The Initial Public Offering Process

Jonathan Lepre and Adam Wood, Harvard University

Published by Aaron Gose

IPO Overview

An IPO is summarized as the first time the stock of a private company is offered to the public. The term “public” implies the general investment community, but at first mostly to institutional investors such as a hedge fund. The Institutional investors are the clients of the underwriting firm, typically an investment bank such as J.P. Morgan or Morgan Stanley with prestige and accessibility to raising large amounts of institutional capital.

The underwriter not only helps raise awareness and capital for the IPO, but the bank also assists the issuer in determining which type of security to issue, along with the number of shares in accordance with the best offering price and timing to bring the company to market. The issuer’s major selling point is the company’s prospectus report, which is circulated to potential investors containing relevant information of background overview, future expectations in financial performance, and price outlook.

Before the due diligence process can begin, the deal construction process is underway. For larger offerings where there is an expectation for a sizeable amount of investor interest, investment banks may choose to form what is called a syndicate of underwriters, when multiple investment banks have their banking teams work together. The selected firm may also choose this method for a riskier offering if they wish to spread the risk around the street.

The other two types of agreements that are constructed between the underwriter and issuer are called best efforts and firm commitment. A firm commitment is a guarantee to the issuer that the underwriter will sell a certain amount of shares to the public by purchasing the offer itself, and conversely, a best efforts agreement is formed when the underwriter does not guarantee the amount raised.


Main Initiatives for Going Public

Companies may elect for an IPO for a variety of reasons, but the list below are some of the primary justifications.

The first reason may be the company is looking to market themselves. As a seemingly lesser-known company, there is no better way to put the brand in the center stage spotlight by going public in the eyes of attracting new investors and clientele.

More common reasons are to raise capital for expansionary opportunities such as acquiring companies via stock equity, or a quicker strategy in paying back debt burdens.

If the firm is private equity or venture capital-backed before the Initial Public Offering, they can also be looking to provide an exit strategy through the IPO transaction.


Historical IPO Stock Price Trend

As graphed in the chart below, IPO’s tend to perform very well on the first day the company is brought to market, as the demand and typical hype is high, but the stock will usually under perform the wider market over time.

Investors interested in IPO’s are willing to accept a high probability of below-average returns for the opportunity in being a part in rolling the dice for a low probability in major returns of these companies that are seeking to be high growth percentages.

Secondary market selling after the initial offering also strongly effects prices. Since the prices are set by optimistic views as mentioned above, there can tend to be an initial overpricing which will effect long-term performance. Fundamentals will additionally later be closely assessed as for the most part much newer company’s going public have a shorter cash flow history.


The Truth Behind the Economics of Unemployment

Jonathan Lepre and Adam Wood, Harvard University

Published by Aaron Gose


Many individuals are not well informed of how economists measure statistics such as unemployment, and how the general population is educated of these metrics. The U-3, U-5, and U-6 rates are analyzed below.

The official unemployment rate or U-3 is the lowest rate. The U-3 looks the most appealing, and it is the percentage publicized widely in the eyes of all members of the economy. The U-6 unemployment rate is considered by many economists to be the most revealing measure of a country’s unemployment situation.


The Unemployment Rate Breakdown

U-6 rate covers the percentage of the labor force that is unemployed, underemployed and discouraged workers. Underemployed is categorized by people who have settled for part-time jobs, when they are ideally looking for full-time employment. This particular part of the U-6 is especially important, as it includes many college graduates who are carrying large burdens of student loan debt. They can be underemployed by taking a job well below their qualifications and credentials. Discouraged job seekers are the second category under the U-6 and are defined by those who have given up looking for work.

U-3 rate is the official unemployment rate recorded by the Bureau of Labor Statistics. This category includes those who are unemployed and actively seeking employment over a time frame of the past four weeks before the measures are officially documented. The sub-portion of the unemployed who have not looked for a job during this four-week time frame is not recorded in this statistic. It is clear from this why the U-6 is an essential rate to analyze as it accounts for the true economics behind a country’s employment situation.

U-5 rate is defined as the unemployment rate calculated by incorporating total employment, plus discouraged workers, plus all other individuals marginally attached to the labor force as a percent of the labor force, plus all persons marginally attached to the labor force. This rate does not include the part-time element mentioned in the U-6 rate.


Current Unemployment Rates

The chart below shows the breakdown of current unemployment rates.

U-3 at 4.1%. (6.706 million unemployed workers / 161.921 million in the labor force.

U-5 at 5.2%. (6.706 million + 1.602 million) / (161.921 million + 1.602 million) = 8.308 million / 163.523 million. The formula adds marginally attached workers as per the definition above.

U-6 at 8.2%. (8.308 million + 5.160 million) / (163.523 million) = 13.468 million / 163.523 million. The formula adds in those who settled for part-time employment.


(Note the U-6 rate at 8.2% is double the official unemployment rate at 4.1%)

February Nonfarm Payroll Jobs Report

Jonathan Lepre and Adam Wood, Harvard University

Published by Aaron Gose

Positive Sign For FED/Market Uncertainty

The US added 313,000 jobs in the most recent month of February, which was reported yesterday Friday, March 9th. The Dow jumped 400 points on the impressively optimistic news published by the Bureau of Labor Statistics. 


The key metric was average hourly wages, which rose just 0.1%, which is below the 0.2% expectation. The slower wage growth was seen as a positive sign for market certainty as this will enable the FED to slow the anticipated rate increase speed. The surprise wage gain from last month’s report was the reason for market volatility. Therefore, the slowdown in wages this month is a calming mechanism for market players. The FED is however expected to increase rates in the upcoming meeting March (20-21), and possibly two more times before year-end.


Industry Breakdown by Jobs Growth

The below is a further detailed breakdown of the February Jobs Report: It is important to see which industries are hiring, as this means there is growth in the industry and a positive outlook for investors looking for value in equity. It can be inferred below that many of the sectors listed here have posted large increases in job additions for several months in a row. Some sectors are at highs for over a year’s time. The breakdown additionally shows the subcategories of which business units within the specific sectors are generating positive job growth.

Employment metrics increased in the construction, retail trade, professional and business services, manufacturing, financial services, and mining sectors.

Construction jobs amplified by 61,000. Construction has grown 185,000 jobs over the past 4 months.

Retail trade employment grew by 50,000. General merchandise stores added 18,000 jobs, and clothing store jobs increased by 15,000.

Employment in professional and business services increased by 50,000 jobs and has risen by 495,000 over the past year.

Manufacturing sector added 31,000 jobs. The breakdown within the sector is as follows: Transportation equipment +8,000, fabricated metal products +6,000, machinery +6,000, and primary metals +4,000. Over the past year, manufacturing has added 224,000 jobs.

Financial services added 28,000 jobs over the month, with gains in insurance carriers and related activities +8,000; and securities, commodity contracts, and investments +5,000. Over the year financial services has further improved by 143,000 jobs.

Employment in mining increased by 9,000 jobs.

Employment in health care grew by 19,000, with a gain of 9,000 in hospitals. Health care has added 290,000 jobs over the past year.

Retail Trading Psychology & Mindset for Dealing With Market Volatility

Jonathan Lepre and Adam Wood, Harvard University

Published by Aaron Gose

Psychology of Trading:

Arguably the most important aspect of investing in any global market is emotional intelligence. Whether you are a retail investor with a few thousand dollars in a brokerage account or an institutional trader executing billion-dollar transactions for sizeable clientele, the ability to rationally think in times of high-pressure situations is essential for success. Traders are faced with difficult decisions every second of the day, as it can be straightforward to act on emotion, especially in times of more aggressive market volatility.


Here are some tips for staying rational during intricate investment decision-making circumstances:

Stay true to your goals and fundamentals. Everyone in the marketplace has his or her own opinion. Since you have the ability to buy Amazon at $1552 a share, this means that someone has a contrarian opinion to your outlook, and is selling at that same price. This phenomenon is one that every investor should understand, and speaks to the reality of the market sentiment. 

After you build your model while setting your price forecast and timeline, stick to it. As your investment begins to approach your target, start to reassess.

Set clear goals for underperformances. If your investment is falling below your timeline, return to your fundamentals and look deeply into company specific, industry, and economic indicators that could be affecting your upside potential.

Protect yourself against the downside. Set price floors/limit orders, especially if you are trading on margin. There is nothing wrong with confidently admitting you made a seemingly unfortunate trade and reassessing. The strong emotional mindset of returning to the drawing board will enable you to succeed, even after a loss.

Try to avoid companies you are emotionally attached too. If you would still like to invest in such equity, remember to make decisions based on third-party analysis, not emotion.


Strategy for Success with Market Volatility:

Many relatively new retail traders have seen the market move in only one direction for the most recent period, upwards. Market volatility can act as a reminder to review your current investments and investment strategies routinely. Instead of divesting, look to distinct areas of the global market to reduce your overall portfolio beta. These areas can be anything from large or small cap US Equities, International Equities, Emerging Market funds, and Fixed Income instruments for example.

Remain alert and prepared for volatility. Understand that upturns and downturns are normal market conditions and are relatively transitory. The chart below shows the VIX or Volatility Index, Volume, and the reaction of the S&P 500 index. Notice how events of uncertainty triggered market reactions, as the storm of volatility and downturns calmed to return to upward trends in due time.

The chart above is fascinating in that the trends are clearly portrayed over this small sample size. The basis of this chart leads to the next principle in not trying to time the market as a long-term investor. There are many arguments to both sides, such as moving in and out of positions, or staying fully vested over that period. A simple solution is to partake in active money management and avoid putting all cash flow into one strategy. As stated above, stay true to your investment strategy, goals, and remain up to date on developing market outlooks.

Financials & Technology Performance Outlook

Jonathan Lepre and Adam Wood, Harvard University

Published by Aaron Gose

Why Financials Are Outperforming

Investors have been taking advantage of the increased value of bank stocks due to conditions such as higher interest rates, tax cuts, deregulation, and increased market volatility. When markets become more volatile, sophisticated investment management firms, such as Hedge Funds, begin to pick up trading activity. These actively managed funds are investment bank’s most significant clients, as increased trading on the buy side increases revenue on the sell side in fulfillment of rapid order execution. Hedge Fund investor Outlook for 2018 is at 8.5%, a six-year high as of most recent reports. The chart below shows investment management investor outlook regarding hedge funds ROI over a more substantial span since 2009.

Additionally, higher interest rates allow banks to increase lending rates and make it more attractive for consumers to deposit cash in bank accounts, thereby increasing their profit margins. They also increase the profitability of insurance companies, who sell interest-rate sensitive products. As you can see above these are all positive signs for the industry. 

As shown in the chart below, which compares the Financial Services SPYDR (XLF) to the Technology SPYDR (XLK), the Financial Services sector performance is right behind that of technology stocks in terms of the best performing sectors since the US Presidential Election.


Technology Outlook

FAANG refers to the robust large-capitalization technology and internet stocks: Facebook, Apple, Amazon, Netflix NFLX, and Alphabet (Google). Their growth over the last several years has paved the way to impressive returns in the tech sector. These companies have proven to be few that have not needed any potential portfolio management, just buy and hold.

The outlook for this sector (especially these major brand names) remains fairly strong. Ecommerce in terms of Amazon, Cloud Computing in reference to Google’s growth after advertising revenue, and video streaming for Netflix are industry-leading businesses.

Many analysts see the bull market continuing but at a less intense pace. After four consecutive years of high-level outperformance, tech companies face escalating concerns about the potential for increased government regulation and transformation by investors into higher-taxed industries as a result of U.S. tax reform.

Keep an eye on this sector as volatility continues to pick up, as historically volatility has had large effects on this sector specifically.

Recent Market News

Jonathan Lepre and Adam Wood, Harvard University   

Published by Aaron Gose

Earnings Season Update

97% of S&P 500 companies have reported positive earnings and revenue results.


Volatile Week Overview

On Tuesday, Fed Chair Jerome Powell’s hawkish tone stirred market volatility. The Dow decreased 1.16%, the S&P 500 dropped 1.27%, and the Nasdaq gave up 1.23%. The comments that particularly sent indexes for a downward trend were established when he claimed that the Fed could change its’ interest rate forecast during the scheduled March (20-21) meeting.

On Thursday, President Trump announced that his administration planned to impose a 25% tariff on imported steel and a 10% tariff on imported aluminum. The Dow Jones Industrial Average lost 420 points, or 1.68%, on this news, the S&P 500 lost 1.33% and the Nasdaq declined 1.27% throughout the trading day.


Strong Retail Earnings & Consumer Discretionary Outlook

The positive results for the week were centered on retail sector earnings. Same-store sales were the drivers of strong results for companies including retail giant Macy’s, The GAP, Nordstrom, and TJX. The below is a chart comparison of these companies with an addition of the retail SPYDR XRT, showing the recent gains.



The Week Ahead

This upcoming Friday will be an important day for the markets, as the Bureau of Labor Statistics latest reading on employment in the United States is expected to show the addition of 205,000 jobs in February. 

Dividends & Bond Yields

Jonathan Lepre & Adam Wood, Harvard University

Published by Aaron Gose

More than one-fifth of the companies in the S&P 500 have enhanced their dividend payout to shareholders so far this year, while no participators in the index have reduced their payouts, the first occurrence since the fiscal year end 2011. Furthermore, eight of the eleven key S&P 500 sectors are currently generating a higher dividend yield than last year, led by energy firms, consumer staples, and healthcare companies.

Even before the tax cuts last year, we saw mega industry leaders such as Chevron and Abbvie electing to issue the most substantial corporate bond distributions of all time. This tactic is another form of reinvestment as an alternative to dividend payout ratios. A company can issue corporate bonds with the mindset of taking advantage of a low-interest rate environment, using the proceeds to buy back shares outstanding, making the company look more attractive by raising it’s per share price. Additionally, the proceeds can be used in other forms of distribution as mentioned such as dividend payout or reinvestment in research and development to enhance future revenue.

There is an inverse relationship between bond yields and dividend payouts. Dividends are on the rise when investors have fewer reasons to buy the actual equity investment vehicle that pay these dividends to shareholders. An overvalued valuation, uncertain economic times, and rising interest rates are all reasons as to why an investor could have fewer reasons to buy the dividend yielding stock. Many investors may even look to a specific stock just to collect the dividend.

The above outlook leads to the changing of the current consensus around Wall Street. For example, higher volatility has kept investors cautious in recent weeks. A fearful train of thought makes bonds relatively more attractive than they have been in years, as this would threaten to supersede high-dividend stocks as the investment of choice for those around the street seeking yield with lower risk in price fluctuation on the equity side.

The chart below portrays the dividend payout percentage via sector specific breakdown over the last two calendar years, and thus far in 2018. It is very interesting to see the trends in this analysis and essential to keep in mind when considering sectors to invest in for sustainable income growth.

Retail Sector Volatility Expected

Jonathan Lepre & Adam Wood, Harvard University

Published by Aaron Gose

For the remainder of the trading week, volatility in the retail sector is anticipated. Large US retail companies will be reporting earnings, which began with a positive note via Macy’s results this morning before market open.

Tuesday – Macy’s

  • Earnings per share: $2.82, adjusted, vs. $2.71 expected
  • Revenue: $8.67 billion vs. $8.68 billion expected
  • Same-store sales: a 1.3 percent increase vs. growth of 0.1 percent expected
  • Macy’s expect the momentum to continue through the remainder of 2018, a positive sign for the retail sector.

Wednesday Lowe’s, TJX, L Brands.

ThursdayKohl’s, Nordstrom

Macy’s expects the momentum to continue through the remainder of 2018, a positive sign for the retail sector.

Since Macy’s did report better performance figures than expected, there will be more pressure on the above large competitors this week to beat analysts’ expectations, which therefore could likely increase volatility over the next few days.

The importance of these earnings results will include essential metrics from the holiday season. Consumer Discretionary spending was high in the year-end, prompting for expected positive results. Battling with e-commerce giants such as Amazon has proven to be difficult for retail company store-fronts. These companies have struggled to get consumers into their stores to make multiple impulse purchases. The fact that same-store sales were up 3% in January is a very positive sign for Macy’s, as this shows the firm was able to turnover inventory at a steady pace from the holiday end of year season.

It is important to keep an eye on the University of Michigan Consumer Confidence index for gauging how the average consumer feels about spending, as markets continue to deal with uncertainty in inflation data and interest rate momentum. The below is additionally a chart of the retail benchmark SPDR ETF for further technical view of the current trend.

Federal Reserve Chairman Jerome Powell's Key Address to Congress

Jonathan Lepre & Adam Wood, Harvard University

Published by Aaron Gose

Today: The below are principal points asserted by the new FED chairman, as market participants closely eyed the Fed’s expectations for the future of the economic outlook in terms of inflation, interest rates, jobs/wage growth, and a volatile market in recent weeks due to uncertainty.

  • The main thesis of the speech minutes was focused around the Economic Outlook remaining strong and a positive disposition toward hitting inflation targets.
  • FED is on track to continue gradual rate increases.
  • Powell was not concerned with recent market volatility.
  • The strong labor market will boost consumer confidence & business spending, which therefore should increase productivity.
  • “Medium-term” was the phrase used in describing when the inflation metric (price index for personal-consumption) should move up to the 2% target.
  • Avoiding an overheated economy while balancing out inflation will continue to be of paramount attention.
  • Wages are expected to increase. It was stated that average hourly earnings were up 2.9% in January over the previous year, the largest increase since fiscal year 2009.
  • Resilient hiring has started to attract workers back into the labor force and has pressed the unemployment rate at slightly above 4% in January, down to its lowest point in 17 years.
  • The question of how many rate hikes expected this year was not directly addressed, as the Chairman responded that every official has his or her own forecast on hike expectations going forward. The first hike is likely anticipated next month (March 20-21 meeting), but no indication if four hikes was a probabilistic chance for this year.


Market Reaction

As a market reaction to the speech, most major indexes have fallen slightly, with the S&P 500 falling 0.8%, the Nasdaq Composite decreasing 0.9% and the Dow Jones Industrial Average dipping by 0.5%.

Treasury yields are at session highs, with the yield on the 10-year note recently at 2.923% versus 2.862% Monday and the price-sensitive yield on the two-year note at 2.274%, versus 2.230% Monday.

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