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PostMore on Stock Lending, SPACs, NFTs (from Ric Mauricio) (John Eipper, USA, 04/20/21 4:13 pm)
Ric Mauricio writes:
An excellent post on stock lending by Michael Frank (April 2nd). Allow me, if you may, to expand upon the subject.
Index funds that primarily invest in large cap stocks benefit the least in lending out their securities due to the smaller spread between the bid and ask (a result of their increased liquidity in the markets), while the index funds that invest in mid cap or small cap stocks will benefit the most due to the larger spread, thus they are able to offset more of their expense ratios that would benefit their shareholders.
Now, here's the rub. When an investor opens a brokerage account, they can open an account with margin capabilities. Now the brokerage firms that hold these accounts now have the privilege of lending out the investor's holdings and they don't even have to tell the investor. More so, unlike the index funds (or any fund, for that matter; doesn't have to be an index fund), the brokerage firm earns the lending fee, which they keep. Imagine, they are earning fees on securities they don't even own.
Now, here's a further rub. Let's say the funds and brokerage firms lend the short sellers the securities, which, in turn the short sellers sell to another investor, who now holds the borrowed securities. Keep in mind that the short sellers no longer have the borrowed securities (otherwise they would be long and not short) but are obligated to buy back the borrowed securities if their brokerage calls them to do so. Now let's go once step further. The investor who purchased the borrowed securities from the short seller now has those securities in their "margin" account. Ha, the brokerage firm that administers their account can now lend those same securities to another short seller. This is why some companies can have a 125% short interest on their float, as we saw on one very visible stock in the last few months. A very dangerous game, if I may say. Does anyone remember October 1987? I couldn't even get a good quote from my market makers on the NYSE or NASDAQ.
Now onto JEZZ. I recently received an email from a neophyte investor asking me what I thought of cryptocurrencies, the stock market in general (and the "fact" that it will now collapse along with the economy because of Biden), and gold. Oh my, my JEZZ antenna is tingling. Whenever I hear, read, or see these comments, it usually signals that you may not want to play in this game. I am sure that this neophyte investor is also wondering about SPACs and NFTs. SPACs (Special Purpose Acquisition Corporation) are created to bypass the normal IPO (Initial Public Offering) that are run through a consortium of brokerage firms. SPACs require less due diligence than IPOs, but save on costs because they don't have to share anything with the big bad greedy brokerage firms. But they do require greater due diligence on the investor's part because of this. By the way, due diligence by the brokerage firms does not guarantee that the company is a company that will do well. Remember the dot com bubble? All IPOs. Ouch!
NFTs are Non Fungible Tokens. Note the word Fungi in the description. Well, some fungi aka mushrooms are poisonous, but most I fear are hallucinogenic. I mean, if I hold an original Honus Wagner card in my hands, or hang a Monet in my family room, I get that touchy feely tactile sensation. But something digital? I may be wrong, but sorry, I'll stick with companies and real estate that generate real revenues. Sure, I'll collect that coin or Pez, but at least I can enjoy it by holding it. By the way, the TV shows that sell collectible coins are scams... they are overpriced.
As to John E's Pets.com, it was a matter of execution. Great idea, but terrible execution. Chewy had the same concept and is doing well. Takes a little research to separate the wheat from the chaff.
One member in the gym commented to me that the reason he doesn't invest in the stock market is because of the volatility. Well, if you removed the volatility from the markets, you will end up with a return on investment equal to a CD, which underperforms inflation, so you will not be building a nest egg. Now there is the concept of market timing, to avoid the volatility. The issue of market timing is that most timing systems are based on moving averages. And the problem with moving averages is getting whipsawed. You sell when the security falls below a certain moving average and you buy when the security rises above a certain moving average. Many times you end up buying above your selling point, only to have to sell again, and buy again. Not only are you not getting anywhere or ending up where you would have been if you did nothing, but you incurred transaction costs (and yes, even though you may have zero commission cost, there is the spread between the bid and the ask prices) and possible tax consequences.
Now what I found is that most investors tend to think too much and start ignoring or waiting on the signals. I like to embrace the volatility. I like to buy good companies when they are on sale. I execute the JEZZ system and buy when there's maximum pessimism and sell when there's maximum optimism. I also avoid, like my neophyte investor above, investments that are being highly touted (especially by the media and brokerage firms).
JE comments: Lots of acronyms here, but I'll start with most arcane: JEZZ is the only known acronym in my honor, coined by our dear friend Ric Mauricio: the John Eipper Zig-Zag approach (i.e., zag when others zig, investment-wise). Ric also brings up one of the more bizarre "investment" vehicles of our age, the Non-Fungible Token/NFT. The NPR radio show Marketplace did a segment on them recently. In short, via NFT exchanges you can "buy" an digital token, such as the first-ever Tweet. Who would pay good money for such nonsense?
I'll change my mind when I can visit a Museum of NFTs. Granted, the Henry Ford Museum in Dearborn, Michigan houses a test tube containing Thomas Edison's last breath.