July 31, 2021
Here we go again: wash, rinse, repeat. I really thought we would have been at heard immunity already, as it looked like the economy was wide open. Hopefully the scientists are correct, and we will be on the other side of the Delta Variant in the next couple of weeks.
Now that we are in the middle of the Summer Tokyo Olympics, apparently this year will be remembered for two things: the least watched Olympics in years, and the “twisties.” The cute-sounding term, well-known in the gymnastics community, describes a frightening predicament. When gymnasts have the “twisties,” they lose control of their bodies as they spin through the air. In golf, this would be known as the “yips.” The only difference is with the yips, you don’t have the chance of severely hurting yourself. Speaking of the Olympics, I watched the US Women’s team play the Netherlands this morning, and Soccer has a really strange rule called “offsides.” You can’t breakaway from your opponent and try to score if you have to wait or them to catch up! There would be way more scoring and exciting games if they just got rid of that silly rule.
Today, the Federal Reserve’s preferred inflation measure accelerated in June by the largest percentage on an annual basis since July of 1991. Core personal consumption expenditures increased by 3.5%, excluding food and energy. You don’t need me to tell you that, though; we have all seen the prices at the grocery store and gas pump lately. Let’s just hope the Fed doesn’t have the “twisties.”
I want to take the rest of this edition to wish my mom a very happy 92nd birthday. I’ve been so blessed to have a mother who taught me so many things in life, and one lesson in particular is that its Better to Stand for Something than to be Against Something. She was born into the Depression in 1929, and she has shared so much about how great this country is and how many things we have overcome. I hope our younger generations have the good fortunes that we have had from the greatness of our past generations. As mom always likes to say, if we don’t remember history, we are doomed to repeat it.
Mom, I love you so much, and I hope you have a great time during your special day.
Three Market Drivers
Here at 401karat, we focus on three market drivers that lead to notable movements in the stock market: market economic fundamentals, technical environment, and investor sentiment.
Our fundamental indicator follows 19 points economic datapoints that track the underlying health of the US economy. From unemployment to homebuilding, changes in these economic datapoints tend to confirm recession or recovery after the technical and sentiment indicators have already reversed.
Dynamic Asset Level Investing, or D.A.L.I., is a technical indicator that compares each of the major asset classes, sectors, and sizes and styles against each other to discover emerging trends in the market. D.A.L.I. compares daily price action of each of these elements on a point-and-figure chart to illustrate momentum. The chart at the bottom of this page shows the current leadership in D.A.L.I.
Our sentiment indicator tracks how everyday investors currently feel towards the US economy and the stock market. Between 401karat’s own polling and professional surveys like the American Association of Individual Investors (AAII) Investment Sentiment Survey and Citigroup’s Panic/ Euphoria Model, 401karat tracks the two most dangerous emotions for investors: fear and greed.
Here is a breakdown of where each market driver currently sits:
The M2 Money Supply increased by its lowest amount since COVID began this past month, with June posting an increase of only $20 billion. Increasing M2 Money Supply tends to be a positive for capital markets, so it is worth keeping an eye on this growth rate moving forward.
On a technical basis, many of the short-term measures of market overbought levels have returned to normalized levels, although most of this return to normal is simply due to lesser participation by smaller stocks in the market as of late.
Even with a strong year in the broad indices, Americans still have nearly double the historic average of assets in risk-free money market funds, indicating that we have dry powder available and have yet to reach a level of euphoria in the market.
The Covid Hangover
With Amazon having its worst day in over a year today, we believe it’s time to face a phenomena other companies are experiencing during this earnings season: the COVID hangover. To better explain the COVID hangover, we first need to provide a quick reminder of how earnings season works.
As we mentioned in our previous newsletter, earnings season has two main components that analysts and investors observe: revenue (sales growth) and earnings (EPS, or earnings per share). However, there is another element that investors look at: forward guidance. In short, forward guidance is an estimate that companies give for what analysts and investors can expect in the near future, whether it be the next quarter or the next year. As a general rule of thumb, when you see a company beat analysts’ expectations for revenue and earnings and its stock price still significantly drops the next trading day, pessimistic forward guidance is a likely culprit.
This time last year, companies that benefitted the most from the COVID lockdowns were having the opposite of a COVID hangover. Time and time again, these companies were blowing analysts’ estimates out of the water in spite of the lockdown headwinds the world was facing. Also, these companies provided forward guidance that was, if not optimistic, much less pessimistic than most analysts and investors had anticipated. As such, many of these companies enjoyed generational returns based on these earnings beats and positive guidance.
A year later, many of these companies that benefited dramatically from the lockdowns are now beginning to feel the hangover of these lockdown-inflated numbers. For example, Pinterest reported that its monthly active users, or MAU, had dropped 5% in the second quarter of 2021 and that this drop-off has continued into July. As a result, Pinterest stock was down nearly 20% at one point today, with investors and analysts viewing declining MAU as a red flag. However, this decline in users requires context. Consider that, as the world continues to reopen and make vaccine progress, there are less people staying at home and using social media all day and night. Now, people are beginning to go out at night, shop in traditional retail stores, and other activities that keep them from being on their phone screen all day. In short, it shouldn’t be a surprise to analysts or investors that Pinterest can’t maintain that level of MAU momentum with lockdowns ending.
That last point brings me back to Amazon, who has been hammered today as well. Amazon beat analysts’ estimates for earnings but missed on revenue estimates by 1.7%. An earnings beat and a slight miss on revenue aren’t what caused Amazon to fall so dramatically today; the issue is its forward guidance. Amazon expects revenue in the range of $106 billion to $112 billion in the third quarter, well below analysts’ expectations of $118 billion. It seems nonsensical to penalize these lockdown beneficiaries for being unable to maintain unsustainable, astronomical growth brought on by the COVID lockdowns, but then again, we are living in a nonsensical time.
ROBINHOOD IPO: A BUST?
On Thursday morning, the infamous Robinhood Markets Inc. went public through an initial public offering, or IPO. As a way to promote its image as being a company of “the people”, Robinhood’s IPO had the greatest percentage of shares made available for retail investors compared to its institutional investors since Facebook’s IPO in 2012. Unfortunately for them, Robinhood had the worst IPO debut on record for a company that had at least raised as much cash as Robinhood had, ending the day -8.4% off its debut price of $38. While Robinhood is best known as being the fuel behind the meme stock revolution we saw begin last year, we wanted to breakdown its business model and what investors can expect moving forward.
Known for its commission-free trading, there has always been the question of how Robinhood actually makes money if it doesn’t receive trade commissions. The answer lies behind something known as payment for order flows, or PFOF. When a Robinhood user makes a trade, Robinhood submits this order to groups known as market makers to execute these trades. The largest market makers in the industry are familiar names to the average investor: Morgan Stanley, Deutsche, and more, with Citadel Securities being the largest customer for Robinhood. To put it in simple terms, market makers compete amongst each other by offering rebates to Robinhood and, in turn, the best prices to Robinhood’s users. In Q4 2020, Robinhood earned roughly $0.0023 per share traded on its system, better visualizing how PFOF is a numbers game regarding making money.
As a means to avoid a conflict of interest, Robinhood has a fixed percentage that they receive from any market maker as a rebate, meaning that there is no financial incentive for Robinhood to choose a specific market maker. However, there is another potential conflict of interest that Robinhood has been facing lately: options. Robinhood and other retail brokers make a notably larger amount on rebates for option trades. As such, there is a greater incentive to guide users towards purchasing options, even if they aren’t sophisticated enough of an investor to deal with options.
Now that we have a greater understanding of Robinhood’s business model, the real question is: what will happen with the IPO moving forward? If history is to be our guide, the IPO crystal ball doesn’t seem very optimistic. A study done by UBS analytics on data from Jay Ritter of the University of Florida found that, of the 7,713 IPOs that occurred between 1975 and 2011, over 60% of them had negative returns five years after their IPO. In fact, only a little more than 19% of these companies had five-year returns of greater than 100%, indicating a significant lag in an IPO’s first few years being public.
Between the vitriol Robinhood has faced after it infamously froze trading during the GameStop bubble in January and the lagging that IPOs have historically experienced during their first five years, Robinhood stock may have some headwinds to face moving forward.
Chairvolotti Financial, Inc. dba 401karat is a Registered Investment Advisor