ETF Edge - Embracing Leverage & Chances of a Recession 06/01/22

Episode Date: June 1, 2022

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The ETF Edge podcast is sponsored by InvescoQQQ, Supporting the Innovators Changing the World, Invesco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you're in the right spot every week. We're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Popizani. Today on the show, if ETF flows all over the map as we kick off a new month,

we'll do a deep dive on where retail investor sentiment is and get the little. down on where the flows are going, including the Titanic trading volume we've seen in leveraged and inverse ETFs to track the triple Q's. That's the NASDAQ 100. Plus, how are corporate earnings holding up for the rest of the year? Here's my conversation with Anthony DeNierre. He's the CEO of Weebel, below with Nicholas Coles, co-founder of Data Trek. Anthony, most traded ETF on your platform, I have been noting this for weeks now, not on your platform, but everywhere. Ultra-Shure QQQQ, symbol SQQQQQ. This is three three times the inverse of the S&P 500 on a daily basis. And normally you see the S&P 500 funds most

actively traded. Why have retail investors suddenly embrace leverage and inverse ETFs, particularly the NASDAQ 100 ones? Right. Well, NASDAQ 100, as you know, is very tech-heavy. Tech-heavy seems to be what our customers are into trading, right? It's the ones that move intraday, right? It's less boring, to put it that way. And I think there's a couple different reasons. One, I don't think is talked about enough, is the retail investor, the average account went from 5,000 to now averaging about 3,000 on a platform like Weebel. That would also apply to a Robin Hood type investor. They sometimes won't even qualify for leverage in terms of utilizing margin because of their account balance. So they're utilizing these leverage ETFs to make up for their account being downgraded maybe from a margin or to a non-leverage margin account or possibly even only only a cash account to trade their stocks.

Yeah. So, Nick, every day, the most actively traded ETS in terms of shares traded are what we told about, that SQQQ and the TQQ, which is the other side of the whole thing, three times leveraged on the triple Q. Spy is still the largest in terms of dollar value, but I see $5 billion in notional trading of SQQQQ every day. I would have thought professional traders would be using these, but Anthony says retail traders are starting to use them now. Is this a sign that retail is pessimistic? What do we take away? Is there a risk about all of this use of leverage and inverse ETFs around triple Q's?

You know, I think from a market standpoint, it tells us that a lot of retail traders are trying to claw back maybe some losses from earlier in the year. They're down, they want to get back up, and so they view the riskier bets is the most efficient way to try to claw back some of those losses and get back flat on the year, even make some money. So I think what we're seeing is a really interesting adjustment in risk tolerance. You'd think that when markets go down, risk tolerance goes down? For a lot of accounts, for a lot of clients, it goes up, and that's what we're seeing here.

So the risk tolerance is going down, you think? Risk tolerance, as far as how a long-only investor would think, maybe is going down. Hey, I want to be out. This is what we see on the fund flows. But for a trader, somebody who wants to make money in the market, you've got to take your risk tolerance up in order to make that money back. Yeah, yeah. You know, the fund flows have really been confusing me recently. I follow them, and they tend to make – I think they tend to mean something at extremes.

The problem I have here is, let's look at the flows here. April we saw peak outflows. It changed in May, but it's still not consistent. So I see inflows into the S&P 500 and outflows in energy here. That's kind of interesting because energy was the big outperformer in May. I'm not sure what the make of this. And then on Bonds, I want you to comment on this separately, we see modest inflows after huge outflows early in the year.

Tell me what your expert at making sense of fund flows here. I want to just address equities first. Sure. What is this trying to tell us? It tells us primarily that investors are pulling back. And the energy point you made is really critical. Energy of XLE was up 17% last month. Made a lot of money in that name.

People were pulling back because they're pulling back on risk exposure generally. In our tracking of these fund flows, the money seems to be going directly into consumption. It's not going to bank accounts. It's not going to money market funds. It's being used primarily for consumption in an inflationary economy. So that's where the money is going. And as long as inflation is high, that's going to be, I think, the trend that we see. But the trend follower in me says, gee, energy is the biggest performer of the year.

And yet we saw some modest outflows. You'd think there's still be money going into it. I'm trying to sort of make sense about it from the traditional way. I understand trend following for crying out loud. You coined a marvelous phrase in the last decade, The most hated bull market in history, right? Why was it? Because flows were negative and stock prices kept going up.

This energy rally is turning into the most hated sector rally of this year. Yeah. Anthony, it looks like the active trader is still pretty active. And I see that in your numbers. But you've told me separately that the fair weather trader is gone. I love that phrase, the fair weather trader is gone. Explain to us what that means when you say the fair weather trader gone. The active trader is still there.

I mean, the equity markets for the past 10 years has been operating with a lot of tailwinds helping it along, especially for newer and less experienced traders, right? It was basically buy, stock goes up, buy more. Obviously, that has changed over the last several months. We're now entering bare market

territory, and there's a lot of traders that have never seen a down market, and they've been burned, and they just walk away. These are, you know, not necessarily traders that aren't long-term investors, but these are traders that thought they could make money actively trading. Yeah.

Right? So those are the fair weather traders I talk about. Not, I don't want to differentiate, right? They're still investors. Yeah. But not the traders. Active traders are still remained very, very active. I mean, short sales alone, we're seeing up 400% this quarter on our platform, right?

Which, you know, compared to last year, you know, that's, that's an active trader utilizing this volatility. But I'm looking at the numbers here. Average assets under management, 5,000 a few months ago and now $3,000. So it looks like, what do you call them? self-directed trader, whatever you want to call them, it seems like they're having a rough time of it right now. So you run a business. You run a trading platform. What are you and other trading platforms? What are your competitors doing to keep people on the platform, if not actively trading? What are they doing?

What are you doing to keep them there? Well, like our customers, we're new, right? So we've all been around for four years. We're evolving and maturing just with our users. So we started off self-directing. We're now offering products of recurring deposits, recurring investments. and we're soon going to be rolling out more passive investment options. Not everyone is happy looking at their phone 12 hours a day nonstop trying to chart or time a market. A lot of people, especially with these volatiles, would rather kind of set and forget it. When you say passive, my heart leaps when I say past because I'm a Jack Bogle guy, as you all know.

But what does that mean to you? How do you encourage people to do passive investing from the active retail environment we've been seeing for several years? offer easy to navigate portfolio building indexing tools that customers can then create to their own risk assessment profile and then actively invest in that on any given period of time that is sufficient for their for their own budget portfolio building index tools I mean this is an amazing thing to hear from you know retail trading platform is this signs that the retail traders are evolving in the way they they look I'm hearing talking about passive investing here from a I'm not active retail trading platform. Look at our generation. We grew up in the 1990s trading tech stocks. Then they blew up. Then we realized we've got to get serious.

Start putting more into the 401K. Start putting more into personal investments. Understand indexing and passive investing. Every generation goes through the same evolution, I think, starting with an exciting bull market, but then realizing this is a very long game and you've got to play it as a long game. So it sounds like it's time for a lot of younger traders to grow up and think a little bit longer term. Just like we did.

Yeah. Yeah, right? Well, what happened in 99 in 2000? I grew up, people grew up fast. Yeah, to death for doing that, that's for sure. So, Nick, tell me where you stand on the markets right now. You're one of the great market watchers out there. Those of you don't know, Datatrek puts out an outstanding daily newsletter. You're sort of a, you're not a quant trader, but you use quantitative analysis for the stock market.

You analyze massive sets of databases and look for clues. mine for clues. What do you see happening in the markets right now? The big question is, are we going to avoid a recession or not? Yeah, so the short answer is we're in for some more trouble. We've got two problems. The first is oil prices. Seems to still want to go higher. At 140, they're a double year over a year. That's the signal of a recession coming. It always happens. When oil doubles in a year, you get a recession in the next 12 months. So that's the thing to worry about. My other concern is earnings expectations are way too high for the back half of the year. We've been doing $54 a share in S&P EPS every quarter for the last four quarters.

The streets at $60 and $61 a share in the back half of the year. Those numbers have to come down. They're just irrationally high. And the markets understands all that. The market's discounting those already. But until we see earnings cuts and continued growth and oil prices come in, I think we're in for more trouble. I honestly don't understand this. I've been watching the markets for 25 years as the stocks corresponded. And I am amazed they have not taken the earnings estimates down this year appreciably. So we're still looking at 10% earnings growth for the S&P this year. Another 10% in 2023. And so the decline in the S&P 500 this year is entirely due to the multiple being compressed. It's not the earnings actually going down. If we, if earnings go, I think it's

228 now we have for the S&P from 208. And if we go flat on earnings, that would imply another potential 10% downleg in the market. That's how a lot of these strategies. to just get to 3,400 really quickly. But you were an analyst, right? You write about this all the time when you were an analyst. Why aren't they? The market seems to believe that they should be taking the numbers down, that the estimates are too high for the second half of the year,

even if there isn't a recession, and yet they're not doing anything. What is it that everyone else sees that the analysts don't want to see? Or is there a lack of creativity among the analyst community? No, the analysts really want the guidance of the companies before they cut numbers. want to go out on a limb and cut a number that the company will say, why are you putting out this low number? It's that feedback loop between the analysts and the company that prevents the right numbers coming out. But what's the value of an analyst? If the only thing they're going to do is we're not going to do anything until the company guides us, who needs that? There used to be

a lot of more independent thinking on Wall Street. There was. Look, there's an old saying about analysts. In a bull market, you don't eat them. In a bare market, they'll kill you. We're in the second part. Yeah. Remember the 2003 analysts set them, the global settlement that Spitzer did. Spitzer correctly called out the conflict that existed, sued the community, and came to a deal. And what I saw after that, you tell me, you were around the brightest left. On the sell side analysts, went to the buy side. Some of them tried to set up their own shop. I saw pay dramatically dropped. I saw a lot of people making a million plus a year in 2003. I don't know what the average pay for a cell site analyst.

now is, but I'll bet you it's probably 300,000 somewhere around there. So the best and brightest left. The pay dropped dramatically. And what I see, this is a broad statement, so forgive me, the intellectual quality of cell-side research has declined dramatically. I get most of the streets' research on a daily basis, and a shocking amount of it is garbage. There's no real value in it. My point is there was more creativity outside-the-box thinking and, yeah, meta-analysis, whatever. than there is now where you correctly point out, they're just waiting for the CEO to tell them something.

So I'm editorializing a lot here, but I feel very strongly about it. If we believe the direction of earnings is important for the street and where prices go, and analysts are just no longer doing anything, the whole model kind of gets called into question here. The street starts moving independently of the analyst community.

Yeah, no, that's true, but at least the market discounts it before. So at least asset prices are being correctly set. What we're seeing right now is that worry. And by the way, the market peaked out at 3387 in February 2020. The S&P is still 20% higher than that today. Every other global market is below its February 2020 levels right now. So we're outperforming, yeah.

Dramatically. Yeah. Although I did note in May, Europe did a little bit better. I think we were up 1%. China was up 1 or 2%. S&P was fine. But that's a pretty small dispersion. It was pretty even overall.

It's kind of, you know, everything kind of flattened out the second half of May. I had exactly the same thought running the numbers last night. Everything's so tight. A little bit here, a little bit there. EFA was up to. EM's up point six. S&P and NASR flat or S&B and Russell are flat, but still very tight. Yeah.

And it's a tight year to date. Yeah. What does this mean for your investors? Do they pay more attention to things like earnings? or are we actually sitting around saying, the active traders are more interested in momentum trading, classic momentum trading? So they'll look at earnings when there is momentum behind it.

I mean, on our platform, we also offer analyst ratings for customers or our clients to look at for every stock. Right? And this is not naming Goldman Sachs, JP Morgan. It's an average of all analysts across the street. It's one of our least looked at pages on the platform. So retail investors, at least active retail investors, are looking for that momentum. They are playing earnings, but not taking sides because

of analysts says so, taking sides because of peers. Because this is an ETF show, I want to get your thoughts on sectors, because that's what people trade the most. Give us your view on sectors in the second half of the year. It's energy going to continue? I mean, give us some large macro themes here. Sure. So, yes, we still love energy right here. I think it still has a lot of room for multiple expansion, and the numbers are going up. Unlike the conversation with the market as a whole, the numbers have come down, Exxomobile, Chevron, all the energy names, estimates are rising. Energy is fine. A lot of our customers are looking for safe havens. And for us, it's health care, like the XLVs, the large half health cares of the

world, because when growth investors can't buy tech, because it's been imploding, and can't buy retail, because that's also not doing well, the only third road left is health care. And we see this over and over and over again. Every cycle sees health care as a percentage of the S&P peak at the bottom of the market. Happened in 2000, 2002, happened in 2009 and 10. We have another point or two to gain with health care. So that's got multiple expansion in it as well. We saw this every day.

I mean, Lilly, last week, new highs. Merck was at new highs the week before. You know, Bristol was stronger. So all of that is playing out exactly like you're saying on the playbook. And it will continue to do so as long as we have these worries about recession, numbers have to come down. So do we avoid a recession? I'm sorry to hit you with such macro stuff.

It makes you uncomfortable, but that's what people want to know. Tell me if there's a recession, and I'll tell you if we're at some bottom right now. Tell me if oil goes to a buck 40, and I'll tell you if there's a recession, because if it goes to 140? 140. And that's the doubling that you were talking? That's the doubling, yes. In the current environment, I don't see a way to avoid a recession.

If Russia, Ukraine solved that war, and oil prices came back down. below 100 we could easily avoid a recession in the current environment with current trends very hard to see so you think there's a good chance oil goes back over 140 yeah because the last peak at 140 was July of 2018 right around July 4th weekend which is peak summer driving season and we're heading there right into exactly the same setup right now that's a good point Anthony any final word here I just think people aren't looking at the macro version of what happens with China Taiwan intervention. I think there's a lot more rain down the road, so I think we need to be cautious.

On Taiwan, China, you said? Taiwan, China, yeah. Do you think there's chances for conflict in 2023, for example? I mean, is there... It's going to look different than Russia invading Ukraine, but from, you know, from the conversations I've had with people overseas, it seems like China is definitely going to make some sort of headway into Taiwan by the end of this year, maybe even next year. And that's something we're not even talking about in this macro environment. Yeah, that would certainly be another kind of game.

How would that change the world? Oh, then you got global recession, for sure, in a pretty deep one. And forget about electronic supply chains, right? Yeah, yeah. So the probability of this you think are fairly high? You think you're certainly? Maybe talk to Ian Bremmer on that one. Yeah, yeah.

Well, that's an important point here. So we, this is another potential, not a black swanagan, because it's a known unknown. wouldn't be an unknown unknown that's actually weighing out there. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the market's 102 portion of the podcast. Today we'll be continuing the conversation with Nick Coles from Datatrek. Nick, you're such a great guy on, you know, quant analysis. By quant analysis, I mean data mining, large data sets for information on directions of the stock and the bond market.

One of the things that disturbs me a bit is this trend of de-globalization that we are seeing. So globalization, it seems to me, brought very obvious benefits, improved supply chain, more efficient distribution, lower inflation, lower interest rates potentially. If you believe that that's true,

I think that is reasonable to believe, if we are truly seeing de-globalization, Is it reasonable to assume that the opposite may be happening, that we may be in for a period of, for example, higher inflation, partly due to the de-globalization, just as one aspect of this. Is that a reasonable train of thought? It's absolutely a reasonable train of thought, and you're right. We had a 20-year period of declining interest rates, declining inflation, and from about 1993 and four on, a lot more globalization. So opening up global supply chains to provide cheaper goods to a wider market. That's what globalization did. And we hit a wall with that over the last two years. And everything that I read and I see tells me that it's going to start to reverse. We're going to see more onshoreing now. And that should drive higher prices and inflation because it's more expensive to do.

Well, just look at, for example, what it's going to cost to build a fab plan, you know, a semiconductor manufacturing plan. If you can efficiently do this in two places in the world, and all of a sudden now you have to do it in five places, normal economists would say the costs are going to be higher. Yes, absolutely. And then we've suddenly decided that certain things are national security issues, not just semiconductors, but pharmaceuticals, for example.

All of a sudden, maybe it's not safe to have the manufactured in China. We have to manufacture them now in the United States. So there are all sorts of implications here that I think are very troubling for the fight against inflation. And that's why I think it may be more persistent than some people actually think. is even if we get the supply chains unravel a little bit, if we're just, if we're scrambling the supply chains, unraveling the current supply chains is still not going to solve the long-term problem if you're building new plants all over the place. Yes, and I think in a very real sense,

the market is trying to figure this out as well, because if you invest in lower return on capital projects as a business, because you have to, because you have to onshore supply chains that used to be offshore, your return on capital declines, your margins decline, and you're valuation will decline. So the real question is, is a 17 or 18 multiple that we used to have on the S&P pre this break-up of globalization? And that's still a valid target multiple for the S&P. Or because companies have to invest in lower return projects, lower margin projects. Do we then have a problem where multiples perhaps have capped out? And maybe the right multiple is 15 or 16 or 17 times earnings. We're going to know that in the next couple of years. But the discussion that we're having now is the baselining exercise to understand which direction we go. Right. And right now the multiple is about 17 times forward earnings, which is close to the historic norm.

But we don't know if the earnings are going to hold up. But we had this discussion before. We're expecting 10% earnings growth in the S&P in 2022, 10% in 2023. And yet the market doesn't seem to want to believe that we're going to have 10% earnings growth at this point. Is it your baseline case that that's going to come down? It will have to come down. So the analysts are, we've just done three quarters, four quarters of $54 a share on the S&P. Analysts are looking for $60 of sharing Q3 and Q4. So we can't go from 54 to 60 over two quarters. It's not going to happen. More realistic number is 55 or 56, assuming some modest growth.

So the numbers have to come down. For next year, same thing. And I think we can ask ourselves the question against a backdrop of de-globalization. Do we think multiples will be higher or low in three years than today? And the answer logically is probably slightly lower. Because you're not going to pay as much for businesses that have to invest in. in higher cost manufacturing regions, for example. So if we do 17 times forward earnings and we get zero earnings growth this year,

that means 10% earnings of 10, it would be rational to assume 10% lower earnings potential, 10% lower S&P 500, right? Yes, that's right. That's right. Look, we're still up versus where we were before the whole crisis happened. We're still up versus the 3387 eyes. This is an ETF show, and I know we keep talking about macro, but you're such a great macro guy. I've wanted to focus on that. But in terms of fund flows, what's remarkable to me is that even this year with the S&P down almost 20% at one point, there are consistent flows into plain vanilla ETFs. The S&P 500, whatever iteration, whether it's an I-shares or Spider or whatever Vanguard,

consistent inflows into plain vanilla indexed ETFs. Now, some of this clearly is people taking money out of mutual funds. higher costs into lower cost, but I'm still heartened by the fact that the ETF industry continues to keep growing on the plain vanilla side. Yep. No, it's absolutely true and it is very good to see and I agree with you that its money flows probably coming out of higher cost mutual funds. Look, I mean, ETFs are the greatest disruptive force in finance in the last 20 years and I say that in the most positive sense of the word. A disruptive technology always comes in at the

low end of a market with people who are underserved. SPY did that in 1993 because you couldn't get a plain vanilla ETF or a plain vanilla fund. And it's just grown from there. And now we have thousands of ETFs and they serve a whole variety of uses. But at the end of the day, the most important thing is provide access to regular investors in the lowest cost manner possible so that can have the highest potential of future return with the lowest fees.

And they're still doing that, which is great. Yeah. Are they going to, we sort of hit the rock bottom. I mean, it's three basis points for the S&P 500 for some of these funds right now. It's not going to get much cheaper than that. I feel very ambivalent about active management because to me, if you're a crummy active manager in a mutual fund, you're going to be a crummy active manager in an ETF. It's just a wrapper.

That's all it is at this point. I guess the bigger issue is how the public feels about active versus passive investing. despite the academic evidence that long-term passive investing is a superior strategy than active investing because market timing generally doesn't work. Active management never quite dies. Is that a good thing? I mean, the active people keep saying, we've got to have people picking stocks out here. You can't just have passive investing.

Is there some empirical reason why you must continue to have active investors? What's the argument here? I mean, the argument used to be that you needed active investors to differentiate between actual stories and managements and have that real touch point with the real world. Given how algorithmic the market has become, it's a little bit harder to make that argument because the machines are away pretty much any short-term variability that a human might have done 20 years ago. So the only big picture thing is to have people who can really see into the future and pick stocks well, and there's not very many of those.

But I will say active management has one great utility, and that is that if an investor would not invest in anything other than an active, manager, it's still better being in the active manager than not being in the market at all. So if you need to believe in somebody's ability, great. Just stick with that person. Because even if they underperform their index, they'll still do better than cash. Yeah, it's time in the market, not timing the market, is the old phrase. You mentioned an interesting word there. It's really the algorithms that are arboring away a lot of the human advantage. But some people take that to an extreme. They say, well, the machines

are in charge, as if the problem I have with that is it's the, The machines are not self-employed. They're not writing algorithms. They don't have a bank account. There are people that are writing the algorithms that tell them when to buy. There are people at the end of the day who own the stocks. There are pension funds at the end of the day that own the stocks, even if it's traded in between by some kind of high-frequency trader

that doesn't hold on to it for more than a fraction of a second. So at the end of the day, people are still writing these algorithms that are out there. I find it disturbing that a lot of people seem to think that there are extraterrestrial intelligences that are in charge of the stock market, that they're not there. It's just not. So this phrase, the machines are running everything, seems to paper over everyone's inability to understand what is going on in the markets. And ultimately, I guess this question is, do you still think fundamentals matter? Do you think ultimately prices still move on the direction of fundamentals for these companies? Yeah, I am very much still a fundamental analyst at heart

and view the world through a fundamental lens. I think it helps to think like a machine sometimes. We do a lot of correlation work for clients, analyzing how a machine might look at the current market and say, oh, look, I mean, energy still is not very highly correlated, or all the major sectors are very highly correlated, or the VIX gets to 36. If you go back and look at a chart,

when the VIX gets to 36, the market bottoms in a day. And that's, I think, because a lot of algroes, no 36 is two standard deviations from the long run mean on the VIX. That's a very unusual level, and you should bias perhaps your bids to be a little more aggressive, and things begin to work their way higher. But even there, this algorithm that controls the universe that buys the 36 is based on historical trends with humans who have noted this who programmed an algorithm. It's not an extraterrestrial sitting there controlling the market.

It's not dark, unseen forces controlling the universe. And there's no guarantee that VIX can't go to 44, which is another stand deviation. And it has. And it will again. Even the machines get surprised. Well, that's what's good about it. We always get surprised. Nick Cole is co-founder of Datatrek.

Thank you very much. And those of you who don't know about Dat Trek, I encourage you to look it off. Terrific daily read on a large scale, 3,000-foot view of the stock market. Nick Coles, thanks very much. And thank you, everyone, for joining us on the ECF Edge podcast.

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