Month to date, both the S&P and NASDAQ indices have each fallen by about 4%. That’s roughly half the average decline for September, the signature month for mutual fund selling.

The tepid fall comes on the heels of gains through August of close to 20% for the major indices–which suggests that a correction might be on the cards. And it is occurring while the financial news is at best mixed. JP Morgan CEO Jamie Dimon is suggesting short rates could rise another 150bp from the current 5.5%, in a potentially stagflationary (i.e., high inflation + economic stagnation) environment, auto workers and Hollywood actors are on strike, and, channeling Latin American politics, the party of Lincoln is warming up to nominate for president the would-be dictator who tried unsuccessfully to overthrow the government after he lost the 2020 election.

Of course, a September-October selloff may still occur, even though it’s pretty late in the day by past experience for this to happen. And there could also be yearend selling by December-year corporations like banks and insurers. Nevertheless, the current resilience suggests to me that the stock market has defensive qualities that the consensus, which I take to be relatively bearish, doesn’t appreciate.

Where would pockets of value be?

Two areas strike me as potentially interesting:

–beaten-down tech stocks, especially companies that IPOed during the pandemic. The key here, I think, to separate high-quality survivors that have been caught in the overall tech downdraft of 2021-22 from today’s functional equivalents of pets.com during the dot com bubble, that is, firms that have little merit but were able to raise a bundle of cash in a highly frothy environment (e.g. think: SPACs). Firms like this may look attractive on a price/book basis, but the worry is that outsiders like us have no control over how managements use the company’s cash.

–steady growers among mid-caps outside the tech area. I’m not sure there’s any one thematic area to concentrate on. There may be something in the population shifts that working from home are prompting, or the winners from the shift to electric vehicles. But I think this is more a company-by-company search for firms that re cheap relative to their growth prospects.

I was writing a post last week that involved the Rocket Companies (RKT). I knew RKT, successor to the Quicken companies, was the largest mortgage originator in the US and I also believed (correctly, as it turns out) that RKT has a very complex capital structure that would be outlined somewhere in the 10K available on the SEC EDGAR site.

I didn’t have much time, and I worried that I might have to dig through a bunch of material scattered through the filing, complying with legal disclosure requirements but requiring a lot of work to see the true structure of the firm. So I thought I’d ask Chat GPT.

Big disappointment. What I got was a selection of financial newspaper/website articles, whose authors, however sincere, and displaying a wide range of writing skills, had close to no knowledge of finance or of the stock market.

Just before beginning this post, I went to the EDGAR site, anticipating staying a while. The most recent entry was the kind of stuff I’d hoped to avoid, in an 8K from earlier this month:

“On September 8, 2023, Rocket Mortgage, LLC (the “Company”), a Michigan limited liability company and indirect subsidiary of Rocket Companies, Inc., as guarantor, RCKT Mortgage SPE-A, LLC, as seller and Bank of America, N.A., as buyer, entered into Amendment No. 4 to Amended and Restated Master Repurchase Agreement (“MRA Amendment”) and the related Transaction Terms Letter for Amended and Restated Master Repurchase Agreement, which extended the expiration date of the existing Amended and Restated Master Repurchase Agreement dated as of June 29, 2021, as amended, by and between Bank of America, N.A., as buyer, RCKT Mortgage SPE-A, LLC, as seller, and the Company, as guarantor (the “Master Repurchase Agreement”) from May 4, 2024 to September 8, 2025. No other material terms of the Master Repurchase Agreement were changed.

The foregoing description of the MRA Amendment does not purport to be complete and is subject to, and qualified in its entirety by reference to the full text of the MRA Amendment, a copy of which will be filed with the quarterly report on Form 10-Q of Rocket Companies, Inc. for the period ending September 30, 2023.” Welcome to financial companies. Good to know, I guess.

Then I opened the most recent 10K, filed on March 1st. There in plain sight on page 4 was the business overview, explaining that RKT consists of nine businesses: Rocket Mortgage, Amrock, Rocket Money, Rocket Homes, Rocket Loans, Lendesk, Rocket Mortgage Canada, Rocket Central, Core Digital Media.

There are brief descriptions of each, which I’ve omitted.

I have two points:

–the answer I got from AI about RKT was is instance of GIGO (garbage in, garbage out). Inconvenient for me, but not a huge surprise. (A friend who’s worked with AI for twenty years has told me it’s a mistake to think AI tells the truth.)

–what if GIGO becomes the norm? How does this change one’s approach to investing?–my idea is I should act on knowledge I think you have, but not many others do, and wait for the world to figure it out. On the one hand, there may be greater opportunities with AI spewing out suspect answers to queries; on the other, it may take longer (much longer?) for the market to realize the truth and act.

My fitness tracker went berserk yesterday with stock price updates. The texts were mostly about former pandemic darlings that have since fallen on hard times, many of them online financial companies. All of them were tumbling out of bed, hitting all-time, or at least ytd, lows.

No doubt part of this had to do with the latest Fed pronouncements indicating that interest rates in the US will stay higher than the market consensus has been hoping for, and for longer. But I think there’s more than that going on.

RKT

One of my alerts was about Rocket Companies (RKT), the largest home mortgage originator in the US. It’s typical of what I was seeing.

RKT peaked in August 2020, shortly after going public, at $28+ a share. It faded and then rallied to $25+ in early March 2021. It’s been mostly downhill from there. As I’m writing, the stock is trading at $8.42, down about 70% from its all-time high, and by 20% so far this month. In contrast, the S&P 500 is up by around 10% since 3/21, and is down by 3.5% so far this month.

Morningstar, which I regard as a very reliable, if a bit prosaic, information source estimates the stock is worth $13, or about 50% more than it’s trading for now. The analyst cautions, however, that the stock is not likely to do much until there clear signs interest rates have peaked and are on their way down.

Why the selling?

…and now, in particular.

I see several reasons:

–no one wants to have a stock that’s cratered like this in the year-end list of holdings sent to shareholders. It potentially opens up a whole can of worms as you’re asked to explain what has happened.

–as a PM, you may try to console yourself (a bad idea, in my experience) for your mistakes–i.e., buying too high and holding on too long–with the thought that once all the buyers at $20+ sell (or their bosses force them to sell) the stock will go up, well, like a rocket. The paradox here is that you’re one of those mistaken bulls whose holding on is keeping RKT in the doldrums. In other words, you’re in a no-win situation.

–there’s an income tax value in realizing losses. If you bought at the absolute top, you have an unrealized loss of ~$17. This probably has a tax value of $4 a share. Why not recognize this and come back to reevaluate the stock in early 2024? (Btw, dollars to donuts (or doughnuts) you’ll sell but never come back–which tells you again how little reason #2 tends to be worth).

Of these reasons, the first is, I think, the most powerful and most commonly used.

Anyway, what my watch showed me yesterday is a surprisingly large number of potential housecleaning cases like RKT. What’s unusual to me is that the overall market is holding together relatively well (so fr, it least) despite this activity.

Typically the US stock market sells off in September/October. What motivates the decline is preparation for the end of the mutual fund tax year on Halloween, and the distribution of realized gains that follows. In the earliest days of my investing career–that is to say, in the late 1970s-early 1980s–the seasonal selloff came in November/December instead, because the biggest market players back then were banks and insurance companies, whose fiscal year ends on New Year’s Eve.

As I’m writing this, we’re three weeks into September and the S&P 500 is roughly flat so far this month. Typically, fund accountants ask managers not to transact a lot during the last two weeks of the fiscal year, to minimize the (miniscule, in my experience) chance of an unsettled trade carrying over past yearend. So we’re running out of time for a significant period of portfolio overhaul. What’s going on?

Three thoughts:

–there’s still time for something to trigger selling–like the rising oil price–so it’s too early to conclude that no seasonal selloff will occur this year. It is time for some head scratching, though

–large flows tend to come into mutual funds/ETFs at the top and to go out at the bottom. So it’s thinkable that stock mutual funds in general already have large tax losses from redemptions late last year and early this. Remember, too, most Wall Street strategists were calling for a substantial market decline in early 2023, creating an atmosphere encouraging customers to sell (at much lower prices than today’s). So maybe funds already have a bunch of realized tax losses. If so, that part of annual tax planning is already done. What remains is to offset those losses by trimming winners

–there’s some evidence that this last is happening. NVDA, for example, is off by about 10% this month, MSFT and AAPL by around 5% each. ARKK, which is still up by 30%+ in 2023, has declined by about 7% this month (not a comment about the ETF’s flows, rather the recent performance of holdings that have been up a lot so far in 2023).

I’d been thinking that if the typical seasonal selloff were to happen, that would be a great chance to pick up stock being sold purely for tax reasons, not for any weakness in company business. Maybe there’s still a chance, but time doesn’t seem to be on my side.

…has been unoccupied since the financial crisis of 2007. As I understand it, someone bought it during the heady housing-boom days of 2006, when it would have been worth about $150,000, but in short order mailed the keys back to the bank that held the mortgage and left town.

There were a couple of early, unsuccessful attempts at sheriff sales to recover unpaid property taxes. But the property has lain dormant since, until the mortgage owner held an online auction a month or so ago.

The most interesting part of this to me is that there had been a lien against the house of around $600,000, or almost 4x the eventual selling price.

I presume this loan was part of a larger package sold to institutions, the nuts and bolts of which I have no idea about. I think the rationale for keeping it on the books for such a crazy amount must have been:

–the 2006 mortgage could have been for, say, $300,000. If so, the major purpose for seeking the original loan was to take the money and run, but the mortgage-holding entity never detected this and relied on the original appraisal

–the entity that held the loan continued to accrue unpaid interest and penalties, showing this in the accounting statements either as income or an addition to reserves, even though no money was coming in. …making a big minus into an apparent plus

–there was no mechanism in the package for regular portfolio pruning–seizing a non-performing property, paying accrued taxes and selling it

Please comment if you have any ideas.

Two conclusions:

–I think we’re in the early days of a cyclical shipwreck of unusually large size in the office building market in the US. My guess is that we’ll be seeing a similar period of loan holder reluctance to write either office building asset value or the loans they secure down to fair market value

–my guess is that this mortgage is part of a large package that has come to the end of its life and is being liquidated. It would be a lot worse if banks were clearing the decks of housing exposure to accommodate a large inflow of dud office building loans.