parts of an email from yesterday

I guess you’ve seen all the stuff about huge buying of options on individual tech stocks, both by Bar Stool-style traders and by Softbank, driving tech stocks up.  My guess is that has ended for now.  If so, it will probably take a week or so for trading in the big tech names to settle down.

I’ve read that when the Tokyo market found out what Son had been up to, and had made $4 billion on speculative options trading, Softbank dropped by 8% (?), losing shareholders $20 billion in market value.  That’s because what he did is bet-the-company crazy.

One of the things I’ve noticed is that some second-line names are doing much better (meaning falling more slowly) than what must be Robinhood-ish favorites.


It’s never clear what triggers a market selloff.  In this case, though, it’s doing a healthy thing by readjusting relative values among different groups of stocks–something I’ve thought would happen by a temporary reversal of leadership in an uptrend.

I think the fact that at zero interest rates stocks are the only game in town means stocks will drop to some longer-term trend line, stabilize, and then begin to move up again.  A hope, not a belief–at the close today NASDAQ seems to have hit the bottom of a channel it’s been in since April.  (It’s also about 25% above its March high, which says these are not bargain-basement levels.)


Over the past 5 trading days, NASDAQ is down by -9.2%, the S&P by -5.5%, and the Russell by -4.7%, so there is outperformance of a sort by the R2000.
Very often after a big selloff, market leadership changes.  That didn’t really happen in March, although afterwards the R2000 began to keep up more with the S&P for several months.  My sense is that the market wants to broaden out to find non-tech stocks that will do well over the next year or two.  This is why consumer discretionary names have been doing well recently.  But because some kinds of tech are going to be long-term winners, the move has to be based on finding consumer names that have good growth prospects, not just that they’re in another sector. 

The market hasn’t gotten conviction yet with this idea, probably in large part because Trumponomics gets loonier by the day.  The near-term economic outlook in the US had already been deteriorating before his latest China ideas, and won’t have a chance to be better unless he’s defeated in November.

Then there’s the human side of things. Who’d have thought we’d see George Wallace reincarnated, or the Waffen SS recreated, or scary abuse of power in the Justice Department–or that the Joint Chiefs would feel the need to say they would not obey any Trump orders to use troops to deny Americans their civil rights.

 
The last two paragraphs both bear on stocks like NWL.  Arguably, NWL is a true “value” name.  That is, all the bad stuff–and more–that could reasonably be expected to happen has already taken place and been factored into the stock price.  So it has some downside protection. It’s also economically sensitive and non-tech; and maybe if management can use the company’s assets competently, good things will happen. 

Another way of putting this is that in a world where TSLA can be down 30% in a week maybe the value formula of dead money for now with the hope of upside later on isn’t so bad to have as part of a portfolio.

Wall Street and US elections

There are two pieces of Wall Street lore about market performance around presidential elections that have passed their sell-by date but which continue to float around. They are:

–the last year of a presidential terms is a good one for stocks; the first year of the new term is a bad one.

The idea behind this is that the incumbent president would successfully pressure the Federal Reserve into a looser-than-necessary money policy in the runup to the election. This would give an artificial boost to the domestic economy, enhancing his reelection prospects. This extra stimulus would be reversed after the election, slowing the economy down in the first months of the new term. Gerald Ford’s refusal to follow this custom is often cited as the reason he lost the 1976 election to Jimmy Carter.

With the exception of Donald Trump, who has continually pressured the Fed to loosen money policy throughout his term, this no longer happens. I’m not 100% sure why. My leading candidates: the world is a much more complex and mutually integrated place than it was a generation ago, so it’s not so easy to use the domestic money supply to give the economy a pre-election jolt; over the past quarter-century there have been a succession of crises, from Y2K/Internet bubble to 9/11, to the Great Recession, to Trump’s wrongheaded tariff wars, to his coronavirus bungling, that have dwarfed any monetary tweaking the Fed might contemplate .

In any event, there’s no reason to believe that the world economy will be weaker in 2021 than it is now or that a post-election tightening in money policy is on the cards.

–Republicans are good for stocks, Democrats are not.

The idea here, from a generation ago as well, is capital vs. labor. A high-level Republican goal is to protect the accumulated wealth of its country club backers. This means having low taxes and low inflation. The Democrats, on the other hand, represent workers whose chief asset is their labor. Their main economic goal is to obtain real wage/benefit gains. The inflation that results doesn’t hurt them because they have no wealth to begin with. And it makes them better off by eroding the real value of the goods and services they need to buy from Republicans.

Again, the class warfare that defined the old Democrat/Republican battle lines is mostly gone. As a former work colleague of mine was already writing thirty years ago, neither party has a relevant economic program for today’s world. Ironically, despite its business roots, the current Republican administration is supported mainly, I think, by workers disenfranchised through the demise of heavy industry in the US (and ignored in a worst-in-the-world fashion by both parties). And the head of the party is a stunningly inept businessman who continues to do enormous economic damage to the country.

A more reasonable worry about the election might be that a Democratic administration would partially reverse the corporate income tax cuts of 2018. That might lead to after-tax results from the S&P 500 next year being, say, 3% lower than expected. 3% is not a big number, though. And there might be positive effects on growth from reopening the borders, a more intelligent approach to the potential threat from China than shoot-yourself-in-the-foot tariffs, removal of some of the white racist tarnish of the American brand abroad…

Trump underpins tech stocks …for now

The EU has a third more people than the US, has an older population and was in worse Covid shape than the US in early April. Today, however, US daily new cases are about 15x those in the EU; daily new deaths here are 7x those in the EU. The difference? The EU followed the recommendations of US medical scientists; Trump urged his supporters to ignore them.

The economic result for the US is a deeper, longer-lasting downturn than elsewhere in the OECD, huge amounts of Federal government assistance to keep the economy afloat–with a resulting budget deficit that could soon reach $6.0 trillion, vs. $0.6 trillion when he took office.

Rather than try to mitigate the suffering the US is going through, Trump appears to have decided to try to shift national attention away from his central role in creating this tragedy by creating a second, competing disaster. After the armed forces refused to help, Trump organized a gang of from other Federal agencies. Members wear identical camouflage combat gear and carry weapons. No identification on their bodies or vehicles, however. Not a thought about probable cause or excessive use of force, either. In other words, they’re shaped on the Gestapo/KGB/Stasi secret police model. Empowered by executive order and against the wishes of state and local officials, Trump envisions sending these groups into Democratic-leaning cities to instigate violence. Portland is his test case. News reports of the Navy veteran beaten in Portland (he decided to remind Trump’s minions they took an oath to defend the Constitution) show what’s going on. Kristallnacht in America is something no one would have believed possible four years ago. Talk about the banality of evil.

Relevance for the stock market? …a lot.

I’ve been writing for a while about the divergence between NASDAQ and the Russell 2000. The former is the part of the US stock market least tethered to the US by customers, revenues or physical assets; the latter represents the part most closely linked to domestic economic health. NASDAQ is up by about 55% since the beginning of 2018; the Russell 2000 is down by 4% over the same span. I read this 60 percentage point divergence as the stock market’s response to the ongoing economic damage Trump is doing to the US. The spread is very long in the tooth. It’s also so wide that it is begging for at least a temporary reversal of form. So far, however, every attempt at a counter-trend rally has been nipped in the bud.

How so? I think the pro-NASDAQ portfolio configuration has a second motivation. It is also the first step in capital flight from a country moving in the wrong direction.

Recently, coinciding with Trump’s more explicit white racist actions and the resurgence of Covid in the South and Midwest, we’ve begun to see a second aspect of capital flight–a 5%+ decline of the dollar vs. the euro over the past few weeks. The US currency has even lost ground to perennial weaklings sterling and the yen.

It’s hard to know how this all will play out. A Trump win in November is the easier case. I imagine it would create a seismic negative shift in global attitudes toward the US. That would result in a steady outflow of our most productive human and financial capital. The dollar would continue its decline. Maybe, government bonds would begin to sag, too. At some point, Washington would presumably close the border to outflows, a la Mexico 1982. NASDAQ would likely go up, led by firms announcing the relocation of intellectual property-creating operations abroad. Maybe dual listings in New York and China. China and the EU stand to be the big long-term winners.

I think a Trump loss would much more complicated. There’s the issue of repairing the enormous economic, financial and cultural damage he has done to the country. There are also the former heavy industry areas, core sources of Trump strength, which have been ignored by both parties for decades at great national cost. A counter-trend rally might finally happen–maybe even pre-election if a pro-Biden outcome were clear. Would it have legs, if so?

Special Purpose Acquisition Companies (SPACs) and speculative fever

SPAC is a new name for an old capital-raising form. The first instance I’m aware of is a mention in Extraordinary Popular Delusions and the Madness of Crowds, a famous 1841 book on the craziness that happens in financial markets at times of speculative fever. The author, Charles Mackay, cites an operator during the eighteenth-century South Sea Bubble in the UK. He writes:

“…the most absurd and preposterous of all, and which shewed, more completely than any other, the utter madness of the people, was one started by an unknown adventurer, entitled ‘A company for carrying on an undertaking of great advantage, but nobody to know what it is.’ Were the fact not stated by scores of credible witnesses, it would be impossible to believe that any person could have been duped by such a project.”

According to Mackay, the “adventurer” set up an office, issued shares and then disappeared.

I came across this form early in my investing career, when the vehicles were called blind pools. They’ve also been called blank check companies. My reaction was the same as Mackay’s. Now, as SPACs, the name is fancier but the idea is the same, as far as I can see. An entrepreneur offers to use his skills to make shareholders a lot of money by means not specified in the offering document. Unlike the case in 18th-century London, the adventurer doesn’t simply close up shop and disappear. My impression is that the entrepreneur mostly pays himself fees while he looks. I have no idea about the ultimate outcome from such blind pools, but the fact that promoters don’t seem to point to past glories suggests that results aren’t that great–for shareholders, at least.

The current reemergence of blank check offerings is important to me in only one sense. They appear at times when speculation is rampant. They serve as an unambiguous signal that government policy is too stimulative. In other words, they typically signal market tops.

In the present case, I’m not so sure. Even before the pandemic, Trump had somehow managed to get a vibrant US economy to grind to a halt. Now, a second tour de force, as Canada and the EU are opening up again–crediting this outcome to having followed the advice of US medical research–the coronavirus is spiking again here. Why? …because Trump pressuring state and local governments to ignore medical protocols. Sort of Trump’s Atlantic City debacle twice over, only a lot worse.

The upshot is that while I can imagine more economic stimulus from Washington, I can’t see the punch bowl being taken away any time soon.

the current market: apps vs. features

sizing up the market

In some ways, current trading in tech stocks reminds me of the internet boom of 1999.  To be clear, I don’t think we are at anything near the crazy valuation levels we reached back twenty+ years ago.  On the other hand, I’m not willing to believe we’ll reach last-century crazy, mostly because nothing in the stock market is ever exactly the same.

On the (sort-of) plus side, three-month Treasury bills back then were just below to 5% vs. 1.5% today and 10-year Treasury notes were 4.7% vs 1.9% now.  If we were to assume that the note yield and the earnings yield on stocks should be roughly equivalent (old school would have been the 30-year bond), the current PE supported by Treasuries is 50+, the 1999 equivalent was 21 or so.   This is another way of saying that today’s market is being buoyed far more than in 1999 by accomodative government policy.

On the other, the economic policy goal of the Trump administration, wittingly or not, seems to be to follow ever further down the trail blazed by Japan during the lost decades starting in the 1990s.  So the post-pandemic future is not as cheery as the turn of the century was.

what to do

I think valuations are high–not nosebleed high, but high.  I also know I’m bad at figuring out what’s too high.  I started edging into cyclicals a few weeks ago but have slowed down my pace because I’m now thinking that cyclicals might get weaker before they get stronger (I bought more MAR yesterday, though).

With that shift on the back burner, what else can I do to make my portfolio better?

features vs. apps

Another thing that’s also very reminiscent of 1999 is today’s proliferation of early-stage loss-making companies, particularly in software.

The 1999 favorites were online retailers (e.g., Cyberian Outpost, Pets.com, eToys) and internet infrastructure (Global Crossing) whose eventual nemesis, dense wave division multiplexing, was also a darling.

The software losers were by and large undone, I think, not because the ideas were so bad but because they weren’t important enough to be stand-alone businesses.  They were perfectly fine as features of someone else’s app.  A number were eventually bought for half-nothing after the mania ended, to become a part of larger entities.

 

One 2020 stock that comes to mind here is Zoom (ZOOM), a name I held for a while but have sold.  The video conferencing product is inexpensive and it’s easy to use.  It’s also now on center stage.  But there are plenty of alternatives that can be polished up and then offered for free by, say, Google or Microsoft.

 

Another group is makers of meat substitutes (I bought a tiny amount of Beyond Meat on  impulse after reading about 19th-century working conditions in meatpacking plants).  Same issue here, though.  Where’s the distribution?  Will BYND end up as a supplier, say, to McDonalds?  …in which case the PE multiple will be very low.  Or will it be able to develop a brand presence that separates it from other meat substitutes and allows it to price at a premium?  Who knows?  My reading is that the market is voting for the latter, although I think chances are greater for the former outcome  …which is why I’m in the process of selling.