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Robo-surveillance shifts tone of CEO earnings calls

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When Man Group chief executive Luke Ellis discusses his investment company’s results with analysts he chooses his words carefully. He knows better than most that the machines are listening.

The crown jewel of Man is its $39bn hedge fund group AHL, whose algorithms scour huge data sets for profitable signals that feed into investment decisions.

One of the hottest areas in this field is “natural language processing”, a form of artificial intelligence where machines learn the intricacies of human speech. With NLP, quant hedge funds can systematically and instantaneously scrape central bank speeches, social media chatter and thousands of corporate earnings calls each quarter for clues. 

As a result, Mr Ellis’s quant colleagues have coached him to avoid certain words and phrases that algorithms can be particularly sensitive to, and might trigger a quiver in Man’s stock price. He is much more careful about using the word “but”, for example.

“There’s always been a game of cat and mouse, in CEOs trying to be clever in their choice of words,” Mr Ellis says. “But the machines can pick up a verbal tick that a human might not even realise is a thing.” 

This is a growing phenomenon. Machine downloads of quarterly and annual reports in the US — scraped by an algorithm rather than read by a human — has rocketed from about 360,000 in 2003 to 165m in 2016, according to a recent paper by the US’s National Bureau for Economic Research. That was equal to 78 per cent of all such downloads that year, up from 39 per cent in 2003.

Machine downloads of corporate 10-K and 10-Q filings

The paper — How to Talk When a Machine Is Listening: Corporate Disclosure in the Age of AI — points out that companies are keen to show off their business in the best possible light. They have steadily made reports more machine-readable, for example by tweaking the formatting of tables, as a result of this evolving analysis.

“More and more companies realise that the target audience of their mandatory and voluntary disclosures no longer consists of just human analysts and investors,” authors Sean Cao, Wei Jiang, Baozhong Yang and Alan Zhang note. “A substantial amount of buying and selling of shares are triggered by recommendations made by robots and algorithms which process information with machine learning tools and natural language processing kits.”

However, in recent years the corporate adjustment to the reality of algorithmic traders has taken a big step further. The paper found that companies have since 2011 subtly tweaked the language of reports and how executives speak on conference calls, to avoid words that might trigger red flags for machine listening in.

Not coincidentally, 2011 was when Tim Loughran and Bill McDonald, two finance professors at the University of Notre Dame, first published a more detailed, finance-specific dictionary that has become popular as a training tool for NLP algorithms. 

Since 2011, words deemed negative in the Loughran-McDonald dictionary have fallen markedly in usage in corporate reports, while words considered negative in the Harvard Psychosociological Dictionary — which remains popular among human readers — show no such trend. 

Moreover, using vocal analysis software, the authors of the National Bureau for Economic Research paper found that some executives are even changing their tone of voice on conference calls, in addition to the words they use. 

“Managers of firms with higher expected machine readership exhibit more positivity and excitement in their vocal tones, justifying the anecdotal evidence that managers increasingly seek professional coaching to improve their vocal performances along the quantifiable metrics,” the paper said. 

Some NLP experts say some companies’ investor relations departments are even running multiple draft versions of releases through such algorithmic systems to see which scores the best. 

One word can say a lot . . .

Positive:

Proactively

Satisfying

Revolutionise

Negative:

Aggravate

Restated

Bottleneck

Uncertainty:

Anomaly

Appears

Clarification

Litigation:

Affidavit

Felony

Litigation

Source: Loughran-McDonald dictionary

“Access to NLP tools has become an arms race between investors and management teams. We see corporates increasingly wanting to have access to the same firepower that hedge funds have,” says Nick Mazing, director of research at Sentieo, a research platform. “We are not far from someone on a call reading ‘we said au revoir to our profitability’ versus ‘we recorded a loss’ because it reads better in some NLP model.”

However, Mr Mazing said that NLP-powered algorithms are also continuously adjusted to reflect the increasing obfuscation of corporate executives, so it ends up being a never-ending game of fruitless linguistic acrobatics. 

“Trying to ‘outsmart the algos’ is ultimately futile: buyside users can immediately report sentence misclassifications back to the model so any specific effort to sound positive on negative news will not work for long,” Mr Mazing says. 

Indeed, most sophisticated NLP systems do not rely on a static list of sensitive words and are designed to both identify problematic or promising combinations of words and teach themselves a chief executive’s idiosyncratic styles, Mr Ellis notes. For example, one CEO might routinely use the word “challenging” and its absence would be more telling, while one that never uses the word would be sending as powerful a signal by doing so.

Machines are still unable to pick up non-verbal cues, such as a physical twitch ahead of an answer, “but it’s only a matter of time” before they can do this as well, Mr Ellis says.

Twitter: @robinwigg



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Gensler raises concern about market influence of Citadel Securities

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Gary Gensler, new chair of the Securities and Exchange Commission, has expressed concern about the prominent role Citadel Securities and other big trading firms are playing in US equity markets, warning that “healthy competition” could be at risk.

In testimony released ahead of his appearance before the House financial services committee on Thursday, Gensler said he had directed his staff to look into whether policies were needed to deal with the small number of market makers that are taking a growing share of retail trading volume.

“One firm, Citadel Securities, has publicly stated that it executes about 47 per cent of all retail volume. In January, two firms executed more volume than all but one exchange, Nasdaq,” Gensler said.

“History and economics tell us that when markets are concentrated, those firms with the greatest market share tend to have the ability to profit from that concentration,” he said. “Market concentration can also lead to fragility, deter healthy competition, and limit innovation.”

Gensler is scheduled to appear at the third hearing into the explosive trading in GameStop and other so-called meme stocks in January.

Trading volumes in the US surged that month as retail investors flocked into markets, prompting brokers such as Robinhood to introduce trading restrictions that angered investors and drew the attention of lawmakers.

The market activity galvanised policymakers in Washington and investors. Lawmakers have focused much of their attention on “payment for order flow”, in which brokers such as Robinhood are paid to route orders to market makers like Citadel Securities and Virtu.

That practice has been a boon for brokers. It generated nearly $1bn for Robinhood, Charles Schwab and ETrade in the first quarter, according to Piper Sandler.

Gensler noted that other countries, including the UK and Canada, do not allow payment for order flow.

“Higher volumes of trades generate more payments for order flow,” he said. “This brings to mind a number of questions: do broker-dealers have inherent conflicts of interest? If so, are customers getting best execution in the context of that conflict?”

Gensler also said he had directed his staff to consider recommendations for greater disclosure on total return swaps, the derivatives used by the family office Archegos. The vehicle, run by the trader Bill Hwang, collapsed in March after several concentrated bets moved against the group, and banks have sustained more than $10bn of losses as a result.

Market watchdogs have expressed concerns that regulators had little or no view of the huge trades being made by Archegos.

“Whenever there are major market events, it’s a good idea to consider what risks they might have placed on the entire financial system, even when the system holds,” Gensler said.

“Issues of concentration, whether among market makers or brokers at the clearinghouse, may increase potential system-wide risks, should any single incumbent with significant size or market share fail.”



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European markets recover after tech stock fall

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European equities rebounded from falls in the previous session, when fears of a US interest rate rise sent shares tumbling in a broad decline led by technology stocks.

The Stoxx 600 index gained 1.3 per cent in early dealings, almost erasing losses incurred on Tuesday. The UK’s FTSE 100 gained 1 per cent.

Treasury secretary Janet Yellen said at an event on Tuesday that rock-bottom US interest rates might have to rise to stop the rapidly recovering economy overheating, causing markets to fall.

Yellen then clarified her remarks later in the day, saying she did not think there was “going to be an inflationary problem” and that she appreciated the independence of the US central bank.

Investors had also banked gains from technology shares on Tuesday, after a strong run of quarterly results from the sector underscored how it had benefited from coronavirus lockdowns. Apple fell by 3.5 per cent, the most since January, losing another 0.2 per cent in after-hours trading.

Didier Rabattu, head of equities at Lombard Odier, said that while investors were cooling on the tech sector, a rebound in global growth at the same time as the cost of capital remained ultra-low would continue to support stock markets in general.

“I’m seeing a healthy correction [in tech] and people taking their profits,” he said. “Investors want to be much more exposed to reflation and the reopening trades, so they are getting out of lockdown stocks and into companies that benefit from normal life resuming.”

Basic materials and energy businesses were the best performers on the Stoxx on Tuesday morning, while investors continued to sell out of pandemic winners such as online food providers Delivery Hero and HelloFresh.

Futures markets signalled technology shares were unlikely to recover when New York trading begins on Wednesday. Contracts that bet on the direction of the top 100 stocks on the technology and growth-focused Nasdaq Composite added 0.2 per cent.

Those on the broader S&P 500 index, which also has a large concentration of tech shares, gained 0.3 per cent.

Franziska Palmas, of Capital Economics, argued that European stock markets would probably do better than the US counterparts this year as eurozone governments expand their vaccination drives.

“While a lot of good news on the economy appears to be already discounted in the US, we suspect this may not be the case in the eurozone,” she said.

Brent crude, the international oil benchmark, was on course for its third day of gains, adding 0.7 per cent to $69.34 a barrel.

Despite surging coronavirus infections in India, the world’s third-largest oil importer, “oil prices have moved higher on growing vaccination numbers in developed markets”, said Bank of America commodity strategist Francisco Blanch.

Government debt markets were subdued on Wednesday morning as investors weighed up Yellen’s comments with a pledge last week by Federal Reserve chair Jay Powell that the central bank was a long way from withdrawing its support for financial markets.

The yield on the 10-year US Treasury bond, which moves inversely to its price, added 0.01 of a percentage point to 1.605 per cent.

The dollar, as measured against a basket of trading partners’ currencies, gained 0.2 per cent to its strongest in almost a month.

The euro lost 0.2 per cent against the dollar to purchase $1.199.



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Yellen says rates may have to rise to prevent ‘overheating’

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US Treasury secretary Janet Yellen warned on Tuesday that interest rates may need to rise to keep the US economy from overheating, comments that exacerbated a sell-off in technology stocks.

The former Federal Reserve chair made the remarks in the context of the Biden administration’s plans for $4tn of infrastructure and welfare spending, on top of several rounds of economic stimulus because of the pandemic.

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy,” she said at an event hosted by The Atlantic magazine.

“So it could cause some very modest increases in interest rates to get that reallocation. But these are investments our economy needs to be competitive and to be productive.”

Investors and economists have been hotly debating whether the trillions of dollars of extra federal spending, combined with the rapid vaccination rollout, will cause a jolt of inflation. The debate comes as stimulus cheques sent to consumers contribute to a market rally that has lifted equities to record levels.

Jay Powell, the Fed chair, has said that he believes inflation will only be “transitory”; the central bank has promised to stick firmly to an ultra-loose monetary policy until substantially more progress has been made in the economic recovery.

The possibility of interest rates rising has been a risk flagged by many investors since Joe Biden’s US presidential victory, even as markets have continued to rally.

Yellen’s comments added extra pressure to shares of high-growth companies, whose future earnings look relatively less valuable when rates are higher and which had already fallen sharply early in Tuesday’s trading session. The tech-heavy Nasdaq Composite was down 2.8 per cent at noon in New York, while the benchmark S&P 500 was 1.4 per cent lower.

Market interest rates, however, were little changed after the remarks, with the yield on the 10-year Treasury at 1.59 per cent. Yellen recently insisted that the US stimulus bill and plans for more massive government investment in the economy were unlikely to trigger an unhealthy jump in inflation. The US treasury secretary also expressed confidence that if inflation were to rise more persistently than expected, the Federal Reserve had the “tools” to deal with it.

Treasury secretaries generally do not opine on specific monetary policy actions, which are the purview of the Fed. The Fed chair generally refrains from commenting on US policy towards the dollar, which is considered the prerogative of the Treasury secretary.

Yellen’s comments at the Atlantic event were taped on Monday — and she used the opportunity to make the case that Biden’s spending plans would address structural deficiencies that have afflicted the US economy for a long time.

Biden plans to pump more government investment into infrastructure, child care spending, manufacturing subsidies and green energy, to tackle a swath of issues ranging from climate change to income and racial disparities.

“We’ve gone for way too long letting long-term problems fester in our economy,” she said.



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