.
No matter how much you and I and all the pundits discuss how some company is going to perform, it’s not the driver of the market. It was in 2000. It’s not in 2021 because it’s not what the money is doing. Money will allocate itself to assets and we can see this by the data and it will periodically make shifts. So the question really is for all of us, what should we expect as earnings begin and options expire?
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