Trader Talk

Cathy Wood Crystal Mercedes | CNBC Some called it the "Cathie Wood sell-off."   At the open Tuesday, the top names owned by Ark Investment Management were the biggest decliners in the market.  Shares of Palantir, Tesla, Roku, Square, Paypal, Teladoc, Baidu, Zillow, Shopify and Spotify were all down big, in many cases by double-digits.  All were major holdings in funds like her flagship Ark Innovation ETF (ARKK) and Next Generation Internet ETF (ARKW). Shortly after the open, her flagship Ark Innovation Fund was down 11%. By 10 a.m. ET, a half-hour after opening, it had already traded more than 8 million shares, a full day's volume.  By midday, it had traded 30 million shares. And then, a half hour after opening, the selling let up. The fund closed down by 3.3% and was down about 10% for the week. Arrows pointing outwards "It was like a mini-panic," Alec Young from Tactical Alpha told me.  "The market is getting concerned that the Fed is risking getting behind the curve on inflation.  The market is pricing in more inflation, which means lower prices for tech stocks." The market stopped dropping as Federal Reserve Chair Jay Powell's congressional testimony was released.  Powell repeatedly emphasized he does not expect inflation to rise to troublesome levels:  "Monetary policy is accommodative and needs to continue to be accommodative," he said. Too many people on the boat? Still, the damage had already been done.  Fear of higher rates may have been an initial catalyst, but now, as Peter Tchir from Academy Securities told me, "People are very aware they are long a lot of stocks at very high valuations." "The frothiness is now the catalyst, not rates," he told me. As for the current mania with everything Cathie Wood and Ark Investments, Tchir on Tuesday penned a piece called "Noah's Arkk?" for clients, telling me, "Too many people are on that boat.  A lot of people, I think, have bet more than their risk appetite is comfortable with." Ark Innovation is off about 13% from its recent high. "I don't think this is over, I think this may be the start of an unwind.  Everyone assumed these are super-safe companies.  Her management style has been to double-down on her bets, and a lot of this is starting to feel a little evangelical.  People now view those funds as can't lose, and that's where you get into trouble," said Tchir. Most of the ten top holdings in Ark Innovation were underperforming the Nasdaq on Tuesday, before they rebounded. ARKK's top 10 holdings Wood did not respond to a request for comments on Tuesday's trading, but in an interview on CNBC last week, she made it clear that on days or weeks when her favorite stocks were down notably, she was often a buyer: "We are considered a liquidity  provider, which means when people are selling, we will be buying and when people are buying, and these are investors in retail and institutional, we are likely to be taking profits," she said. As for the worries about interest rates, she also made it clear that a sharp upturn would undoubtedly hurt her portfolio: "I do believe that if the rate were to take a sharp turn up that we would, we would see a valuation reset, and our portfolios would be prime candidates for that valuation reset."
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With attention focused on Robinhood, GameStop and retail traders at Thursday's congressional hearings, trading volumes are very much in focus, as is the practice of "payment for order flow." Talk about a comeback story. A year ago, retail traders were a declining part of the trading world. Then Covid hit. Millions stayed home and got stimulus checks. They went online. With sports largely shuttered, many looked at retail stock trading for the first time.  In December 2019, retail trades averaged 13% of total trading share volume, according to data from Piper Sandler. By the end of December 2020, that figured had almost doubled, to 22.8%.  And those retail traders engaged in more than their fair share of trading.  "Not only did the retail share of trading go up, but they drove volumes much higher," said Rich Repetto, who tracks trading at Piper Sandler. Overall trading in 2020 was up 55% from 2019, Repetto noted, much of it driven by retail traders. And the trend is continuing into 2021. Average daily share volumes year to date are 42% higher than 2020, though Repetto noted that first-quarter volumes are usually higher than the rest of the year. How payment for order flow works That increase in retail trading has come with increased scrutiny for a practice known as "payment for order flow" whereby some brokers receive payments from market makers (dealers) for routing trades to them. The majority of retail trading is not done on exchanges, it is done by market makers that "internalize" the trades. Here's how it works. Let's say you want to buy 100 shares of Tesla. When you push the button on a trade, you have given your broker an order to buy 100 shares of Tesla at the market price. Your broker will usually have a prearranged agreement with market makers who will compete for the order flow. The bigger market makers include Virtu, Citadel Securities, Susquehanna, Jane Street, Two Sigma and UBS. Virtu CEO Doug Cifu said his firm competes fiercely for that order flow:  "Most of the brokers have a 'routing wheel,' and within that wheel, they will send client orders to the market makers based on the amount of price improvement they have provided," he said. The rate of payment for order flow varies from broker to broker, Cifu noted, but is usually fixed within the broker. A broker may charge 10 cents per 100 shares, for example. Others may charge more, some nothing. The key point, Cifu says, is that Virtu and the other firms must meet best execution obligations, which will usually include price improvement. Let's go back to that Tesla trade, to buy 100 shares. Suppose the bid (what a buyer was willing to pay) was $792.80, the ask (what a seller was willing to sell for) was $793.20. The midpoint is $793. Cifu said it would be typical to offer some kind of price improvement, perhaps $792.90. "It's a riskless trade," Cifu insisted. "As soon as the price hits us, we guarantee the broker they are getting the best price." Cifu also noted that in the last several decades bid-ask spreads have declined, execution speed has improved, and fees have declined, all as a result of technological innovation. Is payment for order flow a good deal for the retail trader? Still, many market observers have been critical of payment for order flow, among them Better Markets, a nonprofit organization that seeks to promote public interest in the financial markets. In a paper distributed prior to the Robinhood-GameStop hearings, Better Markets claimed payment for order flow "is widespread and causes an inevitable conflict-of-interest between the retail broker-dealer's duties to seek best execution for its customers and its duties to shareholders and others to maximize revenues. … These execution costs can outweigh the benefits to retail investors associated with so-called 'commission-free trading.'" Cifu says there is no data to support those assertions. "At a minimum, you are getting the same price you would get if you went to an exchange," he said.  "Every single broker is routing based on price improvement and a best execution obligation." A recent study by Bloomberg Intelligence's Larry Tabb and Jackson Gutenplan casts doubt on the idea that retail investors are being disadvantaged by payment for order flow: "Retail brokers' controversial practice of selling client orders to market makers (payment for order flow) benefits equity investors by enhancing execution quality, with our analysis showing that Citadel Securities and its peers returned $3.7 billion in 2020 to investors in the form of price improvement," the study concluded. "That's nearly 3x what they paid for that equity flow." Still, the idea persists that if market makers are making money, they must be taking it from retail investors. UBS' Art Cashin, the dean of floor traders at the NYSE, also is a skeptic on payment for order flow: "If you're paying for my order flow, is it to get me the best price? What is the advantage? Is it because the dealer is going to trade against it? It's the public meets a dealer, it's not like the public meets the public with an exchange."  Cashin offers a simple formula for determining if the transaction is worth it: "Is the payment you are making for order flow enough to offset the free commission, and give you price improvement? If you believe that is true, you should be comfortable with doing it commission free." Cifu agrees with Cashin's sentiment and again insisted that his firm competes fiercely to provide best execution. "This is a very competitive business," he said. NYSE worries about 'degradation' of price discovery The exchanges have a different concern: retail trader orders that are routed to relatively "dark" venues like broker-dealers without interacting with public orders from the exchanges. "Growing retail investor interest is a welcome development," said Michael Blaugrund, COO of the NYSE.   "But all of this trading in private dark venues means liquidity is becoming less accessible for institutional investors and the price discovery process is becoming degraded." Subscribe to CNBC PRO for exclusive insights and analysis, and live business day programming from around the world.
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Traders on the floor of the New York Stock Exchange. Source: The New York Stock Exchange The market is expanding to new highs on the back of a magical phrase that is being sprinkled like pixie dust among the conference calls this earnings season: "operating leverage." "The market is set to see a substantial acceleration in earnings growth on better than expected operating leverage," Mike Wilson from Morgan Stanley wrote in a recent note to clients. "Operating leverage" is an accounting term that measures how a company can increase profit by decreasing costs and increasing revenue. Simply put, Wilson and other strategists are expecting that the cost-cutting efforts of corporate America in 2020 — reducing rent, cutting travel, and especially eliminating jobs — will dramatically improve the bottom line and accelerate profits even more when revenues are expected to increase in 2021. More revenues + lower expenses = more profit. How Covid helped companies restructure Corporations try hard to control costs, and the Covid epidemic has forced companies to aggressively reduce those costs. Costs fall into two broad buckets: fixed, such as insurance, rent and interest payments, and variable, like energy, materials, and labor. Fixed costs don't change, but variable costs do. If you can control variable costs, or turn them into fixed costs, you can usually take in more on the bottom line. Labor is the largest single cost a company has. Labor is variable. There's many pay grades, people come and go, the workforce fluctuates depending on demand. If you can replace your workers using technology — robots, or better software — you can substitute a variable cost (labor) for a fixed cost (technology). Voila. Higher profits, particularly once revenues pick up. That's operating leverage. Of course, there are other way to reduce costs, including cutting real estate and travel costs, or reducing debt. If you're looking for an example of how reducing expenses can help a company's bottom line, look at the energy companies, which have been aggressively reducing staff and cutting costs. Kinder Morgan, for example, operates oil and natural gas pipelines and terminals. The company saw year-over-year revenues decline by 7.1%, but earnings per share increased by 3.8%. How did they do that? They cut operating expenses by 44.8%. Companies are anticipating higher profits in 2021 due to cost cutting Kinder Morgan isn't alone. Many companies hit hard by Covid have restructured — cutting jobs and other expenses — and are now anticipating higher profits and higher margins in 2021. These include casinos, railroads, oil services, restaurants, and retail. "These business have reorganized substantially in 2020 so investors will probably see surprises to the upside," Nick Mazing, head of research at Sentieo, told me. Take railroad firm Kansas City Southern. They consolidated trains, had fewer crew starts, reduced work hours, and had fewer locomotives and freight cars out. "For 2021, we expect our headcount growth to remain well below volume increases as we continue to lengthen trains, creating further operating leverage," Michael W. Upchurch, Kansas City Southern CFO said on a recent conference call. Mark R. George, Norfolk Southern's CFO, expressed similar sentiments: "So another quarter of expense reductions, far in excess of the volume decline, leaving us well primed to deliver strong operating leverage as 2021 unfolds." Fastenal's CFO Holden Lewis attributed his company's improved operating margins to reducing headcount: "Nearly half this leverage came over labor costs as our record fourth quarter sales were achieved with headcount that was down mid-single digits versus last year." Understandably, many companies avoid using words like "layoffs" or "headcount reductions." Instead, we hear about "structural changes" or "cost actions" or even "structural cost reductions" to describe cost cutting and layoffs, as in this comment from Jeffrey Allen Miller, CEO of Halliburton, on its recent conference call: "We completed the most aggressive set of structural cost reductions in our history, giving us meaningful operating leverage in a recovering market." Another often-used term to describe cost cutting and layoffs is "efficiencies," as in this comment from Dale Francescon, Co-CEO of home builder Century Communities: "In 2021, we expect to see continued margin and leverage improvement as we realize further operational efficiencies across our organization." Harley-Davidson's CFO, Gina Goetter, uses similar language: "We also expect the motorcycle segment operating margin to show steady improvement from 2019, our most recent comparable year, driven by increased efficiencies across our operations, and leverage within SG&A as we maintain a lean cost structure." "SG&A" refers to "Selling, General & Administrative Expenses" and refers to the corporate costs that are not directly related to manufacturing the product. It includes salaries of corporate staff, as well as rent, utilities, and supplies. Wall Street vs. Main Street Lost in the corporate swoon of higher profits and higher stock prices is that operating leverage is increasingly being viewed as a whitewashed term to describe corporate layoffs, and for many illustrate the disconnect between Wall Street and Main Street. An analysis by the Washington Post in December found that 45 of the 50 biggest U.S. companies had turned a profit since March. The majority of firms had cut staff. A particularly sensitive issue is corporate buybacks resuming, even in the face of layoffs. "This is a global crisis but the big companies are not treating it as one — they haven't skipped a beat," William Lazonick, an emeritus economics professor at the University of Massachusetts at Lowell, told the Post. "Apple gave back tens of billions of dollars to shareholders. It's sick." The issue now is, will Main Street catch up? Peter Tchir from Academy Securities thinks it will. Forty percent of his firm are veterans, and he has been hiring. He freely admits that corporate America has been seeking to cut jobs: "Part of the layoffs are companies realizing they can do more with less employees using technology." He believes that the several rounds of stimulus, combined with the reopening of the economy, will be a big benefit for Main Street: "We are due for some catchup on the employee side of things. I think 2021 is going to be a year where it's going to be great for the economy and OK for markets. The economy is going to lead the markets, which is the opposite of what has happened in the last decade." He is particularly optimistic for those with modest skill levels. "I think by the end of the year we can have a job market that is very good for those who have been laid off. It's easy to hire a barista, but it's hard to find someone to run a good coffee shop." Transcripts provided by Sentieo
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Traders work on the floor of the New York Stock Exchange. NYSE Blowout earnings are forcing analysts to up estimates for 2021. With a little more than half of companies reporting, earnings are proving to be a pleasant surprise for the trading community. The GameStop/Robinhood fiasco is turning out to be a minor blip in the markets in the first months of 2021. The main theme that ended 2020 — the belief in the effectiveness of a vaccine —remains intact. "The markets are advancing to new highs as Covid cases are dropping, stimulus is coming in at the higher end of expectations, and we are continuing to see very positive earnings surprises," Nick Raich at Earnings Scout told me. Surprises and raised earnings Stocks are expensive. The S&P 500 is trading at 22 times 2021 earnings, historically high. For stocks to keep advancing, two things had to happen: very large earnings beats for the fourth quarter, and corporate guidance needed to be sufficiently clear that earnings estimates for Q1, 2, and 3 would keep rising.  Both of these conditions have been met. First, earnings are beating estimates by more than 17%, about five times the normal average and on a par with the third quarter. The reason: analysts have underestimated the strength of the economic recovery. Q4 earnings:  halfway point (53% reporting) Beating:  83% Earnings beat:  17.3% EPS growth: up 1.6% Second, earnings surprises are now translating into higher estimates for the first and second quarters. S&P 500:  Q1 2020 earnings estimates Jan. 1:    up 16.0% Today:    up 20.5%  S&P 500:  Q2 2020 earnings estimates Jan. 1:    up 45.7% Today:    up 49.9% Source:  Refinitiv Analysts typically are overly optimistic and start cutting estimates as the quarter wears on, but in the second quarter the opposite has happened. "That's an unusual occurrence; the Street is usually cutting numbers by this point in the current quarter," Nicholas Colas from DataTrek said in a recent note. Technology, materials and real estate earnings have been particularly strong. Sell the news? With stocks this high, it's little wonder that even strong earnings reports don't move individual stocks much. Christopher Harvey, head of equity strategy at Wells Fargo, has noted that in the 24-hour period companies reported positive earnings beats, the average stock traded down 0.8%. Ann Larson, senior analyst at Bernstein, noted that the S&P 500 had run up about 18% in the previous two and a half months, "perhaps discounting much of the good earnings results in advance." Low rates + strong earnings = stocks at new highs Another factor pushing stocks to new highs: low interest rates. "The U.S. has never begun an expansion with yields as low as today," Jim Paulsen, chief investment strategist at The Leuthold Group, said in a recent note. "A combination of extremely low yields and strong EPS gains has historically proved to be a uniquely positive opportunity for stock investors." What could derail the earnings lollapalooza? Barring another out-of-left-field event like Gamestop, it's still all about the stimulus (go big is going to succeed, it appears) and the vaccine: "Covid is still a huge X-factor," Nick Raich told me. "Will there be mutuations and will the vaccines still be as effective as advertised?  Barring that, stocks should continue to climb higher." Subscribe to CNBC PRO for exclusive insights and analysis, and live business day programming from around the world.
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Wall Street is concerned about the Yellen regulator super-summit, and with good reason, market watchers say. "The Street should be worried," Jamie Selway, former head of electronic brokerage at ITG and now an investment advisor, told me. "There's clearly questions about gamification, and whether a lot of these approaches are suitable and inducing unnecessary trading activity. Regulators are starting to look at what kind of behaviors can be induced through those apps." Treasury Secretary Janet Yellen has announced she will be meeting with the heads of the Securities and Exchange Commission, the Federal Reserve board, the New York Fed and the Commodities Futures Trading Commission, to discuss "whether recent activities are consistent with investor protection and fair and efficient markets." The meeting could take place as early as Thursday. Was there market manipulation involved in the GameStop story? Several of those regulators have already made preliminary statements. The SEC has a three-fold mission: 1) protect investors, 2) maintain fair, orderly and efficient markets, and 3) facilitate capital formation. The commission already has put Wall Street on notice that it is concerned investors may not have been protected. "We will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws," the SEC said in a statement. "Market participants should be careful to avoid such activity." Does the GameStop trade, largely instituted by the Reddit trading community, amount to abusive or manipulative trading? That may be difficult to prove. "There may have been some bad actors, but the narrative in the media does not suggest a traditional pump and dump," Philip Moustakis, former senior counsel in the SEC's Division of Enforcement and current counsel at law firm Seward & Kissel, told me. "There is no indication yet that the Reddit crowd was engaged in coordinated actions or disseminated false and misleading information," he added. "Those are not the elements of a traditional market manipulation case. There was certainly a lot of decentralized chatter, but it would be difficult to call that market manipulation." Another issue regulators will be examining is the stability of the clearing system. The clearinghouses are nodes in our system that cannot afford to fail," Jay Clayton, former SEC chair, said on CNBC. What FINRA may be up to The Financial Industry Regulatory Authority is the agency that directly regulates brokers and broker-dealers. In a recent report on 2021 priorities, the agency stated that one of its main areas of focus in 2021 was the "gamification" of the markets: "This focus includes risks associated with app-based platforms with interactive or 'game-like' features that are intended to influence customers, their related forms of marketing, and the appropriateness of the activity that they are approving clients to undertake through those platforms." Moustakis says this is a warning shot to the brokerage community. "FINRA was putting those with game-like feature on notice. These trading apps are marketing to a younger customer base, and I think FINRA feels that comes with increased know-your customer obligations," he said. A FINRA spokesman declined to comment, but the agency clearly has indicated it is concerned that the gamification of trading may have caused investors to trade excessively or make investments not suitable for them. A key feature of regulation of the broker-dealer and broker community is "suitability", the requirement that advisors place their clients in investments that are suitable for the risk they want to bear. FINRA clearly warns brokers and broker-dealers that certain features they offer may trip so-called "suitability" requirements: "If your firm offers an app to customers that includes an interactive element, does the information provided to customers constitute a 'recommendation' that would be covered by Reg BI, which requires a broker-dealer to act in a retail customer's 'best interest,' or suitability obligations under FINRA Rule 2360 (Options)? If so, how does your firm comply with these obligations?" FINRA said in the report. "If your firm's app platform design includes 'game-like' aspects that are intended to influence customers to engage in certain trading or other activities, how does your firm address and disclose the associated potential risks to your customers?" Eric Noll, CEO of Context Capital and now a board member of FINRA, said there were even broader issues for FINRA and other regulators to consider: "Regulators will ask, do we have the risk metrics right around these broker-dealers, particularly those that have big concentrations around small numbers of companies?" "The most likely regulatory move is increased capital requirements around brokers," he told me. "Robinhood needed to put up money they didn't have. They had a big concentration in a very small name. To preserve their business, they had to shut down taking longs in GameStop because that was the only way they could control their obligations." (Note: Noll said he is not speaking on behalf of FINRA). Should regulators stop investors from doing stupid things? A final concern is whether regulators will feel some obligation to encourage the brokerage community to be more vigilant protecting investors against engaging in what seems like foolish behavior, like trading stocks for prices divorced from any rational fundamentals. Former SEC Chair Clayton cautioned against erecting what he called "blunt guardrails and blunt regulations." Clayton said it would be difficult to put up guardrails that would prevent investors from making investment mistakes, but said that certain guardrails like margin requirements were necessary: "I'm a believer in that and I believe those guardrails should be examined." Where's Gensler? One key player is missing: Gary Gensler, former chair of the CFTC, and now the nominee to run the SEC. His presence is greatly needed to preside over this difficult moment, but it may be months before he is confirmed. "We would love to see his confirmation sped up and confirmed quickly," Selway said. "Doing this without him seems difficult." Subscribe to CNBC PRO for exclusive insights and analysis, and live business day programming from around the world.
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A pedestrian wearing a protective mask exits from the Wall Street subway station in New York, on Monday, July 20, 2020. Michael Nagle | Bloomberg | Getty Images Wall Street is getting bulled up on earnings, and that is highlighting the divide it has with Main Street. Earnings season is two days old, and already Wall Street pundits are optimistic. Corporate profits "have been more resilient than we expected and we are raising our estimates," UBS chief investment strategist David Lefkowitz wrote in a report to clients. The firm is raising its earnings estimates for the S&P 500 for both the full year 2020, and full-year 2021. Dennis DeBusschere from Evercore ISI is equally optimistic, stating that the rise in earnings would support a move in the S&P 500 toward 3,650 over the next few quarters, a 4% gain from the current level. This, after one day of (admittedly) blowout earnings from JP Morgan, Citigroup and Blackrock? It's more than that. Even before bank earnings, nearly two dozen companies — including heavyweights like FedEx, Lennar, and CarMax — that have already reported third-quarter earnings have beaten estimates by roughly 25%, an unusually wide earnings beat, according to Earnings Scout. What's going on? A combination of a slowly improving economy, a lack of earnings guidance, an overly cautious analyst community, an emphasis on corporations improving efficiency, and a belief that a vaccine will become available in early 2021 is slowly but surely nudging corporate earnings estimates higher. Analysts, who have underestimated the extent of the corporate profit recovery, are now busily revising earnings estimates upward: "There are twice as many S&P 500 stocks receiving upward earnings revisions vs. those experiencing cuts, which is well above average levels seen over the last 40 years," Ann Larson at Bernstein noted. The Main Street divide But why are earnings so much better when much of Main Street is in such dire shape? This earnings outperformance is again highlighting the difference between Wall Street — the investment economy — and Main Street — the so-called real economy. Main Street observers have long complained of this disconnect: with GDP estimated to be down 4%-5% this year and millions out of work, how could the stock market be approaching new highs? Shouldn't there be some correlation between GDP and corporate profits? There usually is, but Wall Street does not exactly represent Main Street, and the Covid downturn has highlighted those differences. The main reason for the divergence is that the U.S economy is heavily weighted to services like retail, restaurants, and doctors, rather than selling goods. But the earnings profile of the S&P 500 is more heavily weighted toward companies that sell goods. How big is the difference? UBS estimates that services comprise 83% of U.S. economic activity but only 54% of S&P 500 profits. "This is a crucial difference because spending on goods has actually increased since the pandemic hit. In contrast, spending on services has contracted fairly sharply," Levkowitz wrote. That goes a long way toward explaining the Wall Street/Main Street disconnect. The strong showing from goods companies is one reason the earnings decline this time has not been nearly as bad as 2009, when both goods and services collapsed. Third-quarter earnings are expected to have declined by roughly 20% in the third quarter, but the second quarter, when earnings declined 30%, is likely the trough for earnings, UBS noted. By contrast, earnings dropped 45% in 2009 from peak to trough. That's not all: publicly traded companies have been able to take more advantage of the Fed's programs to support the economy and have been able to raise more debt through the public markets. They also have had more exposure to the work-from-home trends that have accelerated during the pandemic, as witnessed by the huge run-up this year in shares of Apple, Microsoft, Amazon, Alphabet and Facebook. Earnings have been so strong it's reasonable to ask, is this the best it's going to get? The issue, as UBS' Levkowitz admits, is that earnings remain hostage to Covid-19 and the elections: "The range of outcomes for S&P 500 profits remains wide due to uncertainties about: the timing of vaccine availability; the size and timing of additional fiscal stimulus; and possible changes to corporate taxes in a Democratic sweep election outcome," the firm wrote. What about stock prices? If you're expecting a huge run-up in prices, it's already happened, with the S&P only 2% from an historic high. "Unfortunately, price action following beats was extremely muted last quarter," Jonathan Golub at Credit Suisse noted.
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A view of NASDAQ in Times Square during the coronavirus pandemic on May 7, 2020 in New York City. Noam Galai | Getty Images Entertainment | Getty Images In the ETF space, success begets success. Just look at what Invesco is doing Tuesday. It's launching a new product, the Nasdaq Next Gen 100 ETF (QQQJ). It might more appropriately be called the Nasdaq 100 Junior Varsity list. The Invesco QQQ Trust (QQQ) started tracking the Nasdaq 100 Index in 1999. Since then, it's become the fifth-largest ETF listed in the U.S., with $135 billion in assets under management. Now, Invesco is looking to capitalize on the interest in technology and growth stocks by offering a new "junior" QQQ. Any why not? QQQ is up nearly 40% this year. Shares outstanding are up nearly 20% since March, a sign of the exploding interest in the growth stocks the fund is famous for. The Invesco Nasdaq Next Gen 100 ETF will consist of 100 mid-cap companies that are using technology in interesting or innovative ways. Included are obvious tech choices like Seagate and internet security firm Zscaler, but also companies like Garmin, Lyft, and social game developer Zynga, not necessarily tech companies. Why, in an ETF known for tech heavyweights, would it want to include nontech companies? "QQQJ will give investors access to 100 mid-cap companies using technology to disrupt their sector," said John Hoffman, Invesco's head of Americas ETFs. "While this does include companies in the technology sector, the commonality across these companies is their legacy of using innovation and technology to create competitive advantages across multiple sectors and industries." Besides, the Nasdaq 100 has never been exclusively about tech. It has always had a healthy weighting of consumer stocks (Pepsi), consumer cyclicals (Costco, Starbucks), and even health care (Amgen). This junior QQQ is part of a series of new products Invesco is launching around the QQQ on Tuesday, which Invesco is calling an "Innovation Suite." Also launching is the Invesco Nasdaq 100 ETF (QQQM), a lower-cost version of the QQQ for longer-term buy and hold investors, Invesco Nasdaq 100 Index Fund (IVNQX), a mutual fund tied to the QQQ for investors (like some retirement plan advisors) who can't invest in ETFs but can invest in mutual funds, and the Invesco Nasdaq 100 Growth Leaders Portfolio (QQQG), a unit investment trust. This isn't the first time we have seen a "junior varsity" version of an ETF. In 2009, Van Eck, on the heels of its very successful Gold Miners ETF (GDX), launched its Junior Gold Miners ETF (GDXJ), which has become a regular part of the gold trading space.
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People walk by the New York Stock Exchange (NYSE) in lower Manhattan on October 5, 2020 in New York City. Angela Weiss | AFP | Getty Images Stock market bulls, rejoice.  Third quarter earnings season begins Tuesday with JPMorgan Chase.  The good news: in the second quarter, companies delivered surprisingly large earnings beats as analysts underestimated the strength of the recovery.  That is happening again. The bad news: fourth quarter earnings — which is the quarter now on the minds of traders — remains hostage to the vaccine and reopening story, and to a lesser extent to the election.  Third quarter estimates rising, an unusual development  In most quarters, estimates for the quarter start out high, and then are adjusted downward — typically by 3% to 5% — as the quarter ends because analysts are too optimistic. Not in the third quarter.  Analysts started out assuming that the S&P 500 would see an earnings decline of 25% compared to the same period last year.  But that was the bottom, and the estimates have been steadily improving since:  S&P 500 Q3 earnings:  improving July 1:              down 25.0% September 1:  down 22.4% Today:             down 21.0%  (Source:  Refinitiv) Still, it's a pretty bad number.  If the decline comes in at down 21%, "[I]t will mark the second largest year-over-year decline in earnings reported by the index since Q2 2009," according to John Butters, who tracks earnings for Factset. Early reporters are killing it  Another encouraging sign:  of the 22 S&P 500 companies that already reported, 20 beat estimates, a much higher beat rate than usual. And they are beating by a very wide margin of 25%, according to Nick Raich, who tracks corporate earnings at Earnings Scout.  That is way above historical averages.  Typically, companies will beat by 3% to 5%.  This implies, Raich said, than analysts are again underestimating the extent of the recovery.  "Analysts have not had the benefit of corporate guidance, and without that guidance they assumed the worst, and the worst has not come," Raich told me. Most importantly, the majority of the companies that have reported are seeing their fourth quarter earnings estimates raised by analysts, a sign that it is not a one-quarter fluke.   Early reporters like Darden, FedEx, CarMax, Lennar, AutoZone, and Nike saw their fourth quarter estimates raised due to either commentary or their strong third quarter performance. Guidance is still light, but commentary is more positive In the second quarter, the markets cratered when corporate America decided that the economy was so bad they would, for the most part, stop providing guidance.  Wall Street freaked out. There is still a problem providing longer-term guidance for many companies.  More than 25% of the companies in the S&P 500 are still not providing any earnings guidance for 2020 or 2021, according to Factset.  However, some companies are starting to loosen up on near-term quarterly guidance.   "[I]t does appear that some S&P 500 companies have better visibility on future earnings heading into the third quarter earnings season than they did heading into the second quarter earnings season," Factset's Butters said in a recent note to clients.  You can see that for the third quarter.  While the number issuing guidance was still below normal, more companies issue positive guidance than negative guidance.  That is the opposite of what usually happens.  Of 69 companies that gave guidance, 46 were positive, 23 were negative.   So what does this mean for markets in the fourth quarter?  Unfortunately, for veteran trader Art Cashin from UBS, while the good earnings news remains a tailwind, the market remains hostage to Covid headlines.  "Earnings will be important but not a dominant factor, because any news on the virus and any sudden change on reopening or the economy is what is really going to move the markets," he told me.   "This is not a normal earnings season."
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The New York Stock Exchange is pictured in the Manhattan borough of New York City, New York, October 2, 2020. Carlo Allegri | Reuters Some are calling it "a la carte stimulus," with aid for airlines in Column A, PPP aid in Column B.  Whatever it is, hopes for stimulus — preelection, postelection, comprehensive package, stand-alone deal, whatever and whenever — is supporting breakouts in cyclicals like industrials, materials, consumer discretionary and banks. Many big names like Caterpillar, Eaton and FedEx have broken to new highs. Materials stocks like Martin Marietta, Vulcan Materials and Nucor are up 10% in the last week. Even bank stocks like US Bancorp are breaking out to multimonth highs.  For some, the cyclical rally is getting way too stretched. "The action over the last couple weeks is baking a lot of positive news into the market," said Jack Miller, head of trading at Baird. Alec Young, chief investment officer at Tactical Alpha, agrees. "We are quietly getting overbought. The market is looking a little tired, the size of the rallies is getting smaller, with little waves of selling," he said. "It's true cyclicals are rallying, but they have not shown any ability to do longer-term rallies." "I don't think this market is very compelling, and I am pulling back and waiting to see what happens," he added. Others also have doubts about this rally. They note that volume on up days has been notably light while on down days it's notably heavier. This implies there's not much buyer conviction, that much of the rally is simply sellers holding onto stocks unless prices rise. Jim Besaw, who manages $3 billion as chief investment officer at GenTrust, said this signals that many still don't believe the rally: "The market is underpositioned. That's why the markets go up on light volume days.  The pain trade is still higher because most people are underweight the market." So is the market moving on a pipe dream? Besaw doesn't think so.  "Stimulus will get done," he said. "If we have another big downturn like we did in March, it will get done sooner rather than later, but it will get done." As for the outperformance of cyclicals,he said: "Biden ahead brings in the likelihood that infrastructure will likely be very high on the list, and that is why materials and industrials are outperforming." Still, what if there is no stimulus until well after the election? Could the market handle that? Besaw thinks it could: "If Biden continues to poll well, there is still room for the markets to run, particularly if corona cases don't increase dramatically. When investors are underweight, you don't necessarily need good things to happen to have the market go higher, you just need the absence of bad things."  For the moment, traders are not as focused on the other side of the story — that Biden would likely mean higher taxes and weigh on stocks. "You can say that means higher taxes, but the market seems to be saying that the contested election was an even bigger issue," Besaw said. So what should traders do? Besaw agrees it's tricky to add equity risk, and that option prices are high now.   His advice to bullish clients is to use call spreads. For example, buy a higher strike call on the S&P 500 (say 3,700) and then sell an even higher strike call (say, 3,800). "So if everyone goes smoothly and there is no contested election, and if the market goes through 3,800 (up 10% from where you are now), the call spread you bought" would net a handsome profit.
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