Mad Hedge Technology Letter
November 22, 2019
Fiat Lux
Featured Trade:
(THE REAL STORY BEHIND THE CHARLES SCHWAB/TD AMERITRADE MERGER),
(SCHW), (AMTD), (ETFC), (IBKR)
Posts
There are certain parts of tech that I routinely bash on like travel tech, music streaming tech, and the usefulness of social media companies.
One other group of companies that I’m just as sour on are the discount e-brokers.
Yes, tech has embedded deflation into every company causing operations to become more efficient while boosting performance.
That doesn’t necessarily translate into more sales for some, and they have cut down the barriers of entry to e-brokers who have struggled.
The race down to zero finally hit rock bottom a few months ago when Interactive Brokers (IBKR) announced doing away with trading fees.
Buying and selling stocks and ETFs now costs the consumer nothing and this has been great news for investors and traders who don’t need to shoulder the extra trading costs.
But what about the e-brokers themselves?
Today Charles Schwab (SCHW) announced they are in negotiations to buy out the smaller TD Ameritrade (AMTD).
This was due to happen and is just another round of an industry-wide reshuffle.
I have never once thought these e-broker companies were a candidate for a tech alert, there are so many better companies out there.
Smaller commissions mean less revenue and the exact opposite of what investors should hope for in a tech company.
The lack of pricing power stems from the issue that e-brokers offer a commodified service of selling standard products and pricing is the only way to differentiate themselves.
The first startup company to offer zero was Menlo Park, California dark horse Robinhood which was recently valued at $7.6 billion.
They make money on the interest from customer deposits and sell data flow to high-frequency traders who in turn monetize the numbers using faster internet connections.
The spirited startup was found in 2013 and has added over 6 million users who are mostly from the Millennial age group.
These 6 million also represent the numbers lost to the discount e-brokers.
Robinhood’s influence in the industry cannot be understated as they singlehandedly forced an e-broker to cut commissions one by one blowing up their business model.
E-brokers had no choice but to cut to zero unless they were content to bleed customers.
Don’t forget that TD Ameritrade acquired competitor Scottrade just two years ago as the consolidation merry-go-round began.
The Schwab and TD Ameritrade deal will create over $5 trillion in asset management together.
Moving forward, the big question is how can these companies sustain themselves.
Exactly, there appears to be no panacea and I would recommend any investor to avoid investing in these e-brokers.
Schwab appears to be hanging their hat on their additional financial services they will be able to provide customers like offering mutual funds.
In addition to offering online brokerage accounts and robo-advisor services, Schwab and TD Ameritrade play a pivotal role in the independent advisory space because they custody assets and offer related services to RIAs.
According to Financial Advisor magazine, Schwab is the leading RIA custodian, and TD Ameritrade ranks third after Fidelity.
A merged company can theoretically offer more services to RIAs, but could also create opportunities for others.
Could these services become a race down to zero as well?
Disruption is in the early innings and round two could see Interactive Brokers or E*Trade (ETFC) in the next round of consolidation.
Smaller e-brokers will in time go bust or get bought out.
This reaffirms the broad trend of financial jobs eroding rapidly as the onslaught of technology has made certain jobs obsolete.
U.S. financial jobs are set to slide by 10% in the upcoming years.
Back office bank jobs are disappearing as we speak and the next big wave of job losses after that will be the front-office broker.
Yes, your Schwab broker could become an algorithm.
At some point, there will be a few managers left over, a handful of executives, and an army of software engineers.
Global Market Comments
October 7, 2019
Fiat Lux
Featured Trade:
(MARKET OUTLOOK FOR THE WEEK AHEAD, or WILL HE OR WON’T HE?)
(INDU), (USO), (TM), (SCHW), (AMTD), (ETFC), (SPY), (IWM), (USO), (WMT), (AAPL), (GOOGL), (SPY), (C)
Once again, the markets are playing out like a cheap Saturday afternoon matinee. We are sitting on the edge of our seats wondering if our hero will triumph or perish.
The same can be said about financial markets this week. Will a trade deal finally get inked and prompt the Dow Average to soar 2,000 points? Or will they fail once again, delivering a 2,000-point swan dive?
I vote for the latter, then the former.
Still, I saw this rally coming a mile off as the Trump put option kicked in big time. That's why I piled on an aggressive 60% long position right at last week’s low. Carpe Diem. Seize the Day. Only the bold are rewarded.
Or as Britain’s SAS would say, “Who dares, wins.”
It takes a lot of cajones to trade a market that hasn’t moved in two years, let alone take in a 55% profit during that time. But you didn’t hire me to sit on my hands, play scared, and catch up on my Shakespeare.
I think markets will eventually hit new all-time highs sometime this year. The game is to see how low you can get in before that happens without getting your head handed to you first.
Last week saw seriously dueling narratives. The economic data couldn’t be worse, pointing firmly towards a recession. But the administration went into full blown “jawbone” mode, talking up the rosy prospects of an imminent China trade deal at every turn.
This was all against a Ukraine scandal that reeled wildly out of control by the day. Is there a country that Trump DIDN’T ask for assistance in his reelection campaign? Now we know why the president was at the United Nations last week.
The September Nonfarm Payroll Report came in at a weakish 136,000, with the Headline Unemployment rate at 3.5%, a new 50-year low.
Average hourly earnings fell. Apparently, it is easy to get a job but impossible to get a pay raise. July and August were revised up by 45,000 jobs.
Healthcare was up by 39,000 and Professional and Business Services 34,000. Manufacturing fell by 2,000 and retail by 11,0000. The U-6 “discouraged worker” long term unemployment rate is at 6.9%.
The US Manufacturing Purchasing Managers Index collapsed in August from 49.7 to 47.9, triggering a 400-point dive in the Dow average. This is the worst report since 2009. Manufacturing, some 11% of the US economy, is clearly in recession, thanks to the trade war-induced loss of foreign markets. A strong dollar that overprices our goods doesn’t help either.
The Services PMI Hit a three-year low, from 53.1 to 50.4, with almost all economic data points now shouting “recession.” The only question is whether it will be shallow or deep. I vote for the former.
Consumer Spending was flat in August. That’s a big problem since the average Joe is now the sole factor driving the economy. Everything else is pulling back. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, edged up 0.1% last month as an increase in outlays on recreational goods and motor vehicles was offset by a decrease in spending at restaurants and hotels.
The Transports, a classic leading sector for the market, have been delivering horrific price action this year giving up all of its gains relative to the S&P 500 since the 2009 crash.
Oil (USO) got crushed on recession fears, down a stunning 19.68% in three weeks. The global supply glut continues. Over production and fading demand is not a great formula for prices.
Toyota Auto Sales (TM) cratered by 16.5% in September, to 169,356 vehicles in another pre-recession indicator. It’s the worst month since January during a normally strong time of the year. The deals out there now are incredible.
Online Brokerage stocks were demolished on the Charles Schwab (SCHW) move to cut brokerage fees to zero. TD Ameritrade (AMTD) followed the next day and was spanked for 23%, and E*TRADE (ETFC) punched for 17. These are cataclysmic one0-day stock moves and signal the end of traditional stock brokerage.
The Mad Hedge Trader Alert Service has blasted through to yet another new all-time high. My Global Trading Dispatch reached new apex of 341.86% and my year-to-date accelerated to +41.72%. The tricky and volatile month of October started out with a roar +5.40%. My ten-year average annualized profit bobbed up to +35.06%.
Some 26 out of the last 27 trade alerts have made money, a success rate of 96.29%! Under promise and over deliver, that's the business I have been in all my life. It works.
I used the recession-induced selloff since October 1 to pile on a large aggressive short dated portfolio. I am 60% long with the (SPY), (IWM), (USO), (WMT), (AAPL), and (GOOGL). I am 20% short with positions in the (SPY) and (C), giving me a net risk position of 40% long.
The coming week is all about the September jobs reports. It seems like we just went through those.
On Monday, October 7 at 9:00 AM, the US Consumer Credit figures for August are out.
On Tuesday, October 8 at 6:00 AM, the NFIB Business Optimism Index is released.
On Wednesday, October 9, at 2:00 PM, we learn the Fed FOMC Minutes from the September meeting.
On Thursday, October 10 at 8:30 AM, the US Inflation Rate is published. US-China trade talks may, or may not resume.
On Friday, October 11 at 8:30 AM, the University of Michigan Consumer Sentiment for October is announced.
The Baker Hughes Rig Count is released at 2:00 PM.
As for me, I’m still recovering from running a swimming merit badge class for 60 kids last weekend. Some who showed up couldn’t swim, while others arrived with no swim suits, prompting a quick foray into the lost and found.
One kid jumped in and went straight to the bottom, prompting an urgent rescue. Another was floundering after 15 yards. When I pulled him out and sent him to the dressing room, he started crying, saying his dad would be mad. I replied, “Your dad will be madder if you drown.”
I never felt so needed in my life.
Good luck and good trading.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
Mad Hedge Technology Letter
September 30, 2019
Fiat Lux
Featured Trade:
(COMMISSION-FREE TRADING IS HERE)
(IBKR), (ETFC), (SCHW), (AMTD)
It’s been a long time coming since I first started trading 50 years ago and was charged 25 cents a share to place an order.
The race to zero is over in internet discount brokering world as Interactive Brokers Group, Inc. (IBKR) announced IBKR Lite, a new offering that will provide commission-free, unlimited trades on US exchange-listed stocks and Exchange Traded Funds (ETFs).
It was just a matter of time before one of the big internet brokerages started to offer zero commissions and this move will force the likes of Charles Schwab (SCHW), E-trade (ETFC), TD Ameritrade (AMTD) to follow suit in order to stay competitive.
I’ve written numerous times that this was going to happen and Robinhood, the millennial broker of choice, was the trendsetter coming out the gates with zero commissions and forcing the traditional broker’s hand.
The future is now and welcome to the funeral of trading commissions.
IBKR Lite is for traders seeking a simple, cost-free way to trade US exchange-listed stocks and ETFs and will complement Interactive Brokers’ existing services, which will be rebranded as IBKR Pro. IBKR Lite will be available in October.
I am not surprised that it is Interactive Brokers that is first to roll out a no-commission product.
They are, by far and away, the king of big volume trading and their commissions weren’t that high in the first place.
The customer they deal with is not like the Schwab’s or Fidelity’s who hardly generate large volumes.
Interactive Brokers is able to provide superior pricing because they specialize in data and automating.
This will enable the firms to offer no account minimums and means it will be free to maintain an account for IBKR Lite for professional and retail investors.
What will happen is that Interactive Brokers will sell off your data to analytic companies who know how to scrape the value out of these numbers.
Investors can choose between using IBKR Lite and IBKR Pro and switch between the two levels of service up to three times and then once per quarter.
The broker will re-route the orders of IBKR Lite clients to market makers in exchange for receiving payment for order flow.
Clients that prefer IBKR Pro will continue to receive the best prices generated from a sophisticated algorithm.
So, it becomes a backdoor revenue-generating function like Facebook who resells personal data to third-party analytics companies and in turn allow users to use their platform.
Order flow is inherently valuable for many high-frequency traders (HFT).
But I would say offering trade execution is an actual service where Facebook doesn’t offer anything of note.
A platform to “share” your personal information is not an actual product in my world no matter how you tweak the verbiage.
Either way, the price to the trader is now zero and anyone who trades large volumes is incentivized to go sign up with Interactive Brokers.
This industry has been getting away with highway robbery for years by not only selling order flow but also charging $4.95 or more to trade stocks and ETFs on top of the order flow revenue.
Once the best of the rest see trading volume evaporating as order flow migrates to IBKR, what other options do they have?
I predict that not every broker will be able to execute in this new model and consolidation will be ripe in the future as the weak perish.
As long as these other broker’s stick with the $4.95 per trade of yore, I hate to do it, but slapping on a sell rating is justified.
Welcome to the brave new world of discount stockbroking.
Mad Hedge Technology Letter
August 23, 2018
Fiat Lux
Featured Trade:
(THE RACE TO ZERO FOR BROKERAGE COMMISSIONS)
(JPM), (WFC), (ETFC), (SCHW), (AMTD)
The other shoe has dropped.
No more waiting for it as it was only a matter of time, but it was going to happen soon enough.
The acceleration of the race down to zero for brokerage commissions has moved into full throttle.
In a bid to engage new customers, especially millennials, J.P. Morgan (JPM) will offer its customers 100 free stock or ETF trades for one year.
The new service will be available on Chase’s mobile banking app called “You Invest” and also does not require a minimum balance as do so many of the competitors.
Last year, J.P. Morgan was still charging customers a horrific $24.95 per trade, a ridiculous sum in an age of brokerages slashing fees left and right.
Recently, I chronicled the start-up fin-tech brokerage Robinhood, which rolled out the zero-commission model to the chagrin of the traditional brokerages on the verge of major disruption.
Well, Wall Street has stood up and taken notice. There is no way back from this new normal.
The catalyst for J.P. Morgan to change direction was its lack of competitiveness in the digital brokerage space and a free model of luring in business is seen as a quick recipe to correct its ills.
J.P. Morgan has pumped in $300 million in the past two years into digital initiatives but still lacks the volume it was hoping for. This could help capture fresh accounts that could eventually turn into a meaningful business.
Freemium models made popular in Silicon Valley are catching fire in other parts of the economy as potential customers can dabble with the service first before committing their hard-earned money.
This is dreadful news for the fin-tech brokerage industry as it indicates a whole new level of acute pressure on margins and revenue.
The brokerage business has been under fire the past few years after regulators discovered Wells Fargo (WFC) was cunningly ushering clients into higher fee trading vehicles, taking a larger cut of commissions.
Wells Fargo did everything it could to rack up costs for high net worth clients. The atrocious behavior was a huge black eye for the entire industry.
Technology has forced down the cost of executing a trade and each additional trade is almost nil after fixed costs because of software and hardware carrying out these functions.
E-brokerages are set for a rude awakening and their cash cows are about to be disrupted big time.
Charles Schwab (SCHW) has 11.2 million brokerage accounts, and no doubt clients will get on the ringer and ask why Schwab charges an arm and a leg to execute trades.
Schwab might as well start charging clients for emails, too.
The cut in commissions has already started to affect margins with Schwab revenue per trade sliding from $7.96 in 2017 to $7.30 in the most recent quarter.
TD Ameritrade (AMTD) is experiencing the same issues with revenue per trade of $7.83 last year dropping to $7.30 last quarter.
The beginning of the year provided e-brokers with respite after euphoric trading sentiment pushed many first-time equity buyers into the markets, making up for the deceleration in revenue per trade.
However, that one-off spike in volume will vanish and margins are about to get punctured by fin-tech start-ups such as Robinhood.
J.P. Morgan’s move to initiate free trades is a huge vote of confidence for upstart Robinhood, which charges zero commission for ETFs, option trades, and equities.
I recently wrote a story on the phenomenon of Robinhood, and the new developments mean the shakeout will happen a lot faster than first anticipated.
TD Ameritrade, E-Trade (ETFC), Fidelity, and Charles Schwab could face a deeply disturbing future if Silicon Valley penetrates under the skin of this industry and flushes it out just like Uber did to the global taxi business.
E-Trade shares have experienced a healthy uptrend and it is now time to pull the rip cord with the rest of these brokerages.
It will only get worse from here.
Investors should be spooked and avoiding this industry would be the right move at least for the short term.
The golden age of trading commissions is officially over.
Turning this industry into a dollar store variety is not what investors want to hear or hope for.
The decimation of commission fees has coincided with the rise of passive investing.
Only 10% of trades now are performed by active traders.
Brokerages earn demonstrably less with passive investing as the volume of trading commission dries up with this buy-and-hold-forever strategy.
Index funds have been all the rage and quite successful as the market has returned 400% during the nine-year bull market.
When the market stops going up, the situation could get dicey.
The real litmus test is when a sustained bear market vies to implode these ETFs and what will happen with a massive unwinding of these positions.
A prolonged bear market would also scare off retail investors from executing trades on these e-brokerages.
Many will take profits at the speed of light not to be seen or heard again until the next sustained bull market.
Moreover, it is certain the global trade war is scaring off retail investors from their trading platforms as the uncertainty weighing on the markets has thrown a spanner into the works.
Tech has been the savior to the overall market with the top dogs dragging up the rest, but for how long can this continue?
Other industries are experiencing minimal earnings growth and tech cannot go up forever.
Regulations are starting to bite back at the once infallible tech narrative.
Chinese tech is also having its own headaches where Tencent has been perpetually stymied by local regulators blocking access to gaming licenses needed to monetize blockbuster video games.
Tencent missed badly on its earnings report and there is no end in sight to the delay.
Social media has been torn apart as of late and the weaponization of its platforms is accelerating with government operations moving onto them to fight against each other.
Interest rate revenues are the saving grace for these brokerages that account for 50% or more of revenue.
As interest rates rise, there will be a bump in interest rate revenues. However, as competition heats up and commission falls to zero, will these clients stick around for the e-brokers to reap the interest rate revenues or not?
Millennials are hard-charging into Silicon Valley start-ups such as Robinhood, and the traditional brokers’ clientele are mainly directed on the lucrative middle-age cohort.
The next development for e-brokers is who can best harness artificial intelligence to best enhance their customer experience and products.
If the Charles Schwab’s of the world must compete with nimble Silicon Valley start-ups in technology, then they will find a hard slog of it.
One of these big e-brokers is likely to implode setting off another round of consolidation.
The race down to zero is fierce, and I would avoid this whole industry for now.
There are better secular stories in technology such as the e-gaming phenomenon capturing the hearts and minds of global youth.
________________________________________________________________________________________________
Quote of the Day
“Expect the unexpected. And whenever possible, be the unexpected,” – said Twitter and Square cofounder and CEO Jack Dorsey.
