You Can't Handle the Truth

Ouch! US equities took a beating last week. When the FOMC minutes were released on Wednesday, we saw that they were all looking at pulling back their asset purchase programs, so they have more flexibility around rates. Reducing the $9T balance sheet is looking like a priority. It seems like Colonel Nathan Jessup was right, we can't handle the truth. Any indication of the Fed slowing it's QE program sends equity owners scurrying. Last week was a fine example of this. I'm wondering if Biden ordered this code red though trying to save the Democrats chances in the mid-terms. 

The NASDAQ was the worst of major US indices, falling 4.5%. It was the index’s worst week since February. This one is looking to be wide spread, as the Sentiment Trader chart below shows nearly 40% of the constituents are down 50% from their 52-week highs. S&P 500 was only off 1.8%. It was buoyed by strong performance from Energy and Financials. The Russell 2000 was lower by 2.9%. European equities were mixed, and the same with Asia. Even though it ended the week lower, Apple hit a $3T market cap on a decent day Monday.

Crypto currencies were under pressure again. Bitcoin was down 9.1% and that’s now the 6th in the last 8 weeks that it’s been down and down 6% or more on the week. That makes 34.5% in total over the last 8 weeks. Ethereum was down even more, as it fell more than 14%. It’s also down 7 of the last 9 weeks, though “only” 31.3% in that 9 week time frame.

On the other side of things Commodities were mainly in the black. Crude and NatGas were both up about 4%. Lumber continues to its uptrend, as it ended the week up 4%. Some Ags were up decently too. Coffee (5.6%) and Soybeans (5.4%) lead this group. Metals didn’t do so well though, silver was the worst, off 4%.

Outside of the earnings of the Banks, the big highlight this week is the JP Morgan Healthcare Conference. It usually has a good amount of guidance and updates. This conference really sets the table for the year in biotech. Seeking Alpha noted that Healthcare stocks have a five-year trend of outperforming during the conference. Below are some names I’d pay attention to. They saw a large jump in their Implied Vol (IV) over the last week or have an IV rank in their 90th percentile or greater using the last six months of data.

Earnings Watch

Last Week

It was a very light week to open the year. Walgreens had a decent beat, but the market didn’t seem to care much. Lamb Weston, who makes frozen potatoes, crushed on the top line, but missed on the bottom line and the market loved it. The stock jumped 9% on the open and ended the week up more than 11%.

This Week

It is now the unofficial start of earnings season. It used to be when Alcoa reported, but now it’s the banks. JP Morgan, Wells Fargo, and Citigroup along with non-bank financial Blackrock are the largest names reporting. Delta Airlines could be the most volatile after they report on Thursday. The estimates are all over the place and have been changing with frequency. The stock also has 3 positive Bold Estimates. First Republic Bank is another name to watch. There’s a nice 2.1% Predicted Surprise and the EPS estimates have some positive momentum. One final name on my watch list will be Tilray. The stock has been trending lower, has a Predicted Surprise in the negative, and a ton of short interest. If positive news comes out of their call, the stock could rip.

ECM Update

The year got off to a decent start even though many don’t expect the same fireworks as 2021 offered. US markets issued $1.2B in SPACs, which included the largest deal since March. Traditional IPOs were very light. In what looks like another light docket, this week has one small listing in Justworks and one large $1B listing in Private Equity shop, TPG.

Best of the Week

Another fantastic piece here from the FT. The article highlights the research found in a research paper from PhD student Sida Li, second link below. This has been a problem for the large widely followed indices. When I started in the industry, my desk was responsible for trading all the rebalances for the trust for both the NASDAQ 100 and the S&P Midcap 400. The amount of front running on some of these trades was unreal. It was quite bad in the early 2000s, but as we got later into the decade some hedge funds countered this trend and things got messy around the close. I thought I remembered the trust legally having the ability to trade three days before or after the index event. They never really took advantage, aside from small trades at the next open to true up their cash. I looked for the information, but couldn’t find it in the current prospectus. You can see, from a couple of the charts shared below, that the impact is quite large. One note in the paper was that ETFs that were “self-indexed” against an in-house benchmark were better off. That’s because these indices do not make it clear on what their rebalancing trades would be. While I find this interesting from a trading perspective, Li argues that for investors, they should consider low turnover ETFs to combat this.

Passive ETFs hit by billion-dollar rebalancing costs

Should Passive Investors Actively Manage Their Trades?

Best of the Rest

A nice quick one from Coalition Greenwich on topics that drove 2021 and will continue to impact 2022. These 10 topics cover multiple areas of the industry. Tokenization should be the one that impacts the widest number of people and possibly the long term future of finance. I’m also interested to see where the transparency topic goes. Numbers 4 & 7 will impact my own job the most, as those two cover the fintech space mergers and acquisitions, as well as the technology in the portfolio/order/execution management systems.

Top Market Structure Trends to Watch in 2022

I caught this post from Henry Schwartz from CBOE. Off a record 2020, the options market did not slow down one bit. Volume up a huge 32% increase following 2020's 52% growth. Single stock was up 50% leading that growth. Premiums were north of $5T, which is a smaller 15% increase YoY. The one stat that was down and has been trending that way for the last few years was trade size. Individual investors are driving up volumes buy their size is much smaller than the institutional players.

US Listed Options Market Summary

The Andy Constan part of this interview was fantastic. Andy was at the forefront of some of the quantitative methods of valuing securities for trading. He notes that he was the first person in his firm to have a hard drive on his computer. It was a 10MB hard drive. Ha! He has spent time at some of the most impressive firms at some of the key periods of recent financial history. For example, he worked on a Federal Reserve committee while at Solomon that did the research on what caused the 1987 crash. Another thing that makes this one a great one for me is when Andy talks about his time in the convertible bond business. Andy also spent some time at Bridgewater and shares some thoughts on the culture of that firm. The second part is also interesting where Paul Schulte discusses his new book on how crypto is reinventing finance. That interview is the next 42 minutes. The remaining 80 minutes or so is the normal weekly chatter that makes this my favorite weekly show.
Forced Patience (guests: Andy Constan, Paul Schulte) - Listening time: 294 minutes (Andy’s interview is the first 80 minutes)

This one had to make the list, because I wrote it. I’m not sure it stands up to the writing of some of the professional authors. The post covers some of the variability around single stock volume. I find this important to those that trade and use a trailing 20 day average as an input in the transaction cost analysis models. To summarize the post, even the largest cap names in the Russell 3000 show a ton of variability.

Volatility of Volume

Last week I shared an interview with writer Robin Wigglesworth. This interview is with one of the people that was there at the beginning. He was with Wells Fargo when the first index fund was formed. He helped found Dimensional Fund Advisors. This conversation focuses around index funds and the historical significance of Mac’s career.

John 'Mac' McQuown: The Data Will Sort That Out - Listening time: 46 minutes

A very short article that might be more of a news story, but it highlights the investment into NHL franchises by private equity firm Arctos Sports Partners. The fund has raised more than $5B and invested in The Tampa Bay Lightning and Minnesota Wild. This on the back of investments in the Sacramento Kings and Golden State Warriors in the NBA. It also has stakes in ownership groups Fenway Sports Group and Premier Lacrosse League.

Arctos Becomes NHL’s First Private Equity Investor

This is another summary of a recent research paper. This one looks at the impact quantitative investors see when accounting standards change. The article notes that quant funds account for 35% of US stock ownership and 60% of trading volume. I know they were my largest clients when I was a sales trader. The paper looked at three recent changes and studied performance from 2003 through 2020. There was 2.73% of performance in the year following the changes. Of note was the fact that the second year there was none, so the effect was temporary. Underperformance was worse for funds with higher book to market valuation. Also of note, was the higher portfolio turnover in those years.

WHAT IMPACT HAVE NEW ACCOUNTING STANDARDS HAD ON QUANT FUNDS?

One for the Road

Jimmy Cayne was a former CEO of Bear Stearns. He passed away a couple of weeks ago. I thought this was a good piece to close out the post on. Cayne was a big name in the 2008 financial crisis. He was a big personality amongst the biggest names in finance during this tumultuous period.

Lessons of Jimmy Cayne’s Bear Stearns historic rise and fall

Thanks for reading. Have an amazing week.

Michael