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February 8, 2021 – Market Update Table of Contents

I. Last Week...... 2 A. Markets (Barron’s) (Barron’s) ...... 2 B. Why Shares Rose Last Week (WSJ)...... 3 C. Employment Report (Barron’s) (Bloomberg) (WSJ) ...... 3

II. Different Views on the Stock Market ...... 4 A. Bill Gross’ Investment Outlook: “Little Bit Softer Now” (PR) ...... 4 B. Fed Can’t Ignore its Role (Bloomberg) ...... 4 C. Bonds vs. Equities (Bloomberg) ...... 5 D. Merger Arbitrage Bets (WSJ) ...... 5 E. Bubble (WSJ) ...... 6

III. Free Trading and Payment for Order Flow (PFOF) ...... 7 A. Free Trading Costs (WSJ) ...... 7 B. Hidden Costs (WSJ) ...... 7 C. Payment for Order Flow (Matt Levine -- Bloomberg) (WSJ) ...... 8 D. Citadel Profits (WSJ) ...... 9 E. Time to Stop Trading Conflicts that Cost Investors Billions, by retired Senator Levin (FT) ...... 9

IV. Special Purpose Acquisition Companies (SPACs) ...... 10 A. SPAC (CNBC) ...... 10 B. SPACs Performance After the Acquisition (Barron’s) ...... 10 C. GME Traders Moving into SPACs (WSJ) ...... 10

V. General Interest ...... 11

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I. Last Week A. Markets (Barron’s) (Barron’s) 1. Last week: DJIA +3.9%; S&P +4.6%; Nasdaq +6%; Russell 2000 +7.7% a. Hedge funds had “degrossed” last week and had to reload i. They had closed short and long positions last week b. While jobs report was disappointing (49K jobs and December report revised down to 227K from 140K), other news was more positive i. ISM services survey new order and hiring components point to growth ii. More stimulus payments iii. Improving Covid news 1. Weekly number of new cases down 30% from two weeks ago 2. New vaccines coming a. JNJ has filed for emergency-use authorization b. Novavax headed in right direction 3. Clorox dropped 8% (this was a pandemic play) iv. Oil and interest rates may be signaling growth 1. Energy ETF (XLE) +8.2% as oil climbed 8.9% ($56.85 / barrel) a. Oil is highest it’s been since January 2. Financial ETF (XLF) improved as 10-year yield hit highest level since March v. VIX receded to the low 20s 2. Yield curve is most upward sloped in years a. 2-year yield: .09%; 10-year: 1.19%; 30-year: 1.97% i. Since Aug: 30-yr +73 bps and 10-yr +63 bps ii. 2-year stays low b/c Fed is not expected to raise rates b. Higher yield seems to be higher inflation expectation i. Seem to be expecting higher inflation 1. Got a boost from Biden’s $1.9T plan 2. 5-yr breakeven inflation: 2.28% (+80bps since Sep); 10-yr 2.21% ii. Stimulus will also bring higher growth, but TIPs yield falling c. Implications: i. As 2/10 spread approaches 1.3%, may be sign of Fed raising rates ii. Maybe the steady rise in yields could help preclude a “taper tantrum” iii. Bank stocks may continue to post strong performance iv. Treasury yields will eventually climb high enough to draw investors back into the market 3. A little bit of irony… a. Koss shares had been at $3 at the end of last year and hit $127 last week i. The Koss family and executives sold $45MM of stock 1. Greater than the market cap at the end of 2020 2. Mostly sold at $20 - $60 ii. Who would have ever thought that Robinhood would be an entity that moved money from the poor to the wealthy!

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B. Why Shares Rose Last Week (WSJ) 1. Possible new stimulus a. Particularly with a weak jobs report 2. New vaccines (such as JNJ) 3. Decline in volatility 4. Earnings growth 5. Low interest rates

C. Employment Report (Barron’s) (Bloomberg) (WSJ) 1. Nonfarm payrolls increased by just 49K a. December was revised down from 140K to 227K b. Remember that the economy lost 9.3MM jobs in 2020 – still need them back 2. Jobless rate (U-3) fell from 6.7% to 6.3% (6.9% if no misclassification error) a. More people employed b. More people leaving workforce (lower participation rate) 3. U-6 rate fell to 11.7% 4. The negative news: a. Private payrolls increase by only 6K last month i. Job cuts in retail trade, transportation and warehousing, and leisure and hospitality b. Almost 40% of the unemployed have been out of 27 weeks or more (4MM+) i. Highest percentage since 2012 c. Large differences in unemployment rates: i. Whites (5.7%); Asian (6.6%); Hispanics (8.6%); Blacks (9.2%) 5. Some bright spots: a. Household survey implies that employment rose 381K i. And this was led by full-time jobs (300K+) b. Americans working longer hours i. Average weekly hours rose to 35 1. Highest in data back to 2006 ii. Average weekly hours for non-supervisory workers rose to 34.4 hours 1. Longest workweek since 2000 c. Employment at temporary-help services jumped most in three months (+3.1%) i. May foreshadow a pickup in hiring ii. Payrolls at temporary-help services climbed almost 81K d. As of last month, financial, tech, and management consulting have returned to pre-pandemic levels i. Job postings for tech and finance are up 20% and 11% e. Average hourly earnings rose .2% MOM and 5.4% YOY

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II. Different Views on the Stock Market A. Bill Gross’ Investment Outlook: “Little Bit Softer Now” (PR) 1. The “bubblicious” stock market a. IPOs like DoorDash soared 80% on its first day b. Airbnb jumped 110% -- giving it a $100B market cap 2. Market is being driven by fiscal stimulus and monetary policy a. Negative real rate 3. Two points of caution a. What if the reassembled economy, absent a large amount of office space, retail stores, and new Boeing airplanes doesn’t create a capitalist creative destruction replacement in short order i. How many fiscal packages can the stock market stand before it realizes that GDP is now opioid-like (dependent on more) 1. If we have to constantly run trillion-dollar deficits, the market should trade at a lower P/E a. We’re more like the Nordic and European markets b. Stock prices and p/e multiples are affected by interest rates i. Low bond yields result in low earnings yields (high P/Es) ii. Low yields mean that distant cash flows retain their value 1. The 200 bp decline in real 10-year yields since Jan. 2019 have been instrumental in the 50% market rise since then 4. Real yields need to stay low for all of this to continue

B. Fed Can’t Ignore its Role (Bloomberg) 1. It’s hard to miss the tell-tale signs of a bubble: a. IPOs are popping more on the first day of trading than they have since the dot- com days i. Airbnb, DoorDash, Snowflake b. Recent speculation on GameStop and other heavily shorted stocks c. Hertz and other low-priced stocks that speculators chased d. Bitcoin 2. In some ways, it’s like the tech bubble with everyone getting rich a. SPACs b. Whatever Chamath Palihapitiya is touting c. WallStreetBets d. Digital currencies 3. The current mania is different for one reason: monetary policy a. During the tech bubble, Fed had raised rates to 6.5% heading into 2000 4. Negative real yields are probably the chief source of all this speculation a. If real yields are positive, why take risk in stocks b. Now JPM says that households’ equity allocation has risen to record highs, surpassing the beginning of 2000 sandyleeds.com 4

C. Bonds vs. Equities (Bloomberg) 1. For the past ten months, investors have justified the huge melt-up in stock prices by pointing to low bond yields 2. This case is no longer compelling: a. Stock yields are lower (b/c prices have increased) i. The S&P is up 8% since September 1. S&P earnings yield is at a record low 3.16% 2. S&P dividend yield is 1.5% ii. Nasdaq 100 is up 9% since September 1. Earnings yield of 2.5% 2. Dividend yield of .72% b. 10-year UST yields have almost doubled to 1.14% i. 30-year is close to 2% 1. Yield on long bonds now exceeds the S&P 500’s dividend yield by the most since before the crisis 2. Bloomberg Barclays index of AA-rated corporate bonds with an average maturity of 13 years yields 1.6% (highest since June) a. This also exceeds the S&P’s dividend yield c. In some ways, this is a return to normalcy i. It’s been rare for equities to yield so much more than USTs and high- quality corporate bonds 1. In late July, the S&P 500 dividend yield was 54 bps higher than AA corporate bond yields a. Highest level ever d. Currently, 64% of S&P 500 stocks have dividend yields higher than 10-year UST notes i. This would drop to 44% if the yield increased to 1.75%

D. Merger Arbitrage Bets (WSJ) 1. When hedge funds had to close out long positions in order to pay to close out their losing short positions… a. The result was that they sold some securities that were part of recently announced deals 2. Now, there are wide spreads available to merger arbitrage investors

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E. Bubble (WSJ) 1. Signs of bubble a. Growing army of individual investors i. On Wednesday of the prior week, 24.5B shares traded hands ii. 57.1MM option contracts changed hands b. Options activity is surging c. Bitcoin prices are near records d. Businesses rushing to sell stock through: i. IPOs 1. Companies have raised $13.4B through 24 IPOs this year a. 300% increase from last year ii. Listings of SPACs 1. 91 have raised $25B a. Nearly 1/3 of total raised in last year’s record year iii. Follow-on shares 1. 11 so far…double the number at this point last year e. Valuations look stretched i. 22X next year’s earnings 1. Was 25X in 2000 2. But today, rates are low f. Incentive to put money into stocks b/c of low rates g. Bullishness among money managers is at three-year high i. BAC survey of 194 money managers overseeing $561B in assets h. Average share of cash is at lowest level since May 2013 2. A Deutsche Bank survey said that nearly 90% of some 627 market professionals think that some financial markets are in a bubble 3. Google searches for “stock market bubble” reached an all-time high in January

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III. Free Trading and Payment for Order Flow (PFOF) A. Free Trading Costs (WSJ) 1. Low commissions means that brokers have to rely on other sources: a. Margin lending b. Payment for order flow (PFOF) i. Sending customers’ trading orders to wholesale market-making firms 2. Another potential pressure on the trading business: liquidity and capital requirements a. Clearinghouses demanded more capital i. If a broker is going to cater to retail investors, they may need more capital 3. May need more client services (when trading is disrupted)

B. Robinhood Hidden Costs (WSJ) 1. Zero commissions may promote trading a. Can result in losses b. Can make market more volatile 2. We’ve made stock market gambling cheaper than sports gambling 3. Last year, an average 10.9B shares changed hands across U.S. exchanges each day a. This year, 15B per day b. On Jan. 27, 24B changed hands 4. On Robinhood, daily unique users have tripled since the start of 2021 a. Traffic grew 1,200% in the week ending Jan. 29 5. In December, 13.6B shares of non-S&P 500 companies traded on the app a. 4X as many as Jan. 2020 b. Of the 100 most-held stocks on Robinhood, 12 have a price <$5 6. Robinhood accounted for ~1/4 of all options trading across retail brokerages last year a. The most for any single platform 7. Robinhood makes deposited cash immediately available 8. It makes sense to keep promoting trading -- PFOF

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C. Payment for Order Flow (Matt Levine -- Bloomberg) (WSJ) 1. Example: a. Exchange is offering stock with bid/ask of $58/$58.25 i. Could send trades there and get that price and you pay an exchange fee b. If broker had enough orders, they could “internalize orders” i. Sell for $58.15; buy for $58.10 1. Everyone gets better price 2. And broker keeps 5 cents (and no exchange fee) ii. Doesn’t happen b/c not enough orders at same time c. So, broker sends orders to “wholesaler” (high-frequency trader) i. Wholesaler will do trade at $58.10/$58.15 1. Keep 3 cents; send 2 cents to broker (payment for order flow) 2. General rule is customer gets 80% of benefit and broker 20% 3. Wholesaler fills trades inside exchange’s nat’l best bid and offer a. Called “price improvement” ii. In reality, buy and sell don’t happen instantaneously 1. Wholesaler holds inventory and uses balance sheet iii. If retail traders bought before stock went up and sold before it went down, wholesaler would consistently lose money (adverse selection) 1. But the retail trader is uninformed 2. Spread on exchange is larger b/c institutional traders are trading there and the traders are informed 2. In reality, wholesaler doesn’t take every trade a. Some orders are passed on to exchange 3. Wholesalers compete to offer best price improvement 4. There is no reason to front-run the retail investor – b/c his trade is uninformative a. Front-running is also illegal 5. Robinhood had a crucial insight…PFOF would allow them to charge zero commission a. And at zero commission, you’ll do many more trades 6. People are talking about banning PFOF, which could mean (three options): a. No PFOF, so wholesaler passes on 100% (rather than 80% to customer and 20% to broker) i. Broker loses a revenue source 1. Maybe broker charges commissions (or makes money as bank) b. Ban internalization i. Could force trades to exchange ii. With exchange fees, brokers would need to charge commissions c. Banning zero commissions i. This could reduce the number of trades 1. But, it’s politically unpopular 7. Some argued that the trading curbs were imposed at the behest of the giant trading firms

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D. Citadel Profits (WSJ) 1. Citadel Securities executes trades 2. Had net trading revenue of $6.7B in 2020 a. Double the previous high of 2018 3. Reasons for increase: a. Zero commissions b. Pandemic c. Increase of day-traders 4. Citadel participated in $2.75B bailout to Melvin Capital a. Propping up firm that lost by betting against GME b. While Citadel is profiting from all of the bullish trades in favor of GME 5. Data showed that Citadel handled 29% of GME trading volume last week a. Overall, ~41% of US retail stock trading volume goes through Citadel i. Virtu Financial has 32% 6. Through Q3 of 2020, Citadel paid $700MM to major online brokers a. Payments skew incentives of online brokers i. Seek to maximize revenue rather than seek best price ii. Citadel says that they execute the orders at better prices than the exchanges

E. Time to Stop Trading Conflicts that Cost Investors Billions, by retired Senator Levin (FT) 1. Time to end a conflicted practice that siphons billions out of US investors’ funds each year a. This is like paying a hidden, private tax on savings 2. Broker’s responsibility is to get the best execution a. Many brokers sell order for a fee 3. Fees are really high – so are brokers trying to get best execution or just largest payment a. These wholesalers are trading against customer b. They offer price improvement to appear to satisfy the best execution requirement 4. These firms are generating large profits a. This can only happen if the traders are getting better prices than they are providing the brokers’ customers i. If this is the case, what about the brokers’ best execution oblgation

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IV. Special Purpose Acquisition Companies (SPACs) A. SPAC (CNBC) 1. A SPAC is essentially a shell corporation set up by investors with sole purpose of raising money through an IPO to eventually acquire another company a. Only asset is typically the money raised in IPO 2. SPAC is created or sponsored by a team of institutional investors 3. SPAC investors don’t know what company will be acquired 4. Money that is raised goes into an interest-bearing trust 5. Once an acquisition is completed, SPAC investors can either: a. Swap their shares for shares of the merged company; or b. Redeem their SPAC shares to get back their original investment + accrued interest 6. The SPAC sponsors typically get a 20% stake 7. SPAC allows a company to go public quickly

B. SPACs Performance After the Acquisition (Barron’s) 1. Edge Consulting Group examined 115 completed SPAC mergers from 2016 to the end of 2020 a. Found that 65% of their stocks had declined a month after their merger closing and 71% were down a year later 2. 248 SPACs raised $83B in IPOs last year (2020) a. Another 118 have already gone public in 2021 3. The upside for SPAC stocks happens before the deal closes 4. Remarks about future growth and far-out financial targets are protected by the standard disclaimer that actual results may vary 5. The founders often get 20% of the SPAC (called the promote) a. Look for sponsors who have compensation tied to post-merger performance

C. GME Traders Moving into SPACs (WSJ) 1. SPACs are rising more than 6% on average on their first trading day in 2021 a. Last year, it was 1.6% b. 117 in a row have gone up in the first week 2. Companies that don’t have any underlying business is indicative of speculation 3. 91 SPACs have raised $25B so far this year a. On track to shatter last year’s $80B

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V. General Interest

Here are some other articles that are not about the markets or the economy or that I just couldn’t include…but they’re really interesting.

1. A Vast Web of Vengeance (NYT)

2. American Parents Set Out to Find a Son Lost in Syria’s “Bermuda Triangle” (WSJ)

3. The Hidden History f Trump’s First Trip to Moscow (Politico)

4. The Perfect Target: Russia Cultivate Trump as Asset for 40 Years ()

5. 50 Ways the World is Getting Better (A Wealth of Common Sense)

6. Who Owns Stock? Explaining the Rise in Inequality During the Pandemic (NYT)

7. McKinsey Agrees to $573 Million Settlement Over Opioid Advice (WSJ)

8. Young and Ambitious? Move to New York, Not Austin (Bloomberg)

9. Hong Kong Imposes Sweeping Pro-China Curriculum on Schools (Bloomberg)

10. Forget GameStop and Scrutinize Chinese Listed Companies (Bloomberg)

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