Introducing Confluence
Welcome:
I want to share our new project with you. This is the first issue of a weekly newsletter that surveys the emerging growth universe.
When it came time to name our investment research business, one idea quickly leapt out as lead contender. ‘Third Stream’ captured what we had long been practicing and it also charted our future direction. In simple terms, the process attempts to make connections between top-down and bottom-up research. Third stream is the deliberate merging of the two, with the purpose of stimulating in-depth investigation.
Confluence, by definition, is a coming or flowing together, meeting, or gathering at one point. It is also the flowing together of two or more streams. In the investment world, confluence occurs when multiple ideas or strategies are used together to form a single, coherent idea or strategy.
Another meaning of 'confluence' is a crowd or meeting place, and that's what we're aspiring to create here!
About this newsletter
This section is brought to you by our ‘About’ page. For brevity here we omit the section titled ‘Tributaries Form Confluence’. It highlights the various projects since the mid-nineties that led to the creation of this newsletter. Take a look if you’re unfamiliar with our background.
Confluence is for anyone interested in the:
· Emergence of high-growth companies,
· Inefficiencies in financial markets, and
· Endeavor of price discovery.
Asymmetry of information flow is greatest in the universe of companies under $5 billion in market capitalization. Naturally, the gap truly widens as we descend below the $1 billion threshold. When equity research at this level relies too heavily on macro currents and corporate filings, it detracts from what is arguably the backbone of research on emerging growth companies.
A focus on innovation, intangibles and narratives, or what we describe as the 'third stream', can be more illuminating than any quantitative analysis. We believe time is best spent on qualitative factors, alternative data, comparable analyses, and market intelligence from diverse stakeholders like investors, customers, partners, suppliers and competitors.
Ultimately, a synthesis of all streams is most successful when it activates deeper inquiries into companies. Continuing along this path the effort improves decision-making when evaluating corporate strategies and stocks.
Our audience includes tech and growth stock investors, equity analysts, hedge fund managers, investment bankers, CEOs, CFOs, technologists and many others. We are committed to delivering engaging content and original research & analysis to save you time.
What to expect
We aim to support your own research by helping to distill complex information and trends into actionable ideas. Through this process, we seek to increase your understanding of the emerging growth universe and how to navigate the financial markets.
As a subscriber, you will receive Confluence once per week. Each issue has three sections:
Feature is an article, essay, special analysis or interview.
News & Trends covers interesting things we found in our work over at Third Stream Research.
Act of Discovery offers insight and inspiration from diverse sources.
All together now!
We encourage you to forward this or any future issues of Confluence to friends and associates who you think might be interested in this content. Our objective is to steadily reach out further and to engage with more investors, corporate management and a diversity of financial industry participants in the EG universe.
If you are reading this newsletter because it was forwarded to you, consider subscribing to ensure that you continue receiving it weekly. Every new member is another step towards building an expert network that heightens our journey in the exciting and rewarding world of emerging growth stocks.
News & Trends
Rise of the New Retail Investor
A team of JP Morgan strategists led by Nikolaos Panigirtzoglou believes markets are likely to stay on a positive track until individual investors stop charging into stocks. The group asserts that as younger investors buy stocks and equity funds aggressively, they force asset prices higher, compelling other retail investors – presumably older folks – to “inadvertently overweight equities.”
JP Morgan’s strategists point to year-to-date equity fund flows of nearly $700 billion, or more than $1 trillion annualized, well above the prior 2017 record high of $629 billion. Those flows have not only pushed stocks higher, but forced other investors into equities.
Roughly speaking, 21- to 34-year-olds with time on their hands due to the COVID-19 pandemic took to the financial markets. Drawn in further by Robinhood's friendly, gamified interface, this fast-growing investor cohort quickly displayed their influence by rallying meme stocks like GameStop, and also the broader markets.
During Robinhood Market’s Q2 2021 earnings call on August 18, CEO and co-founder Vlad Tenev spoke about his firm’s mission:
“I’d say, at the top level, we want Robinhood to be the most trusted, most culturally relevant money app worldwide. For the investing business, the goal is really to take our first-time investors and turn them into long-term investors onto the platform. … we’re continuing to invest in the technology, the tools and the educational content to empower our first-time investors and make them long-term investors….”
Demographic and cultural realities favor Robinhood’s business plan to act as a gateway. In the company’s latest quarterly presentation, it shows that monthly active users have more than doubled from Q2 2020 to Q2 2021, surging from 10.2 million to 21.3 million.
Indeed a weighty demographic shift is underway and it’s a tidal wave with enormous momentum. In our March 2021 article Generational Dis(ruption), we highlight data illustrating the potential reach of the Robinhood phenomena:
“It’s useful to step back from the headlines to take a broader view of Millennials. This group was the largest generational segment in the U.S. in 2019, with an estimated population of 72 million. Born between 1981 and 1996, Millennials recently surpassed Baby Boomers in size, and they will continue to be a major part of the population for many years.
“Yet their impact is negligible, owning just 5% of all wealth in America, far below the 26% share baby boomers amassed at a similar age. But things will dramatically change in the coming years: Fundstrat estimates $6 trillion could flood into stocks over the next decade.”
We concluded that this generation wants to own world-changing companies like the FAANGs and Tesla; consequently, we're only just beginning to experience the full force of this group.
Robinhood’s success at attracting younger investors (and capital to expand its business) is happening amid a competitive time for the fintech industry. Payment platforms Square, PayPal, and SoFi offer a list of overlapping products and are vying to be a one-stop-shop for finance. Cryptocurrency and stock trading are seen as ways to engage the primarily young consumers.
Interestingly, Robinhood shares tumbled nearly 7% on Aug. 30 after CNBC reported that PayPal was exploring ways to let U.S. customers trade individual stocks on its platform. PayPal, with more than 400 million accounts worldwide, would have to first become a FINRA member. This process would take at least eight months, according to reports.
‘Modern Times’ for EGC Equity Analysts
In our article Walk on the Sell Side written earlier this year, we suggest that equity research on emerging growth companies can do more to expand understanding of strategic strengths and weaknesses, map central narratives, and better articulate the stories and prospects.
Perhaps a good starting point would be for investment banks to treat equity research as a valuable resource for corporate clients and sell-side, rather than a factory-made product or menu item. We write:
“It’s debatable how the quality of research for EGCs has developed over the years, but anecdotal evidence suggests it has been affected by efforts to cut the cost of production. Analysts appear to cover more companies, leaving them less time to compile detailed research on each.
“A team of associates and an analyst will usually cover at least 5 companies and could cover as many as 15, depending on their seniority, the sizes of the companies, and the industry, according to the Corporate Finance Institute.
“H.C. Wainwright & Co, one of the most active investment banking firms in the EGC market, recently tweeted that its 18 publishing research analysts cover 480+ public companies. In other words, on average each of their analysts covers 26+ companies.”
It appears that Wainwright’s operating model for analysts is sliding further downhill. A tweet by the firm last month said the following: “18 publishing #equityresearch analysts provide insights on 550+ public companies.”
In less than four months the investment banker’s 18 analysts went from covering 480+ public companies to 550+ public companies, raising the average per analyst to more than 30. Not a single analyst was added to their roster, yet their research team is covering an additional 70 stocks.
Why do they choose to publicize this information as if it’s a competitive advantage? Larger profit margins for the firm’s owners aside, it is difficult to imagine this builds confidence in their banking services and the equity research charged to support those efforts.
China Trumpets a New Small-Cap Market
China, the world’s second biggest economy, is setting up a stock exchange in Beijing to serve small and medium-sized enterprises. The new market aims to be a primary platform for smaller firms to meet their financing needs. It would be the third on the Chinese mainland, after the Shanghai and Shenzhen exchanges.
Shanghai and Shenzhen, with combined listed market capitalization of $8.2 trillion, ranks them as the fourth and eighth largest global stock markets. In first and second place are the NYSE ($28.5 trillion) and The NASDAQ ($10 trillion).
In 2012, Beijing established the National Equities Exchange and Quotations (NEEQ), or Third Board, allowing over-the-counter trading for smaller companies that fall short of listing requirements for the Shanghai and Shenzhen exchanges.
The initial batch of 66 companies to list on the new Beijing exchange will be plucked from stocks already traded over-the-counter in the ‘select’ section of the New Third Board, according to China Securities Regulatory Commission (CSRC). Only five of the projected companies have market caps above $1 billion, while nearly 70% of the firms currently in the select tier come from the materials and industrials sectors, with smaller portions from IT and health care.
Authorities did not say when the Beijing exchange would begin trading. Barron’s reports Goldman Sachs noted that the timetable should be shorter than the seven-month preparation period it took for the Shanghai Stock Exchange’s STAR Market – touted as Shanghai's equivalent to America’s Nasdaq – in 2019.
Introduction of the new exchange is curious because global investors have been rattled by a flurry of Chinese regulations targeting companies in technology, private tutoring and other sectors. However, tighter scrutiny on Chinese listings in the US by both countries’ governments has essentially halted the flow of Chinese IPOs to New York in recent months.
For Chinese firms, both large and small, the mainland’s slow IPO-approval system and high earnings requirements will continue to be a high barrier until systemic changes are made. Foreign companies looking to raise funds through China's equity markets has long been rare, partly due to the country's strict control of foreign exchange.
Moreover, government attempts to open China’s stock markets to foreign firms and investors via ‘stock connect’ projects including the London-Shanghai Stock Connect have struggled against a backdrop of geopolitical challenges. Stock Connect is a Mutual Market Access program through which investors in the Mainland China and Hong Kong can trade and settle shares listed on the other market via the stock exchanges and clearing houses in their home market.
Act of Discovery
Third Stream’s Roots
Inspiration is owed in part to the obscure musical genre known as Third Stream, often described as a style that is a synthesis of classical music and jazz. This idea aligns nicely with our philosophical outlook. As a serious jazz fan whose musical tastes extend across a multitude of categories, it hit the right notes for me.
Gunther Schuller coined the term in a 1957 Brandeis University lecture to identify an emergent sensibility, not a set of stylistic parameters. In a Jan. 2001 article by Bill Shoemaker for JazzTimes, Schuller explains he had realized that composers as diverse as Duke Ellington and Ralph Burns were already streaming:
“The die was already cast; there was no one formula at work,” says Schuller of his formative observations. “Since the ideal for me was to create an absolutely new concept of composition in which the jazz and classical would be so blended that you would not be able to identify the jazz roots from the classical roots, I approached this amalgamation process in a different way in each of my pieces….
“In the meantime, since my early postulation about bringing jazz and classical music together, the entire world of ethnic, folk and vernacular musics, of which there are several hundred thousand, some of which represent traditions that are 5,000 years old, have come into the streaming pot,” Schuller adds. “So, the third stream is now 100,000 streams. The original third stream concept now seems like a trickle, the headwaters, and now third stream is like the Mississippi delta, a vast complex that has been fed by countless tributaries. But the idea of combining the various concepts and traditions of music is still very much at its beginnings.”
We feel similarly about Third Stream Research and Confluence. Lots of possibilities to explore and your ideas are welcomed!
Let’s close with a recent sample of music that represents the spirit of third stream. It’s a piece from Wayne Shorter’s latest project, Emanon, released in 2018. Shorter, at 88 today, is one of the masters of jazz.
Here’s an interview with Wayne Shorter published last month in JazzTimes, where he discusses Emanon. Responding to a question about the third stream, he tells the interviewer: “The line between the jazz world and the classical world has never really been a line. [There’s] much more overlap than you think.”
See you next week, and thank you for your support.
Josh
Disclaimer
The content provided in this newsletter is intended to be used for informational purposes only. It is important to do your own analysis before making any investment based on your own personal circumstances. You should take independent financial advice from a professional in connection with, or independently research and verify, any information that you find on our Website and wish to rely upon, whether for the purpose of making an investment decision or otherwise.