Reading time: 8 minutes

 Have you ever looked at something, and imagined what it would be like if it were… different? Say, what would the education system look like without the written word, or arithmetic without the concept of zero? Or what would the financial system be without interest? Many centuries ago, in Europe and all the Christian world, collecting interest was forbidden by the Church on the grounds of immorality, being universally recognized as a sin – the sin of Usury.  

Nowadays, the official stance of most western nations with respect to interest is significantly different – not only is it not condemned, but is actually regarded as a vital part of our economies. And it definitely is. It is impossible to imagine how our current financial system would ever work without this tool. Interest is a crucial part of loan taking, house buying, and savings. Politicians talk about it, economists worry about it, investors use it to generate returns. The concept of interest is inseparable from the concept of money itself. In most of the world, at least. 

Like the Catholic Church once did, some still consider interest to be immoral, or simply impossible to reconcile with their religious beliefs. Such is the case of the Islamic Faith.  


Before we look at how this financial system is different from the main one, it is worth spending some time understanding its foundations.

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A member of the Islamic community is supposed to comply with certain rules and guidelines, living their lives according to the teachings of the Faith in order to lead a moral life. To this code of conduct, we call Sharia (or Shari’ah) Law. Sharia is a complex subject. It requires interpretation of the will of God, something that has divided humankind for millennia. We are not likely to solve it in 1400 words. It is not the purpose of this article to explore the religious and legal complexities of Muslim-majority countries. Sharia law exists, and millions of people in the world follow it. Our focus is on how Sharia, and by extension the individuals that try to guide their actions by it, think of financial transactions

The Institute of Islamic Banking and Insurance states the objectives of Islamic Financial Transactions (i.e. Sharia compliant financial transactions) as follows: 

  • To be true to the Sharia principles of equity and justice
  • Should be free from unjust enrichment
  • Must be based on true consent of all parties; 
  • Must be an integral part of a real trade or economic activity such as a sale, lease, manufacture or partnership. 

The first three points can be considered more or less subjective – what constitutes equity, injustice or true consent are open for debate. Interesting as that debate may be, it falls out of our scope today. Let us then look at the fourth point. 

Sale, lease, manufacture and partnerships are no strangers in the traditional financial system. The key is the one missing – can you spot it? That’s right – debt! Debt-based instruments, so common in traditional financing, don’t have the same centrality in its Sharia compliant counterpart. Why is that? Well, we’ve stated the reasoning before: the Islamic Financial System absolutely prohibits paying/receiving “any predetermined, guaranteed rate of return”, that is, interest.  

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But why does the Islam forbid someone to be compensated for departing from their capital for a period? Doesn’t it recognize the Time Value of Money (the notion that having money right now is more valuable than the promise of the having money in the future)? As a matter of fact, it does! The difference is in understanding what constitutes capital. Ask any non-Islamic banker, investor or economist, and they will almost surely tell you that money is capital – a production factor, something that can be used to create more wealth. Islamic thinking draws a line: money is only seen as potential capital. It is only considered actual capital when it is employed in an actual productive activity together with other resources. Simply put, money sitting still is not productive, so you are not entitled to any compensation for lending it to someone who will actually put it to use. 


So, what can actually be done inside this system? Well, any activity that complies with some basic principles

As previously discussed, interest (riba) is forbidden. It is regarded as an “unjustifiable increase of capital whether in loans or sales”. This is the central principle ruling mutual dealings. Borrowers and lenders should equally share the profits and risks – profits are a symbol of a successful enterprise, while interest is a cost independent of success, only on the side of the borrower. A supplier of funds is not a creditor, but an investor. Since money has no purpose unless tied to a real asset, speculation and gambling (maysir) are forbidden. Uncertainty or asymmetrical information (when one of the intervenients possesses information that the other one has no access to) are also prohibited in any transaction – contracts are sacred, and agents have a duty to disclose all relevant information beforehand. Hoarding is also not permitted, as well as trade in forbidden commodities (pork, alcohol, dealings with casinos, etc.).  

Many instruments that are present in the traditional financial system are also used by the Islamic Financial System. The most basic ones, which can then be combined to create more complex products, are cost-plus financing, profit-sharing, leasing, partnership and forward sale


As you can see, Islamic Financing is no more than a selection of the financial instruments and products that comply with certain religious and, especially, moral principles. If you think about it, it is not so different from how a food restriction works – if you and your friends go to dinner, the vegan friend will order something with no meat, the one with a seafood allergy will probably not get the shrimp, and some may choose to get water instead of wine or other alcoholic drink. And, of course, you are perfectly free to order a salad if you’re not vegan, or to ask for no peanuts in your dessert even if you have no allergy. And you are equally free to partake in a Sharia-compliant financial transaction, whether you are a Muslim or not

People can invest in an Islamic Financial Product regardless of their faith 

Islamic finance has been growing, and not only inside the Muslim Community. Its principles appeal to many, and it does have some advantages over the traditional system: as interest is forbidden, predatory loans can’t happen at all; income and wealth are more equally distributed, as every intervenient receives a part of the profits, regardless of how much capital they had at the beginning of the enterprise; speculation is forbidden, meaning the system is not so exposed to market bubbles (goodbye, 2008-like financial crisis!); and it is significantly more transparent and accessible. Many argue that it can help lift many out of poverty, especially if combined with ideas like Microfinancing. These characteristics indicate that Islamic Finance may be better equipped for sustainable development, a point that may prove to be of great importance in the years to come.  

Of course, it has some significant disadvantages too: it does not provide funds for all businesses (religious prohibitions prevent it from dealing with pork, alcohol and gambling firms) and, for all its efficiency in allocating resources to businesses with a greater chance of success and encouraging money to be fueled into real and productive activities, it can be argued that it does not maximizes investment profits (as interest is not charged). 

There is another detail that is worth pointing out: Islamic Finance comes with a moral compass (or at least a baseline). Whether this is a positive thing or not will probably depend on the degree to which you agree with the moral principles it is rooted in, but it is, undoubtedly, a point of difference between this system and the traditional one. 

The islamic Financial System serves millions of people worldwide

It is easy for some to look at the presented characteristics and to regard this system as limiting. We cannot argue it may not be limiting, but it is so in order to provide an option that answers the needs of millions of people, who do not wish to compromise their faith in exchange for a piece of wealth. Different cultures have different approaches, and we live in a wonderfully differentiated world. Imagine how boring it would be otherwise. 

Sources: Institute of Islamic Banking and Insurance, Corporate Finance Institute, Investopedia, World Bank, Blossom Finance, Wikipedia 

Joana Brás

Leonor Cunha

The Collapse of SVB: A Cautionary Tale for the Financial Sector 

Growing concerns on the stability of the financial sector 2023 has seen a wave of bank failures, from Credit Suisse in Switzerland to Signature and Silicon Valley Bank (SVB) in the United States (US). These recent collapses of prominent banks have sparked concerns about the stability of the financial sector, leading to a surge in Google searches for “financial crisis” not seen since 2008.  Given the already-present fears of a recession, the collapses only added to the public’s anxiety, shaking consumer confidence in the economy. While the situation is unsettlingly familiar, the uncertainty and fear of contagion remain daunting. This latest banking crisis highlights the potential side effects of financial disarray and underscores the need for swift and effective intervention to restore stability. To exemplify the bank failures and bankruptcy, this article will focus on the case of SVB.  

A perfect combination of events leads the “bank of start-ups” to collapse 

Known as the “bank of start-ups”, especially for those in the tech sector, California-based SVB was established in 1983, with the mission of helping “individuals, investors and the world’s most innovative companies achieve their ambitious goals”, counting as their clients start-ups and tech companies of the likes of Shopify or Insight Partners. In 1988, they went public through an IPO on Nasdaq and, in 2008, they went international. But how did a bank that was the 16th largest bank in the United States, reporting, in Q4 for 2022, $212B in assets, $342B in total client funds and $74B in total loans, collapse on the 10th of March? 

Silicon Valley Bank

The short answer to this question revolves around the typical suspect when referring to the failure of banks: bank runs, which are a self-fulfilling prophecy. However, in the case of SVB, it can be seen as a perfect combination of events which led to this disastrous outcome. The first motive can be linked to the Federal Reserve’s decision to increase interest rates to fight the increasing inflation rates, which are corroding American consumers’ purchasing power. This macroeconomic environment would lead SVB’s long-term investments in government bonds to be eroded as SVB had $21 billion invested with an average yield of 1.79%, as they had been purchased when interest rates were near the zero-lower bond. In comparison, currently, a 10-year Treasury bond has a yield of around 3.9%. Simultaneously, startups were raising fewer rounds of venture capital investment, due to the current economic environment, which decreased the amount of deposit inflows and increased the outflows. So, SBV’s cash decreased, such that the bank had a lower amount of resources to finance its operations. Consequently, in order to raise funds, SVB resorted to the sale of their government bonds. However, as they were yielding a lower interest than those that investors had access to if they bought directly from the government, this led SVB to sell a portion of said bonds at a discount to compete with the competitive market, resulting in a loss of $2 billion. The ultimate blow to SVB’s credibility would be the capital raise announcement, resulting in a generalised panic amongst SVB’s depositors, as more than 90 percent of them exceeded $250,000 in guaranteed Federal Deposit Insurance Corporation (FDIC). At the end of last year, according to the Wall Street Journal, SVB had over $150 billion in uninsured deposits. Fear led to large withdrawals, with depositors pulling out $42 million, in just one day alone. Consequently, SVB’s stock plummeted.  

To avoid a widespread panic and broader contention, despite appearing that SVB’s problems spilt over to Signature Bank, the government intervened in the form of California regulators shutting the bank down and placing it in receivership under the FDIC with SVB’s senior managers, including its CEO, Greg Becker, being removed. SVB’s collapse has been deemed as the 2nd largest in American history, only losing to Washington Mutual which collapsed in the 2008 Financial Crisis. Furthermore, in an unusual decision, the FDIC agreed to guarantee all SVB deposits, even those above the $250,000 per account threshold.  

SVB stock price performance month-to-date in US dollars
Annual nº of US commercial bank failures and total associated assets

What else is being done? 

Deputy Treasury Secretary, Wally Adeyemo, sought to reassure the public about the health of the banking system after the sudden collapse of SVB, in an exclusive interview to CNN, stating: “Federal regulators are paying attention to this particular financial institution and when we think about the broader financial system, we’re very confident in the ability and the resilience of the system”. In reality, the 2008 financial crisis prompted stricter regulations in the United States and around the world. In response, regulators imposed more rigorous capital requirements on American banks, with the aim of preventing the collapse of individual banks from having a ripple effect on the wider economy and financial system. 

Following the collapse of SVB, federal regulators acted promptly to mitigate depositors’ losses and restore trust in both the banking system and the broader economy. To achieve this, they put into effect a series of measures aimed at reassuring the public and bolstering confidence in the financial sector. The government introduced a program called the Bank Term Funding Program (BTFP) – a lender of last resort facility- which serves as a safety net for financial institutions. This program, which is backed by the Federal Reserve, provides loans to banks, credit unions, and other deposit-taking institutions in times of need. The loans can last for up to one year and enable these institutions to meet the needs of their depositors without having to resort to selling their high-quality securities at short notice.

Discount Window Borrowing

Another way the government relied on to regulate the financial industry differently was through a discount window, a facility that offers banks the option to borrow cash on a permanent basis, typically for short periods, such as a few days or weeks. From March 9 to March 15, borrowing at the discount window escalated from $4.6 billion to $152.9 billion, before declining to $88.2 billion by March 29. However, the decrease was mostly offset by augmented borrowing through the BTFP. 

Numerous banks overseas borrow and lend in U.S. dollars. Although foreign central banks possess the capability to print their own currencies, like Euros, Yens, and British pounds, to lend to their struggling banks, they do not have the authority to print U.S. dollars. In response to the Global Financial Crisis, the Federal Reserve initiated a sequence of agreements with foreign central banks, whereby it would exchange U.S. dollars for foreign currencies with other central banks. On March 19, 2023, the Federal Reserve announced that it would conduct daily swaps at least until the end of April to enhance the efficacy of the swap lines.

In the end, the FDIC’s race to find another bank willing to merge with SVB to safeguard unsecured deposits was successful as First Citizens Bank purchased SVB’s remaining assets, deposits, and loans. 


Bank failures like this have happened before—there were more than 550 banks shut down between 2001 and the start of 2023. But this one was particularly newsworthy due to its dimension, being the second-largest bank failure in US history. 

There is now less anxiety about the stability of the banking sector due to the significant regulatory reforms put in place after the crisis in 2008 and the steps taken by the Federal Reserve following the collapse of SVB to improve confidence in the banking system and prevent future banking failures. The risks of broader contagion are thought to be limited for now but, even if a recession occurs, analysts don’t think it would be as long lasting as the Great Recession. 

According to Mike Mayo, a senior bank analyst at Wells Fargo, back in the prior crisis “Banks were taking excessive risks, and people thought everything was fine. Now everyone’s concerned, but underneath the surface the banks are more resilient than they’ve been in a generation.” 

Sources: The Economist, TIME, Silicon Valley Bank, Wall Street Journal, CNN, The American Prospect, CNN Business, Investopedia, Brookings, Expresso 

Hannah Ribeiro

Pedro Teixeira

The Looming Russian Default

Reading time: 7 minutes

Russia’s relationship with its debt has not been easy throughout history. In 1918, the embryonic Soviet Union repudiated the debt carried from the previous regime; in 1998, and after an attempt from the Russian Federation to gain credibility and integrate in international capital markets, Russia ended up defaulting in its domestic debt and in the Soviet-era external debt; in 2022, a Russian default seems to be looming once again.

With the Russian invasion of Ukraine, international markets price in the potential for a Russian sovereign debt default in external debt. Yields on Russian 10Y bonds, for example, have climbed vertiginously to nearly 20% since the beginning of the war.

An international bond from the Tsarist regime which was repudiated by the Bolshevik Regime.

An history of missed payments

Following the Bolshevik revolution and the overthrowing of the Tsarist regime, the embryonic Soviet Union, in 1918, repudiated all the debts of the previous regime. Despite this, throughout the Soviet experiment, the Soviet Union accumulated large levels of debt up until its dissolution in 1991.

After the breakup, the newly independent, former Soviet states, had an arduous road of restructuring their systems with more market-oriented economies in their sights. At that time, the Russian Federation assumed all foreign assets and debts of the former Soviet Union, an action that it viewed to be necessary to begin to integrate international capital markets and to build a good international reputation.

However, the restructuring of the economy proved to be more challenging than expected. Russian GDP suffered large contractions, decreasing nearly by half in the following years. At the same time, fiscal policy was quite loose with the government running large deficits and real interest rates were kept high as the new Central Bank tried to rein in inflation and create credibility. Together, these factors meant that Russian debt was not on a sustainable path throughout the 1990’s. In 1998, and although Russian debt was still not very high (60% of GDP), with the Asian financial crisis echoing throughout the markets, and the exchange suffering sharp devaluations, Russia ended up defaulting on its domestic debt, as it found itself unable to rollover existing short-term debt. And although Russia did also default on foreign Soviet-era obligations it honored all the external debt it had issued after the 1991, attempting to maintain good credibility.

With this same goal in mind, following this default, Russia sought assistance from the IMF, and was able to restructure the defaulted debt and implement structural reforms that placed it on the path towards sustainable debt management.

These changes can be seen in the evolution of sovereign debt ratings, which had deteriorated significantly during this crisis (S&P – SD), but that steadily rose in the early 2000’s. S&P rated Russian debt with a B in 2001 a grade of BBB in 2008. This grade was kept quite constant until recent months. Even now, although Russia finds itself in danger of defaulting, similarly to the 1998 crisis, its debt to GDP ratio is not very high (18% of GDP in 2020).

The importance of international capital markets and the credit rating system

Countries issue bonds in external debt markets as a way to collect the necessary funds to finance their sovereign debts; the associated price and respective interest rate at which they will trade will reflect a number of conditions that determine their risk level, which usually comes attached with a given credit rating.

Credit ratings will reflect the creditworthiness of the country in question, posing as an indicative tool for investors of the possible risks that are being undertaken when investing in said debt – which in turn will be translated into the interest rate at which the loan will be repaid. This risk represents the likelihood of the government failing to make the future payments associated with its debt obligations, either because it is unwilling or unable to do so, with risky investments being linked with low credit ratings and high interest rates. The level of risk assigned to each country will be determined taking into consideration the country’s economic and political environment, assessing several important indicators such as the country’s debt service ratio, variance of its export revenue, domestic money supply growth, among others. Overall, a good or bad credit rating could make or break a country’s economy, being a key factor in attracting foreign direct investment.

These credit ratings are assigned by independent credit rating agencies, with the three most widely known being Moody’s, S&P Global and Fitch Ratings. Each of these credit agencies will attribute a credit rating to the investment in question expressed in letter grade format, in accordance with their personal measurement scale: in alphabetical order, usually from A to D (best to worse), with specific intermediate categories for each agency. For example, S&P attributes a BBB- (or higher) rating to countries it considers to be within investment grade and Moody’s does so for Baa3 (or higher) rated bonds. Any rating of BB+ (or lower) for S&P and Ba1 (and below) for Moody’s falls to speculative grade, commonly referred to as the “junk” bonds territory.

Credit ratings are most definitely not static and may change all the time based on the newest data available on a multitude of political and economic factors, as the recent case of Russia government bonds´ credit rating steep downfall showcases. In fact, in just a few weeks, given the recent turn of events – with Russia´s economic panorama suffering a major hit facing the tight trade restrictions from the West and being essentially cut-off from Western financing – all major rating agencies have downgraded the country´s status by considerable significant notches from its secure position in the “stable” B territory, fearing Russia´s inability (and even to a certain extent its willingness) to service its debt. The situation further escalated upon President Putin´s announcement of the possibility of a “redenomination of foreign-currency sovereign debt payments into local currency for creditors in specified countries”, prompting the rating agencies to believe “that a sovereign default is imminent”, as illustrated by Fitch´s C rating and Moody´s equivalent Ca score, both only one level above default.

The impact of the Russian Invasion

The invasion of Ukraine has seriously influenced Russia’s economic and monetary landscape, mainly due to the package of sanctions applied by several European Union countries and the United States. Indeed, Putin admitted that such sanctions “effectively declare Russia default”, as they imply an increasing probability of default on its public debt (20% of its GDP). Nevertheless, what frightens Putin is not this amount, but the current lack of payment capacity.

Firstly, the sanctions applied to Russia, which include its exclusion from the SWIFT banking system and the blocked access to western financial markets, place this country in a possible economic drowning situation. In fact, according to the public finance sustainability theory, debt is only sustainable if the GDP growth rate is higher than the interest rate. Therefore, given all the economic and commercial exclusion to which Russia is currently exposed, it is possible that its GDP growth will not be satisfactory enough, consequently increasing its financial susceptibility and its risk of default. Besides the economic point of view, other sanctions applied imply the freezing of Russian assets located in institutions outside Russia, such as foreign exchange reserves and Russian bonds, which strongly limits the Russian capacity to pay its obligations.

Furthermore, apart from all the economic implications that trigger the default, another reason is closely linked with the monetary problems faced by Russia. For now, since the invasion of Ukraine, the ruble has devalued by around 40% against the dollar, once again compromising Russia’s monetary capacity to pay its debt. Then, the problem starts when its $480 billion foreign debt is denominated in US currency, so it must be paid in dollars. In fact, according to international declarations by financial institutions, the inability to pay debts in the original currency is formally considered as default. Moreover, nominally paying in rubles will get much more expensive for Russia given its huge drop in recent weeks.


Against the general feeling that Russia wouldn’t be able to make its next bond payment due on March 16 (with a 30-day grace period), it was able to do so. Still, it seems to just be delaying the inevitable given the weak economic outlook and the impact of sanctions.

What this will represent for the world economy is still murky but seeing as only a relatively small sum of the nation´s debt is held by foreigners; all points out to the country´s potential default not posing a major systemic risk to the global financial system.

Sources: Reuters, Fortune, IMF Elibrary, Carnegie Endowment For International Peace.

Diogo Almeida

João Baptista

Sara Robalo

Inês Lindoso

João Correia

The Inversion of the Eurodollar Yield Curve

Reading time: 6 minutes

Despite being the second biggest market in the world after the U.S. Treasury market, the truth is that you most likely haven’t ever heard of the Eurodollar system. This market, where some of the most sophisticated markets participants operate, is giving us warning signs of slowing economic growth. This might clash with some of the inflationary thesis defended nowadays.

But what is the Eurodollar system? And how does it work? What signal is this market giving us and why should we care about it?

What is the Eurodollar system?

In its simpler definition, as the name indicates, the term Eurodollar refers to US dollar deposits held at foreign banks or overseas branches of American banks, which originally operated mostly in Europe, hence the name. Indeed, while it is not entirely clear when this Eurodollar market was initiated, it is believed to date as far back as the post-World War II period, when Europe experienced a wide circulation of American dollars via the financial aid that the US provided to the war-torn continent in the form of the Marshall Plan. Thus, when the Eurodollar system began, it was mainly supported by the emergence of dollar money centers in Zurich, Munich and, of course, London.

However, what started as a fundamentally European-based independent and less regulated market of US dollar funds, rapidly spread across the globe in the next few decades, with many American branches opening operations in all continents. Therefore, as globalization grew and this “secondary” dollar market started expanding – going as far as replacing a lot of the traditional roles of global reserve currencies, such as gold – the Eurodollar system became a much more complex concept that now encompasses a much wider dimension of currencies and operations, representing one of the world´s biggest capital markets.

As Eurodollars are largely held and traded outside of US jurisdiction, they are not subject to the Federal Reserve´s regulation, particular in terms of reserve requirements, leading these deposits to be able to pay higher interests. Furthermore, by operating outside of the FED´s radar, this currency-like system of interbank liabilities allows for sophisticated financing and monetary transactions of US dollars to take place, making it so these international banks that deal with Eurodollars get to work with their own money multiplier, thus being in charge of creating and controlling their supply of US dollars.

Overall, the Eurodollar system became an alternative to traditional currency reserves, being able through its independence to provide the liquidity needed to satisfy demand in a way that, on many occasions, other systems (ex.: Bretton Woods) failed to do so, conferring the confidence that this “shadow” money would be the modern alternative to easily supply financing under the panorama of a globalizing world. This has consequently been reflected in high volume circulation of major international capital flows between countries under the Eurodollar system in the past decades, – with most transactions in this market being conducted overnight – which could potentially have significant geopolitical ramifications, seeing the power that this reserve-less, regulation-less system confers to the major international bankers that oversee it.

How does the Eurodollar work?

As mentioned previously, the offshore banks operating in the Eurodollar are not subject to regulations from Central Banks meaning that they don’t suffer from reserve requirements. This allows for a much higher flexibility to create dollars (being it a purely ledger transaction).

The deposits in the Eurodollar system have a minimum amount of $100.000 and are generally above $5 million and are priced in two different ways: either Overnight Deposits or, for longer maturities, tied to the London Interbank Offered Rate (LIBOR).

Overnight deposits are the most common transaction in this market, they mature on the next business day and usually start on the same date they are executed, with money paid between banks. The overnight bank funding rate is computed according to federal funds transactions, certain Eurodollar transactions and certain domestic deposit transactions.

Regarding longer maturities, Eurodollar is a LIBOR-based derivative. In this situation Eurodollar’s price reflects the market gauge of the 3—month U.S. dollar LIBOR, a benchmark for short-term interest rates at which banks can borrow funds in the London interbank market, interest rate anticipated on the settlement date of the contract.

Inversion of the Yield Curve

Eurodollar futures are derivative contracts that allow buyers and sellers to hedge against interest rate risk in the future. It also allows speculators to bet on the future movements of the USD LIBOR rate. In the Eurodollar yield-curve, the short-term tenors are heavily affected by the Federal Reserve actions (namely by the defined interest on reserves – IOR), while the longer tenors correspond to market expectations on inflation and economic growth.

A Eurodollar futures curve can be built similarly to the treasury rates yield curve: the different future contract maturities are plotted on the x-axis and their associated interest rates are plotted on the y-axis. Under normal conditions, the curve should be upward sloping, reflecting the expectation of economic growth further down the line.

Inversion is not a normal shape for the curve, and it has, historically, preceded turmoil periods for global markets. For example, the last inversion happened on the 13th of June of 2018 where the inversion occurred in the Dec’20 to Sept’21 contracts. This doesn’t mean that the Eurodollar market predicted the Pandemic crisis but that it rather anticipated the deflationary forces existing in 2018 to play-out, namely the collateral scarcity on the Eurodollar system.

            Figure 1 – Eurodollar Yield Curve Inversion in 13th June 2018. Source: Alhambra Investments

This same phenomenon was seen on the 1st of December of 2021, where the Eurodollar yield curve inverted between Sept/Dec’24 and Mar’26 contracts. This means, once again, that the sophisticated participants in this market expect the existing deflationary forces to impact economic growth.

Figure 2 – Eurodollar Yield Curve Inversion in 1st December 2021. Source: Alhambra Investments

The inversion of the yield curve in the maturities around 2024, 2025 and 2026, might suggest that the market doesn’t believe that the Federal Reserve will be able to maintain higher interest rates for a very long time. This could be the case because the market believes that the upcoming contractions in the supply of money in 2022 will cause a slowdown of economic activity, which would cause the Federal Reserve to cut interest rates once again.


The inversion of the Eurodollar yield curve, the flattening of treasury yields and the shortage of dollars in the system are some of the signs that indicate that deflationary forces are threatening economic growth. This might invalidate some of the inflationary thesis as the market participants reiterate their belief that there is no monetary inflation. This inversion might also be a response to a possible monetary policy error by Central Banks, as they plan to tighten into a seeming weak economy.

Sources: Investopedia, Alhambra Investments, Fxstreet

Diogo Almeida

João Baptista

Inês Lindoso

João Correia

The Wall Street Crook

Reading time: 6 minutes

“In today’s regulatory environment, it’s virtually impossible to violate rules […] it’s impossible for a violation to go undetected, especially for a considerable period of time” was Bernard Madoff’s opinion on how “wrong” people misjudged Wall Street, in October 2007, one year before being considered the greatest scammer of Wall Street history for having ran, more than 15 years, the largest Ponzi Scheme the world had ever seen. Madoff has passed away on the 14th of April 2021, at the age of 82, due to health complications, in the Federal Medical Center, in North Carolina.

Bernard Madoff: The Rise

Bernard Lawrence, known as “Bernie” Madoff, was an American hedge-fund investment manager and former chairman of the NASDAQ stock market (in early 1990s), who executed the largest Ponzi scheme in history. This scheme translates into a financial fraud in which the first investors are reimbursed with money acquired from subsequent investors, instead of the real return on investment. He defrauded thousands of investors by tens of billions of dollars over at least 17 years, and possibly more.

Bernie Madoff started his career as a penny-stock trader in Wall Street. At age 22, in 1960, he created “Bernard L. Madoff Investment Securities, LLC”. He started by trading penny stocks with $5,000 earned by working as a lifeguard, and then persuaded family friends and others to invest with him.

The success of the company began when Madoff and his brother Peter started developing electronic capabilities that attracted a large flow of orders and boosted the business by providing insights into market activity. By the 1990s, Madoff’s broker was processing 10% to 15% of all trading orders for the New York Stock Exchange (NYSE).

Madoff was so well-respected on Wall Street that he also served three terms as chairman of NASDAQ stock exchange board of directors. This would later provide him the reputation and networking he needed to create a Wealth Management unit within his investment firm. It was in this department that Madoff pulled off the largest Ponzi scheme in history.

The Scheme

It is hard to comprehend the reason why Madoff started his Ponzi scheme, in the first place. Equally shrouded in mystery is the time at which it all started.

Madoff claimed in court that his scheme started in 1991. However, one of his closest associates, Frank DiPascali, who had worked at his firm since 1975, said the fraud had been occurring “for as long as he remembered”.

Madoff’s Ponzi scheme story is, in many ways, a story of successful marketing. Indeed, one of the reasons why Madoff was able to sustain the operation for so long was his great ability to bring in new investors. He started off by introducing a brand-new investment approach that would involve a highly complex derivatives trading strategy. He named it the Split-Strike Conversionstrategy, and began pitching it to his investors, stating that it was able to provide them with steady returns, alongside low-risk.

Madoff would sometimes reject new clients at first, to create a feeling of exclusivity around his money-management services.  Overall, his reputation in wealthy social circles grew and the steady and high annual returns, always between 10 and 20%, made it so that he did not have any shortage of new people wanting to invest their capital. Madoff did not attract wealthy investors from the social elites only. His scheme also affected many people who were not very wealthy and that entrusted him with their life’s savings. Among his clients were also several non-profit organizations and major banks and corporations, such as BNP Paribas, Banco Santander, and Bank Medici.

Madoff mostly kept his investor’s funds at an account in Chase Manhattan Bank and would pay out their supposed “returns” from the capital acquired from other investors. The great complexity of the whole operation was in forging the return statements and other documents that might come under scrutiny from clients or from the SEC (U.S. Securities and Exchange Commission). Madoff would work from his returns backwards, that is, he would start off from a certain return and then see how to forge a trading record that could justify that return. So, Madoff and his associates would look at previous price changes in stocks and other assets and would create an investment strategy that would have corresponded to the paid returns.

Overall, Madoff’s great attention to detail when forging all the required documents, and his intelligence to lay low, sometimes fake negative returns, either during stock market rallies or crashes, allowed him to go under the radar for so many years.

Madoff’s Fund returns vs the Benchmark (Sentry was Madoff’s largest investor). Madoff’s scheme almost always provided the same results, even laying low when the market spiked in the Dotcom bubble (1994-2000). Source: Investing Per Excellence

There were also some special clients, the so-called Big 4 (not the ones you are thinking about, but unknown multimillionaires), whose accounts stood out and were handled differently from the other clients’. There were instances when some of these clients would send back their forged trading statements to Madoff and his accountants, when they thought that their returns were too low. Miraculously, the amended accounts would then show higher returns. Indeed, this proves that there was some pressure on Madoff for higher returns from clients who knew about the fraud that was occurring.

The Fall

Well, as the old saying goes, “if something seems too good to be true, it probably is”, and, even though the collapse of Madoff’s wealth management division surprised the financial system, it was not by lack of warnings.

Harry Markopolos, known today as “Madoff’s whistle-blower” was a portfolio-manager at a Boston trading investment firm that first spotted the fraud in 1999. Back then, his boss informed him of a hugely profitable hedge fund, ran by Bernie, that was delivering steady 1 to 2% returns a month, and would latter ask him to recreate his “Split-Strike Conversion” strategy to try and duplicate Madoff’s results for their own firm. In Markopolos’ words: “It took me 5 minutes to know that it was a fraud, it took me another 4 hours of mathematical modelling to prove that it was a fraud”. For Madoff to be executing his trading strategy and perform the way he was, he would have had to buy more options on the Chicago Options Exchange than actually existed. For Markopolos, there were only two plausible explanations for the outstanding performance: either Madoff was insider trading or he was running a huge Ponzi scheme. He later took his suspicions 5 times to the Securities Exchange Commission (SEC), to which they replied that “there was no evidence of fraud”.

Harry Markopolos, Madoff’s whistle-blower, testifying in the senate how he was ignored by the SEC. Source: CNBC

Despite numerous warnings concerning Madoff’s activities, the suspicions of fraud did not themselves led to the collapse of his investment firm. Amidst the 2008 subprime mortgage crisis, multiple investors tried to withdraw their money from the fund only to realize that, from the supposed $20bn he was holding, only $200mn were left. On December 11, 2008, Bernard Madoff was arrested and charged with securities fraud, one day after revealing his scheme to his two sons, Mark and Andrew Madoff.

The End

Following Madoff’s arrest, the case was publicized around the world and was talked about in the news 24/7: it was the largest Ponzi scheme in history. Madoff plead guilty to all charges brought against him in court. The judge sentenced him to 150 years in prison, the maximum for his crimes, and a symbolic sentence for what the judge considered was “extraordinarily evil” conduct by Madoff.

Bernard Madoff arrest. Source: nypost

Following Madoff’s arrest and incarceration, efforts began to try to help victims recover their lost funds. The Madoff Victim Fund was created to try to restore funds to victims of the scheme, many of whom were thrown into financial instability with the collapse of the scheme. People who benefited from Madoff’s scheme had to forfeit their gains and, through this fund, this money is being returned to those who were affected by the scheme. So far, Madoff’s victims have been able to recover about 80% of their losses.

On April 14, 2021, Bernard Madoff passed away at the age of 82, in the Federal Medical Center in North Carolina, due to kidney disease.

Sources: Encyclopedia Britannica, Fortune, Investopedia, The Motley Fool, Wikipedia

Francisco Nunes

Raquel Novo

João Baptista

João Correia

Commodities Super Cycle: Are We Entering One Now?

Reading time: 7 minutes

Over the last few months, commodity prices have been on the rise, and increasingly more market participants are suggesting a new commodity super cycle. But what is this?

The United Nations (UN) describe it as a “decades-long, above-trend movements in a wide range of base material prices”, which differ from short-term fluctuations, in terms of span, with trough-to-trough cycles usually lasting 20 to 70 years, and in terms of range, affecting a broader spectrum of commodities, mostly inputs for industrial production and urban development.

Historical Super Cycles

Comparable previous Super Cycles include the mid 1940’s and 1950’s super cycle, during the reindustrialization and reconstruction of Europe and Japan (after World War II) and, later, aided by fears over the Korean War and its effects on South and East Asian trade, both of which led to a greater demand and a build-up of strategic inventories. As an example, the price of copper per long ton rose from $62.10 during WWII to $420 by 1954, an appreciation of 580% in 15 years.

More recently, in the beginning of the present millennium, commodities also saw their prices spiking, starting in 2000, up until 2013 (though a dip occurred between 2008 and 2010), mainly due to the rising demand from Emerging Markets, such as the BRIC countries, particularly China, which could not be accompanied by the supply side: the price of oil rose 1,062%, copper rose 487% and corn rose 240% from 1999 to 2008. It began showing slowdown signs after the great financial crisis and the Euro crisis in 2008 and 2011, while finally winding up during the 2015 Chinese Stock Market Crash, caused by the deceleration of the Chinese economy.  

Figure 1: GMO Commodity Index 1900-2013
Source: A roadmap for a smart Artic specialization

What is going on with Commodities

This present run, however, has started in March 2020, when markets reached their lows, with commodities’ prices plunging due to lockdowns and global stoppages of industrial activities. Since then, all major commodity indexes have recovered from their losses last year, mainly dragged by the momentum of Oil (up more than 180%), Gold (up more than 15%) and other specific metals, such as Copper and Silver (up more than 100%).

What are the factors driving this new commodity Spike?

The current commodities appreciation, and prospects of a new super cycle since the election of Joe Biden, have been caused mainly by three different forces. Two coming from short-run scenarios: Future Shortages of Supply and Inflation Expectations; and one from a long-run trend:  The Green Transition.

Starting off with the hypothesis of Future Shortages of Supply, this event is expected to be triggered as mass vaccinations and reopening of economies boosts the demand of multiple commodities, whose capacity has been depressed after the 2020 reductions in Capital Expenditure (CapEx), -25% on average for Oil and Gas companies.

Nevertheless, corporations from many other industries, that were forced to divest their activities during the demand crisis last year, are now about to be blessed by worldwide pandemic relief programs that have promised public large-scale infrastructure projects, such as the $10 billion Highway Infrastructures Program in the US and the $26 billion Investing in Canada Infrastructure Program.

Figure 2: CapEx cuts on the largest Oil and Gas companies
Source: Bloomberg

Secondly, the US loose monetary and fiscal policies, alongside a foreseen economic expansion, has left space for concerns regarding a prolonged inflationary and currency devaluation period that will highly benefit investors holding commodities on their portfolios. This asset class may have played a very timid role last decade, but with the Fed targeting an average of 2% inflation, instead of having this value as a threshold, and with investors looking to hedge their Fixed Income and Speculative positions, a commodities momentum has been building recently.

If we look at historical data, there has been a positive correlation between commodity prices and the CPI, with an increase of 1% in inflation resulting, on average, in a subsequent 3.5% appreciation of the BCOM (Bloomberg Commodity Index)

Figure 3: Scatter plot of the quarterly returns of the BCOM and changes in US CPI
Source: Bloomberg, NN Investment Partners

Finally, the transition for environment-friendly alternatives and new technologies, starting this decade, is likely to reshape the near-future of many commodities. On one side, the promotion of renewable energies from the US, Europe and China is going to require large investments for the creation of solar panels and wind turbines, which will pump up demand for metals such as Silver and Copper. Then, the incentives for an EV transition are also going to further risen the demand for other metals, such as Lithium, Cobalt and Nickel, required for its batteries.

However, on the other side, this transition is likely to have a contradictory effect on oil prices. Whilst these are expected to decrease in the Long-Run (given the decarbonisation process), the US re-entry into the Paris Agreement, in which it will agree to decrease its oil production by millions of barrels, will give the OPEC+ the opportunity to control even further the price of worldwide crude. Furthermore, as these countries seem to show no interest in the subject of climate change, they are set to leverage on what might be the last decade of strong demand for this commodity, thus pushing prices as high as they can.

Impact of a super cycle in the Economy              

Fluctuating commodity prices have a significant impact on business, but they also impact markets and the overall economy. Generally, the impact of commodity price fluctuations depends on whether that economy is a net importer, which typically benefits from the reduction in prices, or net exporter of commodities, which should be better-off with price increases.

Oil is the most important commodity for most economies worldwide.It is crucial, because it plays an important role in power generation, logistics and industry. If the price of oil increases due to higher demand, it is a good sign for the global economy, which will continue to expand alongside with the oil price. The intuition behind is that the increased production and consumption in the economy will generate the demand for oil. On the other hand, when the increase in price is due to a supply deficit, it normally means a potential contraction in the economy. Most of these shocks are associated with natural disasters or agreements by oil producers to fix the price.

Copper is sometimes named “Dr. Copper” for its ability to predict where the global economy is heading. When its price increases, the economy is normally on an uptrend. Other commodities, such as Timber, Cotton, Wheat, Corn and Coffee are broadly used throughout the economy. An increase in their price means that the prices for the products they input will increase.

Lastly, it is important to mention Gold, given its special characteristics. It is used in various sectors across the economy and its price also depends on the value of the US Dollar. Contrary to other commodities, gold price normally goes up when the economy is in bad shape, since it is seen as a stable investment.

Future Perspectives

As the world re-opens, demand for commodities has surged throughout countries. Combining this with rising inflation, a weaker dollar and low interest rates, resulting from the highly expansionist monetary policies in response to the pandemic crisis, it might create a new super cycle in commodities in the US, as investors and businesses demand commodities either to hedge these risks or for production. Also, as the US looks to join the Paris agreement, infrastructure will have to be built to meet the requirements.

Overall, the conditions seem favourable for a new super cycle to be starting. Nevertheless, some of the drivers might not play out as expected or even be a temporary glance that won’t be able to impact commodities price on the long run and sustain the cycle over time.

Sources: Australian Financial Review, Blackwell Global, BRINK, Business Insider, NN Investment Partners, The Economic Times, United Nations Industrial Development Organization

Scientific revision: Patrícia Cruz

Francisco Nunes

Jorge Lousada

Diogo Almeida

The Great Rebound | 1-Year Anniversary of Black Monday II

Reading time: 7 minutes

The beginning of March 2021 marks the first anniversary of the elevation of COVID-19 to the status of a pandemic. It has also been a year since the growing concerns about the economic consequences of the pandemic, coupled with the oil war, caused the collapse of worldwide stock exchanges. 

The stock market crash of 2020 began on March 9, when the Dow Jones Industrial Average (DJIA) registered its worst single-day point drop in history of 7.79%. This fall was followed by two further record-high plunges, first on March 12 (-9.99%) and then on March 16 (-12.93%). This alarming tumble ended the 11-year bull-market started in March of 2009, with the lowest point – a 33% fall from February-of-2020 highs – being reached on March 23. The DJIA has been recovering ever since, accumulating a 68% gain by March 17, 2021

Source: CNBC, Figure 1 – 10 biggest one-day point losses in DJIA history

Did the FED finally get the formula right?

Milton Friedman, the renowned Nobel-prize winning economist, published in 1963 what would be then remembered as a ground-breaking book regarding monetary policy: A Monetary History of the United States. In one of its most famous chapters, where the author focused solely on the Federal Reserve’s actions during the Great Depression, he pointed out several reasons to why the FED had not only perpetuated the crisis for more than a decade (after the famous 1929 crash), but also had helped worsen it. Three of the main reasons sustaining his arguments were the lack of liquidity it provided to the economy, enabling disastrous bank runs, the lack of forward guidance, a tool which informs investors about future interest rates policies, and the time they took to put their policies into practice. Consequently, the US faced deflationary and unemployment levels that, to this day, are still regarded as having acted as catalysts for the worst American crisis in history.

Source: Federal Reserve History, Figure 2 – Ben Bernanke speaks about the Great Depression

Ironic enough, it was under Bernanke’s term as Charmain that the second most devastating financial crisis (only less severe than the one initiated in 1929), in late 2007, took place. However, once again, and despite the reduction in the Federal Funds Rate from 5.25% to 0-0.25%, combined with similar forward guidance, the enormous QE, Open-Market-Operations Programs and even the controversial bailouts from the “Too Big to Fail” who had gotten into the subprime mess, the consequences drawn from the time taken to implement these policies are still regarded as a big mistake.

But how does this relate with the current economic downturn and the stock market?

Unlike the previous two major recessions, often described as man-made crises, the stock market collapses that followed were pretty much impossible to contain by any federal institution, as they were caused by investors realizing they held worthless assets from financial companies destined to bankruptcy. These collapses ended up damaging the ability of the economy to bounce back faster, as businesses saw their savings being erased from day to night, then lost the ability to fund their activities through capital raisings and, ultimately, closed doors.

However, this time, society was faced with a nature-made crisis. There was no systemic cancer under the economy. Despite generous stock valuations, the crash starting in March was mostly due to an exogenous shock leading to expectations of yearly negative economic growth. Therefore, the Fed made sure to leverage on that detail as much as possible, by trying to have the stock market at its side and prevent even worse economic outcomes.

By March 15, even before lockdowns started in the country, the Fed had already adopted the same expansionist monetary policies as in 2008 and, on March 23, made QE open-ended, a euphemism for “unlimited funding until needed”, ending there the stock market crash and its bearish trend. It has also been supporting loans to businesses with near-to-0% interest rates, giving rise to the so-called “zombie companies”. These are businesses that were in fragile conditions before the pandemic, but which were able to keep its activities, due to the bailouts. The percentage of these firms in the Russell 3000 as lately reached values close to the dot-com bubble.

Source: Financial Times, Figure 3 – The rise of ‘zombie’ companies

These measures, alongside supporting fiscal policies coming from the government, have been creating a liquidity phenomenon characterized by a shift from fixed income to equities, due to the unattractive yields being carried by investment-grade securities. It has been growing the investors’ appetite for growth and speculative stocks, with valuations as a whole being totally disconnected from the economic reality.

The rise of retail investors and sector performance during the pandemic

Source: Fortune, Figure 4 – The rise of retail traders

There has been considerable surge of day trading since the onset of the pandemic. With many people stuck at home and extra income brought by the Relief Package Deals, there has naturally been an increased curiosity in trying to make money from the stock market.

In the first quarter of 2020, day trading increased dramatically when compared to 2019. TD Ameritrade, one of the online brokers that provides access to such activities, reported that visits to its website giving instructions on trading stocks have nearly quadrupled since January 2020. JPMorgan estimates that the brokerage industry added more than 10 million new accounts during 2020, mainly on commissions-free brokerages.

Some of these new retail investors are induced by the gains other people have made on certain stocks. They follow short-term speculative plays, attracted by the promise of big gains, which do not turn to be the case most  times. The main focus of these new investors were mega-cap growth stocks, especially tech-related. These were among the big winners, alongside industries such as online retailers, cryptocurrencies, housing and solar. On the losers’ side, one can find travel and leisure, oil and gas, banks, and manufacturing.

Stock Market vs Economy: related, but not related

While the past year has seen a great economic downturn, the evolution of the stock market since the crash seems to contradict this pattern, as aforementioned.

With the current economic situation failing to keep up with valuations, there are reasons to believe the stock market is highly overvalued, leaving investors in the fear they may be facing a dangerous speculative bubble that might burst at any moment. History has shown that tables may turn at any moment and this likelihood is increasing with volatility in investors’ confidence and uncertainty regarding the effectiveness of the vaccines.

Source: Bloomberg, Figure 5 – Buffett Indicator

Overall, it is true that most of the times the stock market and the economy do not fluctuate in tandem and there is evidence that they have been negatively correlated (-0.04 correlation over the past 10 years). 

Source: US Bureau of Economic Analysis, Figure 6 – Stock Market Performance vs Economy

All things considered, stock market fluctuations may be due to various reasons external to economic performance, the most prominent one being the unpredictable behavior of investors, whose confidence and moods change drastically from one moment to another, many times for no apparent reason or tied to either unrealistic optimism or subconscious fear of the future performance of the market. 

What does the future hold?

The inability for investors to predict an upcoming crash was still very much present during last year’s rally, with many unable to comprehend how such a big economic downturn could coexist with such a strong bull market. Nonetheless, these past weeks may have brought to light some of the stock market’s weaknesses, by showcasing how fragile it is to inflationary expectations. It seems that the lack of action coming from the Fed to contain inflation at targeted levels and real yields at positive ground have triggered a sell-off from US treasuries and an upward movement in long-term yields. However, with risk-free rates increasing and becoming more attractive, highly-speculative and growth stocks have also been suffering from the new discount factors in play, and from massive corrections leading up to a rotation to bonds and value plays.

It is still unknown whether these events can trigger a potential crash or only minor corrections, but, once these become coupled with possible bad earnings seasons or any slips coming from the vaccines rollouts, you might want to hold on to your cash, stand back, and enjoy the show.

Sources: Bloomberg, CNBC, CNN, Corporate Finance Institute, Federal Reserve History, National Bureau of Economic Research, The Balance, Visual Capitalist.

Francisco Nunes

Diogo Almeida

Inês Lindoso

US Elections 2020 and the Stock Market

General effect of elections on the Stock Market

Political stability is known to be one of the most relevant requirements for one to invest in a given market. Given this fact, it is no wonder that the United States have been the number one place to invest in over a century. One may say its capitalist policies have been the primary cause to that result but it is also important to notice that, unlike many of its European and Asian peers, this country has been under an ongoing democracy since 1776, which ultimately led the country to be seen as one of the most safest and transparent places to do business in.

Since we are talking about one of the main drivers of the current world economy, any political deviation tends to trigger either positive or negative worldwide economic forecasts, thus, influencing financial markets as whole.

Going into the most recent elections between Joe Biden and Donald Trump, and despite the polls pointing from day one to the Democratic nominee, expectations about bullish or bearish views on the market (e.g. Energy Sector) were highly reliant on this election. However, it is important to bear in mind one very important aspect: both the Democratic or Republican parties believe that, under their own policies, the overall economy will grow at a faster and sustainable pace than under the other. Therefore, usually there are no major setbacks in stock markets since a large share of the US population must trust on the chosen economic strategy.


But for how long can this volatility affect the market?

Let’s use for example the two most disputed elections of the new millennial:

Al Gore vs George W. Bush 2000 election

In the midst of a Dotcom Bubble and a slowing US economy, the Al Gore vs George W. Bush clash took place, leading to one of the most disputed elections the country had ever seen, with a losing candidate having more popular votes for the first time since 1888 (Gore had approximately more 500.000 votes than Bush). After a very close race between both candidates, Florida’s 25 electoral votes were called “too close to call” after George W. Bush had won the state by a mere 900 votes out of a 6 million ballots cast. Such a close margin led Gore to demand a recount by hand in vary crucial counties, thus, postponing any official announcement for 36 days, and taking Wall Street into some red territory.

Overall, the S&P 500 had tumbled 7.8% during the recounting of votes and the final decision by Florida’s Supreme Court to overrule that same recounting.

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Hillary Clinton vs Donald Trump 2016

During the final hours of the shocking 2016 elections, investors once again feared that no one would come out victorious as Florida’s counting was already looking similar to the one seen 16 years before. As so, Dow Futures plunged as much as 5% in the after-market, as a close call could once again lead to a lingering recount. Nevertheless, Hillary Clinton conceded the victory shortly after the official results came out, bringing relative calm to the stock market and even giving it some momentum.

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What were the markets betting on?

For months, the world had its eyes on the U.S. Elections and last week’s slow and excruciating wait for its outcome left millions of people worldwide constantly refreshing electoral maps and predicting its result. As millions of individuals around the globe, the stock market also established its prediction, based on one specific indicator: the S&P 500’s performance.

Historically, since World War II, 88% of the times the most relevant equity index in America fell in the three months prior to the election, the incumbent party lost. On the other hand, when the S&P 500 showcased some growth, the incumbent candidate for the presidency has won. This year was no exception. Until little time prior to the elections, the index was predicting a Republican win, yet, on the last Friday of October, markets were shaken and the S&P 500 drop 1.2%, registering a 0,04% plunge between the last days of July and October that, despite the very slight margin, meant a favorable result for Joe Biden, the Democratic candidate.

Despite the general idea that a Trump presidency would ultimately benefit Wall Street due to lower taxes and loose regulations, investors, businesses and the overall corporate America showed no worries of a possible blue wave, even considering Biden’s explicit support of a higher corporate tax rate, stronger unions and an expansion of government-run health insurance.Indeed, according to Harvard Business School professor Deepak Malhotra, “There is a growing sense that for business to do well, [and] for the economy to do well and to grow, you need a government that’s functional” matching JPMorgan statement that, despite the “consensus view” that a “Democrat victory in November will be negative for equities”, the multinational investment bank sees this “outcome as neutral to slightly positive”. Furthermore, Goldman Sachs stated that a Democratic win would increase the possibility of a fiscal stimulus package amounting to $2 trillion by the time of Joe Biden’s inauguration and his plans to increase spending on infrastructure, health care and education would ultimately “match the likely longer-term tax increases on corporations and upper-income earnings”. Supporting such predictions, Moody’s Analytics investigation outcome showed that Biden’s economic policies would create more 7.4 million jobs that Trump’s would, leading the economy to return to full employment by the second semester of 2022.

One should also not forget the fact that Joe Biden, given the current predictions, will rule the US under a Democratic Congress and a Republican Senate accentuating the need for compromise in all future policies. Rumors have it that Mitch McConnel and Biden have a healthy and professional relationship of mutual respect and they have worked well in the past, but only time will tell if the Senate will constitute an obstacle to the future POTUS or a means of achieving bipartisan consensus regarding the future of the United States of America.

The Evolution of the S&P 500 in the post-election: Markets seem to like Joe Biden so far

The Evolution of the S&P 500 in the post-election: Markets seem to like Joe Biden so far

Ultimately, investors dream about stability and smooth transitions of power. The latest remarks made by President Donald Trump before and after the elections, where he refused to concede to Biden and promised to legally contest the voting outcome, worried financial markets. Uncertainty surrounding the most powerful office in the US means trouble for investors and, due to this fact, we dare to say that they are looking forward to a Biden presidency and a peaceful ending to the Trump era. At the moment this article is being written, the outcome of the election does not seem final since top Republican officials are backing Trump’s unfounded accusations of election fraud pushing the process to the courts of law. If there is not a clear victor soon or if Donald Trump continues to refuse the will of the American people, markets will get edgy and volatility will be the law, in the short run.

Day Trading

What is Day Trading?

Day trading is the practice of buying and selling a security on the same day. That is, an investor enters and exits the transaction on the same trading day, and no open positions are maintained overnight. It essentially occurs in any market; however, it is more prevalent in the stock and foreign exchange markets. It entails using large amounts of leverage to make the most of price fluctuations, be it a short or long trade. Given gains are made on swift price changes, investors seek out volatile and highly liquid assets.

 Day traders base their decisions on numerous indicators, news, scheduled announcements (e.g. corporate earnings, interest rate changes) while trying to predict future market inefficiencies that can be exploited for capital gain. Meanwhile, day traders try to rely as little as possible on their gut feeling and emotions, for that reason money invested is often the amount they can afford to lose.

 The most common trading strategies range from making numerous small profits on various small price changes (Scalping), to take advantage of the volatility created by news events (News-Based Trading), all the way to using algorithms to identify and make the most of small market inefficiencies (High-Frequency Trading).

 Day trading can be traced back to 1867, before computers, the internet or even electricity existed. Stock markets used the telegraph’s communication technology to create the ticker tape, the earliest electrical dedicated financial communications medium, which allowed for brokers’ transactions to be communicated. In the past, those who were able to day trade were brokers working for large institutions, which managed the firm’s money, as well as that of its clients. They had access to a direct trading line, a trading desk, great amounts of capital and highly advanced analytical software. Nevertheless, the position of day trading has extended to anyone interested, though with a more limited know-how and access to financial tools, as platforms now offer lower fees.

Different types of strategies 

Each trader usually creates his strategy based on one simple criteria: Risk. As financial markets teach us every day, trading on riskier approaches tend to end up either in disastrous trades or in absolute jackpots or, on the off chance the market shows low levels of volatility, the gains/losses can be closer to zero. However, professional and retail traders tend to focus more on volatile and high beta’s assets that, at the end of the day, can turn a soft overall market movement into a considerable profit return for the portfolio. Traders do have to consider the need to top commission fees so that the high number of trades won’t eat up the gains and leave them holding nothing.

Taking these facts into account, traders choose the strategy of which they feel mostly suits their reach. So, components as the time, money willing to involve on the portfolios, experience in trading, and the knowledge behind market movements may drive different approaches from traders.

Arbitrage Trading:

Arbitrage is solely the act of purchasing and selling a financial instrument by exploiting market inefficiencies.

Take for example the simplest arbitrage trade possible, imagine you hold Apple stocks and you realize that it is selling for $118 on the NYSE and it has a bidding price of $117.5 on the LSE.  With this you could incur in free-of-risk transactions from one Stock Exchange to another until the market gets corrected, which until then, profit would be assured. However, arbitrage opportunities are said to have gone extinct for retail investors due to the highly computerized financial software, which when any dysregulations like this occur, are promptly put to an end by the fastest market-maker that sees it and takes advantage of it with the use of advanced algorithms.

Swing Trading:

Swing trading is a type of trading that implies seeking for a big chunk of a potential price movement, instead of settling for small movements caused from natural volatility. Due to the end goal that this strategy aims to achieve, it usually forces the trader to hold the security overnight and to sell it in the following days. This method highly relies more on technical analysis rather than on fundamental analysis, considering the trader incurs in the purchase and selling of the security regardless of what he believes the intrinsic value of the asset is. A swing trader supports his decisions by looking for common patterns, moving average crossovers, cup-and-handle, as many other multi-day chart patterns in order to set the buying price and then the chosen Stop Loss/Take Profit values.

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News Trading

As the name suggests, news trading strategies implies the trader to make its judgement of pursuing a transaction based on news and rumors, either before they are announced or after. This type of strategy does not require the trader to undergo any detailed technical analysis but rather to focus its trade on the qualitative side of the fundamentals of the company, thus, in this case, to know if the announcement or the new will meet the markets expectations or, if on the other hand, might change the investors’ opinion of the companies’ value.

Merger Arbitrage

Often referred to as Hedge Fund strategy, this strategy comes from the purchasing and selling of a stock that is supposed to be acquired by a second company at a higher price. This type of strategy involves calculating the probability that either the merger is going to be settled at that given price, as it will occur at the time expected.

One controversial example in the Portuguese stock market’s sphere was the “Benfica’s takeover bid” (OPA do Benfica). Benfica filed in for a takeover bid on its “SAD” in November 2019, by willingly acquire about 30% of its shares for a price of €5, when its stock was at the time valued at €2.71. Traders soon pumped up the stock to a value close to the acquisition one, only to see that acquisition takeover overruled by the Portuguese Securities and Exchange Commission a few months after.

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Why is it so controversial?

Day trading is regarded as one of the riskiest ways to invest your money in financial markets nowadays. There is still a general idea that this type of trading is just gambling and a scheme to make bulky profits within days. Furthermore, most experienced asset managers and financial advisors have a negative opinion regarding day trading stating that the risks almost never justify the gains received. When we long at the long-turn, day trading practices tend to underperform traditional investment practices. It is true that it often includes leveraged positions that can make traders lose much more than they initially invested, and this often happens. Although traders are only forced to show their gains and losses to IRS, several studies and market research data show that their success rate is very low, only a small percentage managing to consistently deliver relevant gains, considering the high amount of brokerage fees they pay.

Advantages of Day Trading

 Although day trading practices are shown to be risky, from what we saw earlier, they are quite common today and there are reasons for it. The most advertised by day traders is the huge gains that they can make in relatively shorter periods of time. Despite depending on the amount of money that a trader is willing to risk at each trading session, the leverage mechanisms available can transform small investment sums into robust sums of money. This makes a lot of day traders believe they will be part of the small portion that is able to beat the market.

Final Thoughts

Day Trading is definitively risky by itself, it requires a filled margin account to start with and any potential profit is already cut by the brokerage fees of making many trades every day (this burden will depend on the brokerage firm). Data shows that most day traders lose money and a high percentage of the ones that have any gains have a small profit margin. With all this information in mind and considering the inherent risk, it is a legitimate way to make a significant return with low-enough initial capital and in a few days or weeks. Day trading is not for the faint of heart and is only advisable with the right market information and experience in financial markets. It ultimately falls on each investor to decide if the reward is worth the risk.

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Sources: Investopedia, BeBusinessed, MelMagazine, The Balance

The exuberant IPO (Snowflake Part II)

Snowflake started trading on the 16th September 2020 on the New York Stock Exchange (NYSE) and it could not have a been a more successful Initial Public Offering (IPO). Under the ticker SNOW, the company took the central stage in the largest IPO of an American software firm.

Goldman Sachs was the investment bank responsible for Snowflake’s IPO and it left some people wondering if the respectable Wall Street institution had not made a huge mistake and mispriced this IPO. And the reason was the first day of trading: Snowflake’s shares were priced at $120 and they increased more than 160% reaching $315, before closing at $253.93, which is still almost 112% higher than the IPO price.

Although this is not unheard of, since we have the case of LinkedIn and dozens of examples during the dotcom boom, only a very small percentage of IPOs tend to double in value in their first day. But there is a better explanation than the fact that Goldman Sachs and Snowflake failed to correctly assess the company’s market value. There were several institutional investors that traded the company’s shares for a quick profit and others that just held their position, but the real main drivers of this one-day bubble were retail investors that traded over and over the same number of shares similarly to what has happened in the recent “tech bubble”.

The bottom line is that Snowflake was able to raise $3.4 billion and, by the end of its first day of trading, it displayed a $70.4 billion valuation, which is more than five times its private valuation in February of the same year.

A “sell” rating from Summit Insights Group marked the first analyst rating of Snowflake, earning the title of “the most expensive name in all tech”, despite its impressive debut in the public market. Srimi Nandury, analyst at Summit Insights Group, expressed concerns about Snowflake’s valuation stating that combined with its “limited differentiation” from company’s such as Google’s BigQuery, and Amazon’s Redshift, “For the stock to work from the current levels, Snowflake needs to execute flawlessly quarter after quarter, and have to live up to lofty expectations and grow into its valuation”. Indeed, Snowflake shares are considered to be at risk of a sharp reversal, stepping into bubble territory. Moreover, the tremendous run presented by the stock placed SNOW as an unstable stock, yet investor’s enthusiasm is undeniable and, as previously mentioned, retail investors were primarily responsible for the gains, rather than institutional players.

 If the hype for the cloud-based data provider was already high, news that an unprecedented move coming from Berkshire Hathaway, the half a trillion-dollar company that put Warren Buffet on the map, caught every investor by surprise, sending demand even higher.

The 90-year-old investor is known for its aversion to tech companies, which he has stated of failing to see their potential where there is one. Moreover, the fact that this is a high-growth, money-losing and expensive-looking stock, news stating that Berkshire was investing as much as $250 million in the IPO, plus a 4.04 million shares (at debut price $120) bought from Berkshire directly to a stakeholder (a total investment of $730 million) caught everybody off guard. And if this was seemingly confusing to investors who have followed the investing rationale chosen over the years by Berkshire, the fact that Buffet has been a criticist over the years of investing in new issuers, comparing it mostly to gambling, created the speculation that the decision behind this investment was being made by Buffet’s lieutenants: Todd Combs (also CEO of GEICO) and Ted Weschler, who manage about $14 billion each worth of Berkshire Hathaway’s portfolio.

In fact, in an interview given to CNBC in May 2019, after asked on whether he would be interested in buying Uber’s IPO, Buffet responded saying “ In 54 years, I don’t think Berkshire has ever bought a new issue (…) The idea of saying the best place in the world I could put my money is something where all the selling incentives are there, commissions are higher, the animal spirits are rising, that that’s going to better than 1,000 other things I could buy where there is no similar selling enthusiasm and the desire to get the deal done… we like to buy things where nobody is making a dime”

Right philosophy or not, Berkshire had a return of around 110% just in the first trading day, profiting an absurd amount of around $800M on one stock which, at the end of the day, is a huge outsider under the holding company’s portfolio.

A study conducted by Harvard Business School professor Malcom Baker and New York University finance professor Jeffrey Wurgler uses the first-day return of IPOs as an indicator to quantify investors exuberance and explains “ because it is impossible to short-sell IPOs, the first-day returns are driven by sheer speculation and optimistic buyers who may or may not do their homework on any given deal”. If we calculate the average of the first-day returns of IPOs so far this year we get a value close to 42% – the highest percentage since the internet bubble in the late 1990s. Particularly in the sector to which Snowflake belongs, this year already 12 technology IPOs in the US have priced above their initial range and increased their value since they went public – as an example, take a look at Shrodinger Inc. (229.7%), BigCommerce Holdings Inc. (212.3%) and nCino Inc. (143.7%).

Therefore, it is important to understand the factors in the origin of all this enthusiasm around cloud-software companies. One of the explanations was given by Jacob Shulman, the chief financial officer of JFrog, another company from the software sector which debuted this year on Nasdaq. For Shulman, which defended that the COVID-19 pandemic strengthened the existing relationships between costumers and companies that can help employees maintain productivity while working for home. For Shulman, software is becoming an integral part of our lives and the pandemic just crystalized the need for digital transformation. Indeed, if we take a look at the development of Zoom which increased 1100% since its IPO in 2019, Shulman could be right. Also, some specialists argue that recent enterprise technology companies take into consideration the fact that being a public company enhances their credibility when selling to new costumers – one more possible explanation to the recent increase in the number of IPOs in the tech sector.

However, back to the study of Baker and Wurgler, evidence was found that the stock market historically has produced below-average returns when investors are exuberant. Thus, should we fear a bubble burst like the one back in 2000? For Jay Ritter, a scholar from the department of finance at the University of Florida, defends that new conditions exist nowadays, making a crash less likely. For instance, the decline in the stock market during February and March could have created such fear and uncertainty that IPO underwriters have been reluctant on setting too high an initial offering price. Therefore, as a consequence of setting low prices, IPOs enjoy bigger first-day bumps after going public. Furthermore, nowadays firms have also some differences when compared with tech companies from the 1990s. The new tech companies now go public relatively later and have already demonstrated that their products or services have demand and many of them have inclusively significant sales.