Image Credit: Jill Hoffman-Cuyar

Why Investors and Public Companies Rely on Company-Sponsored Research

Would you meet with someone from a dating app if they did not provide a clear photo?

Regardless of how fulfilling the future may have become with the person or how great they may or may not look, statistically, we know, without a clear picture,  the person is going to get passed over by all except for the greatest risk takers.

It’s easy to understand why even the least appealing dating site profiles with a clear image will attract more interest than the profile without a clear and updated picture. Similarly, product reviews on Amazon serve the seller. If there are two similar products, one with average reviews and another with no review, consumers are more likely to take a shot at the one with more available information – especially third-party reviews – even if the item has a higher price.

Small, lesser-known stocks also need a clear picture to attract broad attention. The broader the attention, the more potential suitors. This is why companies without a  clear picture or without an experienced third-party analysis cause investors to quickly “swipe left.” 

A stock with low third-party analysis available doesn’t serve the company well and is frustrating to investors with positions they may not be getting a fair valuation or adequate liquidity on.

Company Research

Equity research and analysis of a company from analysts known for their experience, industry knowledge, and integrity, provide a picture for investors. As mentioned earlier, without a picture, far less attention is paid. Companies with updated research will increase the number of investors looking at their stock because investors will feel they have more insight and understanding.

Company research is different than company information. Publicly traded companies are required to provide quarterly information to the public. This includes most categories of small-cap stocks and microcaps that are traded over-the-counter (OTC) and trading on a regulated exchange. These SEC-required reports provide a basis for investors to look back on company-provided data. When this financial data is compared to historical trends, weighed against industry growth and ratios, then subjected to “what-if” scenarios, the information derived becomes analysis.

To be deemed research, the analysis is put under a spotlight along with evaluating the strength of management, intangible assets such as patents, market positioning, and a variety of other considerations.

Importance for Smaller Companies

Awareness of the investment opportunities smaller companies represent is typically low. The stocks just aren’t talked about in mainstream financial news. For this reason, companies with a low market capitalization can benefit from any quality research published on their companies, their products, and their economic prospects. This is because any publication which provides a heightened understanding of a company may create interest that leads to added liquidity and aids the market’s price discovery of the stocks’ best valuation.

A Relatively New Gap to Fill

In the past, small and micro-cap companies have benefited from coverage at research departments of broker/dealers that had the capacity to provide investor research. The motivation for these research departments to provide in-depth expensive research was often to act as a door opener for other lines of financial business (quid-pro-quo). While this introduced some risk of compromised integrity, the practice of those that sell stocks (sell-side) providing analysis was common.

What could go wrong with investors relying on research from the company that sells the stock that is researched? Everyone involved in the markets in 2002 or who has read up on market history knows the Enron story. Enron was highly rated by sell-side analysts right up until the week the company collapsed. The event suddenly brought the sell-side research “conflict of interest” to the front pages. 

The New York Times reported: “Lawmakers investigating the collapse of Enron turned their attention to Wall Street today, criticizing financial analysts for continuing to urge investors to buy Enron stock even as the company headed toward bankruptcy. Several members of Congress suggested that Wall Street firms’ hunger for investment banking business and other conflicts kept them from leveling with investors.” (NYT 2/27/02) 

The Wall Street Journal echoed The Time’s sentiment: “Some financial firms have said they felt obliged to participate in the partnerships in order to remain in the running for underwriting assignments from Enron.” (WSJ 2/8/02) “Complimentary” broker/dealer research of smaller companies pose a similar risk, however, when problems occur for investors, they are unlikely to get the attention of large news outlets.

So complimentary research and analysis ran the risk of being partial. And only when a big company failed did the media and lawmakers take notice. This began to open the door to research that was subscribed to and paid for directly by investors. Larger investors that could afford it might still review sell-side research, but the research they paid for was less likely to have an undeserved positive bias. 

Reduced Research Available

For small and microcap companies, both the sell-side research and the paid-for research began to get much less interest as investors changed their focus. 

One overshadowing reason complimentary small company coverage dropped off and quality paid for research became less sought after by investors is that index fund popularity increased. That is, the popularity of investment funds that are managed with the objective of providing returns mimicking a stock index was being advertised as the ideal way to gain diversified exposure to “the market.”  These indexed Mutual Funds (MF) and Exchange Traded Funds (ETF) provide close tracking of an equity index largely by owning the companies within the index. Individual stock selection became less common. This reduced research coverage has shut out companies and particularly hurt those not in a major index. As important, it lessened the number of stock pickers, as many money managers and self-directed investors instead became index pickers. 

From the point of view of investors reviewing stocks and looking to get involved with “the next big thing,”  there was less information to go by. Arguably worse, there were and are still many companies, some of which literally have life-saving products, that aren’t getting the capital flows they would have to manage their needs.

Company-Sponsored Research

Needs have a way of being filled in an open economy. Active research is still highly needed by those that transact in the microcap and small-cap sectors. And top-tier research coverage is still crucial for small public companies looking to expand their visibility among investors trying to unearth and understand companies. With fewer sell-side firms covering stocks, and subscription based-research attracting fewer subscribers, an evolution took place in how institution-quality research is provided.

Filling the gap left by the large bulge bracket broker/dealers and niche subscription services is what has, over the past few years, become the preferred model of equity research and analysis. Company-sponsored research (CSR) sprang from the need for small companies to again provide a clear picture to investors. 

This new model borrowed heavily from the well-established bond market services where firms like Moody’s and S&P provide research and credit analysis on public company debt. CSR providers were able to hire the very best analysts released by the big sell-side shops, and in some cases, subscription-based services converted to the CSR model. The institutional quality research is now compensated by the company that knows it will benefit from an unbiased evaluation from respected analysts. This new practice eliminates the past conflict of interest of investment analysts that may have experienced pressure to err on the side of a favorable outlook to help smooth the way to additional higher-paying services from the client.

A few of the research firms providing company-sponsored research to companies have taken an additional measure. These firms are requiring their analysts to pass FINRA (Financial Industry Regulatory Authority) qualifying exams in order to become registered securities professionals. The exam(s) and ongoing continuing education required to maintain the professional registrations, ensure a high level of understanding, further promotes ethical behavior, and provide for punishment, including loss of career, if some guidelines are not adhered to.

This new standard in who provides research and who it is available to clearly benefits the professional investor who may have always had access. But some firms providing company-sponsored research now make it available to all investors of any size. This was most often not the case as sell-side broker/dealers often only allowed timely access to their buy-side customers, and subscription services were too pricey for small investors. 

The largest CSR provider in the U.S. and Canada today is the research provided by analysts at Noble Capital Markets on a no-cost investor platform Channelchek and various subscription platforms used by institutional investors.

Take Away

Investing goes through regular incarnations and reinventions. The use of technology has provided an environment where passive investing gained in popularity. Just as other trends in investing have fallen out of favor, disruption or innovation will one day turn the tide toward another trend. Fortunately, some of the research activities that have been dropped by the sell-side broker/dealers, effectively decreasing resources to their customers, have been replaced with company-sponsored research. This evolution is growing in appreciation by both those raising capital and those investing assets.

Investors in companies covered by CSR have the benefit of an additional pair of trained eyes on companies they own, the companies benefit from not being overlooked from lack of coverage, and the world benefits as companies that will provide tomorrow’s life-saving drug, mining discovery, medical apparatus, storage innovation, or anything else may now better rely on being able to tap into capital and liquidity.

Paul Hoffman

Managing Editor, Channelchek

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Sources:

https://www.cnbc.com/2019/03/19/passive-investing-now-controls-nearly-half-the-us-stock-market.html

https://www.morningstar.com/news/dow-jones/201909182571/index-funds-are-the-new-kings-of-wall-street

https://channelchek.com/about

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Source: Bloomberg TV (August 17, 2022)

Meme Stock Frenzy 2.0 – WallStreetBets Founder Thinks it Will Continue

Is Bed Bath and Beyond (BBBY) going to rebound? Are AMC Theatres (AMC) and GameStop (GME) just beginning to make another attempt at reaching the moon. In a Bloomberg interview on Tuesday (August 17), WallStreetBets’ founder Jaime Rogozinski shared his thoughts. The interview is made more interesting in that it was conducted before news that Ryan Cohen, GameStop chairman and Chewy (CHWY) founder, filed to sell his entire stake in meme stock BBBY. This move gives pause to meme investors because the value of Cohen’s holdings in Bed Bath and Beyond was roughly 10% of BBBY market value. Rogozinski said he believes meme stock investors are “probably aiming to the moon.”

Meme Momentum

Rogozinski was asked if he was at all surprised to see so much trading come back in light of the lull in self-directed investor activity and inflation-related financial concerns. “I’m not really; summer vacation is over,” he then continued, “that’s when the activity gets to kick back up.” Jaime recognizes the momentum we had seen previously from WallStreetBets had “whimpered down” but he said goes in cycles just like the regular economy. He also pointed out that it would be impossible to retain momentum and make the kind of moves stocks like Bed Bath and Beyond and other meme stocks make without shifts in cyclical momentum.

Image: A Section of Ryan Cohen’s (RC Ventures) SEC form 144

Different Drivers?

Responding to a question about whether the drivers are different this time, Mr. Rogozinski said, “The drivers appear to be the same.” He pointed out that it is early in the cycle, but “we have the meme component that, everyone’s talking about it, the chatter and enthusiasm, you have a stock from a company that is relatively distressed, you have a high short float,” then he said something that may cause an investor in at least one of the current meme stocks to pay more attention, Rogozinski continued, “you have Ryan Cohen dipping his hands into this particular stock and giving his Midas touch to it,” as he expressed that the moves again have a lot of the same components.

WallStreetBets Leader

He was asked specifically about Ryan Cohen, which is interesting to review the morning after the activist investor filed to sell his shares of BBBY and a move to own calls that would expose him to gains for far fewer shares. Rogozinski, without knowledge of Cohen’s plans, said, “There is no one individual. I think that if a high-profile individual decides to get into a stock or just to add to the thesis or find some confirmation bias, then it’s always helpful.” The WallStreetBets founder added, “It could be him, or it can be Elon Musk,” or any one of a number of “quirky public figures or CEOs” that have stock market influence, so it’s hard to pinpoint.

“The thing about retail trading or WallStreetBets is that it’s a collective, right – there is no captain of the ship saying ‘this is where we’re sailing’ the power comes from the numbers, the power comes from the fact that there are collective decisions that are made.” He reemphasized, “There is no individual that makes that choice.”

Will Meme Stock Frenzy Continue?

Jaime Rogazinski thinks the current meme stock resurgence has room to continue. He said, “As long as we don’t disable the BUY button, we probably have a decent chance to keep going forward.” He said he is not active in this move himself; the reason given is that to be profitable, he thinks he would need to have a strategy, and he personally doesn’t have a strategy yet for these markets.

Asked if meme stock frenzy sustainability expectations should change with an entirely different economic backdrop, Rogozinski said he believes there is a bit more of an eye toward the big picture this time. But the fundamentals and price discovery that meme stock investors are adhering to are supply and demand. Standard fundamentals, in his analysis, don’t seem to support GameStop’s price sustainability he used as an example.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://sec.report/Form/144-PAPER/43719

https://www.youtube.com/watch?v=Uv7j1hAhGSk

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Image Credit: Kempton (Flickr)

Michael Burry’s Portfolio is Creating More Speculation than Usual

Four times a year, the quarter-end holdings of famous hedge fund manager Dr. Michael J. Burry become public from his firm’s 13-F filing with the SEC. It’s newsworthy because people are interested in this extremely successful investor’s thinking. Of course, the list of public market positions is just a snapshot in time. One day in time, to be exact, so it is possible to read too much into it. The latest 13-F filing, which became public on Monday (August 15) is especially interesting; his entire stock portfolio is one stock. Channelchek featured this company in an article last month; referring back to the article and also a recent Noble Capital Market’s research report, we offer our own three potential reasons why, out of all the securities available on the planet, he may favor this one.

About Scion Asset Management’s One Position

According to the June 30, 2022, SEC filing, Michael Burry’s fund held one position, Geo Group (GEO). These shares represent 0.404% of GEO’s outstanding stock or 501,360 shares. The average price was listed as $6.42 per share.

The quarter-end market value of Scion’s GEO position was $3,309,000. According to Scion’s Form ADV, filed on April 18, 2022, Scion had assets under management of $291,659,289. The GEO position is not likely a significant portion of his entire portfolio, but it represents 100% of the firm’s 13F reportable securities.

Michael Burry first reported owning GEO Group during the fourth quarter of 2020.

The GEO Group, based out of Boca Raton, FL, specializes in owning’ leasing, and managing secure confinement facilities, processing centers, and reentry facilities in the United States and globally. As of December 31, 2021, the company’s worldwide operations included the management and/or ownership of approximately 86,000 beds at 106 secure and community-based facilities, including idle facilities and projects under development.

In addition to owning and operating secure and community facilities, GEO provides compliance technologies, monitoring services, and supervision and treatment programs for community-based parolees, probationers, and pretrial defendants.

For the year ended December 31, 2021, The GEO Group generated approximately 66% of its revenues from the U.S. Secure Services business, 24% from its GEO Care segment, and 10% of revenue from its International Services segment.

 

Company Trajectory

On August 3, in a research note titled, Continuing
to Outperform Expectations, Noble Capital Markets, Senior Research Analyst Joe
Gomes set a price target of $15.00 and reported on above-expected operating results during Q2 2022.

Mr. Gomes’ report discussed the drivers of GEO’s growth, “Many parts of GEO’s business continue to show operating strength, driving the better than expected performance.” The analyst also discussed the exceptional growth in revenue of the company’s electronic monitoring division.

The report describes management guidance as “upbeat” for the remainder of 2022. The company could get an extra benefit in the coming months if COVID-related restrictions on occupancy are lifted, thus allowing higher capacity within the same facilities.

Michael Burry’s position is not huge compared to his firm’s AUM. However, what is drawing attention is that out of the universe of stocks, GEO Group is a company he finds interesting enough to have as his only position. It would seem appealing to an investor that the clarity of the company’s direction seems to be improving and positive.

 

Political Winds

Will the mid-term elections in November usher in leadership more friendly to GEO’s business? Six days after President Biden was inaugurated, he signed an executive order to eliminate the use of privately operated criminal detention facilities. Section 2 of this order specifically prohibits renewing any contracts with criminal detention facilities. It looked bleak for the two largest private prison (GEO, CXV) operators in the country.

After the order, the private prison industry shifted gears and focused on the $3 billion market of detaining immigrants. This shift has been positive, and things don’t look as dark for the two largest for-profit prison companies in the U.S., CoreCivic (CXW) and Geo Group (GEO). Each is now making 30% or more of its revenue from U.S. Customs and Immigration (ICE) contracts.

If the Democrats lose the significant power they now have in the legislative branch, it would seem that the party that takes power would almost have a mandate from the public to make changes to many of the less popular moves made over the past year and a half. The southern border situation may be one of the reasons Democrats are likely to have fewer seats.

An argument can be made that new doors may open for private prison companies, and there is not a lot of public competition. Perhaps this is the appeal that keeps Michael Burry involved in GEO Group and why his fund has in the past owned CXW.

 

Portfolio Management

As of the end of Q1 2022, the value of Burry’s position in GEO Group was almost twice as large as shown in the current filing. So the hedge fund manager has liquidated a portion of his GEO position along with all other holdings. This unwinding may not be driven by anything more than what he sees as better opportunities elsewhere. He has also complained in tweets about how much attention his activities generate. It may very well be that with all the shifting in economies, in the U.S. and worldwide, that Burry has taken positions in non-reportable investments.

Earlier this year, after the first quarter, when Michael Burry released his holding information, the headlines all read that he hated Apple (AAPL). This was because he held puts on the company. There can be many
reasons a hedge fund would own puts on a company without hating the stock. This latest release brought alarmist headlines about Michael Burry “slashing stocks” in his portfolio and “dumping” everything he owns. He may very well be bearish on every U.S. stock except for one, but this isn’t likely.  As a reminder,  June 30 is just one day on the calendar; his U.S. stock positions could have been quite different by the fourth of July.

Take Away

Michael Burry’s 13F filing for the second quarter showed one holding, an under-the-radar company that has a significant upward trajectory in earnings and growth. The company’s industry had also become challenged when the Biden administration took office since it has successfully found a way to build in a slightly different direction. All indications are that, at minimum, the House of Representatives and possibly the Senate will be more heavily weighted with Republican lawmakers after the upcoming election, the private prison industry could benefit from contracts they may receive with a change in legislative priorities.

If you have not already signed up to receive email from Channelchek with up-to-the-minute research reports on companies like GEO Group and insightful articles, sign-up here.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.channelchek.com/company/GEO/research-report/3910

https://whalewisdom.com/filer/scion-asset-management-llc#tabholdings_tab_link

https://channelchek.com/news-channel/What_Might_be_in_a_Portfolio_Allocated_for_a_Republican_Majority_in_the_House_

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Has the Bear Market Left a Permanent Mark on Indexed Investments?

As much as 25% of the S&P 500 index is comprised of only five stocks. Most active investors can guess them easily enough: Apple (AAPL), Microsoft (MSFT), Amazon.com (AMZN), Tesla (TSLA), and Alphabet (GOOG). As of the end of the second quarter (2022), 7.1% of the S&P 500 index was allocated to Apple alone. Funds that mimic indexes have done extraordinary up until now as the trend has been toward index investing. In the first quarter of this year alone, which includes IRA season, these funds took in $8.5 trillion in retail investments. According to Morningstar, this is more than all active management strategies combined. They have been the go-to investment idea for financial advisors and the way this generation has learned to think about investing.

What Might Change?

The persistent sell-off in the markets earlier this year, and the surprise geopolitical events, may cause investors to question if these funds are properly diversified. Even an allocation of 60% stocks and 40% bonds would place an investor’s exposure, using an S&P 500 fund, to nearly 5% of AAPL. Worse yet, the top five, comprising 25%, often trade in lock-step, both up and down.

They are, after all, the big guys. They certainly have the power to grow further but also much further to fall than most. Will recovering from the bear market, with lessons learned, cause the popularity of these funds to lessen? The funds were viewed as ideal diversifiers when they first gained popularity, but their own success, that is, the amount of money that poured into this good idea, has given them weaknesses. An unsettling weakness is much higher average valuations among holdings than stocks just outside of any large index.

History Until Now

The history of Index funds’ popularity is easy to understand. For financial advisors, they found it provided low-cost diversification for their clients. They got this by placing assets in an indexed ETF; as a bonus, they avoided what were then large transaction fees with individual stocks. 

For most individual investors, transaction fees are no longer a barrier to personally managing accounts; the costs simply aren’t as high.  For individual self-directed investors, buy-and-hold and diversification have been drilled into their heads. So these indexed funds easily accomplish this set-it and forget-it (buy and hold) position. But, the level of diversification isn’t what it once was, and investors forgo the nimbleness of taking individual stocks out of their portfolio or more heavily weighting better risk/reward alternatives. 

For the fund managers themselves, especially those benchmarked off an index, no one can tell you you’re performance is horrible if it is in line with the index. It’s an easy job; just own the index in the same ratio the index weights the underlying stocks. With today’s computers, it is almost a back-office clerical function.

Lifecycle of Investment Products

But, like many products, they may have run their course, something better could replace them, or they more likely start to slide under the weight of their own success.

Index funds, especially those that mimic the large-cap Nasdaq100 or S&P 500, are in theory diversified as to names, but they are also capitalization weighted, which means even new money flows unevenly into the larger, more popular stocks. Over time, the combination of index fund popularity together with index construction favoring the more popular stocks has meant that more has flowed into fewer and fewer stocks. Therefore, capitalization-weighted equity indexing adds to the momentum of stocks that may not be worthy.

Much of this money might not otherwise be in these companies if not for the popularity of index funds and the self-perpetuating, dare I say bubble, that is the result of this setup.

According to an article in Barron’s this month, “The purveyors of indexes, being human, tend to make the concentration in a few expensive stocks even worse.” Barron’s wrote. The article then explains that the committee that oversees the S&P 500 has changed the make-up often, “and in the process tended to add stocks with price/earnings ratios more than twice that of those deleted.”

Are Investors Ready to Transition?

With more new money, in unfathomable amounts, reaching these funds each quarter and then being dispersed into the underlying stocks, weaker stocks fall even farther and strong stocks rise more than they may otherwise have risen. This undermines the efficient market theory as stocks that have sunk low enough to be worthwhile for many investors are not considered. The efficient markets theory is supposed to take into account all available information. Over the years, investors have set their portfolios on “in the market” or “out of the market,” with the market being one of the major indexes.

Could it be that as the market turns around and heads up, value hunters in individual stocks will lead, and indexes and index funds will not have as high relative performance?

Index funds, now that they have grown to the size they have, have developed other contradictions. Aside from ignoring the principle that the price paid represents a key determinant of long-term return, indexing ignores the flexibility to reward. Companies in an index that find themselves in trouble will keep receiving new money as investors add funds to their indexed accounts. This is without regard to how undeserving some companies in the fund are or whether they even will be in business in a year. In the meantime, companies not in the index find inclusion gets further out of reach.

Will Stock-Pickers Replace Index Funds?

In an ideal world, there is a selection of suitable products that all have similar results. For commuting, some take the bus to work, others drive, and still, others Zoom in. No one method of commuting is ideal for everyone. Those that wish to not worry about what many individual stocks are doing but instead concentrate on “the market” will keep adding money to these indexed products. Others that realize that they may be full of relatively expensive stocks will gravitate to old-fashioned stock selection – this time without all the commissions. And there will be those that keep their money in low-interest savings accounts that knowingly lose buying power to inflation.

The next “Apple stock” surely has more potential for growth than today’s top five stocks. Currently, the company may be just a hand full of people working out their idea from a handful of remote locations. Finding that company in the initial public offering stage (IPO) or after it has gone public is the dream of most active investors. It can’t be found in an indexed fund.

There is no functioning crystal ball, but there are resources, including no-paywall  Channelchek to help investors quickly review data on over 6000 small and microcap companies. And access the same research professionals consult with before making decisions. In addition, Channelchek has helpful videos and articles sent to your inbox daily to alert you to new perspectives and actionable opportunities.

Sign-up
here.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.morningstar.com/articles/1087146/us-value-funds-beat-growth-in-the-first-quarter

https://www.barrons.com/articles/the-bear-market-could-finally-break-index-funds-51660287600?mod=hp_LEADSUPP_1

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Image Credit: Global Commodities Forum (Flickr)

Private Funds May Soon be Mandated to Disclose Digital Asset Holdings and Performance

The Securities and Exchange Commission (SEC) and Commodity Futures Trade Commission (CFTC) have issued a joint proposal to better “assess systemic risk” of private fund advisors. The proposal includes language that would require reporting of cryptocurrency positions and performance measures of large hedge funds.

What is Form PF?

The form is a jointly adopted requirement used by both the SEC and CFTC. It’s a regulatory filing that mandates private fund advisers report regulatory assets under management to the Financial Stability Oversight Council (FSOC). The purpose is to monitor risks to the US financial system. Form PF affects SEC-registered managers of private equity funds, real estate funds, hedge funds, and liquidity funds with at least US$150 million in private fund assets.

 

The Proposal

Both Commissions settled on the proposed inclusion after consulting with the Treasury Department and Federal Reserve on potential financial-stability risks in the private-funds industry. SEC Chairman Gary Gensler noted that private funds’ total assets are nearing the size of the banking sector’s assets. “In the decade since the SEC and CFTC jointly adopted Form PF, regulators have gained vital insight with respect to private funds. Since then, though, the private fund industry has grown in gross asset value by nearly 150 percent and evolved in terms of its business practices, complexity, and investment strategies,” said SEC Chair Gary Gensler.

The SEC/CFTC Proposed Amendments to Form PF include a number of amendments designed to enhance the FSOC’s ability to monitor systemic risk and bolster regulatory oversight of private fund advisors. Beyond crypto, the proposal would require hedge funds with more than $500 million of net assets to report more information on Form PF about their investment exposures, portfolio concentrations, and borrowing arrangements.

Image: Selection from

The proposal on Wednesday (August 10) would add “digital assets” for the first time on Form PF. It also defines what a digital asset is in the eye of the regulators. It has opened a 60-day comment period on whether funds should report detailed information about the cryptocurrencies they hold. This includes identifying specifically or describing their characteristics.

The proposal notes that many hedge funds have been formed recently to invest in crypto, while some other existing funds have added the asset class to portfolios.

 

Expected Benefit

The recent drop in the prices of digital tokens like bitcoin and Ether has not spread to other asset classes. But the implosion of a crypto-focused hedge fund earlier this summer created a chain reaction that dragged a number of its creditors into bankruptcy.

Regulators want to get ahead of any chain reaction that could extend into traditional markets if mainstream financial institutions increase their adoption of cryptocurrencies before additional guardrails are put in place. “Gathering such information would help the commissions and [financial-stability regulators] better to observe how large hedge funds interconnect with the broader financial services industry,” Mr. Gensler said.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.sec.gov/rules/proposed/2022/ia-6083.pdf

https://www.sec.gov/files/formpf.pdf

https://www.wsj.com/articles/regulators-weigh-asking-hedge-funds-to-report-crypto-exposure-11660140000?mod=djemalertNEWS

https://www.wsj.com/articles/mainstream-hedge-funds-pour-billions-of-dollars-into-crypto-11646808223?mod=article_inline

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Are Consumer Price Increases Negatively Correlated to Stock Market Price Levels?

Does inflation lift stock prices? It has been long thought that stocks are a better hedge against inflation than cash, which loses purchasing power with rising prices, or even bonds, which lose value when inflation leads to higher interest rates. Excessive consumer price increases (defined as over 2% CPI YoY) come from either hypergrowth where demand outstrips supply or reduced supply while demand has changed little. The current inflation spike appears to be a mix of both supply issues from disruptions during the pandemic and demand issues from a dramatic increase in the money supply.

What Does Inflation Do to the Stock Market?

The answer is not straightforward as it depends on all of the contributing factors. If those factors can be easily modified, the markets are likely to react, in advance, to what it will be that changes them. If monetary policy is expected to be tightened, this can slow economic growth and weigh on equity prices as capital will not be as free-flowing. If it is because there is a shortage of supply, the market is likely to react to how quickly the condition will resolve itself. A shortage of supply could come from short-duration events like weather that impacts agriculture, or shipping, which is usually short-lived – also resource shortages result from a supplier not being available. This could be related to embargos, logistics, etc. Price increases from an imposition of tariffs are one-time additions to prices and don’t lead to prolonged inflation. 

Stock market participants are forward-looking. On an ongoing basis, they monitor current and expected conditions and react to how they will impact company earnings. The sweet spot is when inflation has no risk of dropping below zero and is stable within a percentage point of 2%.

Sources: NYU.edu (Stocks), BLS.gov (Consumer Prices)

The markets clearly dislike deflation or negative price growth. The chart above demonstrates that each time inflation went negative that same year or the following year, stocks dropped. So deflation has a positive correlation to stock index levels (decreasing inflation = decreasing stocks). From the chart, we also see when inflation approached or breached 10%, the markets also gave up ground that year or the following year.

A healthy market comes from a healthy economy; a healthy economy is one where supply is meeting demand. This makes growth more predictable, and the markets enjoy predictability. A lack of being able to assess what the future is likely to bring issues in periods of volatility where bulls and bears are most at odds.  The 40-plus year high in CPI has ushered-in the kind of whipsaw volatility that can hurt active investors and traders.

Some investors may seek stock ownership as a hedge against inflation. Companies that own assets that are rising in value help offset the erosion of the native currency. Alternatively, some investors may also find that fixed return investments like those that pay a known interest rate compete much better than the uncertain returns in stocks. Dividend stocks like utilities are often held by income investors like retirees. These stocks are particularly vulnerable should lower-risk bonds offer the same or higher yield than the expected dividends.

Take Away

Markets react to future earnings expectations. If the demand for a company’s product is little changed as prices increase, its earnings should stay relatively stable (food, medicine, government contractors, other non-discretionary). If the product or service will see reduced demand as prices increase, the company is likely to see reduced earnings and lower stock valuations.

Markets also react to expectations of future conditions. If it is expected that whatever the cause of inflation is, is transitory, market participants may look past current conditions. If instead, the expectations are that an aggressive and prolonged tightening stance will shrink the entire economy, then the markets are likely to respond negatively.

The high inflation the U.S. has experienced over the past year has resulted from both supply and demand-related factors. The supply issues are out of the Fed’s control, but it is presumed that these are transitory and related to the pandemic and war in Europe. Current price increases are also the result of trillions of dollars pumped into the economy over a short period of time. The Fed does have more control over this. If they act with aggressive monetary policy, the markets may initially pull back, if it appears the Fed is winning the battle, markets may become more bullish.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html

https://www.usinflationcalculator.com/inflation/historical-inflation-rates/

https://investorplace.com/2022/06/what-does-inflation-do-to-the-stock-market/?utm_source=Nasdaq&utm_medium=referral

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Image Credit: Senator Stabenow (Flickr)

Who will Regulate Cryptocurrencies? The Senate May Have a Favorite

One ongoing cloud over cryptocurrency exchanges, crypto creators, and even the NFT market is the uncertainty of future regulations. Regulation, while seen as restrictive, would also mean acceptance of the asset class. Acceptance coupled with a more certain playing field would benefit all stakeholders, from the crypto investor to the business that allows purchases in crypto, all the way through to the blockchain companies that are necessary for its digital existence.

SEC vs CFTC

Crypto interests have had a favorite among two potential oversight bodies, the Securities and Exchange Commission (SEC), versus the Commodities Futures Trading Commission (CFTC). And the stakeholders have been vocal to lawmakers in Washington as to the preference.

The SEC Chair Gary Gensler once taught cryptocurrency at MIT, a top school helping to design and study the future of crypto. However, this is not the regulator most crypto interests would prefer. Instead, they prefer oversight from the CFTC. The CFTC Chairman Rostin Behnam is advocating his agency provide the biggest role in cryptocurrency regulation. In a speech last month, he said federal and state regulators sharing responsibility in a “patchwork blanket” approach “is increasingly proving inadequate” as the crypto market rapidly evolves. Lawmakers in the Senate must have been listening.

Senate Crypto Bill

Under a new bipartisan bill from Sens. Debbie Stabenow (Mich) and John Boozman (Ark), the CFTC would take the lead role in overseeing the two largest cryptocurrencies and the platforms where they are traded under the bill. Oversight of the remaining cryptocurrencies would be divided between the CFTC and the SEC – the methodology to be used in determining who has higher jurisdiction is not yet fully specified.

The two agencies have been positioning for more authority over digital assets. As the assets are still very new to the world, there has certainly been confusion in Washington over how to classify and regulate cryptocurrencies and its digital ecosystem. While lawmakers looked to the regulators for guidance, in the end, the official determination is the responsibility of lawmakers. The major goal of the Stabenow/Boozman bill is to provide some clarity by deeming as commodities both bitcoin (BTC.X) and ethereum (ETH.X), which account for roughly two-thirds of the cryptocurrency outstanding.

If passed by the Senate and House and signed into law, both bitcoin and ethereum would primarily fall under the CFTC, which already oversees futures markets for both. Online platforms that allow investors to trade the coins, such as Coinbase (COIN), would be required to register with the agency.

Two other members of the panel, Sens. Cory Booker (D-N.J.) and John Thune (R-S.D.), are co-sponsoring the measure. Stabenow, said the committee could mark up the bill as soon as September.

The bill comes after another introduced by Sens. Cynthia M. Lummis (Wyo) and Kirsten Gillibrand (N.Y.) in June unveiled what they announced as a comprehensive plan to regulate the industry. Their proposal outlines primary responsibility for the industry to the CFTC, but unlike the bill from Stabenow and Boozman, it would make it optional for crypto exchanges to register with the agency.

 

Related News

This week Gary Gensler who Chairs the SEC, is facing massive criticism after being accused of being complicit in criminal activities “perpetuated by Citadel Securities & Citadel Market Maker. He is being accused of “obstruction of justice due to his lack of enforcement of the laws pertaining to naked short selling and lack of competent oversight of the market makers activities,” according to the petitions home page. The petition also demands, “Mr. Gensler needs to step down as the chairman, and a thorough, detailed, forensic analysis and investigation into Citadel Securities and Citadel Market Maker. This cannot go unpunished.”

 

Take Away

Both Senate bills would allow the CFTC to assess fees on crypto industry players to fund an expanded agency budget. The agency, roughly a sixth the size of the SEC, is already tasked with overseeing a section of financial markets, from grain and oil futures to more complex products.

The SEC has been seen as regulating without proper authority. Agencies can not overstep the powers granted to them by Congress. Members of the Senate, to their credit, have been looking to determine how best to develop oversight between these two agencies and the others that are also impacted.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.stabenow.senate.gov/news/stabenow-boozman-booker-and-thune-introduce-legislation-to-regulate-digital-commodities

https://www.change.org/p/retail-investors-fire-gary-gensler-as-sec-chairman-for-obstruction-of-justice

https://www.cryptotimes.io/sec-chair-gary-gensler-accused-in-citadel-market-maker-manipulation/

https://cointelegraph.com/news/senators-stabenow-boozman-introduce-crypto-bill-that-extends-cftc-s-regulatory-powers

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Image Credit: Jernej Furman (Flickr)

Why Alibaba and Other Companies are Changing Their Primary Listing to the Hong Kong Exchange

Will there be a mass delisting of Chinese companies from U.S. stock exchanges? A deadline clock is ticking on an elusive agreement between the SEC and Beijing. Once thought to be assured, the possible negative outcome has now caused companies to resign themselves to the idea that an agreement to prevent mass delistings of Chinese companies from U.S. exchanges may not happen. The companies involved are already preparing for this potential.

Most recently, the highly recognized e-commerce giant Alibaba (BABA) said it will be applying for a primary listing on the Hong Kong exchange. BABA is currently listed on the NYSE (since its IPO in 2014) and has had a secondary listing in Hong Kong since 2019.

 

At
Issue

Under a U.S. law that took effect last year, companies whose auditors are not permitted to be inspected by U.S. regulators for three consecutive years will be delisted from U.S. exchanges. The Securities and Exchange Commission (SEC) has already named more than 150 Chinese
companies that may be removed from trading in the U.S. as early as 2024, or sooner if U.S. lawmakers have their way by shortening the deadline. Alibaba will likely join this growing list after it publishes its 2021 annual report this month.

Beijing and Washington have been negotiating to try to avoid the need to delist, but there hasn’t been noticeable progress. SEC Chair Gary Gensler said two weeks ago that he isn’t confident the two sides can reach an agreement.

The
Benefit to Listing on a U.S. Exchange

Although being listed in the U.S. often means learning new processes and more paperwork for foreign companies, it is considered worth it for the longer term. Although they may be subject to increased scrutiny and transparency, the SEC oversight requires, investors take comfort in the strict regulatory compliance.  

A company like Alibaba can use the extra protection provided by its NYSE listing to position itself as a rival to U.S.-based companies like the online retailer Amazon (AMZN). The listing elevates shares of companies on the “radar” of U.S. investors if they are looking for exposure to, in this case, online retailers. Investors can also be assured of a certain level of uniformity in reporting.

The NYSE states the benefits of their exchange include improved branding and visibility, access to capital, and increased liquidity opportunities.

 

Take
Away

Time is running out for more than 150 Chinese companies listed on U.S. exchanges as the SEC and Beijing are failing to come to terms with U.S. compliance requirements.

Alibaba is likely to be added to that list after its annual report is made public this week. Many of these companies have had a vibrant relationship with the U.S. capital markets but are now preparing to list Hong Kong as their primary market.

This is important for U.S. investors of Chinese ADRs to see coming well in advance. Being delisted from U.S. exchanges could substantially reduce global interest in these stocks and subject holders of the companies to lower transparency standards.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.nyse.com/why-nyse

https://www.wsj.com/articles/alibaba-to-pursue-primary-listing-in-hong-kong-11658794611?mod=article_inline

https://www.investopedia.com/articles/investing/112614/alibaba-ipo-why-list-us.asp

https://www.wsj.com/articles/u-s-listed-chinese-firms-get-a-new-lease-on-lifemaybe-11649073448?mod=article_inline

https://www.wsj.com/articles/alibaba-prepares-for-its-u-s-divorce-11658832946

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Company Reporting Investors Follow Closely

Four times a year, companies that issue shares of stock release financial statements covering the prior three months. The publicly traded companies are required to disclose, among other things, their quarter-end balance sheet and income statement information. There is a big focus from investors on the companies’ income numbers. These reporting periods have come to be known as “earnings season.”

There are no official or specific dates that mark the beginning or the end of the period; however, the majority of publicly traded U.S. companies disclose their quarterly earnings more or less around the same time. The only official requirement is that the earnings reports be released within 45 days of the end of each of the company’s quarter-ends.

When is It?

Most companies follow a fiscal calendar from January 1st through December 31st, with the earnings season being the weeks following the calendar quarter-ends (March, June, September, and December). The end of each month will mark the “beginning” of earnings season for that quarter; at this time, company earnings reports begin hitting the tape, and markets begin to react accordingly.

Why it is Important

By the time a company’s financial disclosures are released, expectations from analysts and market participants have already been baked into the stock price. Earnings season has the power to dramatically move stock prices by how expectations match up with reality. If a company’s results beat or fall short of analysts’ expectations, then its stock may experience an unexpected price move as the market adjusts the price to what it is now believed to be worth with the updated financials.

Volatility in the market tends to be higher during these periods as a higher number of stock prices readjust dramatically. Market sectors may do better or worse if several companies in the sector beat or miss expectations. Others in the industry that haven’t yet reported may trade in anticipation of also performing similarly. There is a ripple effect one company’s results may have on others in its sector and even the broader market.

Earnings Season May Affect Your Stock-Level Investment
Decisions

If you are considering buying a company’s stock, earnings reports and earnings trends offer a way to gauge the health of its business. Channelchek is a resource for financial
information on over 6,000 small and microcap companies, not often reported on mainstream financial news.

Paul Hoffman

Managing Editor, Channelchek

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Image Credit: Ivan Radic (Flickr)

The New Coinbase Insider Trading Case May Finally Define Crypto Tokens

Whether cryptocurrency tokens are securities or should be treated as securities by regulators is being tested yet again. This time a Coinbase (COIN) employee and two others are being charged with insider trading by the Securities and Exchange Commission (SEC). The outcome of this legal disagreement could have industry-changing ramifications for the crypto industry.

 

Details
of Case

In a press release last week, the SEC alleged that, while employed at Coinbase, Ishan Wahi helped to coordinate the platform’s public listing announcements that included what crypto assets or tokens would be made available for trading. According to the SEC’s complaint, Coinbase treated such information as confidential and warned its employees not to trade on the basis of, or tip others with, that information. However, from at least June 2021 to April 2022, in breach of his duties, Ishan repeatedly tipped off the timing and content of upcoming listing announcements to his brother, Nikhil Wahi, and his friend, Sameer Ramani. Ahead of those announcements, this usually resulted in an increase in the assets’ prices. Nikhil Wahi and Ramani allegedly purchased at least 25 crypto assets, at least nine of which were “securities,” and then typically sold them shortly after the announcements for a profit. The long-running insider trading scheme generated profits totaling more than $1.1 million.

The tokens in question would be considered outside of the Securities and Exchange Commission’s jurisdiction if they are not securities. The SEC alleges that they fall within that classification.

The chief legal officer at Coinbase, Paul Grewal, issued a statement in response where he said, “Seven of the nine assets included in the SEC’s charges are listed on Coinbase’s platform. None of these assets are securities. Coinbase has a rigorous process to analyze and review each digital asset before making it available on our exchange — a process that the SEC itself has reviewed. This process includes an analysis of whether the asset could be considered to be a security and also considers regulatory compliance and information security aspects of the asset. To be explicit, the majority of assets that we review are not ultimately listed on Coinbase.”

Grewal’s statement says these charges put a “spotlight on an important problem: the US doesn’t have a clear or workable regulatory framework for digital asset securities.” He continued, “And instead of crafting tailored rules in an inclusive and transparent way, the SEC is relying on these types of one-off enforcement actions to try to bring all digital assets into its jurisdiction, even those assets that are not securities.”

“Coinbase does not list securities. End of story” wrote the chief legal officer.

Struggle to Define

The question of whether tokens should be classified as currencies, commodities, or securities has created a cloud of uncertainty over the industry. According to the SEC, some tokens most likely meet the definition of a security.

One legal battle involving the SEC is the payments network Ripple’s token (XRP.X). According to the SEC, the payments token is a security. Ripple Labs and the Commission are engaged in a legal battle over the distinction.

Bitcoin (BTC.X), according to SEC Chairman Gensler, is a commodity.

The definitions help compartmentalize the assets. If the crypto tokens are not securities, then the SEC isn’t likely under its current mandates to have much jurisdiction over exchanges like Coinbase – then it wouldn’t be in a position to regulate the listing and trading of tokens.

Image: Tweet from Coinbase co-founder and CEO.

Coinbase does not support wrongdoing; according to management, however, they want a clear set of legal guidelines for their industry.

As part of a string of Twitter posts, CEO Brian Armstrong wrote, “we actively monitor for illegal activity and investigate any alleged misconduct.” The company launched an investigation in April after being tipped off about possible frontrunning, Armstrong said the company provided the names of three individuals to law enforcement and terminated an employee.

However, Coinbase intends to strongly dispute the SEC’s premise that some tokens on its platform are securities.

The SEC’s insider-trading case also seems to be at conflict with the beliefs of other regulators. CFTC Commissioner Caroline Pham said that the SEC’s move was an example of “regulation by enforcement.” The SEC’s allegations “could have broad implications beyond this single case,” she called on regulators to work more closely.

Take Away

On the road to defining and classifying digital tokens, the industry is likely to experience higher levels of regulatory scrutiny. The Department of Justice is beginning to get more involved in prosecuting crypto crime; the DOJ filed criminal charges in the Coinbase case, and it has filed insider trading charges against a former employee of the largest NFT platform, Opensea.  

The SEC has said it aims to beef up its crypto
enforcement. The Commission added 20 positions to its crypto asset and cyber unit in May, bringing its dedicated headcount to 50.

The outcome of defining the asset class and proper jurisdiction and rules surrounding cryptocurrency is a process. During the early stages of this process, investors in tokens tolerate an added level of uncertainty surrounding the outcomes.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.sec.gov/news/press-release/2022-127

https://blog.coinbase.com/coinbase-does-not-list-securities-end-of-story-e58dc873be79

https://twitter.com/CarolineDPham/status/1550159347984044033/photo/1

https://www.breakingviews.com/considered-view/bidens-sec-pick-is-ominous-sign-for-wall-st/

https://www.reuters.com/legal/government/gary-gensler-has-set-sec-perilous-path-2022-07-22/

https://www.barrons.com/articles/sec-says-ripple-improperly-sold-cryptocurrency-51608675654?mod=article_inline

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Image Credit: Pok Rie (Pexels)

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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Image: ARK Funds

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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