Infrastructure Bill Could Influence How States Select Transportation Projects
Virginia’s ‘Smart Scale’ program offers an example of how a more-calibrated approach can work—and generate controversy
See attached pdf
Researchers Infect Volunteers With Coronavirus, Hoping to Conquer Covid-19
So-called challenge trials have long been used to study infections, but so far only the U.K. is doing them for Covid-19
See attached pdf
Europe’s power companies still rely on coal despite green plans
Rising prices may spur populist backlash as generators switch to renewable fuels
Even as European power companies report ever-greener long-term transformation plans, they are planning to burn more coal in the near term.
Economically, they have little choice if they are to follow European regulations on carbon price charges while also minimising electricity costs for their end consumers. And in any case, they are likely to be short of gas this winter.
The issue for the generating companies, their regulators and the rate-paying public comes down to the comparative cost of generating power from gas.
The intent of Europe’s regulations and its emissions market has been to raise the total cost of coal-fired power to the point where economics compel the fuel’s replacement with renewables, nuclear, or (somewhat cleaner) gas. But the emissions market has arguably not been doing its job lately.
Under the EU Emissions Trading System, polluters have to buy permits to emit carbon above agreed levels. Companies that emit less than agreed levels can sell permits to pollute, thus providing an incentive to cut emissions. In theory, this should make coal more expensive and gas cheaper.
However, after taking into account the price of emissions allowances, the cost of generating power with gas in Germany in the last week of August was about €104 per megawatt hour, while the cost of generating power with coal was about €97 per megawatt hour. Results may vary, depending on the heat efficiency of a coal or gas generator, but those price levels reflect the current market.
There is no question that the power companies’ managements are unhappy with getting coal for Christmas but it is cheaper to use.
Part of the reason for this is that the prices of carbon emission allowances have not risen as sharply as those for coal or gas. This could be due to the imperfect operations of the European carbon credit scheme.
But I would also suspect that energy trading desks would be chary of owning a lot of carbon emissions credits because of the potential for Russia to increase gas supplies more than expected, leading to a price crash.
At the moment though, “natural” gas, the transition fuel to a fully renewable energy, circular economy future, is in short supply. This is thanks in part to Gazprom, the Russian gas giant and instrument of state energy policy.
As one big investor in Russia put it to me: “They needed to show Europe what would happen if Nordstream 2 (the controversial gas pipeline from Russia to Germany) was not fully approved and completed.” So the investor says Gazprom has been filling storage in Russia, in effect making it more expensive to do likewise in the EU.
Gazprom has long been a convenient villain for those looking to attribute blame for rising gas prices. It has always vigorously defended its actions in the gas market in the past and can be expected to continue to do so. Low levels of gas stored by Gazprom this year in Europe could be because of technical issues, or mere coincidence.
However, it has done well out of the European gas supply squeeze, with the rouble share price increasing from 210 in January to 315 this past week. Even in dollars, Gazprom is above the five-year share price high and has a forward dividend yield in the low double digits. But then other Russian energy company shares have high yields and low prices.
In any event, according to futures market prices for the next several months, the price of gas at TTF, the Dutch delivery hub that is effectively the base rate for European gas prices, should peak in December or January, just as Nordstream 2 is planned to come fully on line.
Even then, though, gas prices will be substantially higher than they were in 2019 and two or three times what is expected in the US. Demand is likely to continue to stay strong.
Renewables-intensive European companies may have to use coal power now, but they, their investors, and their lenders want new cleaner plants.
Take Uniper, the German power generation giant, for example. It put out an investor presentation last month with a proud headline “Decarbonisation efforts in Europe — Coal exit ahead of plan”. Like other European generators, Uniper is closing (or mothballing) coal facilities and spending on “hydrogen infrastructure development”.
If such moves push gas prices higher, though, there has to be a populist political risk to European greening. As ratepayers’ bills are opened this winter, we will see if demagogues seize an opportunity.
Biotech Is Due for a Comeback. 5 Stocks That Could Lead a Revival.
The market is littered with biotech stocks whose prices have fallen by more than half since the start of the year.
The list of big losers is long and, for biotech investors, more than a bit painful. The fallen stocks include established mid-cap biotech names like bluebird bio (ticker: BLUE), now down 57.7% on the year; Acadia Pharmaceuticals (ACAD), down 66.9%; and AbCellera Biologics (ABCL), down 57.9%. Sarepta Therapeutics (SRPT), once a large-cap name, has a market value that is $7.1 billion less than when the year began.
“By mid-August, family and friends were stealthily moving fragile objects out of the reach of biotech investors,” said a recent note from a biotechnology analyst at Cowen.
That widespread pain across small-cap and mid-cap biotech, and beyond, may come as a surprise at a moment when shares of Moderna (MRNA) and BioNTech (BNTX), the two companies that developed the most effective Covid-19 vaccines on the market, have climbed 273.3% and 307.9% so far this year, respectively.
Their skyrocketing share prices, however, are the exception in the sector. The SPDR S&P Biotech exchange-traded fund (XBI) is down 4%, during a period when the S&P 500 index has climbed 20.4%. Another ETF that tracks biotech, the iShares Biotechnology (IBB), is up on the year, but is capitalization-weighted, meaning that much of its assets are dedicated to larger names. Moderna and BioNTech alone make up 13.5% of its portfolio, and Jefferies analyst Steven DeSanctis calculated in a recent note that Moderna contributed 8.4% of its return.
There have been renewed signs in recent weeks, however, of substantial value hiding among the biotech dross.
In late August, Pfizer (PFE) paid a 203.8% premium over the previous day’s closing price for Trillium Therapeutics (TRIL), a biotech with two promising cancer drugs. And earlier last month, Sanofi (SNY) paid a 30% premium for Translate Bio (TBIO), a messenger RNA pioneer.
In an effort to find more-attractive bets in biotech, we talked to investors and analysts who focus on the field. They offered a list of interesting names, including Compass Pathways (CMPS), the United Kingdom–based biotech company testing the chemical in psilocybin mushrooms as a depression treatment, and Acceleron Pharma (XLRN), which is working on a drug for a rare cardiovascular condition.
Other picks include year-to-date losers AlloVir (ALVR), down 48.3% this year; the genetic testing firm Invitae (NVTA), down 27.3%; and the aforementioned Sarepta, down 53.5%.
Close watchers of the biotech market have different explanations as to why the sector has been so weak since early February. The underperformance comes after a notably strong 2020, and the major ETFs that track the sector still slightly outpace the S&P 500 over a two-year window.
“We’ve seen a lot of uncertainty with the FDA. That’s kind of bleeding into sentiment in the sector. ”
— Neena Bitritto-Garg, Citigroup analyst
“It basically overshot during 2020,” says Ziad Bakri, manager of the T. Rowe Price Health Sciences fund (PRHSX). “The sector got a little too hot, and probably got a little bit ahead of itself, toward the end of last year.”
Investors and analysts widely agree that the slump since February has something to do with confounding signals coming out of the U.S. Food and Drug Administration, an agency that has enormous sway over the fate of the sector and one that has been without a permanent leader since President Joe Biden assumed office.
“We’ve seen a lot of uncertainty with the FDA,” says Neena Bitritto-Garg, an analyst at Citigroup. “That’s kind of bleeding into sentiment in the sector.”
In March, analysts started ringing alarm bells about a series of unexpected FDA actions after surprise moves by the agency led to sharp drops in share prices of Acadia and FibroGen (FGEN). The agency’s decision to approve Biogen’s (BIIB) Alzheimer’s disease therapy in June, despite limited evidence for its efficacy, drew widespread criticism and raised even more questions about the agency’s direction.
Investors have also worried about a Federal Trade Commission warning earlier this year that it intended to take a more aggressive approach toward regulating pharmaceutical mergers, not to mention the resurfacing of the perennial drug-pricing debate.
Another drag on the sector has been the slow pace of biotech mergers and acquisitions after a busy 2020.
The investment case for small- and mid-cap biotech stocks often relies on those companies eventually being acquired, notes Alethia Young, an analyst at Cantor Fitzgerald. “I think people had lost hope,” she says.
Another factor, cited by Ritu Baral, an analyst at Cowen, may be that the fire hose of initial public offerings in biotech has stretched investors’ capital very thin. “We think it has eaten into the liquidity in the greater biotech market,” Baral says.
Biotech stocks showed signs of life in late August, and the SPDR S&P Biotech rose 13.8% from Aug. 19 to Sept. 1.
As deal making by pharmaceutical companies seems to be reviving and worries over the FDA ease, investors could place a broad bet on the recovery of small- and mid-cap biotech names by buying the SPDR S&P Biotech.
For investors with more ambition and patience, the broad weakness in biotechnology creates opportunities to find the next breakout star at a bargain price.
Here are five stocks highlighted by the experts we consulted, ranked by market value:
Acceleron Pharma
Acceleron is up 1.4% on the year, and T. Rowe’s Bakri says it has lots of room to grow.
The company is developing a drug called Sotatercept to treat pulmonary arterial hypertension, a rare cardiovascular condition that can become fatal over time.
“This is a market with a ton of value in it,” Bakri says.
In 2017, Johnson & Johnson (JNJ) spent $30 billion to buy a company that focused on the disease. Acceleron’s Sotatercept is in Phase 3 trials, and Bakri says that the Phase 2 results were very positive. “The data look outstanding in Phase 2,” he says. “The doctors are excited about it; it’s a well-characterized market, meaning there’s very little commercial risk if this works in Phase 3.”
While clinical risk remains, Bakri thinks it’s relatively low. “There are multiple lines of evidence that this seems to work,” he says.
Invitae
Shares of the genetic testing firm Invitae are down 27.3% this year, but that hasn’t dampened Eli Casdin’s enthusiasm for the stock.
Casdin, founder and chief investment officer of Casdin Capital, has recommended the stock to Barron’s before, including at our Biotech Roundtable in September 2019. The stock is up 61.2% since then, but has fallen sharply since February along with the rest of the sector. He says that the company’s fundamental business remains strong.
“That’s the thing that gives investors confidence,” Casdin says. “Markets correct on a macro. Business is still ripping on a micro, and penetration rates are incredibly low. Oh, this thing has a long way to go.”
Invitae generated $116.3 million in revenue in the second quarter of 2021, up 152% from the same quarter the previous year. The company offers a range of genetic tests, including prenatal screenings and tests that can help target cancer treatments.
Casdin says that volumes and revenues have tripled over the past three years, and he expects them to triple again over the next three years.
“I think it’s a great long-term opportunity,” he says.
Sarepta Therapeutics
Shares of Sarepta dropped 51.3% on a single day in early January, when the company shocked investors with disappointing data on a small trial of its gene therapy for a serious disorder known as Duchenne muscular dystrophy. The stock has not recovered.
Janus Henderson stockpicker Andy Acker, who leads Janus’ Health Care Sector Research Team and manages the Janus Henderson Global Life Sciences fund (JAGLX), thinks that Sarepta’s next trial of the same gene therapy could turn out better.
“There are a number of reasons why we think that study failed, and why the next study still has a good chance of success,” he says.
Data from the new trial won’t be available until late 2022 or early 2023, so a bet on an improved result will take some time to play out.
Still, Acker says that many had expected shares to climb over $200 if the data had been positive in January, and that they could still get that high. The stock is trading below $80 per share.
Compass Pathways
A pharmaceutical based on the compound that gives magic mushrooms their kick sounds like a dorm-room fantasy, but it’s no hallucination.
Compass is running a Phase 2b trial of a psilocybin therapy in patients suffering from treatment-resistant depression that is expected to report data by the end of the year. Investors have soured on Compass, and its American depositary receipt are down 30.2% this year.
“People are kind of discounting it right now,” says Citi’s Bitritto-Garg. “There’s some skepticism around whether or not psychedelics can actually be FDA-approved drugs.”
Yet as Bitritto-Garg notes, the FDA has already approved one medicine derived from cannabis. Cowen’s Baral, who also likes Compass, says that “there’s significant potential upside for that stock” when it reports its Phase 2b data later this year.
AlloVir
Shares of AlloVir are down 48.3% this year, and Piper Sandler analyst Christopher Raymond says there’s no good reason for it.
The company is developing what’s called a multivirus specific T-cell therapy, intended to treat or prevent viral infections in people who have received stem cell transplants.
“I think they have been, more than anything, victim of the broader sentiment that mid-cap names have fallen out of favor,” Raymond says.
The company already has proof-of-concept data showing that the therapy, known as Viralym-M, can treat those infections. It is awaiting data by the end of the year on prevention of those infections, according to Raymond.
He says that the stock could jump if that data turn out to be positive, as it would substantially expand the opportunity for the drug. Raymond expects AlloVir to have revenue of $1.3 billion by 2028. He has a $55 price target on the stock, implying a more-than 175% share price increase over its recent price of $19.89.
The Stock Market Could Struggle This Fall, Strategists Say. Buy Quality.
This Beauty-Care Company Is Working on a Turnaround. The Stock Is Looking Attractive.
Beiersdorf, the German personal-care products maker that owns the Nivea and La Prairie brands, had a few tough years before the pandemic, and it went downhill from there.
Advertising and promotion—key to sales of cosmetics and toiletries—were reduced between 2012 and 2018, a period in which the company struggled to adapt to a changing market in which smaller players won customers with premium niche products.
Pandemic lockdowns meant that fewer people took vacations and more people stayed home. Sales of Beiersdorf’s beauty and sun-care products declined, and its $550 million purchase of Coppertone in 2019 was unfortunately timed.
In the past three years, Beiersdorf stock (ticker: BEI.Germany) has failed to glow, gaining just 1.84% to 102.65 euros, compared with a 90.25% jump in the shares of rival L’Oreal (OR.France) and a 144.69% increase for Estee Lauder (EL).
But CEO Vincent Warnery, an alumni of L’Oreal, took the helm in May and has made his mark in Beiersdorf’s dermatological division, which includes the Eucerin and Aquaphor brands.
Under Warnery, Beiersdorf has expanded its global footprint and developed new products. As a result, the company produced double-digit growth across its brands in the first half of this year.
Martin Deboo, an analyst at Jefferies, says that Warnery could make Nivea, which delivers almost 70% of group sales, more upscale. It’s currently perceived as a mass-market brand.
Cosmetics comprise 80% of Beiersdorf’s revenue, while the rest comes from Tesa, which makes adhesive products for home, electronic, and automotive uses.
A turnaround won’t be quick. Beiersdorf has benefited from a postpandemic travel lift that helped it beat consensus estimates on second-quarter and 2021 first-half sales. But second-half profit margins are likely to be squeezed by increased costs and investments in innovation and sustainability initiatives. Investors willing to take a gamble at this early stage will need patience.
Beiersdorf has a €4.7 billion ($5.6 billion) cash pile, and Deboo says using that cash for a stock buyback or acquisitions could increase earnings per share by 25% to 30%.
In an August note, he forecast that the shares could rise 18.25%, to €125, with much of the growth coming from Nivea. But the Herz family, which owns 51.2% of Beiersdorf,is known for being cautious and would need to be persuaded to go on an acquisition drive.
The business, which dates to 1882, is based in Hamburg and employs 20,465 workers. It has a market value of €25.7 billion and fetches a high multiple of 31.6 times this year’s expected earnings. It’s valued at a 30% premium to its peers.
Beiersdorf posted a profit of €636 million in 2020 on sales of €7 billion, down from €788 million on €7.6 billion the previous year.
Warnery said in a statement to Barron’s that, despite economic uncertainty due to Covid-19 and the rise in commodity prices and transportation costs, the company expects full-year sales growth “in both business segments, as well as at group level to be in the high single-digit range.”
Management’s focus on innovation, the promotion of Nivea as a more upscale brand, and an expansion of online sales is likely to boost profit margins and help repair past missteps.
“We don’t see these problems as unaddressable and are certainly not advocating a comprehensive repositioning of Nivea,” Deboo says. “We do think there is room to nudge the brand in a more premium direction, as well as to increase its salience to consumers.”
China’s Regulators Are Moving Fast and Breaking Things. Watch Out.
Imagine a large industrial economy with no taxes on property, capital gains, or estates, and no national minimum wage. Such a conservative paradise, by Western standards, does exist: China.
Against that backdrop, the Communist Party’s campaign for “Common Prosperity,” which has roiled markets afresh lately, smacks more of Woodrow Wilson than Chairman Mao, says Jason Hsu, chief investment officer at Rayliant Global Advisors. “I mostly see China trying to be more like the West,” he says. “Creating a social safety net and financing it with more taxes.”
Not that this offers much comfort to investors in Chinese internet companies, whose value has plunged as the state ratchets up regulation unpredictably, if not capriciously.
Just this past week, Beijing cut teenage gamers’ playing time to three hours a week (in theory), banned internet “rumors” about celebrities, and vowed to curb “chaotic” online financial information in favor of “healthy” public opinion. Measures beyond the bounds of Wilsonian progressivism.
In China, the state likes to move fast and break things no less than the private sector. In recent years, it’s broken things Wall Street doesn’t care much about: coal mines, steel mills, shadow banking. This year’s focus, internet “platform” companies, are a different story.
“The target this time happens to be the industry we investors like the most,” says Vivian Lin Thurston, portfolio manager of the William Blair China Growth Fund.
The idea that Xi Jinping & Co. will eliminate Alibaba Group Holding (ticker: BABA) or Tencent Holdings (700.Hong Kong) still seems fanciful, for now.
“Private entrepreneurial companies account for 90% of urban employment,” says Andy Rothman, an investment strategist at Matthews Asia. “There’s no sign the Party wants to go back from that.”
China’s tech stocks have in fact bounced lately, as the Big Four— Alibaba, Tencent, Meituan (3690.Hong Kong), and JD.com (JD)—all beat second-quarter profit or sales estimates. The KraneShares CSI China Internet exchange-traded fund (KWEB) is up 20% from an Aug. 19 low. “Fundamentally, these are great companies,” Thurston says. “I would be nervous going much below the benchmark in my holdings.”
Matthews Asia is less sanguine about a Chinese internet rebound. It’s leaning in instead to the burgeoning biotech sector. Three of the top four Chinese holdings in its flagship Matthews Asia Growth Fund are Wuxi Biologics (Cayman) (2269.Hong Kong), Innovent Biologics (1801.Hong Kong) and BeiGene (BGNE).
Ramiz Chelat, a portfolio manager at Vontobel Quality Growth, also expects more trouble for the platform giants. “The regulatory wave’s impact on socially sensitive sectors is long-term,” he says.
He is focusing instead on humble consumer staples providers, such as fast-food franchisee Yum China Holdings (YUMC), baker Toly Bread (603866.China) and snacks purveyor Chacha Food (002557.China). “The food space has low regulatory risk, and leading players can consolidate,” he says.
Exiting China entirely is also an option, of course. But that risks missing a new boom if the Party gets Common Prosperity right, transforming China’s wealth pyramid into an “olive shape,” with a bulging middle class dominant.
“We still very much believe that China is in the early stages of what will potentially be one of the great bull markets in human history,” says Justin Leverenz, chief investment officer for developing-market equities at Invesco.
SEC’s Gary Gensler Has a Big, New Vision for the Stock Market. There Are Too Many ‘Inherent Conflicts of Interest.’
The plumbing of the U.S. stock market, like actual plumbing, tends to operate quietly in the background.
In January, as if a wall had been ripped open, the market’s tangled and decades-old pipes were suddenly exposed to millions of retail investors who had given little thought to them before. They had piled into stocks like GameStop (ticker: GME).
Then, at the height of the mania, some brokers, including Robinhood Markets (HOOD), whose explosive growth has been fueled by new investors, restricted trading in those stocks. The newbies cried foul, and lawmakers called for change.
Now, a new Securities and Exchange Commission chairman, Gary Gensler, has made it clear that he is interested in the mechanics that burst into the open during the meme-stock turmoil. He seems intent on overhauling market structure in ways that he thinks will make it fairer for the new retail traders and everyone else.
The infrastructure that allows investors to tap on a phone and instantly buy stocks and options has been revolutionary for investors and the financial industry. Yet the trading system is extremely complex underneath, and it could be in for a remake.
Gensler is particularly concerned that the market for executing stock trades has become segmented, with nearly as much order flow going to “dark pools” and other less-transparent venues as goes to exchanges.
It’s not clear how much change Gensler and the SEC can push through. Resistance from the industry and possibly Congress would need to be overcome. Still, his vision for the stock market could lead to its biggest overhaul in decades.
“We cannot take for granted that the U.S. equity markets will always be considered the most efficient, the most liquid in the world,” Gensler told Barron’s in an interview this past week. “We have to be realistic that technology changes, and we’ve got to update things.”
The current trading regime, he said, has too many “inherent conflicts of interest” that are putting investors at a disadvantage.
Among the most prominent of those conflicts are the payments that brokers get from the market makers that process their clients’ trades. So-called payment for order flow could be banned in the U.S., as it is in the United Kingdom and Canada, and it may not be the only change coming.
It’s an important moment to examine how the market works and how trades are processed, because more people than ever are participating. Since the start of 2020, more than 20 million people have opened brokerage accounts in the U.S., a record pace. If the trend continues, it could cause a fundamental shift in the nature of wealth in the U.S.
The changes are also rippling through the financial industry. Retail trading now makes up 22% of trading volume, Bloomberg Intelligence estimates, more than double the share of a decade ago. The influx of all that new money has enriched brokers, market makers, and other players. Fidelity just announced plans to hire an additional 9,000 people to keep up with the growth.
Proponents of the current system say that the increased participation in the markets is evidence that the markets are becoming fairer. Robinhood, which has signed up the largest share of the new investors, doesn’t charge commissions or have account-size minimums. Its business model depends on getting paid on the back end of trades.
When a client makes a trade, Robinhood sends it to one of a handful of market makers, which match buyers and sellers internally instead of sending them to exchanges. Those market makers, like Citadel Securities, Virtu Financial (VIRT), and Two Sigma Securities, profit off the spread between the bid and the ask, and then send a portion of that profit back to Robinhood.
Most other major brokers do this, too, although it accounts for a much smaller percentage of their revenue. At Charles Schwab (SCHW), for instance, payment for order flow accounted for about 5% of revenue in 2020. At Robinhood, it accounts for 75% to 80%.
Trading on the market makers’ platforms happens largely out of the public eye, though the companies have to publish monthly data about their trade execution. What that data show is that they are getting better prices for stocks than the exchanges are. The market makers that execute retail trades, also known as wholesalers, got more than $3.6 billion in price improvement for retail investors in 2020, according to Virtu.
Gensler, however, doesn’t think it’s a fair comparison. Because so much trading happens off exchanges, the “best price” on an exchange may be different from the best overall market price.
“Nearly half of our market is in dark pools or wholesalers, not lit,” he said. Even the orders that go to stock exchanges, a “fair amount of that’s not lit, either,” he said. “So price improvement versus the lit part of the market is not a full measure of the efficiency of the market. And it is not a full measure of best execution. So much is being left out of the measuring stick. It’s sort of like if I was going to measure the height of my children, but I left some of the parts of the ruler out.”
People who want the industry to change say that liquidity on exchanges has suffered as more trading has moved off exchanges, and that is causing price spreads to widen, making the overall market less efficient. Segregating retail trading on its own venues reduces liquidity and transparency in the entire market, says Dennis Kelleher, CEO of Better Markets, a nonprofit that focuses on financial reform.
Some wholesalers think the critics are mischaracterizing their role and how they help the market. Virtu said in a presentation to the SEC this year that the benefits that retail investors get from their operations are probably understated, not overstated. If all of those benefits were included, the value of Virtu’s price improvement would probably be three times as much as the company discloses in securities filings, the company has argued.
Virtu CEO Doug Cifu responded to Gensler’s comments about market structure this past week by warning that “drastic changes to the market ecosystem are not warranted and would likely result in worse outcomes for retail investors.”
Gensler’s concerns are not just about retail brokers and their market makers. He is also critical of the payments, known as rebates, that exchanges pay for certain kinds of orders. Gensler wants more transparency in the market and for trades to compete on an “order by order” basis, as opposed to being segmented based on where the order originated, or to be routed based on how they are paid for.
When markets are opaque, and customer orders are processed differently, the investing public could be at risk. He thinks it is affecting prices.
“It provides an opportunity for the market maker to make more, and for ultimately the investing public to get a little less when they sell, or have to pay more when they buy,” Gensler said. “I think it also affects companies raising money,” he added, because it impacts the efficiency and fairness of those markets.
Does that mean that Gensler wants all trading to happen on exchanges? He wouldn’t say in the interview with Barron’s, speaking more about the principles the agency plans to follow, but not the specific route of each trade. “If, when I place a buy or sell order, I know that it’s going to be in a competitive pool among other investors that are seeking to buy and sell and there’s that broader competition—that’s the tenet of a competitive, efficient market,” he said.
Experts in the field aren’t so sure where Gensler is heading.
“That’s the $64,000 question,” Kelleher says. “Or, I actually think it’s the $40 billion question.”
Kelleher expects that the SEC will float several options and “put them all out there to get a maximum amount of information and make a decision.” He favors a system that requires brokers to get the best price for their client at any given moment, instead of directing trades to a few companies.
“Whether you’re in the dark market or lit market, it doesn’t matter,” he says. “What matters is the best available price at the time. It’s forum-agnostic, but the duty is uniform. And then you require disclosure so that people can see that, in fact, they’re getting the best available price at the time.”
Others want to make sure any rules allow for flexibility. SEC Commissioner Hester Peirce said at a hearing earlier this year that “best execution is not a one-size-fits-all concept.”
“For most retail investors, price might matter most, but institutional investors often have a larger set of considerations,” she added.
Changes to payment for order flow in particular would be controversial. The payments are legal and have been used for decades. The SEC has been expressing concern about them since at least 1984. But Robinhood’s rise has shined a new spotlight on how they work.
There is no evidence that the payments had anything to do with Robinhood’s decision to temporarily ban purchases of GameStop in January. The company has said it was forced to halt purchases because of capital demands from its clearinghouse. And other brokers also limited trading in some stocks or options, though not to the same extent as Robinhood.
Nonetheless, the episode infuriated some retail traders, and led to congressional hearings where the payments became an issue. At a February hearing, Rep. Brad Sherman (D., Calif.) likened it to Facebook’s business model. “When you’re not paying for it, it’s not free,” he said. “You’re the product; someone else is the customer.”
Others have also criticized the practice because they say it gives brokers an incentive to encourage more trading even if that is not the best investment strategy.
Last year, Robinhood settled administrative charges about payment for order flow with the SEC. The regulator found that the company had misrepresented its business model to customers and routed orders from 2015 to 2018 in a way that hurt them—in some cases it cost them more than an up-front commission would have. Robinhood paid $65 million and neither admitted nor denied the findings. It says it has changed its practices since.
Robinhood has vigorously defended payment for order flow as beneficial to customers.
“We think payment for order flow is a better deal for our customers versus the old commission structure,” its chief financial officer, Jason Warnick, said during a virtual road show the company held before its initial public offering. “It allows investors to invest smaller amounts without having to worry about the cost of commissions.”
Robinhood has said that it doesn’t push investors to trade or offer advice—it simply gives them access to markets that had previously been closed off to them.
Dan Gallagher, Robinhood’s chief legal officer, said in an interview with Barron’s that Gensler’s statement about conflicts of interest is nothing new. Gallagher, himself a former SEC commissioner, said that the SEC has accepted that conflict, and has been comfortable with it as long as it is disclosed to customers. But he thinks the rhetoric around it is overblown.
“The idea that the revenue we do receive from payment for order flow is somehow the result of some unmitigated conflict or not earned money is inappropriate,” he said.
He called the idea of banning it “pretty draconian,” and expects that it would result in up-front commissions coming back, at least for some brokers. That’s one reason that Gallagher doubts it will happen. “They are going to realize that payment for order flow is an amazingly good thing for investors,” he said. If it did get banned, “we’d have to seriously consider” legal action. “We’d have to get in line for that, though. There would be a long line of folks who would sue.”
Some competitors that focus on retail trading have managed to get by without accepting payment for order flow. Fidelity, for instance, doesn’t take the payments for stocks, though it does for options. And a start-up called Public decided earlier this year to do away with it, too.
Public’s chief operating officer, Stephen Sikes, says the company now directs orders through a “smart order router” to several venues. And the company now gets better prices than when it was routing only to wholesalers. “What we’ve found is that a meaningful portion of the orders find better prices than what they would have gotten in the old way,” he said.
There is, of course, a downside to brokers of not accepting the payments. Public has more than one million customers but is still figuring out how to make money.
One way it replaced payment for order flow is “tipping,” which allows users to decide how much to pay for the service. It also makes money from securities lending and interest on uninvested cash.
Banning payment for order flow is “on the table,” Gensler said in the interview this past week. But his vision clearly encompasses more than that. When Gensler was chairman of the Commodity Futures Trading Commission from 2009 to 2014, he moved the trading of a derivative product called swaps—which he said contributed to the financial crisis—onto more highly regulated and transparent venues.
A similar change could be coming for the broader stock market.
In 1975, Congress authorized a national market system that the SEC has put into effect in sections over the subsequent decades, establishing how stocks are routed and traded. One former SEC chief says the work is unfinished, opening a door for Gensler. Harvey Pitt, who was SEC chairman from 2001 to 2003, says that “even today, we really don’t have” a national market system.
“Going back to 2002 and 2003, we held public forums where we asked people what the structure of the markets ought to look like, what would you like to see the marketplace look like,” Pitt says. “We just weren’t able to—too many other things took over our attention span. I would say it’s very possible for Gary Gensler to mobilize the commission to do that. It’s not easy. And along the way, he’s going to be met with a lot of opposition. No one who’s part of the status quo wants to change the status quo until they figure out how they’re going to profit from the status quo.”
Closing Market Summary: Nasdaq Tags Another RecordThe stock market ended a quiet week on a mixed note, as the S&P 500 (-0.03%) and Dow (-0.2%) ticked lower while the Nasdaq (+0.2%) hit another new closing record. Small caps underperformed, sending the Russell 2000 lower by 0.5%.
Today's action unfolded inside a 20-point range in the S&P 500 even though the Employment Situation report for August was mixed relative to estimates. The headline reading missed expectations by a country mile (actual 235,000; Briefing.com consensus 750,000) while average hourly earnings increased 0.6% m/m, twice the expected pace, giving some new fodder to the tapering debate.
Stocks slipped out of the gate, but the S&P 500 was quick to find support near its closing level from Wednesday. The benchmark index recovered the bulk of its opening 15-point loss during the opening hour and continued inching higher as the day went on.
The top-weighted technology sector (+0.4%) held a modest gain throughout the day while health care (+0.1%), communication services (+0.1%), real estate (+0.04%), and consumer discretionary (+0.01%) turned positive as the day went on. The technology sector's strength prevented the S&P 500 from falling deeper into the red in early trade and it helped with the daylong rebound.
Chipmakers were responsible for the early strength in technology after Broadcom (AVGO 497.68, +5.78, +1.2%) beat Q3 expectations and issued strong guidance for Q4. Broadcom helped the PHLX Semiconductor Index (+0.6%) narrow this week's loss to 0.2% while top tech components Apple (AAPL 154.30, +0.65, +0.4%) and Microsoft (MSFT 301.14, -0.01, unch) were mixed.
In other tech earnings, Hewlett Packard Enterprise (HPE 15.48, +0.09, +0.6%) touched its best level since mid-June after beating Q3 EPS expectations and issuing in-line guidance for FY21 while MongoDB (MDB 507.41, +105.76, +26.3%) soared to a fresh record after beating Q2 expectations and issuing above-consensus guidance for FY22.
On the downside, utilities (-0.8%) finished at the bottom of the leaderboard while materials (-0.7%), industrials (-0.6%), financials (-0.6%), and energy (-0.5%) ended with slimmer losses. The financials sector widened this week's loss to 2.5% while energy lost 1.4% for the week. Meanwhile, WTI crude fell $0.72, or 1.0%, to $69.24/bbl, but still gained $0.47, or 0.7%, for the week.
Treasuries revisited this week's highs in immediate reaction to the August jobs report but reversed swiftly to their lowest levels of the week. The 10-yr yield rose three basis points to 1.32%, finishing the day between its 50-day (1.309%) and 200-day moving averages (1.341%).
Today's volume was below average with just over 700 million shares changing hands at the NYSE floor.
Reviewing today's economic data:
- August nonfarm payrolls increased by 235,000 (consensus 750,000). The 3-month average for total nonfarm payrolls decreased to 750,000 from 876,000 in July. July nonfarm payrolls revised to 1,053,000 from 943,000 June nonfarm payrolls revised to 962,000 from 938,000.
- August private sector payrolls increased by 243,000 (consensus 650,000). July private sector payrolls revised to 798,000 from 703,000. June private sector payrolls revised to 808,000 from 769,000.
- August unemployment rate was 5.2% (consensus 5.2%), versus 5.4% in July. Persons unemployed for 27 weeks or more accounted for 37.4% of the unemployed versus 39.3% in July. The U6 unemployment rate, which accounts for unemployed and underemployed workers, was 8.8%, versus 9.2% in July.
- August average hourly earnings increased 0.6% (consensus 0.3%) versus a 0.4% increase in July. Over the last 12 months, average hourly earnings have risen 4.3%, versus 4.1% for the 12 months ending in July.
- The average workweek in August was 34.7 hours (consensus 34.8), versus a downwardly revised 34.7 hours (from 34.8) in July. Manufacturing workweek decreased 0.2 hours to 40.3 hours. Factory overtime was unchanged at 3.2 hours.
- The labor force participation rate was 61.7%, versus 61.7% in July. o The employment-population ratio increased to 58.5% from 58.4% in July.
- The ISM Non-Manufacturing Index for August decreased to 61.7% (consensus 62.0%) from a record high 64.1% in July. The dividing line between expansion and contraction is 50.0%. The August reading marks the fifteenth straight month of growth for the services sector.
- The key takeaway from the report is the understanding that services sector activity is still running strong notwithstanding the deceleration in growth from the record high reading in July.
Bond and equity markets will be closed on Monday in observance of Labor Day.
- S&P 500 +20.8% YTD
- Nasdaq Composite +19.2% YTD
- Russell 2000 +16.1% YTD
- Dow Jones Industrial Average +15.6% YTD