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Tuesday, October 27, 2020 1:50pm

Rising Stock Prices And Rising Volatility – Schwab’s Randy Frederick Joins Alpha Trader (Podcast Transcript)


Editors’ note: This is a transcript version of the episode of Alpha Trader that we published earlier this week. We hope you enjoy.

Aaron Task: Welcome to Alpha Trader. Our next guest has said “virtually no upside resistance until the S&P hits its all high of 3,580.” Randy Frederick is Vice President of Trading and Derivatives at Schwab. Randy, welcome to Alpha Trader.

Randy Frederick: Thank you. It’s great to be with you.

AT: It’s great to have you here, and, you know, 3,580 suddenly isn’t so far away after last week’s big week and we’re talking mid-day Monday. Markets are rallying strongly again here, at least to start today. From a technical perspective, what in your mind was so significant about last week’s move?

RF: Well, I spent a lot of time reviewing indicators about call ratios, volume, open interest, things like that coming from the options markets, and frankly, the last couple of weeks, they’ve just been remarkably bullish. You would think that given the – how sharp the rebound has been, since the month of September ended, we’ve nearly reversed the entire decline. And as you said, I – there’s very little technical resistance there. The S&P 500 had been struggling trying to break out above the 50-day for several days, probably about almost a week and a half, and when it finally broke through, until President Trump tweeted about stopping the stimulus talks, which caused a little bit of a reversal, but from other than that, we’ve had just some solid upside momentum and it doesn’t look like it’s going to slow down anytime soon.

AT: Yes, that’s right. And you mentioned obviously, the – what seems to be, I’ll say the elephant in the room, which is negotiations over stimulus. You also wrote, even if they don’t reach a deal, it seems like that negotiations will continue, and if they do, there’s very little to keep the S&P from reaching a new high again, possibly even before our election day. What happens if, again, President Trump comes out and says, forget it, there’s not going to be a deal. Let’s stop the talks?

RF: Well, I think what would probably happen there is the same thing that happened back on Tuesday afternoon, which is you’d have a pretty sizable immediate reaction and usually you get an immediate negative reaction to anything that is a surprise. It may not always be a bad thing, and I’m not saying stopping stimulus’ wouldn’t be a bad thing, but I’m saying, typically the market reaction when there’s a surprise of any kind, and you saw it whenever we first heard about President Trump being infected with the virus.

AT: Correct.

RF: We saw it on Tuesday afternoon, when he talked about stopping the stimulus. Those types of things tend to cause a negative reaction. But oftentimes, once people have a few moments to digest it, then you’ll see a reversal there, and [I’m glad that] he did change his mind later that evening, and then, by the very next day, apparently, the stimulus talks were back on again. And then, as the day progressed, not only were they back on, but now he’s actually advocating for a larger stimulus than what was previously had been discussed. So, generally you see a quick reaction and it’s in a negative direction. But frankly, the markets as, you know, tend to move a lot more on what might happen than what is happening.

It’s always about the future and what might happen down the road. And that’s why I said, even if we don’t have a stimulus prior to the election, and there’s still a small possibility that’ll happen, just the prospect of a potential stimulus is enough to keep the markets moving higher. So, I think in all likelihood, given what happens then, it’s very unlikely that at least President Trump himself would request that the talks end. We might hear that from Mitch McConnell, you may hear that from Nancy Pelosi, but I doubt that you’ll hear that from the President.

AT: Right. And you’ve referenced this, you said, you know, volatility remains not only elevated above historic norms, but is increasingly likely to trend higher as Election Day approaches. Should we be surprised that you think both the market is going to go higher in concert with volatility?

RF: That’s a very unusual development, and in normal circumstances, that would be very unusual. But what you have here is an outside influence. The election that is affecting things in a way that we’ve never seen before or at least we haven’t seen in since the last election and honestly, it wasn’t really there either. I’ve had – if you go back to the election of 2000, you see it a little bit there. But basically, if you look at the VIX futures, which is a – you know, a forward looking volatility estimate, since going all the way back to February, there’s been a sizable spike in the VIX futures out in the October expiration, which was about two weeks before the election. But in the last two weeks, it’s actually even gone higher now for November.

It’s very unusual for volatility to peak after an event that’s likely to cause volatility. But I think that speaks to the uncertainty about how soon we might actually know the finalized results because of all the mail-in ballots, whether there’ll be a peaceful transfer of power, all sorts of different things like that, I think speak to that. But essentially, and I remind people this regularly is that the spot VIX index, which many, many people watch, and this – the futures contracts on the VIX have to converge at expiration. They have to be the same or at least within a couple of pennies.

So when you have the futures for October and November, four, five points higher than the spot VIX that’s almost inevitable that the two will – well, again, they have to come together. Now that can be two things, either the futures can come down to meet these spot VIX or the VIX can go up to meet the futures or a little bit of both is what generally happens, but it’s almost – with almost out any question that you’re going to see the VIX creep higher, and that’s what’s been happening here recently, and as we get closer to that expiration, unless for some reason, we have more certainty about the election. But I don’t think that’s going to happen prior to election day because everybody remembers 2016 too vividly when the forecasts were all that President Trump wouldn’t win and he did. So, I think now, people are far more skeptical of polling.

AT: Right. And also – and I keep reminding myself of this, the conventional wisdom also was that if he were to win, that would be terrible for the market. There was a huge sell-off on election night, but it reversed overnight. And then, obviously, it was straight up for the first several months of his presidency.

RF: Exactly. And that speaks to what I was saying earlier. You’re right. It was a very sharp sell-off. One of the sharpest who’s ever seen, but it only lasted a few hours, and it was in the overnight futures. And most people probably didn’t even know what happened because by market opened, the market was only down modestly. By the end of the day, it was positive. And then, it went up for 15 months after that. But what caused the sell-off was that it was a surprise, nobody expected it, and it was a surprise, so conventional wisdom is often wrong.

Stephen Alpher: What I find fascinating is we had a strategist on last week, who’s telling us the bullish action in stocks, is telling him that the President is going to win reelection. I’m seeing notes from Goldman, UBS, and others saying that the bullish stock market action is telling them that it’s going to be a blue wave with Joe Biden cruising to victory and possibly the democrats taking the Senate. So, I guess everybody sees what they want to say. But is the action in the stocks telling you anything about what the results of the election might be?

RF: I would say that the action in stocks is telling us that we have enormous fiscal and monetary stimulus out there, huge amounts of liquidity and interest rates that are likely going to be zero for the next five years. I think that’s what the action in the markets are telling us. I think even if we knew for certain who was going to win the election, we would not be able to predict what way the market was going to go. As we just spoke about earlier, the conventional wisdom back in 2016 was that if President Trump won, it would be bad for the markets, and it’s been anything but that.

So, I think any thoughts now that a Biden victory or a Trump victory is bad for the markets is mere speculation. And in fact, that’s probably not even the greatest factor. The greatest factor is probably more about what happens to the Senate or whether or not we have a complete blue wave or a complete red wave. Historically, and this may not be the best source to go to, but it’s the only one we have, the markets have typically not liked drastic change. So, a strong blue wave or a strong red wave probably would both be negative for the markets because it sets up an environment for the greatest and most radical change whether – you know, again, it doesn’t really depend on what side of the aisle you’re on, it’s radical change to the right or radical change the left.

Either one of those things causes the market to probably be a little bit uneasy. The market prefers more of a gridlock where anything that gets changed has to go through a full vetting process and you’ve got detractors and supporters and things happen slowly, gradually, and less radically, and markets tend to be – to prefer that. So, frankly, I mean, if you look at the long-term history, you could see that the market has generally done better under Democrats than under Republicans, but actually the markets done well under everybody in the long-term. So, I don’t think that that’s really much help and making trading decisions based on that is not a very good idea.

AT: Right. And I think you just alluded to this, and you know, we’re guilty of it, too. I think maybe we in the media talk too much about these known events like the election as if that’s really what the markets hinging on, and maybe, as you said, it’s about the fiscal and monetary stimulus that’s out there with meeting that almost regardless of whether – you know, this same guest that Steven just referenced also said, we don’t even need a fiscal stimulus package because there’s so much money floating out there and the market’s got momentum and the economy’s got momentum. Is it possible the market is telling us it doesn’t really matter who wins the election here?

RF: I would – that’s kind of the point I’m trying to make is that it really doesn’t matter all that much. What matters maybe, again, is if you have an entirely – if you have the Republicans controlling both the House, the Senate and the Presidency, and – or if you have the Democrats controlling all three, I think that could be a little bit problematic. But I think that that’s probably the least likely scenario of the – of all the scenarios, and so the markets doesn’t – don’t seem to be too worried about that. What the markets are telling us is, again, that it doesn’t matter and I think you’re right.

Yes, that’s kind of the general sense is that we just have, I mean, we’ve heard the expression many times, right? We talked about [indiscernible], there is no alternative. I mean, [indiscernible] are you going to park money in a 10-year treasury for 0.5% for the next 10 years?

AT: Right.

RF: It’s going to do that. Ultimately, people are going to take on more risk because they’re frankly forced to. And in a market that’s moving higher where there’s very little inflation and even few signs of it, I mean, occasionally we heard people bring it up, but if we do have it, it’s a very short clip, it doesn’t last very long. We haven’t had inflation for 12 years. It seems unlikely that that’s going to happen. And at this point, everyone seems to be a modern monetary theorist even if they won’t fit it because we have enormous amounts of debt. We’re running – we have a $4 trillion deficit and who’s going to want – what President is going to want to change that story?

What Fed Chairman is going to want to go in and raise rates knowing that it might cause a bear market, and then, that particular President is going to have to explain why he or she didn’t do as well in the market as Trump did? I mean, it’s – you put yourself into a situation that is almost impossible to get yourself out of. I’m not implying that we’ll never have another bear market, but we’ve seen several times over the last 12 years, every time the market has even a slight hiccup, we jump in to rescue it with – at least with monetary policy, and now, frankly, with monetary and fiscal policy.

AT: Right. And certainly not this Fed Chairman isn’t going to be the one to turn off the [spigot] so at least, you know, based on what he’s been saying, lately. So, let’s turn to, you know, the – sort of the internals of the market or at least how the markets are acting as we’re talking here right now Monday mid-day. You know, the FANG+ stocks, as they are being called, are rallying again sharply. You know, Apple is up above its next big event. Twitter is rallying after it got upgraded by Deutsche Bank. Meanwhile, the energy stocks are getting clobbered again.

So, it’s sort of a continuation of the themes we’ve seen, not just since the March lows, but the last, you know, year plus. Do you believe that that – those trends are going to continue? Is it still going to be technology over cyclical stocks, the work-from-home stocks, you know, and the mega caps continuing to lead here? Or do you see evidence that there’s going to be some rotation?

RF: I think, in general, that trend is probably going to continue. And the reason I say that is because I think the trend of the – an extended bull market. I mean, again, you could easily say, well, we had a bear market in the spring. It was very short and very abrupt, but it was technically a bear market. So, in theory, we are back in a new bull market that began on March 23. But go back and look at who the leaders have been for the last 12 years. Since the financial crisis, it’s been the technology stocks. It’s been the consumer discretionary stocks. Those tend to be the leaders in a bull market. And I know we keep hearing recurring stories that keep coming up every time you have a very short period of downturn like we had in September. [Indiscernible] the cyclicals are coming back.

AT: Yes.

RF: You know, value is going to start to outpace growth again, and active management’s going to do better than indexing. But those things only happen in down markets. They happened in September. They happened back in March and April. They happened in December of last year. Anytime you have a correction or short-term downturn, there’s a little bit of a flip over and it makes sense. I mean, these are the leaders. They’ve outperformed. Their betas are far greater than the S&P 500. And so, they have a lot more room to pull back when we have a temporary blip.

We have another pullback, those sectors will struggle. But by and large, because they’ve outperformed so far and for so long, they can get back a lot and still be way ahead. So, as long as you continue to see an overall bullish, longer-term trend, those sectors in all likelihood will probably continue to lead. And the FANGs are leading, but they’re frankly big stocks that make a lot of money and they have huge brands.

AT: Right.

RF: They are far different than what we saw back during the Internet bubble in the 1995 to 2000 period where we had a lot of companies leading that weren’t making any money and didn’t do anything, but these guys are now big, giant, profitable companies, and so, therefore, it makes some sense and it’s where the safety is, right? I mean, if you’re trying – if you’re being forced into risk assets because you can’t get anything in fixed income, why not be invested in big companies that you know are going to be around tomorrow.

SA: I wanted to talk about one of the thing that might be driving markets. This week is considered – generally considered to be the beginning of Q3 earnings season, but as you point out in your recent letter, we’ve already had a decent amount of S&P 500 companies have reported their Q3, roughly 4% of them or 20 companies and you noted that so far EPS beats and revenue beats are way ahead of recent quarters. Is it possible if we extrapolate out, if this is kind of going to be the pattern throughout earnings season? There’s a very good reason for the rally in stocks over the past couple of weeks.

RF: Right. So, a couple things I would caution. One, yes, it is only – we’ve only had like 4% of the companies report, so that’s a very preliminary number. And what I’ve noticed over the past many, many quarters is that some of the stronger companies have a tendency to report fairly early and as the quarter progresses or this – I should say the earning season progresses, the early outperformance tends to get moderated to some extent. But that said, we did substantially better in Q2 than what was expected. At the end of Q2, the expectation was that earnings would be down 44%, I believe, year-over-year and it was only down about 7%, so substantial outperformance.

And it’s not really that important what the companies earn, it’s always, as you know, what they are earn relative to what was expected? At this point, the expectation is that earnings will be down about 22% year-over-year, still a terrible quarter from that perspective, not as bad as what was expected in Q2. And as you said, we’re only down about 7% year-over-year, so – and so far, it’s already been better than expected. The one caution, I think, is that it’s highly unusual. You don’t see it very often, but we have seen it this quarter that companies and analysts have upgraded their estimates as the quarter progressed prior to the beginning of earnings season.

More often than not, the optimism is the highest at the beginning of the quarter and as the quarter progresses and we get to the end, the expectations come down. And this was one of those rare quarters where the expectations have actually ratcheted up and now many companies are telling us they expect to do better than they thought they would do at the beginning of the quarter. But that said, that’s still a relatively small number. In Q2, only about 50 companies out of the S&P 500 actually gave any kind of guidance at all because there was so much uncertainty related to the virus.

That number has increased only into about the mid-60s, so still the vast majority, less than 20% of all the companies out there have even given us any kind of guidance. So, we’re relying on analysts who are using formulas that have frankly a lot of missing pieces to them and I think that’s partly why the outperformance was so dramatic in Q2 and I think, to some extent that will happen this quarter. The only cautionary point I think is out there is just the fact that the expectations have gone up a little bit.

AT: Right. And so as Steven said, earnings season, for most of us, seems to kick off this week and Tuesday morning, we’ll start to hear from the financial sector, JP Morgan, Citi, BlackRock kicking it off. Around the same time, people will be hearing this podcast, just FYI. So, financials is one of those sectors that a lot of – you know, as you referenced earlier, people say, well, the cyclical stocks, you know, are poised to do better. They’ve been so such woeful underperformers. Do you have a view on financials as a sector? Obviously, you work for Schwab, so with that caveat there is that a place where you think there’s an opportunity here in the context of that rates probably aren’t going much higher, so the net interest income is still going to be very low for that sector?

RF: Right. So, I will give you our – one thing Schwab does do is we do put ratings on individual sectors. So, our actual financials at the moment is the only sector that we actually have an outperformance rating on, an outperform rating on, and the reason being a couple of things. We’ve had a fairly neutral stance for quite a while. We have an underperform rating in utilities and an outperform rating in financials, everything else we’re at market perform. And one of the advantages to the financials, as you pointed out, is the only sector that’s done worse is the energy. And energy, I think, is struggling for a lot of reasons.

One, oversupply, under demand all of the lack of travel because of the virus, but also that there’s a long-term secular shift in energy going on that’s probably a multi-decade shift, and that is just a way from fossil fuels to all sorts of other alternatives, so that just makes it difficult. But financials, I think, have been beaten up, and not necessarily undeservedly so because of low interest rates. Most people know that financials usually aren’t a large portion of their revenues from interest rate spreads. And as the rates come down, that spread gets compressed. And so, I think that that makes some sense. But because they have underperformed, there is an opportunity there for much greater upside simply because they’re not nearly as overvalued from a [VE] perspective as many other companies are.

And they also, you know, have figured out ways to try to generate income from other sources. In many cases, the big banks especially are far more capitalized than they have been in the past because there’s concern of a potential – of another major downturn and they want to be prepared, so they’re not caught off [or like] like they were back in 2008. So largely, when you have sectors like tech and discretionary and even communication services to some extent, that have been such strong outperformers, many of those stocks have gotten to be quite expensive. As the rally continues and people believe that it might, they start looking for bargains elsewhere and financials are one of the more affordable sectors from that perspective.

AT: Right. So that brings back to a point you mentioned earlier about, you know, the big tech being very different than it was in the late 1990s in terms of the profitability of these companies. But are you concerned about the valuations in the mega cap tech stocks and/or just the concentration of those names in the S&P 500? I don’t know what the latest stats are, but it’s somewhere around a quarter of the S&P 500 is in five stocks.

RF: Yes, it is. It’s about that and I don’t know if it is exactly, but it’s very close to that. Well, you know, there’s always a concern about that. But, you know, technology, as a sector, tends to trade at much higher valuations than almost anything else. That’s generally the case and that has been the case for a while. But again, these companies continue to be outperformers. They continue to be very profitable. Obviously, some of them have become so big and so profitable that now there’s a lot of discussion about them being too big and being monopolies which – you know, and anti-trust is a fascinating topic, but it’s frankly only ever been used twice in history.

And the last time we broke up finance – we broke up companies was, you know, back when Bell Telephone was broken up and what was at the 1980s maybe, and then, you have to go all the way back to like the 1920s for Standard Oil or something to find another time when that happened. Even Microsoft, which [had almost] under a lot of scrutiny, ultimately ended up avoiding that, so I’d be very surprised if we’re able to do that. But tech is a greater and growing part of our lives every single day. I often describe it this way, tech – big tech has been trying to convince everyone for a decade or two that they were indispensable. And now that the virus is hit, and many, many people have been forced to work at home, they’ve been vindicated. They are [indiscernible].

AT: Yes.

RF: In fact, without them, we would not be able to do what we’re doing right now. I dare say five years ago, as recently as five years ago, had we been hit with a virus similar to we’ve had right now, we would not have been able to handle it from a people working at home perspective, and to the extent that we are right now. So, I have a hard time of imagining that tech won’t continue to infiltrate more and more parts of our lives going forward. Then you have the benefit of these are big companies that are profitable. They can sell bonds at ridiculously low rates right now and…

AT: Yes.

RF: …stock up on capital, even if they don’t need it, and in many cases, they don’t. Why not pile up huge amounts of cash, which you can then use for R&D and expansions and M&A activity for the next several years, and that just simply makes them stronger. So the environment is very conducive for them to continue in what they’ve been doing.

AT: Right. So, you just referenced the anti-trust issues and there were headlines over the weekend that the Justice Department, some state prosecutors are looking into alleged anti-trust violations at Google and they may want to force the company to sell its Chrome browser and parts of its advertising business, which has really been the secret sauce for Google’s profitability. And without weighing in and whether that’s going to happen or the righteousness of it or not, if the government just becomes more restrictive on these big cap tech stocks, is that a risk in some of these names? Because again, you mentioned Microsoft, it seemed like maybe what’s going to happen anyway, but the anti-trust case against Microsoft came around the peak of the NASDAQ bubble in the late 1990s, early 2000.

RF: Yes, I mean, what obviously, I think the differences are they just victims of being successful? Or are they actually potentially engaged in anti-competitive activity? I mean, that’s really the – sort of the fine line and that’s not an easy line to draw on. It is a little bit fuzzy at times. But, you know, again, companies of this size with this kind of capital and these size – revenues this big can afford to maybe sell off a part, you know, spin something off, and – I mean, think about it, when, say a bank buys another bank, they oftentimes will have to shut down branches in certain areas so that they’re not too monopolistic. You can do those sorts of things. It doesn’t kill them. And oftentimes, they will do just fine.

I have a hard time imagining that they will actually be split apart in a big way because instead of saying, okay, don’t tell me I have to split up. Tell me what I have to do to not split up. And then, they’ll figure out a way around that that’s kind of like what Microsoft did, I think, and that’s more likely what’s going to happen. So yes, it does obviously present a certain amount of risk. But inevitably, tech always bounces back, tech always figures out a way around whatever challenges are in front of them, and they continue to do well. And I think that that’s – again, there’s always short-term hiccups and short-term challenges to overcome. But eventually, they do well and if you’re big enough, and you got enough capital, you can figure out how to do that.

AT: Our guest is Randy Frederick. He’s Vice President of Trading and Derivatives at Schwab. We’ll be right back with more Alpha Trader.

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We’re back with Randy Frederick of Schwab. And Randy, it sounds like you’re pretty bullish here, at least in the near term. And so, positioning wise, you know, how are you positioned or how would you recommend, and I know this is a dangerous word, the average investor be positioned here?

RF: Well, I mean, that’s obviously not a recommendation I can make without knowing a lot about the average investor. It generally has a lot to do with, you know, what is his or her income net worth? How old are they? What are their financial goals? [Indiscernible] way, way, way too many things that we can’t really get into. We can’t just say [blank] and do this. That’s why…

AT: Right.

RF: We do have an algorithmic driven rating system that’s updated every Saturday for all – pretty much all the equities out there. We have an [A, B, C, D, E, F] rating. It’s very simple for everyone to understand. And then, as I said, we’ve talked about this already, we do put either underperform, outperform or market perform ratings on the 11 market sectors. As we’ve discussed, the only sector we have an outperform rating on now is financials primarily because of the underperformance there, which has left them a little bit more affordable. But in general, we’re constructive on the market.

We’ve got a – probably our broadest look at the market is probably more neutral right now. But as we’ve talked about already, there’s an enormous amount of fiscal and monetary stimulus out there that’s not going away anytime soon. And people have been forced out of fixed income simply because there’s just no yield there. So, they’re looking for places where they can get not only capital appreciation, but also income and dividends have been very popular for a whole decade now. It’s hard to imagine that’s going to change anytime soon.

SA: And you mentioned financials. One of the reasons you’re bullish is because of its significant underperformance. But I know in your letters and on your Twitter feed, you talk a lot about put-call ratios as being kind of contrarian indicators. Are you seeing anything in those ratios as it relates to the financial sector or individual financial stocks that has [indiscernible]?

RF: Right. So, let me make sure, its – I clarify this. So the sector ratings, the equity ratings and things like that that we do as a company, as Schwab are – have a long-term timeframe, 6 to 12 months. The work that I do as the short-term analyst at Schwab is usually much, much shorter term. I’m – my weekly trader’s outlook is designed to just be an outlook for one week and most of the stuff I talk about is probably got a timeframe of about a week to maybe a month or so. Put-call ratios that I speak of, and I look at a variety of different ones, I look at them from the perspective of equity only, the S&P 500, and then also on volatility, and I look on both not only the volume put-call ratios, which are day-to-day activity, but also the open interest ratios, which measure total outstanding contracts.

So from that perspective, the indicators have been quite bullish for the last couple of weeks. This week, I had a moderately bullish outlook and it was fairly close to being fully bullish almost frankly, which is pretty unusual. You just don’t get that that often. I study a variety of different things. You know, generally not everything is going to always agree and that’s normal, and part of that has a little bit to do with also the timeframes. Even when you’re looking at a week, some stuff is kind of useful for maybe a day or two, others can maybe go on for a few days.

So, you sometimes get a little bit different perspective from that standpoint. But frankly, some put-call ratios have a tendency to be contrarian. But generally, my research that basically spans my whole 30-plus year career is that they tend to be only really contrarian when they hit extreme levels, extreme high levels or extreme low levels. We’ve had a few instances recently where that has happened. Certainly, just before some of the more recent pull backs going into the late August, we had a little bit of a pullback there. We had another one in mid-June where these ratios got exceedingly bullish.

The number of retail investors out there who are sort of dipping their toes, if you will, into the options markets is at record high levels. Volumes in the options markets are at all-time high levels. The month of – just recently, we’ve hit literally. September of this year was the highest total contract volume month in the history of the options industry, which goes back to the early 1970s. So, it’s huge amounts of volume out there. And you have to separate activity that retail investors are doing, which tends to have a very high equity option component to activity that you see going on in the institutional, which they tend to trade a lot of index options, cash index options, retail investors almost never trade them. They’re available, but they rarely do.

So, they’re being used for entirely different purposes. When retail investors are buying equities is typically because they’re bullish and they’re buying calls and things like that because they think things are going to go up, we see a lot of index activity that are being used to hedge downside movements. So, if I see a reduced hedging in indexes, that tells me that the institutions are fairly comfortable with where things are at, so that’s why I kind of sort of slice into each one of those individually. And they’ve been – for the most part, you know, we’re not quite at those frothy extreme levels yet at the moment where things could reverse lower, but we’re pretty close again.

And frankly, given how close we are to an all-time high, I would say, about the time we get to that all-time high, we’re probably going to be at that frothy – well, I mean rationally exuberant level, if you will, again, and then, probably be in line for some sort of pullback. It doesn’t mean a major correction, but, you know, another 4% or 5% or something like that.

AT: So, do you have a thought in mind, you know, I mentioned at the top, you know, you think there’s very little resistance until we get to the old highs at 3,580 in the S&P 500. And again, as we’re talking here, mid-day Monday, we’re not that far from there. Do you have an upside target beyond that?

RF: No, because I mean, I’m not a hardcore technician, and, you know, to me, once you get beyond the highs and you’re kind of the upside is open, you could apply retracement levels I suppose. I’m not a big believer in things like Fibonaccis, I think they work in nature, but the markets anything, but nature, so I don’t really look at those. It’s difficult to say. I mean beyond that you really can’t see it, so I would probably – I spend a fair amount of time focusing on sort of the combination between both technicals and fundamentals.

AT: Right.

RF: And, you know, once we get on that level, it’s hard to say. I mean, I can’t really say that I see much upside beyond that.

AT: Okay. And not trying to [succumb] to the appeal of pessimism here as Morgan Housel would put it. But, you know, what worries you here?

RF: Well, there are several things to be worried about. Obviously, we talked about the potential for no more stimulus. I think, frankly, almost everyone who’s sort of hesitant right now is kind of waiting for the election outcome before they decide what they want to do there. Obviously, I think President Trump is encouraging further stimulus now because I think he believes that would be beneficial to his reelection prospects. But I think what’s fascinating, and I don’t want to get too political here, but many of the – many of Trump’s supporters in Washington appear to be sort of starting to make a very modest shift to distance themselves from him as opposed to supporting him, people like Mitch McConnell and others, maybe because they’re starting to believe the incessant level of polls that are saying that he’s not going to win.

We don’t know for sure if that’s true or not. And as I said, and I think many people are far more skeptical of polls now than they ever have. But I think it’s quite interesting just in the last maybe two weeks or so that those who were had been – supporters are starting to sort of show themselves to be somewhat maybe pulling back away. So that may be part of the reason why even though – I mean, President Trump clearly wants the stimulus now contrary to what he said on Tuesday, but I don’t believe he even has support of the Republicans in the Senate to get that done, potentially. So that’s part of the reason why I think it’s less likely that we’ll see that until after the election.

AT: Yes. And again, we try to be apolitical here as much as possible. But my understanding is there’s been – there’s a handful of Republican Senators who’ve been taking that point of view for several months now. So, you know, it could be a number of things. But yes, it does appear that he does not have a ton of support in the Senate in his own party for a big stimulus pack at this moment.

SA: It’s totally interesting to me. I agree with both of you. Everyone’s kind of falling in line behind certain pieces, certain things he wants to get done, but not the stimulus package, which seems to me the most immediate need, the most important need. What’s also interesting is what happens if Joe Biden wins the election? What happens in that lame-duck session? Do both Houses of Congress kind of breathe a sigh of relief that the election is over and they move to get something done and then pass kind of a veto-proof bill? Or do we sit and wait for three months or however it is, 10 weeks until the inauguration?

RF: Yes, those are great questions. And again, I always try to stay apolitical as well. But ultimately, politics comes down to self preservation and if you think as a Republican being in support of Donald Trump is going to be – give you the greatest probability of self preservation, you do it. And then, when that starts to look like that’s not maybe the best plan, then you start going the other direction. And I think you could – again, you can contrast the Supreme Court confirmation hearings. It seems like there’s a widespread support on the [indiscernible]…

AT: Right.

RF: …to get that done, and so, it’s likely going to get done. Whereas the stimulus package doesn’t have as much support, so it’s not likely. If you had widespread Republican support for it, I have no doubt they could get that completed prior to the election, but it’s just not there.

AT: Yes, which is, you know, one of the strangest things in politics I can imagine, because you would think it’s be good for any incumbent, but that’s a whole other discussion. So, turning away from politics, which I think none of us are thrilled to be talking about, you did mention before, you know, the volume, the options market, the increase in activity among retail investors. You know, from your vantage point at Schwab, can you give us any sense of, you know, how Schwab’s client base, which is obviously very large retail base, is acting in terms of – is there an unusual amount of activity, trading activity happening right now?

RF: [Above all] I can really tell you is that there has been an increase in interest in options trading from retail investors, and we obviously have a large client base. It’s a very good microcosm, I think, of the industry as a whole and we have seen an increase in that. But it’s pretty straightforward why that’s happened. Certainly, a big piece of it is the fact that commissions have gotten substantially cheaper and that happened late last year and you’ve seen a large increase in interest because of that. From a commission standpoint, options trading has always been more expensive than equity trading just in terms of the cost. That has gotten substantially cheaper, so that helped.

Secondly, obviously trading platforms over the years have gotten far and far – far, far better and better all the time and it’s very easy and there’s an enormous amount of good quality education and research available. I’m part of that team at Schwab, who puts that together, not only with things like my weekly research report, but also articles on different strategies, webcast, which I do pretty regularly, a very robust educational hub. We have daily – literally daily broadcasts that we do in the afternoon every day, not every one of them is about options, but oftentimes they are. My colleague, Nate Peterson, does a broadcast every Tuesday and Wednesday, just simply highlighting the large and unusual option activity that takes place every day and what it might mean, and he writes a report every day about that.

So those types of things have made this a lot easier for everyone. I’m not a big believer in speculation and I don’t want people to day trade and I don’t want people to waste their money in doing things they don’t understand. But I do think if we can make it easier and more affordable for people to get to become investors and if they take a long-term viewpoint, that’s a good thing in general, because it’s – people can’t live on social security very easily when they retire and everyone needs to have a long-term investing plan so that they can live well when they retire.

Options trading could be a portion of that. I believe that everyone needs to be an investor. If you want to also be an active trader, then I’ve always recommended carving out 20% or less of your overall portfolio to trade more actively with, but you should never actively trade your entire portfolio.

AT: [Indiscernible].

RF: That’s been my mantra. That’s been my mantra for my whole career. Again, it’s this. People are sometimes surprised to hear that well, but aren’t you a short-term analyst, aren’t you – you know, don’t you trade daily? Then I can go, I [indiscernible] my trade daily. I don’t day trade and that’s – to me, that is akin to gambling, and so, I don’t recommend that. But to be more engaged in the market, to be actively knowing what’s happening on a daily basis and using strategies that can either help you hedge or generate small amounts of income, I think is great, and that’s kind of the goal that I pursue.

AT: Yes, I meant to that and I think, you know, Steven and I in Seeking Alpha in this podcast, we support all of that. So two quick questions for me, and we appreciate your time here today. First of all, you know, you referenced earlier, you know, comparisons between today and the late 1990s. How would you say the retail trading activity today compares to where it was in the late 1990s? That’s question one. And then question two, what is your advice for investors who are just getting started in trading options? You know, how would you go about approaching it? What’s the best way?

RF: So certainly, from a buying standpoint, there are – there’s a lot more volume now, a lot more participants than there were then, and I – again, you know, for no other reason, just simply that it’s so much cheaper now…

AT: Right.

RF: …and you can invest in these at no commission. Back then, even when it was substantially cheaper than it had been previously, it was still fairly expensive. And so, now it’s far cheaper, you know, the access is easier, the trading platforms are much better. I often hear people lament the good old days, and I always remind them the good old days were not good for an investor. The good old days were only good for people who are market makers.

AT: Right.

RF: So honestly, market makers business used to be a highly profitable business and it was largely at the expense of retail investors. I think back to when we traded in fractions and the minimum spread at the time then was almost $0.25, most of the time, and if you were lucky, you might get $12.5. Today, on actively traded stocks, like FANG stocks and others and actively traded ETFs, it’s a penny most of the time and at no commission. You could not ask for a better market now for a retail investment than there has ever been in history. And like I said, I’ve been in the business for — since 1988, so that goes back a long way.

So what I say is this, look, you have the opportunity now to invest at very little if not zero cost from a commission standpoint. You can now buy very expensive stocks that you might be interested in, infractions at no cost. The risk is fairly small. What you have to do – the best time to invest is never when its, you know, all the markets going up or when it’s going down or before the election or after the election, the best time to invest is always now. And you can ask me that question any day for the rest of my career and I would always say it’s always better to start now because it’s the long-term persistent growth that matters.

And to say that, you know, you start out your career – and I have two kids who are in their 30s and they’re both doing well in their careers and I’m always constantly reminding them, look, first thing you have to do is make sure that you get into your company’s 401(k) plan and you always, on day one invest at least the minimum amount needed to get the maximum match from your company. That’s pretty money, you’ll never get a better return ever than that.

AT: Right.

RF: And after that, the best investment you can ever make is to keep all of your debt as low as possible because if you’re paying 20% on a credit card, that’s the same and you don’t have it, that’s the same as earning a 20% return on your investments, that’s also pretty incredible. So those are the types of things. It’s not [indiscernible]. People always want [indiscernible]. You know, give me a – I have people ask me, Oh! give me – tell me something I can put 10,000 in it and earn 100,000 by the end of the year. And I said, well, I don’t have.

AT: Yes, you have that. We’d love that if you have that.

RF: I don’t have that, sorry. Pay off your credit card, that’s what I usually tell them. Pay off your credit card, pay off your cars, do those sorts of things. But it’s really – it’s – we – a phrase we use often is investing is not a moment in time, it’s not a process in time, it’s a process over time. And it’s all about long-term returns. If your time horizon is long enough, the markets are always bullish.

AT: And so – sorry, Randy. And so before I wrap again, how would you compare today to the late 1990s in terms of the retail investor and the level of activity you’re seeing?

RF: So, as I said, there’s more volume now. There are more participants. The market is more fair than it has ever been. So, I think those are all good things. And it’s cheaper, it’s easier. There’s better information out there. It’s never been more fair and the activity is robust. I would say there’s – I mean, there’s certainly some speculation. There’s always some of that, and, frankly, buying the dips has been a pretty good strategy for the most part.

SA: Yes.

RF: It doesn’t always pay you back in a week. But I mean, throughout – just – I mean, we can just go to the most recent example, the month of September was not a great month. Those who stepped in and bought the dips largely have gotten it all back already. That doesn’t mean we’re never – I guess as I said earlier, well, that doesn’t mean we’re never going to have another bear market. But if you’re looking for opportunities to get into the market, picking up some shares or making – we don’t ever recommend large wholesale changes. I mean, people have been asking just recently, you know should I sell everything and go into cash right now because I’m worried about the election?

If you guys ask me that question any day, I will always tell you that’s a terrible idea. Never ever sell everything and go into cash because first of all, no one knows when the market is going to crash. And even if it does, in all likelihood, it isn’t going to crash to zero and if it does, it won’t stay there forever, so it’s always a bad idea. We – now, if you’re a little uncomfortable, I’ll tell – I can talk to you about ways to hedge. If you’re a little uncomfortable that you’re a little overexposed, okay, pull back 5% on something that you own too much.

Most of the time, it’s tech stocks, we talked about that. If you got [indiscernible] too many tech stocks, as many people do, sell off about 5% of them and take a little bit of profit and then up your cash allocation by 5%, not by 100%, that’s never a good advice, never a good advice. So yes, it’s similar in the sense only that we have seen a large uptick in first-time investors that have never gotten into the markets before. My hope is that it won’t end up like that one did and that people who quit their jobs to become day traders and then they get wiped out when the tech bubble blew up, and then, they never come back because they’ve been left with a bad taste in their mouth. I hope that that doesn’t happen this time.

The people who – if they are speculating and they’re only speculating with small amounts, they also have a long term strategy and they remain investors for the rest of their lives. I dare say there were people who bailed out of the markets back in 2007, 2008, 2009, who have never come back and as a result, unfortunately, they missed out on the best bull market we’ve ever had in history that lasted for 12 years. I would hate to see people end up in that situation again. Inevitably, we will have another pullback and we will have another bear market at some point. So, we – my hope is that that doesn’t happen and we hope by educating people about the long-term benefits of being in the market that we can avoid that.

AT: Alright. Our guest has been Randy Frederick. He is Vice President of Trading and Derivatives at Schwab. Randy, thanks very much for being with us today.

RF: You’re welcome, Aaron. It was great talking to you, and you too Steve.

SA: Thanks, Randy.





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