Is it Better to Shadow Trade Insiders Rather than Congress Members or Fund Managers?
As tricky as the overall market has been, a new crop of investors that had been primarily index investors have spent the past 11 months gravitating more toward creating their own diversified mix of above-average probability stocks. One proven way to put the odds more on your side as a self-directed investor is to watch trends in insider buying. It was Peter Lynch of Magellan Fund fame who said, “Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.” To be sure, management only has so much control over performance, but they are likely to have greater clarity than anyone else evaluating their company.
Why Shadow Insiders?
Following insiders into stocks you otherwise are positive about is a form of shadow investing. Shadowing successful investors is a growing trend. There are websites dedicated to highlighting the transactions of investors like Paul Pelosi, Warren Buffett, Michael Burry, Cathie Wood, and others. But shadowing directors or key executives of publicly traded companies provides investors with much more current information – SEC Form 4 is used to disclose a transaction in company stock within two days of the purchase or sale. Compare the two-day reporting to institutional funds managing over $100 million that report 45 or more days after quarter-end on quarter-end holdings using SEC Form 13F. Or Congress-persons that can wait 45 days after a transaction to report it. Moreover, the insider is generally restricted to trading windows, so their holding time tends to be longer term. So their commitment level may be much higher than say a hedge fund manager like Michael Burry that may have purchased a security just before his 13F statement date, and then sold it a week later.
And the performance is above average. University of Michigan finance professor Nejat Seyhun, the author of “Investment Intelligence from Insider Trading” wrote stock prices rise more after insiders’ net purchases than after net sales. On the whole, insiders do earn profits from their legal trading activities, and their returns are greater than those of the overall market.
Current Example
I thought to write about following legal insider buying of stocks on your watch list after a link to a research note posted on Channelchek appeared in my inbox. It was on a company I follow and it highlighted legal insider trading by an executive. The report, available here, reported that the CEO of an expanding company in the cannabis sector name Schwazze (Medicine Man Technologies), was adding substantially to his ownership of the company he runs. The note by Noble Capital Markets Sr. Research Analyst, Joe Gomes, said:
“In a series of Form 4 filings, between November 14th and November 23rd Schwazze CEO Justin Dye purchased 1,325,852 SHWZ shares at a cost of $2.36 million, or a per share average of $1.78. According to the most recent Form 4 filed on November 25th, Mr. Dye directly currently owns 1,368,062 SHWZ common shares and indirectly owns 9,287,500 SHWZ common shares through Dye Capital & Company.”
How Do You Screen and Watch for Insider Buying Activity?
There are websites such as SECForm4.com and InsiderMonkey.com that aggregate SEC Form 4 filings and post them in a searchable, fully filterable online environment so you may search for characteristics you may prefer in your stock selections. While using insider activity, whether it be raw from the SEC or served up on online screening tools, here are four things to keep in mind to help hone your skills.
Some insiders are better than others. As a rule, directors tend to know less about a company’s outlook than top executives. Key executives are the CEO and CFO. The people day-to-day running the company are better able to assess risk of an investment in their company.
More insiders are better than a few. If one insider is buying in unusual amounts, it is a green flag to dig deeper. If several have begun adding to their holdings, it can be seen as a stronger signal.
People at small companies may have more insight. At smaller companies, a higher percentage of insiders are privy to company plans, changes in strategy, and financials. At big corporations, information is more dispersed, and typically only the core management team has the big picture.
Stay the course. Insiders tend to act far in advance of expected news. This is in part because of trading windows and also to avoid the appearance of illegal insider trading. A study by academics at Pennsylvania State and Michigan State contends that insider activity precedes specific company news by as long as two years before the eventual disclosure of the news.
Take Away
Insider tracking takes some work, but the resources to monitor a list of stocks you are interested in do exist to make it easier. Investors that would prefer to build their own diversified portfolio rather than own an index fund may find that watching insider buys helps point the way toward stocks more likely to beat a particular index. Another Peter Lynch quote says, “Know what you own, and why you own it.” Following insider buying allows you to have a methodology where you do know exactly why you are in a position. And although I have no hard data, I’d guess over the past five years it has paid better to follow insiders’ reported trades rather than social media influencers’ suggestions for a trade.
Will the Fed Indicate an Altered Course This Week?
Economic numbers may take a back seat to Fed Chair Powell’s address on Wednesday and other regional Fed President addresses throughout the week.
The PCE, which is an inflation adjuster to GDP, is reported on the same day as the Fed Chair’s midweek address, the potential for volatility is high.
Monday 11/28
10:30 ET, Dallas Fed Manufacturing Survey, is expected to show general activity down 20.5 vs. down 19.4 the prior month. This would be the seventh straight reduction in manufacturing.
12:00 ET, John Williams, the President of the New York Federal Reserve Bank, will be speaking. Although the NY Fed President has only one vote on the Federal Open Market Committee deciding monetary policy, the NY Fed tends to have more sway as the NY Fed President assumes the role of second after Chair Powell in the level of power.
Tuesday 11/29
9:00 AM ET, The FHFA House Price Index is expected to have fallen 1.2 percent in September after falling 0.7 percent in August and 0.6 percent in July. August marked the sharpest fall and first back-to-back fall in 11 years.
10:00 AM ET, Consumer Confidence for November 2022 is expected to come in at 100 vs 102.5 in October. The report measures consumers’ assessments of the labor market, business activity, and consumers’ own financial conditions. This could be one of the more important numbers of the week as consumer expectations and behavior can lead stock market movements and play into overall expectations as consumer spending is two-thirds of the U.S. economy.
Wednesday 11/30
8:30 AM ET, GDP this will be the second estimate of the third-quarter GDP. The consensus is 2.7 percent growth. The previous estimate for the same period came in at 2.6%. The Personal Consumption Expenditures (PCE), which is considered the Fed’s favored measure of inflation, is expected to show a rise of 1.5% for the month vs. the previous 1.4% monthly increase. The PCE component of GDP may get more attention than the GDP itself since it is considered a measure of inflation.
8:30 AM ET, The U.S. Goods Deficit is expected to narrow by $1.3 billion to $90.6 billion in October after narrowing by more than $6 billion in September to $91.9 billion. Changes in the levels of imports and exports, along with netting the two (trade balance), are gauges of economic trends here and abroad. These trade figures can directly impact all financial markets; however, they do this in how they impact the valuation of the dollar.
8:30 Wholesale Inventories are expected to be revised downward to 0.5%. This follows a build-up in inventories in September. A decline could suggest supply-chain difficulties are increasing.
10:00 AM ET, JOLTS consensus is for job openings to fall 10.4 million vs. 10.7 million in September. This number will be focused on as the September number was at a level that caused some to question whether the economy still has job shortages.
1:30 PM ET, Federal Reserve Chair Jerome Powell will speak on the subjects of inflation and economic outlook; this could very well be the most market-altering event of the week. Watch it live by clicking here.
2:00 PM ET, Beige Book released. A look at how each of the 12 Federal Reserve districts are reporting economic activity in their regions is important in this is a source of information the FOMC uses to make their decisions.
3:00 PM ET, Farm Prices month-over-month is expected to have declined by 0.2%. Year-over-year the inflation contributor is expected to have risen 21%.
Thursday 12/1
8:30 AM ET, Jobless Claims for the November 27 week are expected to come in at 235,000 versus 240,000 in the prior week. Employment is one of the Fed’s mandates; as such, any number that significantly varies from consensus could alter the markets thinking.
9:25 AM ET, Dallas Fed President Lorie Logan is scheduled to give an address.
10:00 AM ET, ISM Manufacturing Index was 50.2 in October; the ISM Manufacturing Index has been gradually slowing to nearly breakeven. November’s consensus is 49.9.
10:00 AM ET, Construction spending is expected to fall 0.2 percent in October. This would be dramatic relative to September’s modest 0.2 percent gain.
Friday 12/2
8:30 AM ET, The Employment Situation or Non-Farm Payroll is expected to rise by 200,000, which would compare with 261,000 as reported in October. October was the sixth straight month and eight of the last nine that payroll growth exceeded consensus. Average hourly earnings in November are expected to rise 0.3 percent on the month for a year-over-year rate of 4.6; these would compare with 0.4 and 4.7 percent in October.
What Else
There are more rumblings about the Fed easing up on how rapidly it is braking to tame an inflationary economy. The Powell’s words and promises on Wednesday, taken alongside of the other Fed President addresses may confirm a turning point – a tapering of the tightening.
Why the Fed Needs to Gain Trust, Gain Momentum, and Gain More Yards
Monetary policy and its implementation is as much sport as science. Economics is actually a social science, so it relies on human behavior to mimic past behaviors as its prediction guide. But as in sports, victory is difficult if there is distrust in the coach that’s calling the shots (in this case Powell), or if there are people on your side that have reason to work against you, (an example would be Yellen). Consistency in blocking and tackling (doing the right thing) and not giving up, over time, wins games. Knowing what to expect from the opposing team (consumers) wins a healthy economy.
One repeated trait in monetary policy is that there is a lag between implementation (easing or tightening) and a change in economic conditions. It isn’t a short lag, and the impact varies. Since it could take more than a year for a policy change to begin to impact the economy, the Fed usually moves at a slow and measured pace in order to not overdo it.
The slow pace allows policymakers to observe the impact of their moves and change tactics (positions on the playing field) mid-game.
Federal-Funds Rate During Tightening Cycles
Note: From December 2008, midpoint of target range. December 2015 hike excluded from 2016-18 cycle
Source: Federal Reserve
Over the past nine months, we have been in a tightening cycle. During this period, the Fed has raised rates by 3.75%. On average (since 1975), when the Fed has tightened rates, they are notched up by 5.00% over 20 months.
The Fed’s current pace is faster than average. This is because inflation took them by surprise, and rose rapidly. Putting up a strong defense against inflation that has been rampant is necessary to not be shut out and allow the Fed to gain control over the outcome.
Because one has to be able to reflect back more than 40 years to have experienced the Fed raising rates this fast. Many have lost confidence in its ability, and are in their own way working against a winning outcome.
Pace of Fed Hiking Cycles
Note: From December 2008, the midpoint of target range
Source: Federal Reserve
The stock and bond markets move in group anticipation of expected policy moves by the Fed. This has been more pronounced in recent years as the Fed has basically shared its expectations after each meeting, setting up for the next. Higher rates make bonds and bank deposits more attractive. Higher rates also weaken the economy and corporate profits, and that induces investors to move away from stocks and even real estate.
Bonds now offer the highest yields since 2007. The stock market may have anticipated what was to come as it peaked in early January of this year, more than two months before the Fed began hiking in March.
Fed Hikes and S&P 500 Bear Markets
Sources: Federal Reserve; Dow Jones Market Data
Sources: Federal Reserve; Dow Jones Market Data
Employment
The Fed is concerned with a wage-price spiral feeding on itself. It likely won’t be satisfied that its tightening has been sufficient until it can be confident that it has avoided a wage-price storm on the economy.
Ideally, this would happen without unemployment rising. Soft landings took place in 1983-84 and 1994-95. But when inflation starts out too high, as it is now, unemployment usually rises notably, and a recession occurs.
Historically, this doesn’t happen until several years after the first increase. This time it is hoped it will be different, since the Fed is playing more aggressively.
Periods of Fed Hiking and Rising Unemployment
Note: The unemployment rate rose to 3.7% in October, up from the pandemic low of 3.5% a month earlier. Sources: Federal Reserve; Labor Department
Inflation
Historically, inflation has only fallen to acceptable levels after unemployment has increased, and long after the first rate increase – the exact timing has varied. If the fall in core inflation (which excludes the volatile food and energy components) between September and October continues, and September proves to be the peak, the time between the first Fed increase and the high point of inflation will be one of the shortest of any Fed hiking cycle.
Often, the break in inflation has been accompanied by a recession. The economy receded in each of the first two quarters and then grew in the third. The changes in the inflation component in Gross Domestic Product may have borrowed from one quarter and have been additive to the next. The fourth quarter reading should help level the growth averages out to see if we were indeed in a shallow recession.
Proximity of Peak Inflation and Recessions to Initial Rate Hikes, from Year Hiking Cycle Began
Note: Inflation refers to core CPI.
Sources: Federal Reserve; Labor Department
Take Away
As in many team sports, once one side gets momentum, they are difficult to stop . The Fed needs to gain the trust of the individual players in the economy in order to be successful. Saying one thing, then doing another, would undermine this trust. So far, despite the Fed originally being wrong about inflation, the Fed has done what it has said it would do. Stock and bond markets, which are a considerable part of the economy, have been slow to understand the Fed’s resolve.
It has been implementing the balance sheet run-off plan and raising rates toward a level it believes would equate to a future 2% inflation rate. Like so many other things in the social sciences, widely held expectations of the future become self-fulfilling.
Will Global Rate Hikes Set Off a Global Debt Bomb?
The higher levels of risky corporate debt issuance over the past few year will need to be refinanced between 2023 and 2025, In numbers terms, there will be over $10 trillion of the riskiest debt at much higher interest rates and with less liquidity. In addition to domestic high yield issuance, the majority of the major European economies have issued negative-yielding debt over the past three years and must now refinance at significantly higher rates. In 2020–21. the annual increase in the US money supply (M2) was 27 percent, more than 2.5 times higher than the quantitative easing peak of 2009 and the highest level since 1960. Negative yielding bonds, an economic anomaly that should have set off alarm bells as an example of a bubble worse than the “subprime” bubble, amounted to over $12 trillion. Even if refinancing occurs smoothly but at higher costs, the impact on new credit and innovation will be enormous, and the crowding out effect of government debt absorbing the majority of liquidity and the zombification of the already indebted will result in weaker growth and decreased productivity in the future.
Raising interest rates is a necessary but insufficient measure to combat inflation. To reduce inflation to 2 percent, central banks must significantly reduce their balance sheets, which has not yet occurred in local currency, and governments must reduce spending, which is highly unlikely.
The most challenging obstacle is also the accumulation of debt.
The so-called expansionary policies have not been an instrument for reducing debt, but rather for increasing it. In the second quarter of 2022, according to the Institute of International Finance (IIF), the global debt-to-GDP ratio will approach 350 percent of GDP. IIF anticipates that the global debt-to-GDP ratio will reach 352 percent by the end of 2022.
Global issuances of high-yield debt have slowed but remain elevated. According to the IMF, the total issuance of European and American high-yield bonds reached a record high of $1,6 trillion in 2021, as businesses and investors capitalized on still low interest rates and high liquidity. According to the IMF, high-yield bond issuances in the United States and Europe will reach $700 billion in 2022, similar to 2008 levels. All of the risky debt accumulated over the past few years will need to be refinanced between 2023 and 2025, requiring the refinancing of over $10 trillion of the riskiest debt at much higher interest rates and with less liquidity.
Moody’s estimates that United States corporate debt maturities will total $785 billion in 2023 and $800 billion in 2024. This increases the maturities of the Federal government. The United States has $31 trillion in outstanding debt with a five-year average maturity, resulting in $5 trillion in refinancing needs during fiscal 2023 and a $2 trillion budget deficit. Knowing that the federal debt of the United States will be refinanced increases the risk of crowding out and liquidity stress on the debt market.
According to The Economist, the cumulative interest bill for the United States between 2023 and 2027 should be less than 3 percent of GDP, which appears manageable. However, as a result of the current path of rate hikes, this number has increased, which exacerbates an already unsustainable fiscal problem.
If you think the problem in the United States is significant, the situation in the eurozone is even worse. Governments in the euro area are accustomed to negative nominal and real interest rates. The majority of the major European economies have issued negative-yielding debt over the past three years and must now refinance at significantly higher rates. France and Italy have longer average debt maturities than the United States, but their debt and growing structural deficits are also greater. Morgan Stanley estimates that, over the next two years, the major economies of the eurozone will require a total of $3 trillion in refinancing.
Although at higher rates, governments will refinance their debt. What will become of businesses and families? If quantitative tightening is added to the liquidity gap, a credit crunch is likely to ensue. However, the issue is not rate hikes but excessive debt accumulation complacency.
Explaining to citizens that negative real interest rates are an anomaly that should never have been implemented is challenging. Families may be concerned about the possibility of a higher mortgage payment, but they are oblivious to the fact that house prices have skyrocketed due to risk accumulation caused by excessively low interest rates.
The magnitude of the monetary insanity since 2008 is enormous, but the glut of 2020 was unprecedented. Between 2009 and 2018, we were repeatedly informed that there was no inflation, despite the massive asset inflation and the unjustified rise in financial sector valuations. This is inflation, massive inflation. It was not only an overvaluation of financial assets, but also a price increase for irreplaceable goods and services. The FAO food index reached record highs in 2018, as did the housing, health, education, and insurance indices. Those who argued that printing money without control did not cause inflation, however, continued to believe that nothing was wrong until 2020, when they broke every rule.
In 2020–21, the annual increase in the US money supply (M2) was 27 percent, more than 2.5 times higher than the quantitative easing peak of 2009 and the highest level since 1960. Negative yielding bonds, an economic anomaly that should have set off alarm bells as an example of a bubble worse than the “subprime” bubble, amounted to over $12 trillion. But statism was pleased because government bonds experienced a bubble. Statism always warns of bubbles in everything except that which causes the government’s size to expand.
In the eurozone, the increase in the money supply was the greatest in its history, nearly three times the Draghi-era peak. Today, the annualized rate is greater than 6 percent, remaining above Draghi’s “bazooka.” All of this unprecedented monetary excess during an economic shutdown was used to stimulate public spending, which continued after the economy reopened … And inflation skyrocketed. However, according to Lagarde, inflation appeared “out of nowhere.”
No, inflation is not caused by commodities, war, or “disruptions in the supply chain.” Wars are deflationary if the money supply remains constant. Several times between 2008 and 2018, the value of commodities rose sharply, but they do not cause all prices to rise simultaneously. If the amount of currency issued remains unchanged, supply chain issues do not affect all prices. If the money supply remains the same, core inflation does not rise to levels not seen in thirty years.
All of the excess of unproductive debt issued during a period of complacency will exacerbate the problem in 2023 and 2024. Even if refinancing occurs smoothly but at higher costs, the impact on new credit and innovation will be enormous, and the crowding out effect of government debt absorbing the majority of liquidity and the zombification of the already indebted will result in weaker growth and decreased productivity in the future.
Europe May Be Saved from the December Planned Oil Embargo in a Nick of Time
On December 5, the European Union plans to cap oil prices at levels where EU nations would then be permitted to buy oil from Russia. This would significantly reduce the petroleum supply of the region going into winter. The day before this goes into effect, (December 4), OPEC+ will meet to set output levels. Saudi Arabia and other OPEC producers are expected to discuss an output increase, according to emissaries from the group. The 11th hour move could keep much needed petroleum flowing into the region at a time that weather-related demand would naturally grow, holiday driving would be expected to increase, and war-related strategies would have reduced oil coming out of Russia. While western news has verified their sources as actual delegates of OPEC+, the Saudi’s are now saying that their plans are always secret.
About the New Expectations
A production increase of up to 500,000 barrels a day is now expected to be the discussion at OPEC+’s December 4 meeting, delegates said. Any output increase would mark a partial reversal of a controversial decision last month to cut production by 2 million barrels a day. This was agreed upon at the most recent meeting of the Organization of the Petroleum Exporting Countries and their Russia-led allies, a group known collectively as OPEC+.
The White House had said the production cut undermined global efforts to negatively impact Russia’s war in Ukraine. Saudi-U.S. relations have hit a low point over oil-production disagreements this year; if the December 4 OPEC+ meeting leads to increased oil, this may warm the cooled Saudi-U.S. relations.
About the EU December 5th Plan
The European Union has agreed to stop all oil imports from Russia on December 5. The plan is to cap the prices at which EU nations would buy oil from Russia, that price is expected to be near $60 per barrel. Russia has reacted by increasing exports to Asia, but the price cap is expected to reduce its exports and lower total supply by up to one million barrels per day.
About the OPEC+ December 4th Expectations
A production increase of up to 500,000 barrels a day is now under discussion for OPEC+’s December 4 meeting, emissaries said.
Any increase in OPEC+ output will partially undo the decision made at OPEC+’s its last monthly meeting. In October the cartel voted to cut production by 2 million barrels per day. The decision by the Organization of the Petroleum Exporting Countries and their Russia-led allies, (OPEC+) was a disappointment to the White House and NATO nations that saw reduced production as strengthening Russia’s ability to fund its war with higher priced exports.
Under normal production discussions by OPEC+ production increases, with oil prices falling more than 10% since the first week of November, one might not expect an increase. Brent crude traded at about $87 a barrel on Monday, while WTI, the U.S. benchmark, fell below $80 a barrel for the first time since September. Production increases could cause prices to fall further.
Emissaries say, a production increase would be to respond to expectations that oil consumption will rise in the winter. Oil demand is expected to increase by 1.69 million barrels a day to 101.3 million barrels a day in the first quarter next year, compared with the average level in 2022.
OPEC and its allies say they have been carefully studying the G-7 plans to impose a price cap on Russian oil, conceding privately that they see any such move by crude consumers to control the market as a threat. Russia has said it wouldn’t sell oil to any country participating in the price cap, potentially resulting in another effective production cut from Moscow—one of the world’s top three oil producers.
Raising oil production ahead of the December 5 EU embargo would give the Saudis another argument that they are acting in their own interests, and not is support of Russia’s.
Talk of the production increase emerged after the Biden administration told a federal court judge that Saudi Crown Prince Mohammed bin Salman should have sovereign immunity from a U.S. federal lawsuit related to the killing of Saudi journalist Jamal Khashoggi. The immunity decision is seen by some as a concession to Prince Mohammed, and heighten his standing as the kingdom’s de facto ruler. The move comes after the Biden administration tried for months to isolate him.
Another factor that helps account for the timing of OPEC+’s discussion to raise output is the two large OPEC members, Iraq and the United Arab Emirates that want to pump more oil. Both countries are pushing the oil-producing nations to allow them a higher daily-production ceiling, which would lead to more oil produced globally.
Saudi officials late Monday denied reports the kingdom is reversing course and helping the West with added production.
Dramatic Collapse of the Cryptocurrency Exchange FTX Contains Lessons for Investors but Won’t Affect Most People
In the fast-paced world of cryptocurrency, vast sums of money can be made or lost in the blink of an eye. In early November 2022, the second-largest cryptocurrency exchange, FTX, was valued at more than US$30 billion. By Nov. 14, FTX was in bankruptcy proceedings along with more than 100 companies connected to it. D. Brian Blank and Brandy Hadley are professors who study finance, investing and fintech. They explain how and why this incredible collapse happened, what effect it might have on the traditional financial sector and whether you need to care if you don’t own any cryptocurrency.
What Happened?
In 2019, Sam Bankman-Fried founded FTX, a company that ran one of the largest cryptocurrency exchanges.
FTX is where many crypto investors trade and hold their cryptocurrency, similar to the New York Stock Exchange for stocks. Bankman-Fried is also the founder of Alameda Research, a hedge fund that trades and invests in cryptocurrencies and crypto companies.
Sam Bankman-Fried founded both FTX and the investment firm Alameda Research. News sources have reported some less-than-responsible financial dealings between the two companies. Image via The Conversation.
Within the traditional financial sector, these two companies would be separate firms entirely or at least have divisions and firewalls in place between them. But in early November 2022, news outlets reported that a significant proportion of Alameda’s assets were a type of cryptocurrency released by FTX itself.
A few days later, news broke that FTX had allegedly been loaning customer assets to Alameda for risky trades without the consent of the customers and also issuing its own FTX cryptocurrency for Alameda to use as collateral. As a result, criminal and regulatory investigators began scrutinizing FTX for potentially violating securities law.
These two pieces of news basically led to a bank run on FTX.
Large crypto investors, like FTX’s competitor Binance, as well as individuals, began to sell off cryptocurrency held on FTX’s exchange. FTX quickly lost its ability to meet customer withdrawals and halted trading. On Nov. 14, FTX was also hit by an apparent insider hack and lost $600 million worth of cryptocurrency.
That same day, FTX, Alameda Research and 130 other affiliated companies founded by Bankman-Fried filed for bankruptcy. This action may leave more than a million suppliers, employees and investors who bought cryptocurrencies through the exchange or invested in these companies with no way to get their money back.
Among the groups and individuals who held currency on the FTX platform were many of the normal players in the crypto world, but a number of more traditional investment firms also held assets within FTX. Sequoia Capital, a venture capital firm, as well as the Ontario Teacher’s Pension, are estimated to have held millions of dollars of their investment portfolios in ownership stake of FTX. They have both already written off these investments with FTX as lost.
In traditional markets, corporations generally limit the risk they expose themselves to by maintaining liquidity and solvency. Liquidity is the ability of a firm to sell assets quickly without those assets losing much value. Solvency is the idea that a company’s assets are worth more than what that company owes to debtors and customers.
But the crypto world has generally operated with much less caution than the traditional financial sector, and FTX is no exception. About two-thirds of the money that FTX owed to the people who held cryptocurrency on its exchange – roughly $11.3 billion of $16 billion owed – was backed by illiquid coins created by FTX. FTX was taking its customers’ money, giving it to Alameda to make risky investments and then creating its own currency, known as FTT, as a replacement – cryptocurrency that it was unable to sell at a high enough price when it needed to.
In addition, nearly 40% of Alameda’s assets were in FTX’s own cryptocurrency – and remember, both companies were founded by the same person.
This all came to a head when investors decided to sell their coins on the exchange. FTX did not have enough liquid assets to meet those demands. This, in turn, drove the value of FTT from over $26 a coin at the beginning of November to under $2 by Nov. 13. By this point, FTX owed more money to its customers than it was worth.
In regulated exchanges, investing with customer funds is illegal. Additionally, auditors validate financial statements, and firms must publish the amount of money they hold in reserve that is available to fund customer withdrawals. And even if things go wrong, the Securities Investor Protection Corporation – or SIPC – protects depositors against the loss of investments from an exchange failure or financially troubled brokerage firm. None of these guardrails are in place within the crypto world.
Why is this a Big Deal in Crypto?
As a result of this meltdown, the company Binance is now considering creating an industry recovery fund – akin to a private version of SIPC insurance – to avoid future failures of crypto exchanges.
But while the collapse of FTX and Alameda – valued at more than $30 billion and now essentially worth nothing – is dramatic, the bigger implication is simply the potential lost trust in crypto. Bank runs are rare in traditional financial institutions, but they are increasingly common in the crypto space. Given that Bankman-Fried and FTX were seen as some of the biggest, most trusted figures in crypto, these events may lead more investors to think twice about putting money in crypto.
If I Don’t Own Crypto, Should I Care?
Though investment in cryptocurrencies has grown rapidly, the entire crypto market – valued at over $3 trillion at its peak – is much smaller than the $120 trillion traditional stock market.
While investors and regulators are still evaluating the consequences of this fall, the impact on any person who doesn’t personally own crypto will be minuscule. It is true that many larger investment funds, like BlackRock and the Ontario Teachers Pension, held investments in FTX, but the estimated $95 million the Ontario Teachers Pension lost through the collapse of FTX is just 0.05% of the entire fund’s investments.
The takeaway for most individuals is not to invest in unregulated markets without understanding the risks. In high-risk environments like crypto, it’s possible to lose everything – a lesson investors in FTX are learning the hard way.
This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of D. Brian Blank, Assistant Professor of Finance, Mississippi State University and Brandy Hadley, Associate Professor of Finance and the David A. Thompson Professor in Applied Investments, Appalachian State University
If Cryptocurrency is not the Safe Haven it was Expected to Be, Will Assets Move Into Gold Investments?
In addition to any information discovered from Michael Burry’s 13F filing earlier this week, he’s been coming out in support of gold. He seems to expect that those that were seeking a “safe harbor investment” in various crypto-related investments are now having a change of mind. Despite his long positions held on September 30 and made public on November 14, he has teased that he could be extremely short the market; presumably, this could include any tradeable asset when you’re an investment analyst of this caliber.
Will Investors Rediscover Gold?
“Long thought that the time for gold would be when crypto scandals merge into contagion,” Burry wrote in a tweet this week.
@michaeljburry
The financial pressures spreading across the crypto industry that have helped destroy the crypto exchange FTX and exposed characters like Sam Bankman-Fried that may have been given too much trust, are causing reduced trust in digital assets.
Supporters and believers in the benefit of crypto had been using bitcoin and other tokens as a means of storage outside of securities. Their expectation has been that crypto is superior as a store of value during periods of inflation, currency depreciation, and economic turmoil.
Crypto prices have not offered much protection against plunging stock, bond, and real estate values. In fact, relative to the strong US dollar, crypto’s value has fallen off a cliff, offering no protection. The overall outstanding crypto worth has gone from $2.2 trillion to around $830 billion. Gold has not been rising during this period, but relative to US dollars, it is down only 3%.
Burry’s likely message is that the escalating cryptocurrency negatives will reduce demand for coins, yet demand for a safe haven asset would not be reduced. This could make gold again one of the only games in town for investors looking to protect against asset erosion.
Is Burry Short?
“You have no idea how short I am,” Burry said in a tweet this week.
@michaeljburry
He does not say he is short at all in this tweet. However, against the backdrop of many previous tweets warning against a market he believes will become more bearish, coupled with a holding report released that has five long holdings, the hedge fund manager of The Big Short fame is likely warning investors not to read too much positive into his fund’s holdings report. That report was released just before the tweet.
The value of long securities held in his roughly $292 million AUM was $41 million. As he demonstrated during the financial crisis, there are non-publicly reported ways to be short, even short beyond your AUM. Fund managers with assets over $100 million only have to disclose US-listed stocks in their 13F filings with the SEC each quarter. Excluded in the reporting are shares sold short, overseas-listed stocks, and other assets such as commodities.
In actuality, Burry’s increased positions in prison stocks and exposure to the company involved in making Artemis’ rocket boosters is more likely a sign that he likes the prospects of some companies while at the same time doesn’t like the broader market outlook.
Positive Tweets
In addition to his positive tweet on gold, Burry has suggested the Federal Reserve’s interest-rate hikes, which have weighed on market prices, could end in the spring. This was reflected in his October 24 tweet “Still think the Fed back off on QT early next year.”
Investing in Gold
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The health of the US Treasury market impacts almost all other markets. This is because the “risk-free” market (US Treasuries) and its relationship to the US dollar is the foundation from which other markets stand. If it is in trouble, all markets suffer. The “health” measure most associated with securities like treasuries is liquidity or whether money can be raised when needed. Other measures include market spread between the bid and the ask, trading activity levels, and price impact or how a large transaction impacts the price.
A just released report by New York Fed economists Michael Fleming and Claire Nelson discuss the current state of the U.S. Treasury markets from the unique point of view and access to information of the New York Fed.
The report follows:
How Liquid Has the Treasury Market Been in 2022?
Policymakers and market participants are closely watching liquidity conditions in the U.S. Treasury securities market. Such conditions matter because liquidity is crucial to the many important uses of Treasury securities in financial markets. But just how liquid has the market been and how unusual is the liquidity given the higher-than-usual volatility? In this post, we assess the recent evolution of Treasury market liquidity and its relationship with price volatility and find that while the market has been less liquid in 2022, it has not been unusually illiquid after accounting for the high level of volatility.
Why Liquidity Matters
The U.S. Treasury securities market is the largest and most liquid government securities market in the world. Treasury securities are used to finance the U.S. government, to manage interest rate risk, as a risk-free benchmark for pricing other financial instruments, and by the Federal Reserve in implementing monetary policy. Having a liquid market is important for all these purposes and thus of great interest to market participants and policymakers alike.
Measuring Liquidity
Liquidity typically refers to the cost of quickly converting an asset into cash (or vice versa) and is measured in a variety of ways. We consider three commonly used measures, calculated using high-frequency data from the interdealer market: bid-ask spreads, order book depth, and price impact. The measures are for the most recently auctioned
(on-the-run) two-, five-, and ten-year notes (the three most actively traded Treasury securities, as shown in this post) and are calculated for New York trading hours (defined as 7 a.m. to 5 p.m.). Our data source is BrokerTec, which is estimated to account for 80 percent of trading in the electronic interdealer broker market.
The Market Has Been Relatively Illiquid in 2022
The bid-ask spread—the difference between the lowest ask price and the highest bid price for a security—is one of the most popular liquidity measures. As shown in the chart below, bid-ask spreads have widened out in 2022, but have remained well below the levels observed during the COVID-related disruptions of March 2020 (examined in this post). The widening has been somewhat greater for the two-year note relative to its average and relative to its level in March 2020.
Bid-Ask Spreads Have Widened Modestly
Liberty Street Economics chart plots the five-day moving averages of average daily bid-ask spreads for the two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022.
Source: Authors’ calculations, based on data from BrokerTec.
Notes: The chart plots five-day moving averages of average daily bid-ask spreads for the on-the-run two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Spreads are measured in 32nds of a point, where a point equals one percent of par.
The next chart plots order book depth, measured as the average quantity of securities available for sale or purchase at the best bid and offer prices. Depth levels again point to relatively poor liquidity in 2022, but with the differences across securities more striking. Depth in the two-year note has been at levels commensurate with those of March 2020, whereas depth in the five-year note has remained somewhat higher—and depth in the ten-year note appreciably higher—than the levels of March 2020.
Order Book Depth Lowest since March 2020
Liberty Street Economics chart plots five-day moving averages of average daily depth for the two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022.
Source: Authors’ calculations, based on data from BrokerTec.
Notes: The chart plots five-day moving averages of average daily depth for the on-the-run two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Data are for order book depth at the inside tier, averaged across the bid and offer sides. Depth is measured in millions of U.S. dollars par.
Measures of the price impact of trades also suggest a notable deterioration of liquidity. The next chart plots the estimated price impact per $100 million in net order flow (that is, buyer-initiated trading volume less seller-initiated trading volume). A higher price impact suggests reduced liquidity. Price impact has been high this year, and again more notably so for the two-year note relative to the March 2020 episode. That said, price impact looks to have peaked in late June and July, and to have declined most recently (in October).
Price Impact Highest since March 2020
Liberty Street Economics chart plots the estimated price impact per $100 million in net order flow for the two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022.Source: Authors’ calculations, based on data from BrokerTec.
Notes: The chart plots five-day moving averages of slope coefficients from daily regressions of one-minute price changes on one-minute net order flow (buyer-initiated trading volume less seller-initiated trading volume) for the on-the-run two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Price impact is measured in 32nds of a point per $100 million, where a point equals one percent of par.
Note that we start our analysis of liquidity in this post in 2019 and not earlier. One reason is to highlight the developments in 2022. Another reason is that the minimum price increment for the two-year note was halved in late 2018, creating a break in the note’s bid-ask spread and depth series. Longer time series of bid-ask spreads, order book depth, and price impact are plotted in this post and this paper. The longer history indicates that the price impact in the two-year note is currently at levels comparable to those seen during the 2007-09 global financial crisis, as well as in March 2020.
Volatility Has Also Been High
Pandemic-induced supply disruptions, high inflation, policy uncertainty, and geopolitical conflict have led to a sizable increase in uncertainty about the expected path of interest rates, resulting in high price volatility in 2022, as shown in the next chart. As with liquidity, volatility has been especially high lately for the two-year note relative to its history, likely reflecting the importance of near-term monetary policy uncertainty in explaining the current episode. Volatility has caused market makers to widen their bid-ask spreads and post less depth at any given price (to manage the increased risk of taking on positions), and for the price impact of trades to increase, illustrating the well-known negative relationship between volatility and liquidity.
Price Volatility Highest Since March 2020
Liberty Street Economics chart plots five-day moving averages of price volatility for the two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022.
Source: Authors’ calculations, based on data from BrokerTec.
Notes: The chart plots five-day moving averages of price volatility for the on-the-run two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Price volatility is calculated for each day by summing squared one-minute returns (log changes in midpoint prices) from 7 a.m. to 5 p.m., annualizing by multiplying by 252, and then taking the square root. It is reported in percent.
Liquidity Has Tracked Volatility
To assess whether liquidity has been unusual given the level of volatility, we provide a scatter plot of price impact against volatility for the five-year note in the chart below. The chart shows that the 2022 observations (in blue) fall in line with the historical relationship. That is, the current level of liquidity is consistent with the current level of volatility, as implied by the historical relationship between these two variables. This is true for the ten-year note as well, whereas for the two-year note the evidence points to somewhat higher-than-expected price impact given the volatility in 2022 (as also occurred in fall 2008 and March 2020).
Liquidity and Volatility in Line with Historical Relationship
Liberty Street Economics chart plots price impact against price volatility by week for the five-year note from January 2, 2005, to October 28, 2022.
Source: Authors’ calculations, based on data from BrokerTec.
Notes: The chart plots price impact against price volatility by week for the on-the-run five-year note from January 2, 2005, to October 28, 2022. The weekly measures for both series are averages of the daily measures plotted in the preceding two charts. Fall 2008 points are for September 21, 2008 – January 3, 2009, March 2020 points are for March 1, 2020 – March 28, 2020, and 2022 points are for January 2, 2022 – October 29, 2022.
The preceding analysis is based on realized price volatility—that is, on how much prices are actually changing. We repeated the analysis with implied (or expected) price volatility, as measured by the ICE BofAML MOVE Index, and found similar results for 2022. That is, liquidity for the five- and ten-year notes is in line with the historical relationship between liquidity and expected volatility, whereas liquidity is somewhat worse for the two-year note.
Note also that while liquidity may not be especially high relative to volatility, one might then ask whether volatility itself is unusually high. Answering this question is beyond our scope here, although we will note that there are good reasons for volatility to be high, as discussed above.
Trading Volume Has Been High
Despite the high volatility and illiquidity, trading volume has held up this year. High trading volume amid high illiquidity is common in the Treasury market, and was also observed during the market disruptions around the near-failure of Long-Term Capital Management (see this paper), during the 2007-09 financial crisis (see this paper), during the October 15, 2014, flash rally (see this post), and during the COVID-19-related disruptions of March 2020 (see this post). Periods of high uncertainty are associated with high volatility and illiquidity but also high trading demand.
Nothing to Be Concerned About?
Not exactly. While Treasury market liquidity has been in line with volatility, there are still reasons to be cautious. The market’s capacity to smoothly handle large flows has been of ongoing concern since March 2020, as discussed in this paper, as Treasury debt outstanding continues to grow. Moreover, lower-than-usual liquidity implies that a liquidity shock will have larger-than-usual effects on prices and perhaps be more likely to precipitate a negative feedback loop between security sales, volatility, and illiquidity. Close monitoring of Treasury market liquidity—and continued efforts to improve the market’s resilience—remain important.
Large-Cap and Small-Cap Stock Return Probabilities
According to Ibbotson Associates’ Stocks, Bonds, Bill and Inflation, small Capitalization stocks outperform Large Capitalization stocks over the long term. (Although there is not a set definition for a Small Cap stock, generally speaking Small Cap stocks are those with a market capitalization below $2 billion today, while Large Cap stocks refer to the S&P 500.) Over the 1926-2018 period, Small Caps produced an average annual return of 11.0% compared to 9.99% for Large Capitalization stocks. (1) But, since 2010, Small Cap stocks have underperformed their Large Cap brethren. From the beginning of 2010 through the end of 2019 the S&P 500 rose 185.2% while the Russell 2000 (a proxy for small cap stocks) was up 145.8%. Over the last decade, the S&P 500 outperformed the Russell 2000 in 6 of the ten years. In 2019, the S&P 500 produced a 28.9% return compared to 23.7% for the Russell 2000. Has the time come for Small Cap stocks to outperform Large Cap stocks?
Positives
Relative Valuation Levels. Valuations for Small Caps are at their most attractive levels since June 2003 relative to Large Caps, according to data from Jefferies Financial Group. Historically, Small Caps have outperformed Large Caps by an average of 6% over the following year when the valuation gaps widens this much. (2)
New Index Highs Are a Historic Positive Sign. This past Thanksgiving, the Russell 2000 hit a new 52-week high after nearly 15 months without breaching it. FactSet and LPL Research data indicate that of the last 11 times the Russell 2000 index hit a new 52-week high, returns for the index were up an average 17% over the next 12 months 10 of those times. (3)
Higher Rate of Earnings Growth. Small Cap stocks produce a higher rate of earnings growth over time than Large Caps. Over the 1987-2017 period, Small Caps average annual recurring earnings growth was 8.15% versus 7.44% for Large Caps. (4)
Positives of Small Caps. As one would expect, most Small Caps are young companies with less international exposure than Large Caps. (5) Small Caps have less research coverage than Large Caps, providing a greater potential of market inefficiencies. (6) Ownership of Small Cap stock is typically concentrated in the hands of founders or management, a group that may be more motivated to increase shareholder value than the highly dispersed ownership of Large Cap shares.
Drawbacks
Higher Returns are due to Higher Risk. According to Alpha Wealth Strategies, Small Caps higher return over time comes with a standard deviation (a measure of risk) of 31.28 compared to just 19.76 for Large Cap stocks. (7) So, yes, an investor is receiving a higher return over time from Small Cap stocks, but the investor is assuming higher risk to achieve those returns.
Greater Volatility. As an example of the greater volatility of Small Caps, the Russell 2000 posted 65 intraday moves of 1% or more in the first 10 months of 2019, double that of the S&P 500. (2)
More Susceptible to Economic Shocks. Given their smaller size, lack of business diversification, and limited access to capital, Small Cap companies have historically been more susceptible to economic shocks. In times of economic uncertainty, many investors flock to Lage Cap stocks that are easier to trade and do not suffer from Small Caps’ business limitations. (8)
Small Caps Risks Relative to Large Caps. Among the greater risks of Small Caps is they tend to be more leveraged than Large Cap stocks with less operational efficiency and pricing power. (3) Small Caps also typically have less liquidity than Large Caps, meaning it may be tougher for investors to either build a position or quickly exit a holding. (6)
The Balanced Case:
While Small Cap stocks make up roughly just 10% of the overall U.S. equity market capitalization, they constitute the vast majority of publicly traded firms. And while Small Cap stocks are more volatile than Large Cap stock, over the last 93 years Small Caps generated positive returns in 68% of the years, compared to 73% of the time for Large Caps. Over the period, Small Caps produced a best one-year return of 142.87% and a 1-year worst return of a negative 58.01%, compared to 53.99% and a negative 43.34% for Large Caps. (7) Given Small Caps superior long-term investment returns compared to Large Caps, Small Caps would appear to be fertile shopping ground for long-term oriented investors.
Billions in Artemis Program Budget Could Cause these Companies to Rocket
What companies could gain from the Artemis missions to the moon?
The multibillion-dollar Artemis program has been unfolding over the past several years. The most recent success is the 322-foot-tall Space Launch System (SLS), the most powerful rocket NASA has developed, and the Orion spacecraft. This is all designed to, in time, safely carry astronauts to the moon’s orbit and provide a platform for the U.S. to return to the moon’s surface for the first time since 1972.
The mission of Artemis One is to test a powerful NASA rocket called the Space Launch System, as well as the Orion spacecraft that the rocket will ferry into orbit. After the Florida launch, NASA plans to use the SLS rocket to direct Orion on a route around the moon, after which the vehicle’s crewless capsule will return to Earth and parachute into the Pacific Ocean. Those steps represent another trial geared toward ensuring the Orion crew module can safely bring astronauts back from orbit.
The initial mission will help set the stage for a crewed mission to the moon that NASA hopes to conduct as early as 2025. These efforts will entail higher technology and special equipment designed especially for a unique purpose. With billions being spent, investors may ask what companies may benefit. Obviously, the major contractors, then subcontractors and material suppliers.
The cost of SLS is shown above. Additionally, the cost to assemble, integrate, prepare and launch the SLS and its payloads are funded separately under Exploration Ground Systems, currently at about $600 million per year. (Source:Wikipedia)
Major Contractors
Keeping in mind that an unsuccessful launch could weigh on these companies, as much as they may be propelled by continued success, these are prime contractors. NASA’s prime contractors for the rock launch system is Aerojet Rocketdyne (AJRD), Boeing (NYSE: BA), and Northrop Grumman (NOC). As a note, AJRD showed up as one of 5 portfolio holdings of hedge fund manager Michael Burry.
Lockheed Martin (LMT) is the prime contractor on the Orion spacecraft, while NASA’s prime contractors for the rocket launch system include Redwire’s (RDW) critical sun sensor components and advanced optical imaging technologies, they will be launching on NASA’s Orion spacecraft as a part of the space agency’s Artemis One mission. Aeva Technologies (AEVA) is also involved with a LiDAR-based mobile terrain-mapping and navigation system for lunar and other planet exploration, while KULR Technology Group (KULR) has a battery safety contract with NASA to test its lithium-ion cells going into battery packs designed for the Artemis Program.
Raytheon Technologies'(RTX) was selected to advance spacewalking capabilities in low-Earth orbit and on the Moon. Goodyear Tire & Rubber (GT) has been contracted to develop tires to perform on the lunar surface.
Rocket Lab (RKLB) has been called upon to test new orbits around the moon. For communications, Lockheed Martin (LMT), Amazon (AMZN), and Cisco (CSCO) are working in conjunction to develop a new voice, AI, and tablet-based video technologies for use around the moon.
The companies being called upon is expected to grow rapidly after scientific experiments begin on the moon’s surface.
There is Potential for a Change in Sentiment Spurred by this Week’s Wholesale Inflation Report
One economic number doesn’t make a trend. The members of the Federal Open Market Committee know this, and certainly, the Chair, Jay Powell, understands. As it relates to last week’s CPI report, he may wish that one lower-than-expected inflation data point could prevent him from needing to do more, but it simply isn’t enough info from which the Fed can glean any actionable information.
As we head into the first trading session of a new week, it’s uncertain what the reaction of interest rates will be. They dropped substantially in response to last Thursday’s inflation data coming in better than expected. However, there was no chance of follow-through or reversal as Friday’s Veteran’s Day holiday left the bond markets closed.
With this, inflation numbers continue to be the most significant for both stock and bond investors. On this coming Tuesday, November 15, wholesale prices will be reported as the Producer Price Index (PPI). This release could have more weight in trade action than usual.
Thursday is another big day on the calendar as the markets will be grappling with a larger-than-normal volume of economic releases.
Monday 11/14
11:00 AM ET, The NY Federal Reserve Bank’s one and five-year inflation forecast. This is not an event that is usually paid much attention to by market participants. However, considering there are many parties interested in what members of the Federal Reserve System are now thinking, a dramatic shift from the previous forecast could inspire the financial markets to adjust accordingly.
Previously the one-year inflation expectation was 5.7%. The five-year inflation forecast was 2.2%.
Tuesday 10/15
8:30 AM ET, The Producer Price Index (PPI) from the Bureau of Labor Statistics (BLS) is an inflation gauge that measures the average change over time in the prices received by U.S. producers of goods and services. The prices are typically considered input costs for final products and can impact CPI, it may also impact company costs of production and, therefore, profits. The trend has been lower, YOY PPI has been running at 8.5%, and last month, it rose 0.4%, the expectation is for another 0.4% increase.
Michael Burry, and Warren Buffet’s holdings. The SEC requires investment funds to file a 13-f disclosing their publicly traded security positions. It is required every 45 days, making all of the information a minimum of 45 days old. Looking at a successful investor’s 13F filings can be revealing, especially when looking at industries they’ve been hot on or comparing one holding period to another.
Wednesday 10/16
11:00 AM ET, The Mortgage Bankers Association (MBA) creates a statistic from several mortgage loan indexes. The Mortgage Applications index measures applications at mortgage lenders. It’s considered a leading indicator and is especially important for single-family home sales and housing construction. Both are considered foundational in a strong economy. Last week the Purchase Index was 162.6.
11:00 AM ET, The Mortgage Bankers Association (MBA) also provides an average 30-year mortgage level which is consistently calculated so that it is an oranges-to-oranges comparison from previous periods. Last period the rate was 7.14%.
12:30 PM ET, Export Prices (MoM), this data set reflects changes in prices of goods and services that are produced in and exported from the United States in the given month compared to the previous one. Last reading, this came in at a negative 0.8%.
12:30 PM ET, Import Prices (MoM) The import price index m/m measures the price changes of the respective month compared to the previous month. Last month they fell 1.2% (not adjusted for fx), this month, expectations are for a decline of 0.5%.
12:30 PM ET, U.S. Retail Sales have been flat, neither rising nor falling. As we head toward Thanksgiving and Black Friday sales levels, the market will be taking more and more interest in how strong the consumer is. Expectations for October are for a rise of 0.8 percent overall, an increase from 0.0 percent. When excluding vehicles, the projection is for an increase of 0.4%, up from 0.1%. and up 0.4 when also excluding gasoline.
1:15 PM ET, Capacity Utilization is expected to remain unchanged at an 80.3% use of available manufacturing capacity. Reading well above, this may be considered inflationary as production could be using less efficient means.
1:15 PM ET, Industrial Production is expected to have been weaker at a 0.2% increase compared to a 0.4% increase.
2:00 PM ET, NAHB Housing Market Index this is expected to continue weakening, the October number was 38.
2:00 PM ET, Business inventories are expressed in dollar value held by manufacturers, wholesalers, and retailers. The level of inventories in relation to sales is an important indicator of the near-term direction of production activity. Rising inventories can be an indication of business optimism that sales will be growing in the coming months. However, if unintended inventory accumulation occurs, then production will probably have to slow while those inventories are worked off. Last month’s inventories increased by 0.8%.
Thursday 10/17
12:30 PM ET, Housing Starts, last month housing starts had declined for the seventh consecutive month by 8.7%.
Friday 10/18
2:00 PM ET, Leading Economic Indicators are expected to show a decline of 0.3% vs. a decline of 0.4% the prior month.
What Else
The focus on signs of economic weakness or receding inflation will be high, and reactions may be extra sensitive. The following week is shortened in terms of trading. The focus will be on how strong the consumer shows they will be for the holidays.
Advice is Plentiful on When to Buy Stocks, But When Should You Sell?
During the fourth quarter of 2022, stocks have climbed dramatically. The Russell 2000 small cap index is up double-digits in percentage, and the S&P 500 is approaching a ten percent increase. This is a welcome run-up over such a short period of time. The sudden move has investors, some of whom still hold paper losses, asking themselves, do I sell now, do I add to my positions, or should I sit tight and wait?
Information on when to buy into a position is abundant. Advice on when to decide your assets are better off elsewhere is much less available. There is just less demand from readers on the topic.
Selling Considerations
First off, one does need to consider their financial plan. Is this money that is needed within the next few months, or can the value of the position or positions change without much impact on future plans? Also, is there a better use for the proceeds? If the position one is holding is still the best use of funds, then the answer, net of any emotions, may be to hold.And emotions can make for bad decisions.
Some investors that were about to pull the trigger on the sale of a position weeks ago when stocks were falling may find their position has regained much of the loss, but now they are back in greedy mode, hoping for more, despite being able to get more.
Let’s take a level-headed look at the factors involved in making the decision regarding selling.
Opportunity Cost
One fundamental question should ask themselves regularly is, do I think the risk-reward of each position and all positions taken together are best for the portfolio? If not, depending on tax consequences, if it’s determined that other opportunities might perform better, then it should be of little concern if the stock is up or down from where it was purchased. In fact, depending on what kind of investor you are, it may make sense to lighten up with the plan to re-evaluate if prices fall again.
One way to get a handle on this is to determine, does the stock underperform in a rising market. Does it fall at a faster pace than the market when the market is falling? The answers to these questions can help identify if the position should be cut loose and may be replaced by a better performer.
Moving Averages
Investors can look to moving averages for a hint as to whether the position might be overbought or oversold. Which moving average you use should be based on the expected holding period and also what works best for the stock you are reviewing. For a seldom traded portfolio with longer-term positions, its common to use a 200-day moving average, but depending on the stock’s past performance, the investor may wish to overlay different averages to guide their thoughts on whether the stock might give back recent gains and fall back in line with past performance.
Time Horizon
Many investors skip the step of determining the expected holding period before a purchase of an investment. This is like leaving for a trip without any directions to get you started. If you didn’t do this before your purchase, do it now. Ask, when do you think this will pay-off, what is the anticipated pay-off, and how do I identify if something has changed and the holding period should change? Investors with a long-term time horizon could find that over the years, they can avoid missing the up periods if they don’t get too intent on missing down periods. If your holdings closely follow the S&P 500 index, it may be down 18% this year, but last year it was up nearly 27%, and that could be a compounded increase from the 16% it was up the prior year.
If instead, your holding period is short, you may know within weeks, days, or minutes if you met your goal or if it is not playing out as expected. At that point, if you would not enter the position (whether you made money or not), getting out may be wise. Smart traders know that if they don’t stick to their plan, even if rewarded, they might be reinforcing a bad behavior that will cost them down the road.
Other Considerations
A large percentage of portfolios managed by self-directed investors are qualified accounts; that is, they are tax-deferred, so any gain does not cost the account holder until funds are taken from the account. This largely takes the tax impact question out of the decision to sell or not. However, if it is a taxable portfolio, it’s important to consider whether the tax consequences and the sale are still worthwhile. In some cases selling at a loss may even help offset gains in some other area of the portfolio owner’s financial condition.
It’s wise to consult a tax professional to review your specific financial and tax situation before selling a stock or investment for tax purposes.
If you have made a mistake and purchased the wrong ticker, it isn’t likely the shares fit your parameters and the best time to sell is usually immediately.
Change in Ownership
Sometimes it may make sense to sell a company if it has been acquired or merges with another company. Often before an event like this, the stock price rises well above the overall market movement. The question once again is, is this the best use of one’s investible assets? The new fundamentals and cost-saving synergies between the two companies may place it in a more competitive or more profitable position, in this case, not taking the sudden profit could pay off long term.
Selling a Portion
Did the stock you are holding just shoot up 5%-10%, and you think it is likely to back-off but don’t want to miss out if the euphoria surrounding it continues? Why not make selling a portion, perhaps with the idea that you will re-enter for that portion if the price does drop? In this way, you stand the chance of capturing some of the original run-up, and while you may miss further upward momentum, you have left yourself the opportunity of buying the shares back at a lower price from which they were sold.
Take Away
The decision on whether or not to sell an investment should be held up against the plan you had when you purchased it. Far too many investors make sensible plans entering a trade, but once in and it is either rising or falling, a less sensible side often takes over. Fear and greed are powerful emotions that can undo a good strategy.
A Return to Gridlock in Washington Could be Healthy for Stocks
Political gridlock has historically been associated with higher stock market prices. So, while staunch supporters of either political party did not become overjoyed by the Election Day outcome, those invested in stocks may wind up better off. With President Biden (D) in the Executive branch, and at least the House of Representatives in the legislative branch holding a Republican majority, a split government is assured. This is true no matter the final outcome of the Senate races. A split government, with its accompanying gridlock, has been accompanied by positive long-term stock market performance.
A Smoother Road
The battles in Washington may take on a more heated tone with a split government, for investors, the gridlock scenario eliminates a lot of uncertainty. In the inflationary period we are in, a government with less ability to institute spending plans, and a reduced ability to change tax rates in an effort to pay for spending, is far less of a concern to market participants – less change will be enacted.
For businesses, there is more visibility to plan, budget, and implement plans to build their business. A split government should lead toward fewer dramatic changes or government intervention that bolsters one technology or product over another. With a lower risk of playing field changing legislation, tax change, or regulations, businesses are more likely to spend and invest as the risk of change is lower.
Historically, stocks have tended to do better under a divided government when a Democrat is in the White House. The average one-year S&P 500 returns have been 13% in a Republican-held Congress under a Democratic president and 14% when the Congress is split. This compares with 10% when Democrats controlled the White House and Congress.
Under the current situation, less spending on Build Back Better initiatives and a lower likelihood of passage of more plans like The Inflation Reduction Act help reduce spending and stimulus, which may allow the Federal Reserve to end its tightening cycle sooner.
The increase in Republicans could bring more attention to several stock market areas, such as biotech and pharmaceuticals. Their increased presence lowers prospects for price controls on prescription drugs. Big tech stocks could benefit from less of a threat to regulate the industry.
Some Choppiness Ahead
In 2011 the credit rating agency Standard & Poor’s downgraded the U.S. credit rating over the long gridlock battle that delayed increasing the Federal Debt ceiling. A possible downgrade, or “credit watch” category, could lead to an increase in rates, not just in U.S. government debt but all loans tied to these benchmark rates.
The enhanced power of Republicans could also slow infrastructure outlays, particularly the momentum in spending that has lifted so many alternative fuel stocks. Incentive plans and grants funded through borrowing and taxation have grown dramatically with both the executive and legislative branches under single-party control, those sectors that were expecting the pace to continue may find growth prospects slowing. Marijuana legalization on the Federal level may also be less of a priority now among lawmakers.
Stocks Post Mid-Terms Track Record
The S&P 500 has recorded a gain in each 12-month period after the mid-terms since World War Two. The markets have been clobbered with declining values since 2022 began; perhaps this is the turning point where the unfairly beaten-down sectors and companies begin to make up for lost ground.
Take Away
The election outcome wasn’t overly satisfying for either party but may lead to stronger stock market performance. Also, just getting past the mid-term elections without regard for the outcome has a stellar record of gains. If history is any indicator, a repeat of what the markets have experienced in the past, along with a slight shifting of those more positioned to take advantage of changes, should put investors in a positive mood as we approach year-end and enter 2023.
