WSJ : The AI Boom That Could Make Google and Microsoft Even More Powerful

The AI Boom That Could Make Google and Microsoft Even More Powerful
Relying on tech giants for both answers and assistance, rather than just information, could entrench them into our lives more deeply than ever

Seeing the new artificial intelligence-powered chatbots touted in dueling announcements this past week by Microsoft and Google drives home two major takeaways. First, the feeling of “wow, this definitely could change everything.” And second, the realization that for chat-based search and related AI technologies to have an impact, we’re going to have to put a lot of faith in them and the companies they come from.

When AI is delivering answers, and not just information for us to base decisions on, we’re going to have to trust it much more deeply than we have before. This new generation of chat-based search engines are better described as “answer engines” that can, in a sense, “show their work” by giving links to the webpages they deliver and summarize. But for an answer engine to have real utility, we’re going to have to trust it enough, most of the time, that we accept those answers at face value.

The same will be true of tools that help generate text, spreadsheets, code, images and anything else we create on our devices—some version of which both Microsoft MSFT -0.20%decrease; red down pointing triangle and Google have promised to offer within their existing productivity services, Microsoft 365 and Google Workspace.

These technologies, and chat-based search, are all based on the latest generation of “generative” AI, capable of creating verbal and visual content and not just processing it the way more established AI has done. And the added trust it will require is one of several ways in which this new generative AI technology is poised to shift even more power into the hands of the biggest tech companies.

Generative AI in all its forms will insinuate technology more deeply into the way we live and work than it already is—not just answering our questions but writing our memos and speeches or even producing poetry and art. And because of the financial, intellectual and computational resources needed to develop and run the technology are so enormous, the companies that control these AI systems will be the largest, richest companies.

OpenAI, the creator of the ChatGPT chatbot and DALL-E 2 image generator AIs that have fueled much of the current hype, seemed like an exception to that: a relatively small startup that has driven major AI innovation. But it has leapt into the arms of Microsoft, which has made successive rounds of investment, in part because of the need to pay for the computing power needed to make its systems work.

The greater concentration of power is all the more important because this technology is both incredibly powerful and inherently flawed: it has a tendency to confidently deliver incorrect information. This means that step one in making this technology mainstream is building it, and step two is minimizing the variety and number of mistakes it inevitably makes.

Trust in AI, in other words, will become the new moat that big technology companies will fight to defend. Lose the user’s trust often enough, and they might abandon your product. For example: In November, Meta made available to the public an AI chat-based search engine for scientific knowledge called Galactica. Perhaps it was in part the engine’s target audience—scientists—but the incorrect answers it sometimes offered inspired such withering criticism that Meta shut down public access to it after just three days, said Meta chief AI scientist Yann LeCun in a recent talk.

Galactica was “the output of a research project versus something intended for commercial use,” says a Meta spokeswoman. In a public statement, Joelle Pineau, managing director of fundamental AI research at Meta, wrote that “given the propensity of large language models such as Galactica to generate text that may appear authentic, but is inaccurate, and because it has moved beyond the research community, we chose to remove the demo from public availability.”

On the other hand, proving your AI more trustworthy could be a competitive advantage more powerful than being the biggest, best or fastest repository of answers. This seems to be Google’s bet, as the company has emphasized in recent announcements and a presentation on Wednesday that as it tests and rolls out its own chat-based and generative AI systems, it will strive for “Responsible AI,” as outlined in 2019 in its “AI Principles.”

My colleague Joanna Stern this past week provided a helpful description of what it’s like to use Microsoft’s Bing search engine and Edge web browser with ChatGPT incorporated. You can join a list to test the service—and Google says it will make its chatbot, named Bard, available at some point in the coming months.

But in the meantime, to see just why trust in these kinds of search engines is so tricky, you can visit other chat-based search engines that already exist. There’s You.com, which will answer your questions via a chatbot, or Andisearch.com, which will summarize any article it returns when you search for a topic on it.

Even these smaller services feel a little like magic. If you ask You.com’s chat module a question like “Please list the best chat AI-based search engines,” it can, under the right circumstances, give you a coherent and succinct answer that includes all the best-known startups in this space. But it can also, depending on small changes in how you phrase that question, add complete nonsense to its answer.

In my experimentation, You.com would, more often than not, give a reasonably accurate answer, but then add to it the name of a search engine that doesn’t exist at all. Googling the made-up search engine names it threw in revealed that You.com seemed to be misconstruing the names of humans quoted in articles as the names of search engines.

Andi doesn’t return search results in a chat format, precisely because making sure that those answers are accurate is still so difficult, says Chief Executive Angela Hoover. “It’s been super exciting to see these big players validating that conversational search is the future, but nailing factual accuracy is hard to do,” she adds. As a result, for now, Andi offers search results in a conventional format, but offers to use AI to summarize any page it returns.

Andi currently has a team of fewer than 10 people, and has raised $2.5 million so far. It’s impressive what such a small team has accomplished, but it’s clear that making trustworthy AI will require enormous resources, probably on the scale of what companies like Microsoft and Google possess.

There are two reasons for this: The first is the enormous amount of computing infrastructure required, says Tinglong Dai, a professor of operations management at Johns Hopkins University who studies human-AI interaction. That means tens of thousands of computers in big technology companies’ current cloud infrastructures. Some of those computers are used to train the enormous “foundation” models that power generative AI systems. Others specialize in making the trained models available to users, which as the number of users grows can become a more taxing task than the original training.

The second reason, says Dr. Dai, is that it requires enormous human resources to continually test and tune these models, in order to make sure they’re not spouting an inordinate amount of nonsense or biased and offensive speech.

Google has said that it has called on every employee in the company to test its new chat-based search engine and flag any issues with the results it generates. Microsoft, which is already rolling out its chat-based search engine to the public on a limited basis, is doing that kind of testing in public. ChatGPT, on which Microsoft’s chat-based search engine is based, has already proved to be vulnerable to attempts to “jailbreak” it into producing inappropriate content.

Big tech companies can probably overcome the issues arising from their rollout of AI—Google’s go-slow approach, ChatGPT’s sometimes-inaccurate results, and the incomplete or misleading answers chat-based Bing could offer—by experimenting with these systems on a large scale, as only they can.

“The only reason ChatGPT and other foundational models are so bad at bias and even fundamental facts is they are closed systems, and there is no opportunity for feedback,” says Dr. Dai. Big tech companies like Google have decades of practice at soliciting feedback to improve their algorithmically-generated results. Avenues for such feedback have, for example, long been a feature of both Google Search and Google Maps.

Dr. Dai says that one analogy for the future of trust in AI systems could be one of the least algorithmically-generated sites on the internet: Wikipedia. While the entirely human-written and human-edited encyclopedia isn’t as trustworthy as primary-source material, its users generally know that and find it useful anyway. Wikipedia shows that “social solutions” to problems like trust in the output of an algorithm—or trust in the output of human Wikipedia editors—are possible.

But the model of Wikipedia also shows that the kind of labor-intensive solutions for creating trustworthy AI—which companies like Meta and Google have already employed for years and at scale in their content moderation systems—are likely to entrench the power of existing big technology companies. Only they have not just the computing resources, but also the human resources, to deal with all the misleading, incomplete or biased information their AIs will be generating.

In other words, creating trust by moderating the content generated by AIs might not prove to be so different from creating trust by moderating the content generated by humans. And that is something the biggest technology companies have already shown is a difficult, time-consuming and resource-intensive task they can take on in a way that few other companies can.

The obvious and immediate utility of these new kinds of AIs, when integrated into a search engine or in their many other potential applications, is the reason for the current media, analyst and investor frenzy for AI. It’s clear that this could be a disruptive technology, resetting who is harvesting attention and where they’re directing it, threatening Google’s search monopoly and opening up new markets and new sources of revenue for Microsoft and others.

Based on the runaway success of the ChatGPT AI—perhaps the fastest service to reach 100 million users in history, according to a recent UBS report—it’s clear that being an aggressive first mover in this space could matter a great deal. It’s also clear that being a successful first-mover in this space will require the kinds of resources that only the biggest tech companies can muster.

Barrons : BMW Is Pouring EV Money Into Mexico. There’s a Big Roadblock.

BMW Is Pouring EV Money Into Mexico. There’s a Big Roadblock.

Proximity to the U.S. has been a mixed blessing for Mexico historically. The mix got a bit more positive, or should have, with last year’s U.S. Inflation Reduction Act. This deftly misnamed legislation provides subsidies up to $7,500 for U.S. buyers of electric vehicles, providing they are largely built in North America—Mexico included.

That could catalyze a new flood of investment for a Mexican auto sector that already exports more than $100 billion annually, mostly North. Bayerische Motoren Werke (ticker: BMW BMW –1.70% . Germany) indicated as much on Feb. 3, pledging 800 million euros ($856 million) to expand Mexican production into the EV age.

“We have an opportunity that we haven’t had all century, and there is no way we will let us pass it by,” Mexican Foreign Minister Marcelo Ebrard promised.

Unfortunately, his boss, President Andres Manuel Lopez Obrador, seems bent on doing just that. AMLO, as the 69-year-old leader is known, “grew up with the standard view of the 1970s and ‘80s: very Mexico-centric and with a strong role for the government,” says Earl Anthony Wayne, a former U.S. ambassador to Mexico, now co-chair of the Wilson Center’s Mexico Institute.

One pillar of that view is the country controlling its own energy resources. AMLO extended that to electricity, pushing through a law loaded with preferences for state monopolies Petróleos Mexicanos and Comisión Federal de Electricidad.

Car manufacturing requires lots of power, which companies are not sure Pemex and CFE can provide. Auto makers also want renewable energy to meet their global green commitments. Not a high priority for the state firms or their president. “While the rest of the world is racing toward renewables, Mexico has created complications,” says Amy Glover, head of Mexico City-based consultant Agil-e.

That could be holding up billions more in EV investment, says Alejo Czerwonko, chief investment officer for emerging markets Americas at UBS Global Wealth Management. “We’d be seeing many times the interest if there were actively supportive state policies,” he says.

Foreign minister Ebrard recently told journalists EV champion Tesla (TSLA) is “very close” to a Mexican announcement. The company has kept mum.

Some state governors are more enthusiastic about auto investment—particularly Samuel Garcia, the 35-year-old leader of Nuevo Leon, which includes the automotive nexus of Monterrey. “He’s been quite clever in negotiating with AMLO,” says Manuel Montoya Ortega, who heads a regional industry lobby. Mexican law puts power generation and distribution squarely under federal control, though.

AMLO himself is slated to leave the stage in December 2024, when his constitutionally mandated single term ends. Ebrard looks to be staking turf as a pro-business successor. No one is holding their breath for a policy sea change, however. “Nationalization of energy resources has been central to Mexican identity,” Glover says. “The energy transition is also a psychological transition.”

AMLO, in power since 2018, has outperformed expectations in other ways. His “republican austerity” has shrunk both budget and current account deficits. (Remittances from the U.S. have nearly doubled, cushioning his domestic cutbacks.) The peso’s value has risen, a global rarity during four years of dollar ascendancy. That’s made Mexico a fixed-income, if not equity, favorite. “On the broad level, AMLO is pragmatic,” says Yong Zhu, portfolio manager for emerging markets debt at DuPont Capital Management.

Barrons : Buy Toast Stock. It’s More Than Just Restaurant Payments.

Buy Toast Stock. It’s More Than Just Restaurant Payments.

Americans who have dined in restaurants abroad have long been familiar with a waiter with a hand-held device taking their credit-card payment at their table. It’s in contrast to the largely U.S. ritual of handing over your card, sitting impatiently while the waiter punches the transaction into a point-of-sale system somewhere in the back of the restaurant, only to return with a paper receipt for you to sign.

U.S. diners are finally getting a taste of their international peers’ more seamless experience, thanks to next-generation providers like Fiserv FISV –0.74% ’s (ticker: FISV) Clover, Block SQ –1.25% ’s (SQ) Square, and, in particular, Toast TOST –0.13% (TOST). Sleek terminals for taking orders and payments are the most visible features to diners, but Toast also has a suite of software that aims to act as an operating system for restaurants. It replaces analog or more labor-intensive processes throughout the kitchen and dining room, saving time and effort for staff and customers alike.

“The efficiency is definitely on another level,” says Criterion Thornton, a 30-year veteran of New York City’s restaurant industry and these days general manager at Ingas Bar in Brooklyn, a neighborhood tavern that offers seasonal menu items like duck poutine croquettes. “Just how intuitive the elements are is its real strength.”

Ingas uses Toast for ordering and payment processing, for its gift-card and rewards program, and for hours tracking and payroll management for its staff of about 30. Toast also offers tools for inventory management; digital ordering and delivery; working capital loans, and more. The company aims to be a one-stop shop for restaurants to incorporate technology into their operations to increase productivity and improve the experience for customers and employees.

Toast is powering the digital transformation of a staid industry with low profit margins and demanding customers. The company is 100% focused on restaurants, setting it apart from competitors like Square or Clover, which offer one-size-fits-all platforms. Its products are currently used by about 74,000, or some 9%, of the estimated 860,000 eateries in the U.S. It takes a percentage of each transaction it processes and sells subscriptions to its software services.

Toast hasn’t had an easy go of it in the stock market. Founded in 2011, the company completed its initial public offering in September 2021 at $40 per share, near the peak of the pandemic bull market. The stock rose as high as $65 in the following months before falling to as low as $12 last year. It has since recovered to the low $20s, giving Toast a market capitalization of about $12 billion, including net cash on the balance sheet of nearly $1 billion, or almost $2 per share.

That cash should be enough to cover Toast’s path to profitability. Analysts expect a cumulative net loss of about $600 million from 2023 to 2025 and net profits in 2026. Management expects Toast to reach profitability on Ebitda—earnings before interest, taxes, depreciation, and amortization—in 2023, while Wall Street forecasts a narrow full-year Ebitda loss but a gain in the second half. The Street sees revenue growing from $2.7 billion in 2022 to $6.7 billion in 2026.

That’s a lot of growth, and payments is a scale business—as more restaurants use Toast’s readers to process more transactions, profit margins will expand. Ditto for many of its software-as-a-service offerings. As Toast’s customer base grows, the cost to bring in new ones should shrink as a percentage of overall sales, and average revenue per user could increase over time as restaurants add more services.

“This is a classic example of a small company in the expensive land grab phase [of its growth],” says Gregg Fisher, founder and portfolio manager at Quent Capital, a global small-cap fund with about $1 billion under management. “There are a lot of acquisition costs to get a customer up and running, but once they’re there, they’ll be there for a while.... As Toast gets bigger, it’s going to become profitable.”

Toast’s most recent reported quarter shows that operating leverage: Total revenue was up 55% year over year, to $752 million, on 53% payments volume growth and 60% subscription growth. The company’s gross profit was up 82%, to $151 million, for a 20% margin. It burned $80 million of cash in the quarter.

That growth is on the back of more restaurants signing up and existing ones increasing their usage. About 62% of Toast’s customers used at least four of its subscription services—out of roughly 15 available—at the end of the third quarter, up from 46% two years earlier.

“We expect them to gain market share going forward,” says Wells Fargo’s Jeff Cantwell. “That’s a function of them having a very high-quality platform across software and payments. So we expect faster revenue growth than peers as well as the ability to expand profit margins as they grow.”

Cantwell expects Toast to earn a market share of 30% of small and medium-size U.S. restaurants, or nearly 200,000 locations, over the next five years. He rates the stock a Buy with a $27 price target, up 15% from Wednesday’s close. That’s based on 3.8 times Cantwell’s estimate of 2023 revenue, a premium to comparable software and payments companies like Block’s 2.2 times and Lightspeed Commerce LSPD –3.73% ’s (LSPD) two times, due to Toast’s potential for faster growth.

Toast is a win-win for restaurants and their customers. While it hasn’t been for its public investors so far, its future looks more appetizing.

Barrons : Nestlé Spent Billions on a New Peanut-Allergy Treatment. It Learned Gr

Nestlé Spent Billions on a New Peanut-Allergy Treatment. It Learned Great Medicine Isn’t Easy Money.


About the author: Allan Sloan is an independent business journalist and seven-time winner of the Loeb Award, business journalism’s highest honor.

A great medical breakthrough doesn’t necessarily make for a great medical investment. Nestlé, which is best known for products like chocolate chips, Purina petfood, and Nescafe coffee but also has a sizable health-sciences business, now realizes this.

Our story involves the first Food and Drug Administration–approved treatment for the peanut allergies that plague millions of families, including mine. It’s called Palforzia. Nestlé NESN +0.44% , a Switzerland-based multinational giant, acquired it in 2020 by purchasing a U.S. company called Aimmune Therapeutics at a cost of about $2.6 billion. The FDA approved the treatment earlier that year.

However, Nestlé’s problems with Palforzia, on which it says it expects a “significant impairment on its books,” are an example of what can happen when a big company decides to try to get a piece of the U.S. healthcare business—only to discover that the business is more complicated than it seems from the outside.

Because so many people are allergic to peanuts, shelling out big bucks for the owner of Palforzia seemed sensible. The name Palforzia, Nestlé told me, consists of “pal” for “peanut allergy” and “forzia” for strength. But alas, the purchase of Palforzia has turned into a financial fiasco.

“It was much, much harder to get the patient takeup that we had anticipated, and that we felt was expected because of the strong underlying medical need,” Nestlé CEO Mark Schneider said at an investor seminar, at which he announced that Nestlé has put Palforzia up for sale.

What’s startling is that the difficulties in signing up Palforzia users seem to have come as a surprise to a consumer-conscious company like Nestlé.

Those problems wouldn’t surprise any family that uses Palforzia. Getting kids with peanut allergies to the point that they can safely take Palforzia, designed for children ages 4 to 17, is difficult and time-consuming. Palforzia, you see, isn’t a magic pill like an antibiotic. It doesn’t cure peanut allergies. Rather, it protects peanut-allergic children from suffering horrible consequences if they ingest small quantities of peanuts or peanut products.

But before being approved to take Palforzia, a child must make at least 11 hour-plus doctor visits over a six-month period to build up tolerance for peanuts. That’s a visit about every two weeks. At each visit, the potential Palforzia patient is given an increased amount of peanut flour—and has to wait for an hour under medical supervision in case the increased dose triggers side effects.

In today’s world, where all the adults in so many households have jobs, it’s difficult for lots of families to commit to all those visits. That’s an obvious hindrance to signing up customers en masse.

I know about the up-dosing situation because one of my grandchildren uses Palforzia. Another grandchild was part of a clinical trial designed to build up children’s peanut tolerance so they don’t have to worry about going into anaphylactic shock if they accidentally consume peanuts. My grandkids were fortunate to have extended family nearby and enough child care and parents with job flexibility to let them do the required visits. But many families don’t have that kind of flexibility.

Another obstacle to Palforzia getting massive numbers of users, I suspect, is the wholesale price that Nestlé put on it: about $1,000 a month. Fortunately, medical insurance covers almost all the cost for my Palforzia-taking grandchild.

Palforzia isn’t a cure for peanut allergy—it’s a continuous maintenance dose of peanut flour. You don’t give a kid a Palforzia capsule to swallow. Rather, you open the capsule, spill the peanut flour inside it into something like applesauce or an unheated drink, and make sure that the kid consumes it—and then ensure that the kid doesn’t do anything excessively strenuous for an hour.

My peanut-allergic grandchild who’s not on Palforzia but whose peanut tolerance was built up by the clinical trial takes a daily maintenance dose of peanut M&Ms after dinner. (Yes, a doctor with a sense of humor actually wrote “peanut M&Ms” on a prescription blank.)

The company declined to say how many people are taking Palforzia compared with its projections. “However,” a spokesperson wrote me, “we can say that the numbers are not where we hoped they’d be.”

I’d love to be able to tell you whether Palforzia’s problems came as a total surprise to Nestlé, or whether it just underestimated them, but the spokesperson didn’t answer that. “We have believed in Palforzia’s ability to dramatically improve patients’ lives from the start and now know that patient recruitment for this type of niche treatment is better suited to a specialized pharma company,” the spokesperson wrote me.

Translated into English from corporatese, this means that Nestlé realizes it messed up.

The new owner of this medical breakthrough may end up paying a price reasonable enough for the purchase to become a great medical investment. And it may be able to cut Palforzia’s price and develop ways to reduce the number of up-dosing visits a kid needs. That could make it an even greater investment.

My family has benefited enormously from Palforzia. I hope that it’s around long enough—and becomes accessible enough—for lots of other families to benefit from it, too.

Barrons : Energy Will Keep Booming. This Spanish Refiner’s Stock Stands to Gain.

Energy Will Keep Booming. This Spanish Refiner’s Stock Stands to Gain.

Energy companies had a great year in 2022. Investors might wonder whether the sector has peaked now that oil prices have fallen, but Spain’s Repsol looks well placed to benefit from the tailwinds caused by Russia’s invasion of Ukraine and its knock-on effect for fuel imports.

Repsol (ticker: REP.Spain) is the product of the privatization of the former Spanish state assets in the energy sector, giving it a dominant position in the country’s refining industry.

It is Repsol’s refining operations that could see it outperform energy peers this year. The European Union’s ban on Russian fuel imports from Feb. 5 is expected to support high refining margins, even as oil-and-gas prices normalize. Repsol makes around 30% of its profit from refining, according to Bank of America, one of the highest levels of all European energy companies.

Rapid international expansion through the 1990s gave Madrid-based Repsol a diversified base of oil-and-gas production assets. The company has a market value of 18.5 billion euros ($19.8 billion).

Repsol was propelled into one of the most high-profile business disputes of recent years in 2012, when its YPF subsidiary was nationalized by the then government of Argentina, forcing it to slash its dividend and sell billions in assets to shore up its balance sheet.

Repsol eventually won $5 billion in compensation for the YPF case, and has subsequently cut back on exploration-and-production spending and invested in building out its renewable-energy portfolio.

Shares are up 33% in the past year to a recent €15. Analysts at Bank of America have a target price of €19.55 on the stock, implying 30% upside.

The potential value to be unlocked in Repsol’s portfolio has been shown by recent stake sales in its upstream and renewables units. Repsol last year sold a 25% stake in its oil-and-gas exploration division to U.S. fund EIG for $4.8 billion, valuing the division as a whole at $19 billion, including debt.

That came after the sale of a 25% stake in its renewable-energy unit to Credit Agricole Assurances and asset manager Energy Infrastructure Partners, with a valuation for the unit of €4.4 billion, including debt.

Investment bank and asset manager Bestinver calculates that those stake disposals mean the downstream unit is valued at just 1.7 times its earnings, and a reassessment of its value could boost Repsol shares toward its target price range of €19 to €20.20.

Repsol is valued at 4.7 times its expected earnings over the next 12 months, against a five-year average of 7.8 times according to FactSet. Full-year sales for 2022 are expected to rise to €88.44 billion from €52.13 billion the prior year, before falling back to €78.91 billion in 2023.

Repsol has committed to distributing 25% to 30% of its cash from operations to shareholders, and Bestinver calculates it could distribute at least €5.10 a share, or more than a third of its market capitalization, up to 2025. Repsol has improved the point at which it breaks even on free cash flow to well below $40 a barrel of Brent crude, from around $50 about five years ago, according to Moody’s.

A long-term question for the stock, as for all the energy sector, is its intention to reduce carbon emissions. Repsol aims for net-zero emissions by 2050 and an installed renewable-energy capacity of 20 gigawatts by 2030, from 1.8GW of current capacity.

However, Russia’s invasion of Ukraine has focused attention on the merits of fossil-fuel operations like Repsol’s, and the resulting profits should ease its path for clean-energy investments.

>>> US Close Dow +0.50% S&P +0.22% Nasdaq -0.61% Russell +0.18%

Closing Stock Market Summary

Today's trade was decidedly mixed with buyers and sellers both lacking conviction ahead of next Tuesday's key inflation report in the form of the January Consumer Price Index. The Dow Jones Industrial Average and S&P 500 closed with modest gains while the Nasdaq finished the day with a decline. Notably, there was a late afternoon push higher, but the S&P 500 was unable to reclaim a position above the 4,100 level.

Market internals reflected the mixed action behind today's price action. Advancers led decliners by an 11-to-10 margin at the NYSE while decliners led advancers by roughly the same margin at the Nasdaq.

Lagging mega cap stocks kept pressure on index level performance. The Vanguard Mega Cap Growth ETF (MGK) fell 0.6% while the Invesco S&P 500 Equal Weight ETF (RSP) registered a 0.3% gain. Tesla (TSLA 196.89, -10.43, -5.0%) was a losing standout among the mega cap stocks amid investors' concerns that a potential Department of Transportation order could force Tesla to make its charging stations available to other electric vehicles. 

A weak showing from Tesla, along with Amazon.com (AMZN 97.61, -0.63, -0.6%), led the consumer discretionary sector (-1.2%) to last place among the 11 sectors. Earnings-driven losses for a few smaller components, namely Expedia Group (EXPE 107.64, -10.07, -8.6%) and Mohawk Industries (MHK 115.77, -5.70, -4.7%), also contributed to the sector's underperformance.

On the flip side, the energy sector (+3.9%) logged the biggest gain by a wide margin as oil prices reclaimed lost ground. WTI crude oil futures rose 2.6% to $79.66/bbl in response to Russia saying it is going to cut production by 500,000 barrels per day in March in response to international sanctions.

The Treasury market was also mixed today. The 10-yr note yield rose six basis points to 3.74%, losing ground after the University of Michigan Consumer Sentiment Index showed year ahead inflation expectations increasing to 4.2% from 3.9%, while the 2-yr note yield fell one basis point to 4.51%.

Nasdaq Composite: +12.0% YTD
Russell 2000: +9.0% YTD
S&P Midcap 400: +8.6% YTD
S&P 500: +6.5% YTD
Dow Jones Industrial Average: +2.2% YTD

Reviewing today's economic data:

  • February Univ. of Michigan Consumer Sentiment - Prelim 66.4 ( consensus 65.0); Prior 64.9
    • The key takeaway from the report is the understanding that the year-ahead inflation expectation increased versus January, raising concerns, along with angst over rising unemployment, about consumers' future discretionary spending capacity.
  • The Treasury Budget for January showed a deficit of $38.8 bln versus a surplus of $118.7 bln a year ago. The Treasury Budget data is not seasonally adjusted, so the January deficit cannot be compared to the deficit of $85.0 bln for December.

There is no U.S. economic data of note on Monday.

WSJ : Wall Street to Pay $1.8 Billion in Fines Over Traders’ Use of Banned Messa

Wall Street to Pay $1.8 Billion in Fines Over Traders’ Use of Banned Messaging Apps
Eleven banks and brokerages admit they violated rules that require storage of written communications

WASHINGTON—Eleven of the world’s largest banks and brokerages will collectively pay $1.8 billion in fines to resolve regulatory investigations over their employees’ use of messaging applications that broke record-keeping rules, regulators said Tuesday.

The firms include brokerage units of Bank of America Corp. BAC -1.15% , Barclays BCS -2.01% PLC, Citigroup Inc., Credit Suisse Group AG CS +3.48% , Deutsche Bank AG DB -3.56% , Goldman Sachs Group Inc., GS +0.73% Morgan Stanley, UBS Group AG UBS -0.76% and Nomura NMR 0.49% Holdings Inc. Brokerage firms Jefferies LLC and Cantor Fitzgerald & Co. also settled the claims with the Securities and Exchange Commission and the Commodity Futures Trading Commission.

The fines, which many of the banks had already disclosed to shareholders, underscore the market regulators’ stern approach to civil enforcement. Fines of $200 million, which many of the banks will pay under the agreements, have typically been seen only in fraud cases or investigations that alleged harm to investors.

But the SEC, in particular, has during the Biden administration pushed for fines that are higher than precedents, saying it wants to levy fines that punish wrongdoing and effectively deter future potential harm. The SEC’s focus on record-keeping is likely to be extended next to money managers, who also have a duty to maintain written communications related to investment advice.

Last month, the SEC alleged that hedge-fund manager Deccan Value Investors LP and its chief investment officer failed to maintain messages sent over Apple iMessage and WhatsApp. In some cases, the chief investment officer directed an officer of the company to delete their text messages, the SEC said. The claims were included in a broader enforcement action, which Deccan settled without admitting or denying wrongdoing.

The Wall Street Journal reported last month that the settlements announced Tuesday were likely to top $1 billion and would be announced before the end of September.

Eight of the largest entities, including Goldman Sachs and Morgan Stanley, agreed to pay $125 million to the SEC and at least $75 million to the CFTC. Jefferies will pay a total of $80 million to the two market regulators, and Nomura NMR 0.49% agreed to pay $100 million. Cantor agreed to pay $16 million.

The SEC said it found “pervasive off-channel communications.” In some cases, supervisors at the banks were aware of and even encouraged employees to use unauthorized messaging apps instead of communicating over company email or other approved platforms.

“Today’s actions—both in terms of the firms involved and the size of the penalties ordered—underscore the importance of recordkeeping requirements: they’re sacrosanct. If there are allegations of wrongdoing or misconduct, we must be able to examine a firm’s books and records to determine what happened,” said SEC Enforcement Director Gurbir Grewal.

Bank of America, which faced the highest fine from the CFTC, had a “widespread and long-standing use of unapproved methods to engage in business-related communications,” according to the CFTC’s settlement order. One trader wrote in a 2020 message to a colleague: “We use WhatsApp all the time, but we delete convos regularly,” according to the CFTC.

One head of a trading desk at Bank of America told subordinates to delete messages from their personal devices and to communicate through the encrypted messaging app Signal, the CFTC said. The head of that trading desk resigned this year, although the bank was aware of his conduct in 2021, the CFTC said.

At Nomura, one trader deleted messages on his personal device in 2019 after being told the CFTC wanted them for an investigation, the agency said. The trader made false statements to the CFTC about his compliance with the records request, the regulator said.

Broker-dealers have to follow strict record-keeping rules intended to ensure regulators can access documents for oversight purposes. The firms settling with the SEC and CFTC admitted their employees’ conduct violated those regulations.

JPMorgan Chase & Co.’s brokerage arm was the first to settle with the two market regulators over its failure to maintain required electronic records. JPMorgan paid $200 million last year and admitted some employees used WhatsApp and other messaging tools to do business, which also broke the bank’s own policies.

Regulators discovered that some JPMorgan communications, which should have been turned over for separate enforcement investigations, weren’t collected because they were sent on employees’ personal devices or apps that the bank didn’t supervise.

WSJ : Wall Street Firm Oversees Billions of Dollars Backing Tether

Wall Street Firm Oversees Billions of Dollars Backing Tether
Cantor Fitzgerald helps manage $39 billion Treasury portfolio that makes up lion’s share of stablecoin’s reserves

Billions of dollars in Treasurys that back the world’s most traded cryptocurrency are being run on Wall Street.

Tether Holdings Ltd., the secretive Hong Kong-based owner of stablecoin tether, is using Cantor Fitzgerald to help oversee its $39 billion bond portfolio, according to people familiar with the matter. Details of how Tether managed those assets haven’t been widely known.

Tether has faced scrutiny and paid fines over how it manages and what it says about the assets underlying its stablecoin. It has tried to allay questions about its holdings by releasing reports from accounting firms. It began moving its reserves into the Wall Street brokerage in late 2021, around the time it reached a settlement with a regulator, one of the people said.

The securities are part of the $69 billion of bonds, cash and loans that back tether, the third-largest cryptocurrency by market cap and most traded by volume, according to CoinMarketCap.com.

Tether’s stability—each coin is always supposed to be worth $1—is a critical piece of the cryptocurrency ecosystem. It depends on investors’ faith in the assets that back tether. That makes the company similar to a more traditional financial institution such as a bank or a money-market fund. And like those institutions, it requires sophisticated portfolio management and trading strategies.

The portfolio is an indication that some firms on Wall Street are willing to look past the regulatory and governance concerns that have characterized the crypto space for a chance to manage some of the billions of dollars in assets that some cryptocurrency companies have amassed.

U.S. regulators told banks last month that they would exercise caution in reviewing banks’ proposals to engage with the crypto market after a series of failures of companies in the industry.

At times, other U.S. financial institutions have been reluctant to involve themselves in Tether’s business. In 2017, Wells Fargo & Co. stopped processing the company’s wire transfers as a correspondent bank for its Taiwanese accounts.

Tether and Cantor didn’t reply to requests for comment.

Despite Tether’s importance to the crypto ecosystem, the company hasn’t shared much information on its ownership or holdings. It has asked courts to prevent the name of its chief investment officer from being revealed or for detailed information on its holdings being made public through open records requests. Last week, The Wall Street Journal reported that 86% of the company was owned by four men and that its executives have little experience at that scale of finance.

That has in the past led to some missteps. In 2021, Tether and related companies paid $61 million to settle two investigations that found Tether had regularly misrepresented the true state of its reserves to the public between 2016 and 2019. One of those settlements also prohibited the company from offering its products and services to New York residents. The company has said it no longer operates in the U.S. or allows U.S.-based users onto its platform.

Tether didn’t admit or deny wrongdoing in either settlement.

Tether has never released audited financials. As part of one of the settlements, it began publishing more information on its holdings. The company produced its most recent data on Thursday, saying it ended 2022 with $67 billion in its reserves backing the $66.1 billion tether issued after generating $700 million of profits in the fourth quarter.

The company said that it no longer held any commercial paper, reduced its loan exposure and that the $39.2 billion in Treasurys it held accounted for 59% of its portfolio. The rest of its assets included billions of dollars held in money-market funds, cash, reverse repurchase agreements, corporate bonds and precious metals.

Cantor, a privately held global financial firm that is one of the largest intermediaries for Wall Street traders, has been interested in crypto for years. In 2017, the firm said it would offer futures contracts tied to the price of bitcoin on a small futures exchange that it runs.

An affiliate of Cantor’s, BGC Partners, was planning to launch a crypto exchange by the first quarter of 2023, Chief Executive Howard Lutnick said last year on a conference call with analysts.

The firm’s aggressiveness in the past has taken it into riskier business lines. In 2016, a sports-gambling affiliate of the company paid $22.5 million to settle an investigation into its involvement in illegal gambling and money laundering.

By hiring Cantor, Tether is getting a firm that is deeply entrenched in the Treasury market. Cantor is one of the 25 so-called primary dealers for the U.S. Treasurys market, a status that allows them to trade directly with the Federal Reserve Bank of New York and underwrite sales of U.S. government debt.