Is Robinhood making money off those day-trading millennials? Well, yes. That’s kind of the point.

As the twin black swans of the coronavirus pandemic and the historic oil price collapse rocked financial markets early in 2020, opportunities emerged.

So did media narratives.

One of the most popular: that bored young people, stuck at home with no access to sports or bars or live entertainment, went day-trading instead, in many cases with an online brokerage that seems tailor-made for the Gen-Y set: Robinhood.

While there’s plenty of evidence that handfuls of millennials are day-trading, and in some cases losing a lot of money, with sad and shocking outcomes, their numbers and any impact they may be having on the market is less certain.

What’s more, for anyone who’s spent a career observing and helping fine-tune the infrastructure behind financial market trading, some of the discussion about what’s actually going on isn’t informed, or helpful, according to one analyst.

“There is a narrative out there that somehow Robinhood was doing something nefarious to make money off their clients in a way that was illegal or unethical or outside the norm,” said Dave Nadig, a veteran of exchange-traded funds, an industry that depends on — and has arguably helped bring to maturity — the financial system’s pipes and plumbing. “Actually, it’s a tempest in a teapot.”

Related:Retail investors are getting ‘hosed’ with the biggest oil ETF down more than 30% this week

The chatter about how Robinhood and other brokerages make money reveals a deep misunderstanding about how trading actually happens, Nadig told MarketWatch. Nadig blogged about order flow, in his capacity as chief investment officer and director of research at ETF Database, but also shared some thoughts in an attempt to set the record straight, and hopefully help the average investor understand what’s going on when he or she makes a trade.

Read:Here’s the right way to trade ETFs

Most investors think that when they try to sell a stock or an ETF, the brokerage platform they use will find another interested investor to buy it — and vice versa.

In fact, all brokerages work with companies called market makers, whose job it is to liaise between everyone who wants trades to happen: the buyer, the seller, and both parties’ brokers.

The term “market maker” and the various metaphors often used to describe them make their role sound very personal, almost bespoke, Nadig thinks. In reality, such firms operate massive algorithm-based programs that allow them to see huge swathes of financial markets at once: who wants to buy, and at what price, who wants to sell and the price they want to get, and, crucially, whether the market maker can make a few basis points on the difference.

“What we’re talking about is an extraordinarily thin margin business,” Nadig said. “It happens millions of times per second.”

It’s so high-volume, in fact, that market makers pay brokerages for the ability to be the middleman in the transactions. That’s known as “order flow,” and it’s the process that’s caught the attention of social media.

“If you’re trading on Robinhood, just know your order flow data is sold to hedge funds so they can front run you,” one anonymous Twitter user wrote.

Nadig thinks that’s misguided. Market makers should benefit a broker’s customers not just by facilitating the trade, but also by allowing them to realize better prices. Just as market makers use huge computer programs to figure out which trades to take, brokerages have their own, rules-based, programs, that route trades so they can happen most efficiently.

Unfortunately, it’s impossible to fact-check any brokerage’s claims of what the industry calls “price improvements,” Nadig notes. It’s worth pointing out that Robinhood was fined $1.25 million in 2019 to settle a complaint from a regulator that it did not ensure its customers received the best price for trades. That’s even more incentive for the company to play by the rules now, Nadig thinks.

There is some transparency into order flow, however: the Securities and Exchange Commission requires that broker-dealers file a quarterly “routing report.” Robinhood’s most recent one is here.

Robinhood media relations department did not respond to specific MarketWatch requests for comment for this story, but referred readers to an online article about how it routes orders. Of the 2019 fine, a spokesperson said, by email, “The facts on which the settlement is based do not reflect our practices or procedures today. The agreement relates to an historic issue during the 2016-2017 timeframe involving consideration of alternative markets for order routing, internal written procedures, and the need for additional review of certain order types. Over the last two years, we have significantly improved our execution monitoring tools and processes relating to best execution, and we have established relationships with additional market makers.”

Perhaps more important than the specific logistics about order flow, Nadig thinks, is the underlying reality: millions of people trade with brokerages like Robinhood (and Schwab, Interactive Brokers, TD Ameritrade, and many more), for free.

Brokerages have other sources of income, of course — margin lending, advisory arms, and so on. But most of all, “Every broker is in the business of getting transactions moving through the system. They just want volume,” Nadig said. Any lubrication that helps that movement is important, he said. Ultimately, “Robinhood is not there to teach you financial literacy or how to pay down your student loan. It is very good at getting you to make transactions. It’s Tinder but for money.”

Related:Are ETFs safe… for retail investors?

The ‘work-from-home’ ETF is here. Get ready for some surprises.

For all the weirdness of the past few months — the Zoom fatigue, the challenge of caring for children and pets and aging parents alongside co-workers — the coronavirus pandemic that’s kept millions of white-collar workers in their homes, not their offices, has presented new opportunities.

It seemed only a matter of time before someone launched an ETF for that, and on Thursday, that fund, the Direxion Work From Home exchange-traded fund — sporting the ticker WFH, naturally — will start trading.

As it does, a look at what’s inside the portfolio shows some surprises. For such a clearly delineated theme that squares so neatly with the reality of life for so many right now, one of the biggest ironies is how nuanced the fund’s holdings actually are.

The fund is made up of 40 equally-weighted companies ranging from old standbys like Amazon.com Inc. AMZN, -1.08% and Microsoft Corp MSFT, -2.01% to the lesser-known, like Proofpoint Inc. PFPT, -0.71% and Perficient Inc PRFT, -5.24%.

It has of-the-moment pandemic darlings, like Zoom Video Communications Inc. ZM, +1.22% — and some old guards like Hewlett Packard Enterprise Co HPE, -4.13%. And its reach stretches from Shenzen, China, with companies like Xunlei Ltd. XNET, -1.33% , to Cincinnati Bell Inc. CBB, +0.13%

“This is global in nature, and the benefit of what they’ve done is not just picking the poster children of the working-from-home phenomenon,” said Todd Rosenbluth, head of ETF and mutual-fund research for CFRA. “This fund gives you a mixture of up-and-comers whose business model is being driven by that theme, and some megacaps that will get stock price growth from many things. This is not really a pure-play work-from-home ETF, which I think is positive.”

Direxion says the fund will focus on companies that fall into four buckets representing sub-themes: remote communications, cyber security, project and document management, and cloud technologies.

Rosenbluth also thinks WFH should sit in an investing sweet spot. As an index-based fund, it offers more diversification, and the benefit of stock-picking from an experienced management team, than if investors were to try to select individual stocks themselves.

But it’s a lot less idiosyncratic than many actively-managed funds, most notably some of the ones run by a company like ARK Invest, which represent strong convictions by a small management team about clear winners among innovative technology leaders.

Related: Wall Street’s road warriors have spent the past three months grounded. How’s that working out?

Still, this ETF, like any fund, will have to prove itself. “I don’t think any investors would dispute that we are going to be working from home and thus using the benefits of cloud computing and telecoms,” Rosenbluth said in an interview. Investor interest and flows into the fund will likely be robust because most people agree with that thesis, he noted.

But what will keep people invested is the performance of the individual companies, and thus the fund’s overall returns, Rosenbluth said.

As ARK’s CEO, Cathie Wood, told MarketWatch in early June, even her team struggles to understand how much of a moat some of the early technology winners really have.

WFH will charge a 45-basis point fee, track the Solactive Remote Work Index, and rebalance semiannually.

See:The first — and only — negative-fee ETF didn’t make it. Here’s what that tells us about investing.

Deep Dive: How to invest in health-care stocks without worrying about who wins the election

There’s plenty of uncertainty for the health-care industry and its investors.

Half of U.S. states are now reporting rising coronavirus infections. And Joe Biden is beating President Trump in election polls, with the potential for Democrats taking both chambers of Congress.

But even if the Democrats once again transform the U.S. health-care system, companies that develop new treatments and improved medical technology will continue to be rewarded.

Ashtyn Evans, a senior health-care analyst at Edward Jones, named six players she expects to perform well over the next three to five years. With that longer-term focus, Edward Jones doesn’t set price targets for buy-rated stocks.

“A Democratic sweep can be a big risk for health care. But if you think about where we can position for the long term, the companies that focus on innovation and not just on cost-cutting and M&A [mergers and acquisitions], are where we would point investors to,” she said in an interview.

Evans said Biden “is not advocating a single-payer system,” meaning fully socialized medicine, which would be “the biggest risk to the system.”

A Biden victory probably pushes that threat back at least four years. But there may be “other pressures on the edge of big pharma, including pricing pressure,” she said.

Ashtyn Evans, a senior analyst at Edward Jones.

Edward Jones

She recommends investors focus on innovation in medical products and services, as well as companies with geographically diverse businesses.

Here are the six stocks Evans named as “buys,” followed by her comments about each company.

CompanyTickerShare of sales in U.S.Share of sales outside U.S.Est. sales growth – next fiscal yearEst. sales growth – fiscal year +2
Eli Lilly and Co.LLY, -1.45%57.0%43.0%7.7%4.7%
Merck & Co.MRK, -1.62%43.6%56.4%7.3%5.1%
Novartis AG ADRNVS, -1.83%34.2%65.8%5.8%4.3%
Medtronic PLCMDT, -4.80%51.6%48.4%13.6%8.3%
Abbott LaboratoriesABT, -4.38%35.7%64.3%12.2%8.1%
Thermo Fisher Scientific Inc.TMO, -2.48%48.4%51.6%8.3%6.1%
Data source: FactSet

The table includes percentages of sales for the most recently completed full fiscal years within and outside the U.S. and estimated total sales growth figures for the next two fiscal years, based on consensus estimates among analysts polled by FactSet. Scroll the table to see all the data.

Eli Lilly

Shares of Eli Lilly & Co. LLY, -1.45% have returned 22% this year through June 23. (All total returns in this article include reinvested dividends.) The dividend yield on the shares is 1.86%.

Evans expects the company’s earnings to increase at an annualized rate of 15% over the next five years, on the strength of its drug pipeline. “They have gotten smaller over time by spinning off non-pharma, non-innovative businesses,” she said.

On June 16, Elli Lilly announced that a Phase 3 study showed its Verzenio medication had “significantly reduced” the risk of recurrence of certain early-stage breast cancers.

Evans expects 60% of the company’s sales in 2022 to come from newly launched medications, as it continues to be a leader in diabetes treatment.

Merck

Merck & Co.’s MRK, -1.62% shares are down 14% this year and have a dividend yield of 3.16%.

During 2019, sales of Merck’s Keytruda immuno-oncology medication totaled $11.08 billion, or 24% of Merck’s total sales. Immuno-oncology drugs use the body’s immune system to fight cancer. Sales of Keytruda increased 55% last year. “This could be a $20 billion annual product by the mid-2020s,” Evans said.

Novartis

Novartis AG NVS, -1.83% is headquartered in Basel, Switzerland. The company’s American depositary receipts are down 2% this year and have a dividend yield of 2.22%.

The company has a widely diversified portfolio of medications, according to Evans, “with a lot of innovation in cancer development as well, in different areas from Merck: Gene therapy to transfer genetic material into a patient for a cure.”

She describes these as “high-price, highly innovative, patient-specific treatments.”

Medtronic

Medtronic PLC MDT, -4.80% is based in Dublin, but its shares are listed on the New York Stock Exchange. The stock is down 17% this year and has a dividend yield of 2.48%

Evans called Medtronic “one of the most diversified” medical-technology companies, including cardiac devices, diabetes pumps, pacemakers and robotic surgery equipment. She likes its geographical diversification and its tax advantage from being domiciled in Ireland.

Abbott Laboratories

Shares of Abbott Laboratories ABT, -4.38% are up 6% this year and have a dividend yield of 1.58%.

Abbott manufactures generic drugs, diagnostic systems, nutritional products and medical devices. Evans sees a strong growth path for the company because of its exposure to emerging markets with increasing access to health care. She also sees a short-term benefit from the company’s coronavirus testing systems.

Thermo Fischer Scientific

Thermo Fischer Scientific Inc. TMO, -2.48% is up 10% in 2020. The company pays a small dividend for a yield of 0.25%.

The company provides equipment and systems used for pharmacological research. “They benefit from increased funding in the biotech space to develop new drugs,” Evans said.

Don’t miss:Bank stocks may ‘rally powerfully’ once investors realize their concerns are overblown

Outside the Box: My dad left me his IRA when he died, is there a way to share it with my siblings?

Q: My father passed last year with an IRA valued at $90K with me as the sole beneficiary. I have a brother and a sister that should have been named. Is there a way to draw a legal document that would instruct the broker to split (roll?) the account into three separate inherited IRAs? I am in a much higher tax bracket than my siblings and don’t want to administer the RMDs.

— Joe

A.: Sorry about your dad, Joe. I appreciate you wanting to share the funds with your brother and sister, but as the sole named beneficiary, all of the IRA is legally yours.

“The simplest way to get your siblings funds is for you to take distributions from the IRA and simply give the money to them after adjusting for the change in your income tax bill from adding the distributions to your income. There would be nothing to administer because you each would do as you please with the cash. Anytime one gives money to someone that is not their spouse, they should consider gift taxes. However, the amount of money involved here is low enough that avoiding a gift tax is possible.

Read: Why your first five years of retirement are critical

You could reduce the tax impact somewhat by paying the funds out over more than one tax year.

If the extra income from paying them out would put you in an even higher bracket than you would face without the distribution, you could reduce the tax impact somewhat by paying the funds out over more than one tax year. Also, if you didn’t want to take your share soon, you could hold back your portion and take your distributions under the RMD rules since your dad passed before 2020.

Read: If you want to live to 100, do this one thing

Alternatively, you can try to petition the court to have the IRA split. The brokerage firm will not deviate from the designation without court order. You would likely need to show that not splitting three ways was a clear error and not what your dad wanted. This is typically done by pointing to the beneficiary designations on other accounts or what’s written in the will or a trust.

The track record on these petitions does not favor the outcome you desire. By law, the beneficiary designation supersedes the will or a trust and is presumed to reflect the deceased’s wishes. Successful petitions typically involve nefarious reasons such as undue influence, fraud, forgery, etc.

Petitioning is not a DIY undertaking. You’ll have a better chance if you engage a good lawyer so there is a cost and hassle factor that has to be considered versus you taking the money out, paying at your tax rate, gifting to your siblings, and being done. Remember, that if this were split like you wanted, your siblings would pay tax on their share at their rates. Therefore, if the petition even succeeds, the cost evaluation comes down to the anticipated legal expenses compared with the difference in taxes saved by splitting versus the taxes paid at your rate.

Read: A traditional 401(k) is better than a Roth 401(k) — except in this surprising situation

Your situation highlights the importance of beneficiary designations. If your two siblings had been also been named, you could easily split into three inherited IRAs and each of you would then make your own choices about taking funds out. In your case, each beneficiary could have chosen to take the funds out over many years, subject to the Required Minimum Distribution rules applicable to Inherited IRAs.

If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.

Dan Moisand is a financial planner with Moisand Fitzgerald Tamayo. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.

Deep Dive: Bank stocks may ‘rally powerfully’ once investors realize their concerns are overblown

Bank stocks have taken a beating, and investors have plenty to fear, including the Federal Reserve’s stress tests, whose results will be released June 25. Investors expect low interest rates to hamper profits, and a decimated economy to increase loan losses.

There’s a lot to take in, especially as the reopening of the U.S. economy is marked by rising coronavirus infections in half of the states.

But some concerns are overblown, and banks’ own change in behavior following the 2008 crisis is expected by many analysts to serve them and their shareholders well.

Doug Peta, chief U.S. investment strategist at BCA Research, said the five bank stocks listed below are ideally priced for long-term investors.

BCA is an independent research firm based in Montreal and founded in 1949. It has more than 60 analysts and doesn’t manage money or run brokerage services. Clients include institutional money managers of all types.

Here’s how the KBW Bank Index BKX, -4.81% has performed this year:

FactSet

The index comprises 24 stocks of universal and large regional U.S. banks. You can see it’s above its low when the U.S. stock market bottomed in March. It also took a dive two weeks ago, after the Federal Reserve projected the federal funds rate would remain near zero through 2022.

If you look at the “big four” U.S. banks — J.P. Morgan Chase & Co. JPM, -3.33%, Bank of America Corp. BAC, -3.95%, Citigroup Inc. C, -4.04% and Wells Fargo and Co. WFC, -4.07% — and add U.S. Bancorp USB, -4.48% of Minneapolis, the stocks are trading on average for 1.2 times tangible book value, down from 1.6 a year ago:

BankTickerPrice/ tangible book valuePrice/ tangible book value – 1 year ago
J.P. Morgan Chase & Co.JPM, -3.33%1.611.92
Bank of America Corp.BAC, -3.95%1.241.55
Citigroup Inc.C, -4.04%0.730.64
Wells Fargo & Co.WFC, -4.07%0.831.43
U.S. BancorpUSB, -4.48%1.742.52
Averages1.231.61
Source: FactSet

These are the largest five U.S. banks by total assets, excluding the investment-banking giants Goldman Sachs Group Inc. GS, -3.30% and Morgan Stanley MS, -1.96%. The big four have diversified businesses, including lending, underwriting, money management and brokerage services. Peta described U.S. Bancorp as a “pure-play commercial bank.”

In an interview, Peta said current valuations for the group are “awfully low, based on history,” and that buying the stocks at similar valuations “has proven to be a really good entry point.”

Moving parts

Let’s look at three areas scaring investors away from big bank stocks: 1. Stress tests; 2. Loan quality; and 3. Interest rates.

Stress tests and dividends

The Federal Reserve concludes its annual two-part stress-test process June 25 at 4:30 ET. The regulator will announce which of the 34 large U.S. banks and U.S. subsidiaries of foreign banks have passed the first part, the Dodd-Frank Act Stress Tests (DFAST).

Some of the economic fallout from COVID-19 has been considerably worse than the Fed’s “severely adverse scenario” that was released in February. So the regulator is augmenting DFAST, but hasn’t provided much detail on how.

One change, described by Federal Reserve Vice Chair for Supervision Randal K. Quarles on June 19, is a “sensitivity analysis” that will consider banks’ capital levels under “a rapid V-shaped recovery,” as well as a “slower, more U-shaped recovery,” through which the economy regains only a small portion of what it lost by the end of 2020, and a “W-shaped double-dip recession,” through a second wave of coronavirus containment.

The second part of each bank’s stress test is the Comprehensive Capital Analysis and Review (CCAR). We’ll find out June 25 which of the bank’s capital plans were accepted by the Fed, but we won’t get all the details until the banks make their own announcements June 29.

Even with the group stress-tested under that last dire scenario, Janney Montgomery Scott Director of Research Chris Marinac wrote in a report on June 22: “While share buybacks may be postponed longer, we feel most banks’ common dividends are secure.” Approval of the Fed to maintain their dividends would do a lot to improve investors’ confidence in the stocks.

Peta said: “My base case is, no, don’t expect mandated dividend cuts. There is nothing in what [Federal Reserve] Chairman Powell has said publicly that is leaning in that direction.”

On the other hand, KBW managing director Brian Kleinhanzl wrote in a note on June 19 that “Quarles’ comments about dividend payouts were opaque in the Q&A and dividend cuts can still not be ruled out.”

Even if dividends are cut or suspended, Peta sees an opportunity to double-down. “If you are a shareholder of a bank trading below book [value], you should vastly prefer a dividend cut to a secondary offering that will dilute your holdings. I really think a one- or two-quarter interruption of the dividend or reduction would be a buying opportunity,” he said.

Loan losses and reserves

The big banks have been careful with their loan portfolios in the years following the 2008 credit crisis. Check out these 10-year compounded annual growth rates for the five banks’ total loans from the end of 2009 through the end of 2019:

BankCompounded annual growth for total loans and leases – end of 2009 through 2019
J.P. Morgan Chase & Co.4.3%
Bank of America Corp.0.7%
Citigroup Inc.1.5%
Wells Fargo & Co.1.7%
U.S. Bancorp4.2%
Source: FactSet

Over recent years, banks have shied away from leveraged loans (that is, highly leveraged lending that was greatly curtailed under the 2010 Dodd-Frank banking reform legislation), with the slack, especially for junior-lien loans, taken up mainly by private investment funds, according to Peta.

“Small- and mid-cap borrowers had been effectively orphaned by commercial banks,” he said, adding that after private investment funds raised capital in 2010 and 2011, “there was competition among direct lending funds [and] a degradation of standards. So borrowers were calling the shots,” he said.

These comments also apply to “excesses in the bond market,” driven by “a frenzied competition among fixed-income investors to find yield,” regardless of risk, Peta added.

So the banks were left out of a lot of the riskier lending activity during the long economic expansion that ended in the first quarter. This makes the pandemic crisis, as bad as it is, completely different from the 2008 crisis. Here’s an FDIC article and a paper by Thomas L. Hogan, a senior fellow at the American Institute for Economic Research and a former fellow at Rice University’s Baker Institute for Public Policy, explaining the evolution of the U.S. loan market.

Credit quality was very strong through the first quarter, although banks began to set aside billions in reserves for expected loan losses in the second quarter and subsequent quarters.

Many sell-side analysts have written that they expect banks’ second-quarter provisions for loan-loss reserves to be similar in size to the first-quarter provisions. The provision is the amount a bank adds to loan-loss reserves during a quarter in anticipation of loan losses. Yes, it is the movement of money from one bucket to another. But it directly reduces net income and lowers tier 1 common equity ratios, which are the “strictest” of the capital ratios that regulators scrutinize.

This table shows massive increases in provisions for loan losses and declines in net income in the first quarter from a year earlier:

BankProvision for loan loss reserves – Q1, 2020 ($mil)Provision for loan loss reserves – Q1, 2019 ($mil)Net income – Q1, 2020 ($mil)Net income – Q1, 2019 ($mil)
J.P. Morgan Chase & Co.$8,285$1,495$2,852$9,127
Bank of America Corp.$4,761$1,013$4,010$7,311
Citigroup Inc.$6,446$1,968$2,519$4,653
Wells Fargo & Co.$4,005$845$653$5,860
U.S. Bancorp$993$377$1,166$1,692
Source: FactSet

That was a painful quarter, but the five banks were still profitable. With the reopening of the U.S. economy, the boost to loan quality from the great increase in unemployment benefits included in the CARES Act, mortgage loan forbearances and various government lending programs for businesses, it is quite possible that second-quarter provisions will be lower than expected, and even that banks begin making much smaller provisions in succeeding quarters.

“This leaves room for bank stocks to rally powerfully once you close the gap between expectations of what will be written down on banks’ books and a much more benign outlook,” Peta said.

Yield curve and profitability

On June 11, the KBW Bank Index dropped after bank stocks had plunged out of fear that an extended period of low interest rates would mean narrower net interest margins for banks, leading to a drop in earnings. The idea is that a narrowing of the rate curve — the spread between short-term and long-term interest rates on U.S. Treasury securities — automatically means a narrow spread between what banks earn on loans and investments and what they pay for funds.

Odeon Capital Group analyst Richard Bove refuted that assertion.

Peta agrees with Bove, because “under the new duration-matched regime, net interest margin has become insensitive to the shape of the curve.” Matching funding and asset durations isn’t new. Banks learned painful lessons during the savings and loan crisis of the 1980s, when the Federal Reserve raised short-term rates to double digits to fight inflation, leaving some lenders with single-digit-rate loan portfolios losing money every day. This is why banks tend to sell most of the fixed-rate residential mortgage loans they make.

Peta shared two charts illustrating that there is no longer a link between banks’ net interest margins and the yield curve for U.S. Treasury securities:

BCA Research Inc.
BCA Research Inc.