Originally published as a weekly letter on Friday, June 19, 2020.
Happy Friday and welcome to letter # 3.
This letter stretches from leaning like Elon to spike in retail trading.
How does Elon Musk learn so fast?
Originally discovered on Twitter posted by @palakzat.
Divergence. What causes the real economy to differ so drastically from the stock market?
Q2 GDP will likely be compressed -42%, 40M people are unemployed, second wave of COVID-19 is likely approaching, and yet the stock market is seeing record highs. What drives this and why are we seeing such divergence between the market and the real economy? If you’re a market participant, this question is lingering in your mind.
The answer is short and simple. It’s The Fed.
Quick history on The Federal Reserve System. It was created by Congress back in 1913 under President Woodrow Wilson. The formal act was called “The Federal Reserve Act of 1913.” The entire purpose was to have a central bank that provides the United States with a safer, more flexible, and stable financial system.
The Fed focuses on 4 key areas:
- Drive monetary policy
- Manage and regulate banks
- Maintain stability of the financial system; protect against systematic risk
- Provide financial service to US government when needed
So, what does The Fed have to do with divergence? Simple. The Fed prints money. The printing leads to liquidity in financial markets. To give you perspective, here is Fed’s most recent balance sheet chart. Those numbers are in $trillions.
The Fed can print money by digitally adding zeros to their balance sheet. And by doing so, it has the ability to buy assets in the market. Currently, it’s busy buying corporate and Treasury bonds. And it shouldn’t surprise us if they start buying equities soon.
If you need entertainment on a Friday night, then watch this 60 minutes interview of Ben Bernanke from 2009. The good ol’ days when the former chairman was discussing injecting $1T into the market. J.Powell is on track to beat that by 7X.
You can fast-forward to 8 min mark to hear Bernanke talk about money printing.
What are long term repercussions? We don’t currently know. What we do know is that money printing at this rate and these liquidity levels are not sustainable. The underlying value creation of the economy comes from the consumers. And if the consumer is hurting, then no band-aid solution can solve the problem; even if it’s The Fed.
Is commission-free retail trading net-positive or net-negative?
Technology drives speculation in public markets. Removal of barriers amplify speculative behavior. Commissions were that barrier in retail trading.
A long time ago, back in 2019 to be exact, several electronic brokers jumped on the train of “commission-free” trades. Robinhood’s primary customer acquisition tactic since inception was commission-free trading. And then all online brokers joined them.
Mobile phones and commission-free trading increases market participation. Millions of people have opened up new online brokerage accounts since the advent of COVID-19. This is a good thing. The issue, however, is that many rookie retail traders are reaching for yield. Daily. And some are indulging in sophisticated financials products like options. Speculative trading vs. investing is the ultimate clash of classes. The former is craving yields and short term wins; the latter cares for long term growth, value creation, dividends and more.
Here’s a quick glance at increase in day trades since the commission barrier was removed:
So, is commission-free trading a net-positive or net-negative? It depends on who you ask. Having direct access to your trading accounts on a mobile phone is likely a net-positive. Commission-free trading, however, removes intent before buying or selling anything and will only increase speculative activity that will drive market volatility. And we will continue to see random spikes in companies like Fangdd that was randomly mistaken to be FANG stocks.
Quote I’m reflecting on
Most of us spend too much time on the last 24-hours and too little on the last 6,000 years. – Will Durant
The internet rewards loud and noisy. Media and publications follow the loud and noisy. Our minds are novelty-seeking and gravitate towards the loud and noisy; it’s what makes us a headline-driven society. To solve critical problems, we need to turn to history, connect the dots and build for the future.
I just finished The Pixar Way. I discovered this book while at Half-Priced Books last weekend. A simple and quick read that you can finish in 1-2 days.
I’m fascinated by Disney’s business; everything from their operational efficiencies at theme parks to their subscription and media businesses to their animation studios. They serve a clear purpose in our society.
The key takeaway from the book was around imagination and dreaming. As kids, we’re encouraged to dream, strive for great things, use our imagination. Somehow, as we grow up, we’re taught to succumb to reality, operate with constraints, and limit playtime.
Dreams and imaginations gave us the airplane, electric vehicles, the internet, space flight, mobile phones, skyscrapers, robotics, AI, and much more. The greatest companies have been built on dreams and imagination.
So, dream on and do not succumb to reality. Create your own reality.