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Gaining Competitive Edge: The Data Arms Race in Capital Markets

Capital markets firms are facing competition from many corners, from the continued dominance of passive investing on the buy-side to retail brokers that operate like quasi-fintechs on the sell-side. Gaining competitive edge over both new entrants and incumbents therefore relies on better use of all of a firm’s available assets.

That means gleaning valuable insights in real time from a wide variety of data sources, both internal and external, to better arm your front office decision-makers and trading desks. It also means better understanding your clients’ activities and tailoring your services more appropriately to their requirements.

Over the last decade, much has been written about the rising tide of external data sources from which firms can gain information about particular market trends or opportunities. Whether it’s the evolution of sentiment analytics based on social media data or the addition of new sources of data for tracking environmental information such as satellite imagery, data has been at the forefront of firms’ development of innovative trading strategies, and it will continue to play a significant role in the future.

However, there are many internal sources of data that firms have yet to mine fully for business insights and opportunities, as well as building a 360-degree view of a firm’s clients. Moreover, it’s often the combination of different data sets that makes for greater insights.

Combining internal transaction data with external sentiment data, for example, can highlight patterns of behavior over time that can feed into predictive models. From a transformation standpoint, the successful implementation of artificial intelligence (AI) and machine learning (ML) also requires a high volume of high-quality data.

The evolution of the sell-side front-office has seen personnel change from pure sales traders to quants, who rely on these technologies and reliable data to deliver better returns. It has also witnessed an increasing role for risk management in a front-office context, with related increased demand for real-time risk data analytics.

Technology has become a catalyst for change and the deployment of next generation tools to handle more volume and to better manage risk is a competitive advantage. On the buy-side, there is also an efficiency play around better managing data to reduce the transaction costs for client portfolios. Staying ahead of market risk is key to better managing liquidity, which has been a regulatory concern over the last 24 months within the funds space.

Static reports based on stale data won’t cut it in today’s fast-moving market environment. The past two years have been characterized by market volatility and black swan events, which make up-to-the-second information critically important. For example, think of the difference in responding to breaking news as it happens versus a few hours or even days later. Everyone in the market understands that revenues can be seriously negatively impacted due to latency of information from a trading perspective. Yet C-suite executives often rely on internal reports that are based on stale data due to legacy technology and operational silos.

Many large financial institutions are in the throes of a multi-year transformation program, and most have placed data alongside digital as a pillar of their strategies for the future. After all, the target of aligning business units from a horizontal perspective across the organization can only be achieved via the introduction of a common data foundation.

From a cultural perspective, transformation requires lines of business to be on the same page as each other and greater collaboration can be enabled via the sharing of common data stores. This is where many firms have introduced application programming interface (API) platforms, taking a lead from the retail banking industry in Europe and its focus on open banking.

The move to a cloud environment is also part of this journey and given the regulatory and industry focus on resilience, ensuring the firm is able to switch cloud providers in the future, if required to, is increasingly important. Avoiding cloud platform lock-in is also a commercial imperative for firms that wish to retain negotiating power with their service providers. A data disintermediation layer between a firm and its cloud or software as a service provider is therefore important to enable faster onboarding and future resilience.

However, firms cannot stop and rebuild everything from scratch; they must work within the parameters of their existing technology architectures. APIs also expose the quality of the underlying data from source systems, which can result in a ‘garbage in, garbage out’ quality problem. This is where technologies such as data fabrics can come into play to normalize data from multiple sources and allow it to be consumable by downstream systems and applications. Business decision-makers can then rely on the high quality of the data on which they base their strategic insights, risk management and future plans.

The industry will continue to find new data sources to exploit and add new data-intensive services and technology applications. Just look at the growth of digital assets or the rise of environmental, social and governance (ESG) investment strategies for proof of this dynamic over the last few years. As these new products and services evolve, the complexity of data is only going to increase, and the volumes will grow as firms add more required data sources. How teams surface insights from this data and how quickly they can turn these insights into client-focused activities is already an arms race within the industry. Adding AI and ML into the mix will accelerate the race further.

Firms will also continue to grow organically and inorganically. Silos are almost impossible to eradicate, so learning how to better live with them is part and parcel of a digital transformation program. Interoperability has become a keyword within the industry, due to  the need to connect multiple entities, internal systems and market infrastructures. Interoperability isn’t something that firms should only demand from external providers; it is equally important within the four walls of their organizations. At the heart of interoperable operations is the simplification of the data stack, not by ripping and replacing but via augmentation.

There is little appetite for big bang projects that require multi-year implementations with promised return on investment (ROI) several years down the line. Firms want to become more agile and deliver incremental benefits to their clients sooner rather than later. Building vast new internal platforms from scratch is therefore something best avoided, especially given the ongoing burden to maintain these systems over time. Partnerships with specialist vendors, who can offer the right level of expertise and support is more palatable for those looking for faster deployment and incremental delivery.

Building a more resilient financial institution that can withstand the volatility of the markets, address the new product and services whims of its varied client base, increase its overall agility, and stand its ground against its competitors, new and old, requires a solid data foundation. Firms with reliable, accurate, on-demand data can adapt as the market, regulators and their clients demand.

About the Author: Virginie O’Shea is CEO and Founder of Firebrand Research. As an analyst and consultant, Ms. O’Shea specializes in capital markets technology, covering asset management, international banking systems, securities services and global financial IT.

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The Winds are Changing for Housing, How Long Can Prices Remain High?

Is the Housing market in a correction? Corrections, although unpleasant if your long the asset class, are viewed as normal and healthy. Home values have been climbing for a while. The forces that helped drive other markets higher over the past few years were also at work pushing residential properties up at an unsustainable pace. This year the stock and bond markets have come off of their steamy highs, it appears real estate and housing are setting up to do the same.

On Tuesday (July 19), it was reported by the National Association of Home Builders (NAHB)  that Single Family Starts fell to a two year low of 2%. This came just one day after it was reported that home builder confidence dropped by a steep 12 points to 55 in July. That separate report was a release of the National Association of Home Builders/Wells Fargo Housing Market Index. Sentiment has accelerated downward since December when it stood at 84 (based on 100). It is now at its lowest level since May 2020 and faced with tighter money conditions going forward.

In addition to tighter money (ie, higher mortgage rates), housing headwinds include building material supply chain bottlenecks and elevated construction costs. According to the NAHB, for the first time since June 2020, both single-family starts and permits fell below a 1 million annual pace.

Housing Starts

By falling 2%, housing starts were at a seasonally adjusted annual rate of 1.56 million units in June, according to the U.S. Department of Housing and Urban Development and the U.S. Census Bureau. The June reading of 1.56 million starts is the number of housing units builders would begin if development kept the current pace for the next 12 months. Using this overall number, single-family starts decreased 8.1% to a 982,000 seasonally adjusted annual rate. This is the lowest single-family starts pace since June 2020. Multifamily dwellings, which include apartment buildings and condos, were on the upswing; this sector increased 10.3% an annualized 577,000 pace.

“Single-family starts are retreating on higher construction costs and interest rates, and this decline is reflected in our latest builder surveys, which show a steep drop in builder sentiment for the single-family market,” said Jerry Konter, chairman of the National Association of Home Builders (NAHB). By itself, fewer homes being built and entering the market could be bullish for home sales, but the reason for the slowdown, according to Mr. Konter, is “Builders are reporting weakening traffic as housing affordability declines.”

NAHB Chairman Konter said 13% of builders who participated in the monthly survey said they had reduced home prices over the last month to lure buyers.

Rober Dietz, the chief economist at the NAHB said, “While the multifamily market remains strong on solid rental housing demand, the softening of single-family construction data should send a strong signal to the Federal Reserve that tighter financial conditions are producing a housing downturn. Dietz is concerned that supply may not match needs, “Price growth will slow significantly this year, but a housing deficit relative to demographic need will persist through this ongoing cyclical downturn.”

Regionally and on a year-to-date basis, combined single-family and multifamily starts are 4.4% lower in the Northeast, 4.7% higher in the Midwest, 11.1% higher in the South, and 0.4% lower in the West.

Housing Permits

Overall, permits to build a new home decreased 0.6% in June. Single-family permits decreased 8.0%. This is the lowest pace for single-family permits since June 2020. Multifamily permits again increased by 11.5% to an annualized 718,000 pace.

Regional permit data on a year-to-date basis, permits are 5.1% lower in the Northeast, 2.5% higher in the Midwest, 2.9% higher in the South, and 3.0% higher in the West.

Interest Rates

The average contract interest rate on a 30-year fixed-rate mortgage climbed to 5.51% for the week ending on July 14. The same rate was just below 3% one year earlier.

 

Take Away

The NAHB indicated a drop in confidence within the housing market due to the impact of high inflation on building costs and rising interest rates. This has resulted in “dramatically slowing sales and buyer traffic.”

Mortgage rate increases come at a time when houses are still at or near their highs from the surge experienced during the pandemic. The housing “correction” could bring monthly costs of owning a home in line with what they had been prior to recent mortgage rate increases. This would mean prices low enough to equate to the same monthly outlay to the buyer. Should the economy weaken further, there is the potential for home prices to decline further.

All markets impact the others. When housing prices rise, people feel better about their financial situation. Owners also find it easier to borrow against their home’s appreciation. The economy and stock markets all tend to do better. Home prices have remained near their highs, a shallow correction might be welcome to those that are just now looking to enter the market for a home.

Paul Hoffman

Managing Editor, Channelchek

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Cathie Wood is Unwinding One of Her Firm’s Nine Funds

On August 31, 2021, ARK Invest, run by Cathie Wood, filed with the SEC to create her company’s first indexed-based fund. Up until then, all ARK funds were managed by the founder and Chief Investment Officer. Yesterday it was announced the fund will close by the end of July 2022. The ETF, Transparency Global (CRTU), an ESG inspired fund based on The Transparency Index™ (TRANSPCY), will have opened, then closed in less than a year.

Fund Description

The ARK Transparency ETF held companies deemed to be the 100 most transparent companies globally by the index provider. The top five holdings included Teledoc (TDOC), Spotify (SPOT), Bill.com (BILL), Netflix (NFLX), and Acushnet (GOLF). Each of the top five represented about 1% of the fund. The ARK website explains the principle behind the fund in this way, “ARK believes that transparency enhances the performance of companies while benefiting the well-being of people. Transparency implies openness, communication, accountability, and trust.”

The ARK Transparency ETF, which was launched in December, will close later this month, according to a regulatory filing. ARK currently has nine ETFs, including the transparency fund. This is the only fund of ARK’s nine ETFs that is not managed but instead index based. The ARK Transparency ETF followed an index developed by Solactive, a German-based financial index provider, and tracked by Transparency Global.

In early summer Transparency Global told ARK it would no longer calculate the ETF’s underlying benchmark after July.

Fund History

It was
reported when the fund was announced last year that Cathie Wood, the founder of ARK Invest, believes that while this carve-out index has many of the same attributes of popular ESG funds, the transparency screen could provide superior performance. The Ark application to register the then new fund came at a time when there was a massive appetite for ESG investing. At the time, ESG funds were on track for a record year of inflows after amassing $21 billion 

The Transparency fund had accumulated $12 million in assets and had fallen nearly 36% since its inception, according to FactSet. Some of the fund’s largest holdings included Teladoc Health Inc. and Bill.com Holdings Inc., which are both down about 50% this year.

The transparency fund will no longer accept creation units after Thursday and will cease trading on the Cboe BZX Exchange after July 26, according to a statement from the firm.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.bloomberg.com/news/articles/2022-07-19/cathie-wood-s-ark-shutters-transparency-etf-in-first-closure

https://etfs.ark-funds.com/hubfs/1_Download_Files_ETF_Website/Prospectuses/ARK%20ETF%20Prospectus%2011.12.21%2021.pdf

https://www.sec.gov/Archives/edgar/data/1579982/000110465921111628/tm2126418d1_485apos.htm

https://transparency.global/transparency-index/

https://www.wsj.com/articles/cathie-woods-ark-to-close-transparency-etf-11658273924?mod=hp_lead_pos12

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Newly Concocted Securities Draws a Warning Statement from Director at SEC

 A new form of ETF with its own risk/reward attributes is about to converge on the markets. The exchange-traded, derivative-based security will, over time, provide investors a new breed of investment vehicle to gain exposure to price changes in an underlying stock. At the Securities and Exchange Commission, Lori Schock, the Director of Investor Education and Advocacy, put out a statement last week on what the Commission is calling Single-Stock Levered and/ Inverse ETFs. 

For the benefit of Channelchek members,  I have reposted the full contents of the SEC statement below.     We know our readers want to keep up to date on all that could impact small and microcap stocks, the broader financial markets, and their investments. This new breed of offering has the power to affect each of them.  

Paul Hoffman

Managing Editor, Channelchek

Statement on
Single-Stock Levered and/or Inverse ETFs

Lori J. Schock, Director, Securities and Exchange Commission

Today and in the coming weeks, a new type of complex exchange-traded product will become available to investors in the U.S.: single-stock levered and/or inverse exchange-traded funds. For years, the Office of Investor Education and Advocacy, staff in other Divisions and Offices, and a number of Commissioners have warned that complex products present several risks to investors. These new products are no exception, as they provide levered and/or inverse exposure to a single security, which can present risks for investors.

Holding a levered and/or inverse single-stock ETF is not the same as holding the underlying stock, a traditional ETF, or even a non-single stock levered and/or inverse ETF. It is riskier for several reasons. Importantly, like many other complex exchange-traded products, levered and/or inverse single-stock ETFs aim to provide returns over extremely short time periods (in some cases even a single day). New risks may emerge for investors who hold these products for longer than that. Investors should be aware that if they were to hold these funds for longer than a day, the performance of these funds may differ significantly from the levered and/or inverse performance of the underlying stock during the same period of time.

Additionally, unlike traditional ETFs, or even other levered and/or inverse ETFs, these levered and/or inverse single-stock ETFs track the price of a single stock rather than an index, eliminating the benefits of diversification. Because levered single-stock ETFs in particular amplify the effect of price movements of the underlying individual stocks, investors holding these funds will experience even greater volatility and risk than investors who hold the underlying stock itself.

Though these products will be listed and traded on an exchange, they are not right for every investor. Levered and/or inverse single-stock ETFs pose risks that are unique and complex. We encourage all investors to consider these risks carefully before deciding to invest in levered and/or inverse single-stock ETFs.

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Source

https://www.sec.gov/news/statement/schock-statement-single-stock-levered-and-or-inverse-etfs-071122

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SEC Claims Authority Over Cryptos and Says Revised Securities Law Could Apply

During an interview this week, Securities and Exchange Commission (SEC) Chairman Gary Gensler covered several cryptocurrency-related topics and shared for the first time how the Securities regulator may define its authority and deal with a myriad of digital-asset issues and concerns. Gensler assured the interviewer and listeners that the regulator does have broad enough powers from Congress to institute changes to protect the public involved in the asset class. His statement about authority seems to give a nod to a recent Supreme
Court ruling related to the FDA but impacting all agencies created through Congressional legislation.

During the interview, which was streamed on Yahoo Finance,  Gensler said that the Commission may exempt parts of securities law in order to help companies involved in cryptocurrency fall into compliance. He referred to other examples where this has been done. The Chairman insisted that there are many non-compliant companies offering crypto, which he views
as securities. Although the SEC Chairman views the digital assets as securities, other regulators, such as the Commodities Futures Exchange (CFTC) have treated them differently. The two oversight bodies have been at odds over cryptocurrency since even before Chairman Gensler was appointed.

Security and Exchange Commission Oversight

Source: SEC.gov

The SEC has targeted several crypto companies, accusing them of conducting unregistered securities sales. The most high-profile case is with fintech firm Ripple, which is to be settled soon. Victory for Ripple would set a precedent that would almost certainly buoy the beaten-down cryptocurrency sector.

In March, the Executive branch issued an Executive Order for federal agencies to “play a leading
role in international engagement and global governance of digital assets consistent with democratic values and U.S. global competitiveness.”

Very little headway has been made since then and crypto legislation is unlikely to be passed this year. It is an election year, and digital assets are more of a political issue than they may seem. Several politicians and bankers are proponents of fostering the innovation that could make the country a fintech hub, which is what the industry advocates want. And others look for a heavy-handed crackdown on the U.S.

Paul Hoffman

Managing Editor, Channelchek

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https://www.youtube.com/watch?v=Gy2IF_og2Nw

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Polls Closing for CFAs Voting to Alter the Institute’s Framework

Forbes Magazine once called CFAs (Chartered Financial Analysts) “The Rock Stars of Finance.” Each year the CFA Institute consisting of 195,000 financial analysts that have succeeded in acquiring one of the top designations in investment and finance, holds its annual meeting. This year’s meeting has created significant disunity among CFAs. The division in thought is with three of the 11 proxy votes. 

Along with the election of four governors and a Chair and Vice Chair, charter holders vote on proposals. This year three of those proposals could serve to change the Institute’s Constitution. One of them would provide for new degrees or classes of membership. This doesn’t sit right with many of the current members that are casting their ballots.

Annual CFA meetings are rarely controversial. However, this year, some of the organization’s 160 regional societies have recommended that their members vote against some of these proposals. 

Battle of the CFAs

The CFA exam is a three-part test, usually taken over as many years. The pass rate for each of the three test levels is quite low. Since 2010 Level 1 ranges from 22%-49%, with an 11-year average of 39%; Level 2 ranges from 29%-55%, with an 11-year average of 44%; Level 3 ranges from 39%-56%, with an 11-year average of 50%. Some financial analysts, who have spent years working to earn the difficult and extremely coveted CFA credential, are pushing back against the CFA Institute’s attempt to become more inclusive and broaden its influence.

Members have until today (July 14) to vote on 11 proposals. This year the Institute’s board is asking for the flexibility to “change quickly and make a lot of changes” without input from its vast membership. This would have the effect of changing the organization’s bylaws.  

Voting Against

A significant number of members of the Chartered Financial Analyst community are voting against the institute’s current governing body by planning to vote against some of the proposals, which they argue would open the door to adding new classes of membership to people who haven’t taken the CFA exam, making the credential less valuable and diminishing the reputation of the Institute.

The overall mindset of those voting against is partly the lack of clarity or definition in the proposals. The concern is it would increase the organization’s flexibility, allowing it to make decisions rapidly without consulting members.

One member and former president’s council representative, Richard Mundinger, told Institutional Investor he is not surprised by the attention CFA members are paying to the proposal.    

“Everybody is an analyst,” Mundinger said, adding that analysts have spent time combing through the 108-page prospectus to determine how to vote and how the proposals will affect the value of their CFA credential. 

Supporter of the Change

The CFA governing board says the changes are mostly semantic changes that won’t affect how it operates. There are no new classes of CFA designations or membership yet.

“CFA Institute has many constituents, including the hundreds of thousands of candidates who take our exams every year but who do not qualify for membership either because they have not yet passed all three levels or because they do not have the required work experience,” Matthew Hickerson, CFA Institute’s head of global media relations and executive communications said to Institutional Investor. “This proposal simply acknowledges the reality of who we serve today, which represents a footprint that is considerably larger than our core charter holder base,” he added. “Full members will remain the only group that can vote.”

The CFA Institute said the passage of the proposal wouldn’t change how the organization operates. 

“It does not remove or diminish the rights of any stakeholder group,” Hickerson said. “The proposed changes preserve the important roles of members and societies, who continue to be featured in detail by the provisions of the CFA Institute Bylaws.” 

Take Away

The CFA Institute Board of Governors, in an attempt to gain more flexibility in directing the organization, is running up against voters who are “Rock Stars” when it comes to analyzing the value of proposals. Many have developed strong opinions and are not afraid to place their thoughts above that of the governing board. 

The board strongly disagrees that the CFA Institute brand is altered in a way by these proposals that would de-emphasize the Chartered Financial Analyst members.  

Paul Hoffman

Managing Editor, Channelchek

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Sources

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SEC Fails to Reach Agreement with Chinese on Accounting Audits

Mass delisting of nearly 150 Chinese companies trading on U.S. stock exchanges may not be avoidable. This, according to The Securities and Exchange Commission Chairman (SEC) Gary Gensler said he does not expect that negotiations in Washington and Beijing on the U.S. Holding Foreign Companies Accountable Act (HFCAA) will reach an agreement. The Act came about as a response to the Public Company Accounting Oversight Board (PCAOB).

The PCASOB says that is pertinent to Gensler’s comments today (July 13): “If you want to issue public securities in the U.S., the firms that audit your books have to be subject to inspection by the Public Company Accounting Oversight Board.” Over 50 jurisdictions have worked with the PCAOB to allow the required inspections; China and Hong Kong have not.

The HFCAA requires audits that the SEC made necessary to prevent Chinese companies from being delisted from U.S. stock exchanges. The HFCAA took effect in 2021 and bans U.S. trading of securities of companies whose auditors can’t be inspected by the American audit watchdog for three consecutive years. This gives Beijing until spring 2024 to comply, though Congress is considering legislation that would shorten the deadline by a year.

Image: Yum Chinese Holdings is among the 150 companies trading on U.S. markets that may be impacted if an agreement is not reached.

In recent months, racing the clock against a looming deadline for American regulators to oversee Chinese companies, the required audit requirements have been the focus of intense negotiations between Chinese regulators and their U.S. counterparts. Chinese authorities had recently indicated that they wanted to avoid these companies being delisted for having missed the deadline.

“It’s quite possible that there’s no deal here,” Mr. Gensler told reporters after an SEC rule-making meeting.

The SEC has identified about 150 companies as noncompliant. Many have become popular stocks for U.S. investors including Nio, Inc. (NIO), Dada Nexus, Ltd (DADA), iClick Interactive (ICLK), and JD.com (JD).    

“If anything has changed, it’s just time,” Mr. Gensler said. “This is the middle of the second year.”

The SEC Chairman, although he didn’t express there was any movement toward agreement, indicated that there was still time. The U.S. and Beijing have not reached the point of no return on finding terms that work to protect U.S. investors and, at the same time, retain the required secrecy expected of these companies back home.

Paul Hoffman

Managing Editor, Channelchek

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Previous Stock Market Crashes Can Teach Us When to Slow Down and When to Speed Up

A significant and usually abrupt decline in the value of the broader stock market is referred to as a stock market crash. There is no standard definition that uses measurements such as a decline over time ratio, or percentage decline from the most recent high. But like most crashes, you don’t see it coming until it is nearly unavoidable. The word capitulation is sometimes used; this refers to the main ingredient of most crashes, panic-selling by investors who want to stop experiencing new losses. Understanding what happened in the past could help to make investors more likely to recognize any trouble in the road ahead.

A stock market crash is usually quicker than the recovery from the setback. Recovery, historically, has taken months in some cases and over a decade in others.

Crash Math

Here is some crash math that stock market investors should know.

The percentage you will need after your stock sinks to return to the same level is a higher percentage than the percent the stock declined. For some, this may seem basic, but I know for others, it takes a bit to wrap your head around.

This could help with understanding why.  A portfolio loss is based on a higher amount, and the recovery is based on a lower amount. If your portfolio is valued at $10,000 and it drops 50%, it is now worth $5,000. A 50% gain on $5,000 will only add $2,500 to your value. The underlying stocks in the portfolio will have to recover 100% for the portfolio to be made whole on its 50% decline. 

Recognized Crashes

Here is a quick understanding of some of U.S. history’s most notable crashes.

1929 – The stock market crash that is tied to the Great Depression is considered to be the worst stock crash in history. It began in 1929 after a long period of expansion (roaring twenties). During the twenties, the economy expanded significantly and the stock market boomed.

The 30 stocks in the Dow Jones Industrials rose from 63 points in August 1921, to 381 points by September 1929. The Dow started to descend from its peak on Sept. 3 and continued through the month and into October. On October 28 and October 29, the fall accelerated. The market on the 28^th, Black Monday, fell 13%. It went down by another 12% on Tuesday.

By mid-November, 1929, the Dow had lost about half its value. The Dow continued to slide until the summer of 1932. The Dow Industrials bottomed out at 41 points or 89% below its peak. It then took 22 years to regain its pre-crash value.

A primary factor leading to the 1929 stock market crash was excessive leverage. Many individual investors and investment trusts had become comfortable buying stocks on margin and more fully benefitting from the growth of the market. For those using leverage, it meant they paid only 10% of the value of a stock to acquire it under the terms of a loan agreement. Consumers had also become accustomed to using debt to make purchases. When the late 20s debt bubble burst, it exacerbated the most famous stock market and economic crash in history.

1987 –  On a different Black Monday in the late 1980s the Dow Jones Industrial Average plunged by nearly 22%. Black Monday, as the day is now known, marks the biggest single-day decline in stock market history. It occurred on October 18, but the remainder of the month was also quite weak. By the start of November 1987, most of the major stock market indexes had lost more than 20% of their value.

There is no single event that caused the stock market to crash in 1987. There were some warning signs of excesses, economic growth had slowed, inflation was ticking up, and a strong dollar was hurting U.S. exports. Stock valuations had reached excessive levels, with the overall market’s price-earnings ratio above 20 while future estimates for earnings were trending lower. These are enough signs that something had to give way.

Computerized trading was growing at this time, and this was known to have created wider daily swings in prices than people had been accustomed to. Whether deserved or not, many accounts say program trading was the primary cause of this event.

Since there was no pervasive economic problem that caused the October 1987 route, market participants soon came back and drove prices higher in November. The market reached its pre-crash level two years later in September 1989.

1999/2000 – The values of internet-based stocks rose significantly through the 1990s. This caused technology-dominated Nasdaq to rise from 1,000 points in 1995 to more than 5,000 in 2000. After some concern surrounding getting past Y2K without a computer glitch, in early 2001, the dot-com bubble began to burst. Nasdaq peaked at 5,048.62 points on March 10. The index kept falling throughout the following months until it reached 1,139.90, or 76.81% lower by Oct. 4, 2002.

The explanation for this crash was overvalued internet stocks. It seemed as though everyone suddenly became an investor and had advice on internet stocks. Investors, including first-timers, speculated that dot-com companies, even those without revenues, would all one day become extremely profitable. As a result, they poured money into the sector, including fledgling fund companies which made it easier to be an investor. This bubble burst when the Federal Reserve tightened its monetary policy. The Nasdaq later took 15 years to regain its peak.

 

2008 – Have you read the book or seen the movie “The Big Short?” Author Michel Lewis did a great job explaining the mortgage bust and its ties to the stock market crash. Here it is, in four paragraphs, and with no mention of someone I follow, Dr. Michael Burry.

The U.S. government during 1999, thought it could make houses more accessible to those with low credit ratings and less money to spend on down payments than lenders typically required. Using agencies chartered by Congress, such as Federal National Mortgage Association (FNMA/Fannie Mae) these would-be homeowners, or subprime borrowers, as they were called, were offered mortgages with payment terms, such as higher interest rates, balloon maturities, and other variable payment schedules, that served to get them in the door.

In economics, nothing happens in a vacuum, and increased mortgage availability causes an increased demand for homes by both previously ineligible borrowers and investors. This created bubble-level growth in mortgage originations and home sales. The demand for homes drove up home values which consumers used to take out second mortgages to upgrade their lives with the equity available in their property.

In corporate America, companies looking to capitalize on opportunities available by a growing economy also took on additional debt. Financial institutions, similarly, used cheap borrowings as leverage to double down on growing lines of business. One of these growing lines was consumer lending.

The easy mortgage money and borrowing on abundant equity caused many assets, including stocks, to rise. But the subprime mortgages were quietly becoming delinquent. And much of this debt was reengineered into SEC-registered securities so that investors could invest in the growing debt. Then things that had been going sour for a little while began impacting large Wall Street firms. The news came out that Bear Stearns could not cover its losses linked to subprime mortgages – still, stocks rose, reaching a high on October 9, 2007; almost a year later, in September of 2008, the major stock indexes had slid nearly 20%. The Dow Industrials reached its lowest point, which was 54% below its peak, on March 6, 2009.

2020 – A health concern that led to “shutting down global economies” caused a dramatic stock market crash earlier this decade. During the week of February 24, 2020, the Dow Jones and S&P 500 tumbled 11% and 12%, respectively, marking the biggest weekly declines to occur since the financial crisis of 2008. On March 12, the Dow Industrials declined by 9.99%, its largest one-day drop since Black Monday of 1987. Then it managed to replace its second-worst day with an even deeper 16% plunge on March 16.

The recovery from this crash was quick. The stock market rebounded back to its pre-pandemic peak by May of 2020. It’s widely viewed that credit for the rapid recovery can be given to an enormous amount of stimulus money, with the Federal Reserve slashing interest rates and injecting $1.5 trillion into markets and Congress passing a $2.2 trillion aid package at the end of March. The quickness to support the economy also served to buoy the stock market.

Take Away

Valid arguments can be made in favor of stocks rallying after a six-month organized decline to down 20%-25%, and a case can be made that what we have experienced foretells accelerating problems. Many ingredients exist that could favor either argument.

What is important to come away with is that within markets, when stock indexes are up, there is a high percentage of stocks that are moving down. And When indexes are down, there are many stocks still climbing and doing well. Stock selection is an important determinant of investing success.

To keep up with industries both weak and strong and what top analysts are saying about many companies with high potential to either grow or slide,
sign-up for Channelchek and stay informed.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.federalreserve.gov/pubs/feds/2007/200713/200713pap.pdf

https://goodreads.com/book/show/26889576-the-big-short 

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The Case for Small-Cap Stocks Leading Out of the Dip Got Stronger

Was June 16 the market bottom? Some investors are cautiously optimistic. But, just like the question, “are we in a recession?” We will only know by looking in the rear view mirror miles down the road. Let’s presume for a moment that markets have bottomed. The Wall Street Journal wrote, “Shares of many small, U.S.-focused companies have raced ahead of the broader stock market in July. Some investors think that signals more room to run for small-capitalization companies, which can often be more agile and react more quickly to economic changes, including a recession. Below we look at the case the Journal makes, and add some other insight as to expected price action.

The broader markets gave up a lot of ground from the very first opening bell in 2022. As of the June 30 halfway point, the S&P 500 fell 21%, its worst first-half performance since 1970. The Russell 2000 index of small-cap companies fell 24%, its worst first half since launching in 1984. So far this month, the Russell 2000 is up 4.3%, while the S&P 500 is up 3.6%.

As with all broad indexes, the return is a deep mix of the overperformers and underperformers. Just yesterday the index was up 2.38% which included Clovis Oncology (CLVS) which traded higher by double digits, while another company in the index, WD-40 (
WDFC), was down double digits.

The move could be the beginning of a return to the more common pecking order for stock indexes ranked by large, and small-capitalization values. The small caps have been trailing, whereas historically the small stocks outperform.

The Journal indicated, “Small caps tend to be sensitive to fears of an economic slowdown, since they often generate the majority of their sales in the U.S., compared with large multinationals. Even though many investors and analysts remain nervous about the potential of a recession, some say that after a brutal first half, the group looks due for a rebound.”

Below are two measures of small-cap stock performance (VIOO and IWM) plotted against the Nasdaq and S&P 500 since the low for all of them this year (June 16).

Source: Koyfin

One reason some market analysts believe small caps could be staging a rebound is valuations. The S&P 600 index of small-capitalization companies is trading at around 11.3 times its next 12 months of expected earnings, while the S&P 500 is trading at around 16.2 times expected earnings. Investors searching for value will find a wider variety of cheaper stocks among smaller caps. The Journal quoted Jurrien Timmer, the director of global macro at Fidelity as saying, “I would argue that a lot of the bad news is probably already in small caps.” Timmer said that small caps, which peaked earlier than the broader market, might be poised to hit their bottom earlier too. He was alluding to The Russell 2000 having hit its peak in November, while the S&P 500 hit its record two months later, in January.

Jill Carey Hall, US equity strategist at Bank of America, told the Journal, “The only other time small caps were this cheap relative to large caps was during the height of the tech-bubble period.”

In a recent interview of Chuck Royce, Chairman and Portfolio Manager at  Royce Investment Partners, by Co-CIO Francis Gannon, Mr. Royce was asked: “What’s your current view on small-cap’s relative attractiveness versus large-cap?” In his response, he cautioned investors to avoid the temptation of being too comfortable with large caps. The reason given is that despite the dramatic decline in stocks in general, there hasn’t been a change in the undervaluation in small-caps relative to large. “Small-caps have averaged a 3% premium to large-caps over the past 20 years. At the end of June, however, small-caps were at a 20% discount, at their lowest relative valuation versus large-caps in more than 20 years,” explained Royce.

Take Away

There is no telling what markets will do tomorrow or the day after. We can only look back to gauge probabilities and expectations for the future – despite hearing over and over that “past performance is no indication of future results.” But by looking back, we can take the most basic statistical analysis, which is averages, and make projections. More specifically, the mean average or unweighted average. If we expect the various indexes to move toward or return to their mean average, we can make a better case than we have been able to in 20 years for the small-cap sector.

If you have an interest in small-cap stocks, arguably the best place to begin gathering data on small and microcap companies is Channelchek. Sign-up for free access to data for over 6,000 companies. Discover even more from current research on many of the companies written by analysts at Noble Capital Markets. By signing up you’ll receive the research and timely articles in your inbox each day. Sign-up
here.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.royceinvest.com/insights/small-cap-interview?utm_source=royce-mktg&utm_medium=email&utm_campaign=insights-interview&utm_content=button-2

https://www.wsj.com/articles/small-cap-stocks-are-starting-to-stage-their-comeback-11657272781?mod=hp_lista_pos2

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Is Robinhood a Prime Target for Acquisition During Weak Markets?

Whether or not Robinhood ($HOOD) is acquired by FTX, (the crypto exchange owned by billionaire Sam Bankman-Fried), or it attracts another suitor or remains a publicly-traded company, there are some things investors should know. Yesterday, a Bloomberg article suggested FTX is exploring whether it might be able to acquire Robinhood Markets, Inc. (June 27); they already own 7.6% of the company. Sam Bankman-Fried denied having interest. But, there is still some surprising data that investors in the company and users of the brokerage app should be aware of, as it could impact future price moves.

The investing app paved the way for free online trading, it then became a public company almost a year ago. At the time, there was still a strong wave of new investors eager to profit from the bull market in stocks and cryptocurrencies. The share price for the initial public offering came out at $38. By year-end, HOOD sank to about $18 per share. It is now trading near half the level it was at the beginning of 2022. 

The company went public with a market value of $32 billion; it now has a total market cap of $7.8 billion. 

Source: Koyfin

Robinhood Markets’ decline in price has been dramatic. The brand is well recognized, and the userbase, though shrinking, is more loyal than others. If it has lost customers, they were primarily the recreational investors and lower value users. Regardless, client trading is down; revenue for the most recent quarter was $299 million, or near half of what it was when Robinhood went public. Stimulus checks that in many cases were used to initially fund retail trading accounts are no longer being sent by the government; in fact inflation, in part caused by stimulus programs, may be the reason many are closing their accounts to reallocate the funds to necessities.

Many of the employees that found motivation in their own equity stake after the public offering have seen their valuations plummet. They might welcome a buyout. Using Morgan Stanley’s (MS) 2020 purchase of E*Trade Financial as a rule of thumb, Robinhood could be worth five times revenue, or $8 billion. One key employee that may wish to cash out as earnings have been trending down is Robinhood’s founder Vlad Tenev. His incentive package is tied to the price per share. To reach his maximum payout of $4.7 billion, HOOD shares would have to go from the current $9 range to $300 per share. As this seems unlikely, the founder may wish to cash out as high as possible and move on.

Other companies, if they served Robinhood’s customers, may be able to capitalize on synergies. According to Bloomberg’s story on FTX, a cryptocurrency exchange founded by Sam Bankman-Fried is considering how to make a bid. Today, an email by SamBankman-Fried, says he is not. But this does not mean the app isn’t attractive to suitors. Two other firms that could make good use of Robinhood’s retail traders (according to Reuter’s) are Goldman Sachs (GS) and JPMorgan (JPM), to complement and distribute their various savings and wealth products.

A buyer would still need optimism and confidence. Robinhood’s revenue mostly comes from paid-order
flow. The Securities and Exchange Commission suggested this source of revenue has potential conflicts of interest. Still, only 12% of the company’s top line comes from selling trade orders. Another activity that has recently slowed is trading in cryptocurrency. When added, it was expected to be a source of growth.

Take Away

Robinhood benefited from the upward momentum of the markets and went public at a great time to capture a very good price for the company. The markets have weakened, and the value of the company may have reached a point where a stronger company with enough synergies may target it to make the acquisition worthwhile. Despite the denial by FTX, acquiring companies is a cat-and-mouse game, don’t count anyone out.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.bloomberg.com/news/articles/2022-06-27/bankman-fried-s-ftx-said-to-be-seeking-path-for-robinhood-deal#xj4y7vzkg

https://www.sec.gov/Archives/edgar/data/1783879/000162828021013318/robinhoods-1.htm

https://www.reuters.com/markets/deals/bankman-frieds-ftx-seeking-path-buy-robinhood-bloomberg-news-2022-06-27/

https://www.reuters.com/breakingviews/robinhood-0-would-start-look-cheap-2022-06-27/

 

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The Final Trading Hours as the Russell Indexes Will Have Changed on Monday

One of the most active trading days of the year is upon us. The last Friday in June is the day index funds totaling $12 trillion are realigning their portfolios. This is because the FTSE Russell
indexes reformulate after the close of business on the 24th and reset upon the opening bell on Monday, June 27^th, with new components. This creates a challenge for those managing
Russell Indexed funds like the Russell 3000, Russell 2000, Russell 1000, and subdivisions, including value stocks. All will change their components which makes this a very busy day for managers of funds that mimic the various indexes. 

Investors in a stock market which is substantially weaker than it was at the beginning of the year, and even much lower than at the beginning of May when the market-cap ranks by the FTSE Russell may find the last hour of trading to whipsaw both widely traded names and less followed companies.

The remix activity in the past has been toward the end of the Friday trading session, just prior to the reconstitution beginning which is at the start of the next trading day.

The resulting buying and selling just before the remix is final, may not only cause price swings but adds to very high volume. Total trading volume on the last Friday in 2021 topped 16 billion shares, putting it among last year’s busiest sessions.

The preliminary lists of Russell 3000 additions and deletions give investors a good idea of some of the stocks that will likely be on the move. Nearly 300 stocks will join the Russell 3000 index. The list of names moving into the Russell 3000 includes Airbnb (ABNB), Bumble (BMBL), Coinbase Global (COIN),  and  Harte Hanks (HHS). It is going to be more heavily weighted in energy and consumer discretionary companies as a result of their performance over the past year.

Roughly 300 stocks are also being removed from the Russell 3000, including Citizens (CIA), Genius Brands International (GNUS), Ideanomics (IDEX), and Kirkland’s (KIRK).

If you’re a participant or even a spectator to the activity, watching the company formerly known as Facebook, Meta (META.O) could provide a good lesson in what recategorizing can do. Meta will be moved to the Russell 1000 value index (.RLV), the index for investors to gauge how value stocks are trading. Facebook/Meta is perceived to be trading at a discount to its fundamentals. The Russell 1000 will experience a greater weighting in energy stocks (.RLG) as a result of strength in many of the related companies.

The Russell MidCap Growth index (.RMCCG) will move up to 5.1% of the index from 3.3% before the reconstitution.

The impact on $12 billion in portfolios creates a high duty of care for FTSE Russell. They are transparent in how they select stocks, they share the information they garner on “Rank Day,” Russell then gives itself weeks to sort through for errors, all the while market participants are aware of what to expect on the last Friday (and perhaps the beginning of trading on Monday).

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.forbes.com/advisor/investing/russell-index-rebalancing/

www.koyfin.com

https://www.ftserussell.com/products/indices/russell-us

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Are Michael Burry’s Twitter Predictions on Point?

I’m bullish on Michael Burry Articles. The demand among investors and other readers is intense. Even those published
two years ago on Channelchek are consumed by new readers each day. And each time he deletes
his Twitter (TWTR) account, even more traffic is driven to those stories. The hedge fund manager, medical doctor, and subject of the movie, “The Big Short,” has again deleted his Twitter account after highlighting through various tweets, how ahead of the curve he has been with his predictions. 

As an investor with a cult-like following, Burry is best known for having predicted the 2008 mortgage crisis, and more significantly, how to line up trades to profit from it. Anecdotally, it seems he’s more comfortable predicting
downside. This year he began suggesting the U.S. economy may succumb to a similar fate. Throughout 2022, with growing concern, Burry has been consistently warned of a painful recessionary period ahead, and has held investments in prisons, military contractors, and has shorted Apple (AAPL), and placed big bets against U.S. Treasuries.

As with his short on the mortgage markets, Burry is usually early with his predictions. Others in the investment world tend to disregard his early warnings well ahead of events that often have eventually unfolded as he predicted. Based on his tweets, this lack of being believed frustrates the successful fund manager. This is likely why he refers to himself on Twitter as Cassandra
B.C.  In Greek mythology, Cassandra was a Trojan priestess with the gift of accurately prophecizing the future. However, she was also cursed with no one ever believing her prophecies – Cassandra was instead described as insane.

It is typical for Burry to disable his Twitter account after tweeting some of his more emotional tweets. He does this and then resurfaces with those tweets deleted. Recently deleted posts show Burry believes that fake Twitter accounts use his tweets. Specifically, he suggests bots and others pump asset purchases as comments on his posts. This helps them boost whatever it is they are trying to pump. He gives the reason for deleting his account as a way to discourage misuse of his famous tweets,“But it’s breathtaking, this religion of real and fake people. The speculation probably tops anything in history,” he wrote.

He is no fan of cryptocurrency. “If you don’t know how much leverage is in crypto, you don’t know anything about crypto, no matter how much else you think you know,” he tweeted. This is a similar cry to his posts in April 2020 when he predicted the U.S. would suffer from runaway inflation. He was also critical of the wisdom of the meme stock frenzy, which skyrocketed the prices of a few nostalgic stocks.

After last May’s CPI numbers, Burry tweeted, “Transitory, no. Peak, no. To the moon? If you mean a cold dark place.” As per Burry, inflation broke the weakest sector with “no buyers for MBS.” His prophecy that inflation numbers have not yet peaked this year and says the mainstream news that are reporting a strong dollar are looking at it incorrectly. In his
measurement system, the dollar is weak. is being heeded by some of his followers, the reduced value of the dollar spending power the inflation of May is not yet at its peak has created profound fear among the masses, as they are already dealing with the reduced disposable income coupled with increasing gasoline prices and other everyday use items.

It was in June 2021 Burry posted, “When crypto falls from trillions, or meme stocks fall from tens of billions, #MainStreet losses will approach the size of countries. History ain’t changed.” While scoffed at the time, and certainly there were many who got in, got out, and grew their accounts back then, but those that held are seeing a lot of red due to both the crypto selloff and the unwinding of the meme stock trade, not to mention the overall market performance. 

Burry’s latest exit from Twitter was after a warning for the rest of 2022. He indicated unfathomable pain. While there is already pain in the market and on main street, his forecast is in addition to what may be a recession this year,  a reduction in savings rates, 41-year high inflation rates, relative dollar weakness, and markets down between 23% and 31%. 

Take Away

Dr. Michael Burry has again tweeted
about doom and complained that people aren’t listening. It is worth understanding his expectations and deciding whether they are viable and if there is action you as an investor should take. Articles surrounding his expectations and his portfolio holdings are widely read by investors. Sign up for Channelchek emails to stay in touch with these stories and many others.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.newtraderu.com/category/michael-burry/

https://markets.businessinsider.com/news/stocks/big-short-michael-burry-inflation-interest-rates-housing-market-mortgages-2022-6 

https://www.tipranks.com/news

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Investors Always Have to Play the Cards They’re Dealt

Keeping your cool when faced with options that affect your investments will more likely translate into making better decisions. But often, when a stock goes against us or a bear market takes a bite out of our portfolio, we forget we have options. This could lead to doing nothing, doubling down at the wrong time, or unloading everything for a loss – then swearing we’ll never invest in another stock for as long as we live. Investors do have options; what is important is to look at where you are and not let the change in your portfolio remove good judgment.

Your Own Soft Landing

Investors are looking for ways to shield their portfolios after stocks gave back 10% so far in June alone. This followed a slow erosion throughout the year that amounted to another 10% or more. Just this Monday, the S&P 500 closed more than 20% lower than the highs reached at the start of 2022. Investors have come to define a bear market as a 20% decline from highs that would place us in a bear market. But it gets even more intense, on Wednesday, the Federal Reserve instituted the largest rate increase since 1994 in an attempt to hit the brakes on an economy that has become inflationary. 

Aside from the market which is anticipating the Fed will be successful at creating a slowdown, the market may already be in a recession. First quarter GDP declined by 1.5%, putting us at risk of being in one already the first half of this year. However, Fed Chairman Powell indicated in his statement this week that the economy had accelerated during the second quarter. Concern is still high among investors, economists, business owners, and households about the path of the economy, or more accurately what the path means for them and what they may do now to have their own “soft landing.” There is a lot of fear bordering on panic across all the stakeholders in a healthy economy.

For investors, this elevated fear can cause questionable investment moves. Below are three typical moves investors have made when their once healthy portfolio took a bad turn. Just knowing them and also that others have lived through similar cycles could lead to better thought processes for an investor.

Doing Nothing – The deer in the headlights approach of just watching an oncoming car that may hit it is not uncommon. You want to do something but you’re frozen. For some, this occurs because each time they move to do something, they see signs that conditions may change. With so much going on in any economy, it is always possible to see anything you want to see.

It may make sense for investors that have experienced this to predefine actions they will take if certain events occur. For example, if the stock decreases in value faster than the S&P 500 index over the next week I will sell X.XX%. If the stock outperforms the S&P 500 index in the coming week, I will retain my holding and then watch for the same circumstances the following week.

Having a rules-based system to guide you or show you when your money is not employed in the best place can help prevent indecisiveness.

Hit the Sell Button on Everything – Individual investors tend to sell after an economic downturn is already priced into equity markets. Selling when stocks are 20% cheaper than they had been and below where you were once comfortable buying them locks in your loss. Getting rid of the paper loss allows the investor to not have to worry or watch it anymore. They bite the bullet and deal with it by making it go away. What caused the pain can’t hurt them any longer.

The decision is based more on figuring out how to stop the worry. If the same investor had missed buying the same stocks and was now looking at them down double digits, they may find the positions attractive. But, the red in their account does not allow for the same, clear, less emotionally clouded disposition for decision making.

The solution is to forget about where you bought it and decide if it is the best place for your money within your investment time horizon. If you believe you can get a better return elsewhere, then move. If you think the potential is strong and better than the alternatives, stop worrying about it.

Most humans are wired to have perfect bad timing when investing. They will watch something go up and wish they had bought it. About the time they give in and buy, the stock has peaked. The same happens with selling; when the holding is losing value, people tend to watch and not sell until it is near the end of its decline.

Doubling Down – With a long enough time horizon or a large enough pool of reserves, doubling down in a diversified portfolio has always paid off. However, sometimes it has taken 30 years. In recent history, the recovery time has been much shorter.

If you are looking to add to losing positions, approach with caution, and know, that the reality is you’re looking to find the bottom when the bottom may not be reached for another year. Average in if you can, spread your risk.

Take-Away

Knowing that the market moves in cycles and having faith that this time it is the same as other times helps one have a clear head to make investment decisions going forward.

Simplifying options and making a plan help the thought process and the implementation of investment moves. Any move should be weighed against the risk of inflation eating away at savings, credit card debt costing more than any investment return expectations, and making sure losses are never so big that you don’t have capital set aside for the next long-lived wave upward.

Paul Hoffman

Managing Editor, Channelchek

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