Algos, Maestros and Cryptos – oh my!A review of the latest and longest trends in the economy and markets.

February 15, 2018

Spencer L. Klein, CFA Robert ThompsonVP & Sr. Portfolio Manager Managing Director

IPPFA Regional Seminar

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Really, really, really long trends• Algos – from “curb” traders at Wall and Broad, runners

and chalk boys, the Edison Teletype, pit trading, to finally off exchange market making

• Maestros – from blissful ignorance, laissez faire capitalism, utpoianism, Fabianism, socialism, Marxism, and communism; modern day economies now seem too important not to “regulate”

• Cryptos – from barter, beads, wampum, shells, coins, currency, credit/debit cards, paypal, mobile payments and bitcoin; how we pay for goods and services

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Algos - A History of Trading• How has buying and selling shares of stock developed?

• 1789 – trading in U.S. Government bonds occurred in Federal Hall on Wall St. (first site of U.S. capital)

• 1792 – “The Buttonwood Agreement”, Corre’s Hotel, thought to be the original 24 members of the NYSE

• 1793 – Tontine Coffee House, corner of Wall and Williams streets

• 1817 – 40 Wall St., New York Stock and Exchange Board formed, $400 annual membership, auction at noon

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Algos - A History of Trading

https://www.dnainfo.com/new-york/20160304/hamilton-heights/alexander-hamiltons-new-york

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Algos - A History of Trading• 1863 – New York Stock Exchange, 11 Wall St.

• 1870s – “The Curb”, brokers who could not afford membership seats traded in the street on the curb outside 11 Wall

• 1890s – Curb brokers move to Broad St., then to the Mills Building

• Chalk Boys, Runners, Telegraph Lines, Ticker Tape

• 1911 – Curb Market Association, certain stocks trade at lamp posts

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Algos - A History of Trading5

https://en.wikipedia.org/wiki/Curbstone_broker#cite_note-nyt-complaints-8

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Algos - Modern day trading• Floor trading at NYSE and AMEX, also Phil-ex, Chicago

Stock Exchange, CBOE, CME, NYMEX, etc.

• From quarters to eights to “teenys”

• Decimalization

• T+5, T+3, now T+2

• Market making moves from the order “book” to levels of quotes, shares of stock to buy or sell at certain prices

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Algos - The Flash Crash• Computers are faster!

• Orders to buy/sell at based on certain mathematical criteria. Eg: above 50 day MVA, declined 1% from previous high, violation of technical analysis rules on patterns as short as minutes or seconds, etc.

• May 6, 2010 - intraday swing of 1,000 points in the DJIA, roughly 9%. It closed down 6% on the day.

• Many theories as to what caused the drop, but algotrading, but algo trading is widely believed to have made it worse.

• https://www.sec.gov/news/studies/2010/marketevents-report.pdf

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Maestros – Conducting Economic Growth• Blissful ignorance – business

cycles occurred with little to no government influence until …

• David Hume – Essays, Moral Political and Literary (1742)

• Adam Smith - An Inquiry into the Nature and Causes of the Wealth of Nations (1776)

By Gerhard Stremingerhttp://members.aon.at/gstremin/zeit_smith.htm, Public Domain,https://commons.wikimedia.org/w/index.php?curid=1388734

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Maestros – Conducting Economic Growth• From understanding economics and national wealth, to

influencing it for societal gain

• Laissez Faire Capitalism

• Utopianism / Religious

• Fabianism / Socialism

• Marxism / Communism

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Maestros – Conducting Economic Growth• Great Depression & World War II

• Markets vs. Planners

• Friedman vs. Keynes

• Most countries are now mixed

• Is China controlled capitalism?

• Is USA relaxed communism?

• Are they moving towards each other?

Shh … Marx argued that they would.

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Maestros – Recent Examples• Volker shock – killed inflation by spiking interest rates,• Did this unleash a stock/bond rally PV = (d*g/k)

• Greenspan – tech bubble, WCOM, ENE, 9/11 all reasons for low rates

• Did this unleash the housing boom (and bust?)

• Bernanke/Yellen – subprime crisis, “Great Recession”• Did this unleash a low vol equity bull market, or did it

pave the way for slow growth to prevent the Depression 2.0?

• Uncle Milton says it’s an unanticipated shock from either energy prices, interest rates or inflation..

• Unintended consequences?

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Cryptos – from beads to Bitcoins 12

• Beads, seashells

• Coins

• Bank notes

• Reserve banking

• Credit/debit cards

• Mobile Payments

• Bitcoin, Etherium, Litecoin et al

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Cryptos – Fool’s gold or a payment system?

https://bitcoin.org/bitcoin.pdf (October, 2008), cryptography mailing list from metzdowd.com

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Cryptos – Bitcoin, facts and figures$233 bln invested in Bitcoin

$710 bln all Cryptos

1400+ separate distinct cryptos

Mineable?

0.6% of global electricity usage, more than all EV, about as much as Argentina

1st bitcoin transaction – 1 Papa John’s pizza for 10,000 bitcoin, 2009

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Cryptos – Bitcoin, what’s all the hype?15

Retrieved from source: https://www.coinbase.com/charts, All data

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Bitcoin – it’s been three days!!16

Retrieved from source: https://www.coinbase.com/charts, 1 month

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Cryptos – is this a bubble?17

SP500 (2014-2017) approx 1.5xRoaring 20s @ 2xJapanese Stocks @ 3xHousing Boom @ 2xTech Boom @ 2xSouth Sea (1719-1721) @ 8xMississippi Land (1718-1720) @ 30xTulip Mania (1734-1637) @ 50xBitcoin (2014-2017) @ 70x

Source: https://www.zerohedge.com/news/2017-12-12/its-official-bitcoin-surpasses-tulip-mania-now-biggest-bubble-world-history

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Cryptos – Is it secret, is it safe?• August 2010 - bug found, 21 million coin max, upped to 184 billion,

fixed • March 2014 - Mt. Gox, $473 million theft, bankruptcy of exchange • January 2015 - Bitstamp, $5.1 million theft, phishing • January 2016 – bug found in Decentralized Autonomous

Organization (DAO), $50 million of Ether, hard fork to fix still in place

• July 2016 - Steemit.com, $85k of steemit• August 2016 - Bitfinex, $72 million • July 2017 - CoinDash, $7 million of Ether • July 2017 - Parity Multisig Wallet, $32 million • August 2017 - Enigma, $500k • November 2017 - Tether, $30.9 million

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Cryptos – Fool’s gold or a payment system?• I’m no expert, but …

• Is bitcoin currency, payment system, or other?

• Stable value? Widely accepted? Secure?

• Warren Buffet – “I’d buy 5 year puts on Bitcoin, it’s going to end badly.”

• despite all the above, Blockchain innovation worthwhile

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Progress [noun prog-res, -ruh s or, esp. British proh-gres]1. A movement toward a goal or to a further or higher stage.2. Developmental activity in science, technology, etc.,

especially with reference to the commercial opportunities created thereby or to the promotion of the material well-being of the public through the goods, techniques, or facilities created.

3. Advancement in general. 4. Growth or development; continuous improvement5. The development of an individual or society in a direction

considered more beneficial than and superior to the previous level. (author’s emphasis bold, underlined)

Source: www. dictionary.com/browse/progress

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Mini-summary• The proceeding maps a path, trajectory or evolution.

• Unifying theme – away from personal interactions, towards rules based systems.

• Technology is a catalyst for these trends.

• Are these “superior to the previous level”?

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Growth of Passive Strategies• Vanguard Index Trust, 1976 - $11 mln 1

• From 11% to 36% market share in 15 years

1 https://www.vanguard.com/bogle_site/lib/sp19970401.html

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Bogle’s “folly” threatens Price Discovery• Market Cap index methodology

• Passive investors buy everything on the way up

• Passive investors sell everything on the way down

• Indiscriminately.

• If nobody does homework, in an up market winners are unduly rewarded. In a down market, unduly punished.

• Could indexing be responsible for the surge and crash patterns of the last 20 years?

• Could active investing recover when passive investing and algo trading/market making are the majority?

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Implications for Investing• Active management = personal involvement

• Passive management = rules based system

• CFAs, CFPs, FCs, CICs, RIAs – all are people

• Indexing, ETFs, “robo advisors” – all are systems

• Would you want a “robo” MD, DDS, JD, CPA?

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