Jobs Claims Rise, a FinTech Hero Looks Less Heroic, and Alternative Currencies Continue Their Euphoria-driven Flight Heavenward
Initial Unemployment Claims at Three-Month High
Sometimes we at goodstead are surprised by the headlines we read in the news rags. Yesterday was emblematic of this befuddling, as Bloomberg carries the headline:
"U.S. Jobless Claims Unexpectedly Jump to Highest in Three Months"
(Underlining is goodstead's.)
As we've written here earlier, the economic recovery has been losing steam for some time now, as increasing COVID-19 case numbers and concomitant restrictions on social behavior have reduced economic activity and therefore labor demand. Increasing unemployment has been entirely foreseeable for several weeks, and so we would challenge the "Unexpected" nature of such a phenomenon. We take no pleasure in being right about the unnecessary pain and suffering caused by Executive and Congressional misers' unwillingness to address our continuing natural disaster. News of an imminent relief package have buoyed risk assets, so it would appear that the markets know better than the ideologues in Washington what makes an economy grow.
Robbin' Hood
goodstead is very happy to see savings and investment rates rise, and for regular people in general to develop financial sophistication. These are unmitigated goods, and among the few reasons goodstead hung up its shingle and declared itself open for business. Robinhood, a trading app popular among Millennials, has seen its user base grow into the 13 millions since its founding in 2013. Over the past few years it has seen its fair share of regulatory attention, as is appropriate given its novel approach to customer acquisition as well as its rapid growth.
As a broker-dealer, it need not operate under the same requirements as registered investment advisors (like goodstead). It is not required to operate in its clients' best interest--as it is not providing investment advice--but is merely a gateway to the capital markets. Although it is exempt from this aforementioned fiduciary duty to its clients, it is nonetheless obligated it to assess the suitability of investments it offers to its clients, as well as to obtain best execution--competitive pricing, that is--for its clients.
Robinhood offers commission-free trading, which it uses to entice users. Frequent followers of goodstead know that we're all for the reduction of usage fees in the capital markets, favor investments with industry-standard commissions and low churn; and free is always our favorite price to pay. A problem arises around the simple of problem of, How does Robinhood then get paid? The answer is that they direct client orders to particular brokers, which is known in the industry as paying for order flow. This means that Robinhood isn't necessarily sending trades to brokers who offer the best prices for their clients, but those that Robinhood gets money from. And it is for this reason that Robinhood has agreed to pay the SEC $65,000,000 to end its ongoing inquiry into its order direction practices.
Even when taking into account that Robinhood charged its clients no commission for trades, its customers lost $34,000,000 in value because they paid more for trades than they would have at another broker. Additionally, Robinhood didn't properly disclose this practice, which is further problematic. Capital markets depend upon the trust of the public, and when market participants damage the public trust, every stakeholder in the market suffers injury. Robinhood must undergo additional scrutiny of its order routing practices, and submit to independent review. That will no doubt require it to seek better execution for its clients. But most likely it will mean that the days of commission-free trading at Robinhood will eventually come to an end.
Next to these, the action brought by the Massachusetts securities regulator is more foreboding. The Massachusetts Securities Division has filed a complaint that alleges that Robinhood has violated state securities laws by gamifying trading. This is a shot to the heart of Robinhood's customer acquisition model. By making trading more like fantasy sports or online gambling, it attracts customers to use its platform. It's likely that its users aren't aware of the risks they are taking--especially in instruments with embedded leverage, like options--and if they lose their shirt, they decide saving isn't for them, and so stop.
We believe that financial speculation, while a legitimate business activity, is nonetheless inherently highly risky, and its practitioners face a significant prospect of substantial loss. Trading is hard, and traders develop their skills over decades of watching tape, making mistakes, and learning from them. Day traders in the tech bubble of 2001 learned this lesson the hard way, as did retail traders in 2008, and casual volatility sellers in 2018. It's not an enterprise to be entered into lightly, certainly not made a game of, and there's quite a bit of question in our mind as to whether this is at all appropriate for retail investors. Certainly the Massachusetts Securities Division agrees, at least that Robinhood is maybe not assessing suitability too rigorously or effectively.
And why would they? Their venture capital backers require growth at all costs, be they regulatory or prudential. All problems in Capitalism are agency problems, and in this case Robinhood has exhibited in its business practices a definitional principal-agent problem. We'll continue to watch developments with interest. In the meantime, always remember: if someone offers to give you something for free, it probably isn't.
Cryptography
The two investing questions goodstead receives most often are:
How high do you think Bitcoin will go?
How high do you think Tesla will go?
These two questions have replaced the following two questions from one decade ago:
How high do you think Gold will go?
How high do you think Apple will go?
We'll address the stock-related questions next week, as they are a longer topic, and one which new research treats well. In the meantime, Bitcoin has broken through the $20,000 resistance level, and is holding steady at $22,500. This asymptotic price action takes goodstead back to the good old days of December 2017, when BTC peaked at $17,400.
The answer I give is the same as everyone else's: I don't know how high it will go, and neither does anyone else. Bitcoin is rising in price because buyers think it will rise in price. Like gold, its price is driven by current demand, current supply, cost of extraction, the inflation rate, and faith in government and/or the financial system. Animal spirits have the reigns now, and they are urging the chariot heavenward.
Bitcoin is a mania, like tulip bulbs and Beanie Babies before it. At 1.6% the size of the US public equity market, it's tiny. Because it is novel, it gives journalists something to write about, and so they do. It's like a celebrity that's famous for being famous. Accordingly, it will go up in price until it falls in price. There is more institutional money invested in crypto assets this time around, but the same problems afflict it as before: prices are too volatile to prove a store of value; and you still can't spend it in most places, so it's not a medium of exchange. Calling it a currency is a misnomer, so we don't.
How high will this asset's price go? We can determine that by using discounted cash flow analysis and a growth factor. Using these methods, which we apply to all other assets to determine value, we can say that crypto assets, which produce no cash flow, are overvalued at this or any price. Their price is set by asset holders' confidence in price stability. Their faith will be tested.