securities analysis and NASDAQ vs. Russell 2000

Three related thoughts:

–Securities analysis, at least as I do it, has something in common with the scientific method. That is, you make up a story (form a hypothesis) about the future possibilities for a company with a publicly-traded stock. You identify the most important points and forecast as best you can future earnings growth. Then you look for evidence that will either strengthen or weaken your belief that your story is true.

Where this process differs from science is not only that lab coast are optional but that by and large it’s observation of events outside of your control–earnings reports, industry or government data…–rather than experiments you carry out, and whose timing you control, that develop the confirming/falsifying evidence. Yes, you can buy and use a company’s products–I used to bring home video games made by publicly-traded firms and leave them on tables to see what my kids would do with them, for example–but if so you have to be aware not to bet the farm on this.

–my most important made up story of the past few years has been that the now-outgoing administration had adopted early on a set of destructive economic and social policies–bad beyond the craziest hopes of Beijing or Moscow–that would slow domestic growth significantly and disadvantage US-based multinational firms enough to cause them to begin to make plans to relocate. I thought of this being a milder version of the capital flight that happens in failing third-world countries. I also thought one very general way to measure the right or wrong of this would be to compare the NASDAQ, chock full of non-US earners, vs. the Russell 2000, comprised of mid-cap domestic firms. Since early 2018, this indicator has been signaling capital flight.

Then came the pandemic. The President of the United States, the ultimate influencer in the land, told us, in effect, that it was unpatriotic to listen to medical advice to avoid exposure to the virus. The result of this horrible misstep has been a second, much more visible, economic and social disaster–and a second wave of flight by investors from the domestic economy.

–we’ve entered year four since the beginning of this dynamic. That’s an extremely long time for any idea to work so One of my main underlying ideas has been that the motive force behind all has been Trump just being what his real estate past showed him to be. If so, this would mean Trump’s losing the election last November could mark the end of the capital flight trade. Certainly, from the day after the election, the R2000 has been outperforming NASDAQ–although smaller tech/biotech companies have continued to show relative strength.

In the aftermarket last night, NASDAQ futures began to weaken, and R2000 futures to strengthen, when early Georgia senate election results indicated strong showings by both Democratic challengers. That has continued through my writing this at around 10am est.

I interpret this as a further indicator that the pro-NASDAQ/anti-R2000 trade has actually been a product of Trump’s bungling.

I also think this year’s market action will be much more complex than in 2018-20. The thing that’s clearest to me is that names whose main attraction has been their usefulness during the pandemic are now a big question mark. My guess is also that once the official federal government position changes from pandemic denial, anti-pandemic public health measures will be more effective. For us as investors, this means thinking harder about what the post-pandemic travel world will look like.

There are longer-term issues about interest rates and the currency, The knee-jerk reaction from the Georgia election has been rates up, $US down. Whether that’s right or not is open to question, I think,

the January effect …or lack of it

The traditional “January effect” in the US stock market, discussed to death in academic finance, is the tendency of sketchy small cap, low share price stocks to bounce strongly during the opening few weeks of the calendar year. That’s mostly because this kind of walking-disaster name tends to attract not so savvy risk-seeking retail investors. They aggressively sell such stocks in December to recognize the losses they’ve racked up so they can get an income tax deduction. The “bounce” is less enthusiasm for the names and more recovery from the downward pressure exerted on them in December.

Historically, there’s also been a (less important) tendency for taxable investors of all stripes to nurse winners they intend to trim or sell into January to defer paying income tax for another year. The increased importance of mutual funds/ETFs and index investing has pretty much put an end to this behavior, although it wouldn’t surprise me if this temporary market pressure returns, as the brokerage industry begins to court a new generation of individual stock buyers.

What I’m noticing so far this January are the developments that are not evincing any reaction on Wall Street. This has to do with the strong outperformance of the Russell 2000, a proxy for smaller businesses focused on the domestic economy, vs. the S&P 500, half of whose earnings come from abroad.

Two distressing recent developments:

–covid cases are mushrooming, to the point where Los Angeles is reported to be instructing ambulances not to bring patients to the hospital who are unlikely to survive

–Trump’s attempts to overturn the election results, which sound like something straight out of the old Soviet Union. There’s the tape of Trump tying to coerce Georgia into falsifying the voting results in that state and there’s the statement form formers Defense secretaries warning of possible criminal prosecution of military commanders who follow orders to use troops to intrude into the election process. The latter suggests Trump may also have made Georgia-style calls to generals. More shockingly, a significant number of senators and representatives have rallied behind Trump in this effort.

The investment point? …the Russell 2000 continues to outpace NASDAQ and the S&P, signaling Wall Street’s belief that none of this will have a negative impact on the domestic economy or on investors’ continuing willingness to prefer domestic to multinational names.

Keeping Score for 2020

I’ve just updated my Keeping Score page for December, 4Q20 and the full calendar year. I’ve also added my thoughts about the sharp reversal of market direction that started the day after the presidential election and continued through yearend.

One thing I didn’t touch on is the “January effect,” which typically consists in the bounceback of losers sold in December for tax reasons. I’m interested to see if we have a selloff of last year’s winners, motivated by shifting capital gains shifting into 2021.

on New Year’s Eve

First of all, Happy New Year.

I really don’t have many detailed, high-conviction thoughts about how 2021 will play out. But I do have a few more general observations:

— the key to 2021 is figuring out when economic recovery in the US will commence and how strong it will be

–current high PEs are a function of near-zero interest rates. As/when they begin to rise, which they will at some point after domestic recovery is firmly established, overall PEs will begin to contract. Investor interest will likely shift, for a while at least, away from secular growth names to beneficiaries of cyclical recovery (e.g., banks, industrials). The smallest-cap, most speculative names will likely be hurt the most

–my guess is that recovery in the US will be later to arrive than elsewhere. I don’t just mean that China is posting its tenth consecutive month of GDP expansion or that the Pacific in general is in decent shape. I think we all substantially underestimate how deeply Trump has wounded the domestic economy through his tariffs, his strong preference for industries of the past and his pandemic denial. So although I’m slowly moving away from 2020’s winners, I’m hesitant to make a big pro-cyclical bet

–the US$ has been steadily declining against other world currencies for the past nine months or so. This bout of weakness coincides with the spread of the pandemic. I’m reading it as being caused by Trump’s hoax narrative. If so, the change of leadership may stabilize the currency. On the other hand, the decline may be a reaction to the large increase in Federal debt. I don’t think that’s going to change much. What’s at issue: weak dollar = higher dollar value for the foreign earnings of US-based multinationals. Stronger foreign economies would also be a plus

–at some point in the next few months I think there’s likely to be a selloff in the big winners of 2020. This would likely affect smaller companies much more than the FAANGs, because the former are perceived as riskier and many smaller names have left the FAANGs in their dust. There’s no way I know of to time this. I think it’s a mistake to try to do so. My approach is to try to separate long-term winners from more iffy names and to gradually shift the latter into more cyclically sensitive areas. Your thoughts on US recovery will determine speed and extent of this shift

–Zoom (ZM). This is the quintessential covid stock. I owned it for a while but began to think that there’d be a time when the market would want to distinguish between apps and features (i.e., things that would fail as stand-alone entities and would end up as part of something else–vintage 2000 internet selloff). I put ZM in the feature category. Maybe that won’t be the case. And of course I missed a good part of the upward movement. The important thing, though, is that the stock peaked in October at $588 and is now $347, a 40% drop since the high. I have no idea what’s going on with ZM. I just think it’s an interesting movement and that we should keep our eyes out for similar occurrences–which would imply the start of the winnowing I wrote about in the preceding paragraph.

FAANGs in 2020

I was watching the crawl on CNBC as I was eating breakfast this morning and happened to hear several of the presenters discuss the influence of the FAANGs on stock performance this year. Then I saw an article in the FT that said that the rise of index investing had funneled, in effect, too much money into large caps, making them outperformers without much regard to their merits. Of the FAANGs, I own only Netflix, so I decided to take a look. Year-to-date prices, as of about 10:30 est this morning:

the indices

S&P 500 +15.8%

NASDAQ +43.8%

FAANGs

AAPL +82.4%

AMZN +79.9%

NFLX +63.8%

FB +34.0%

GOOG +30.8%

under the media radar

ARK Innovation ETF, which owns none of the above +150%

Of the FAANGs, the real star is AAPL, whose two-year performance is up there with the ARK fund. In contrast, while AMZN has gotten a tremendous boost from the pandemic this year it trails NASDAQ by almost 30 percentage points on a two-year view.

I mention ARKW because it shows the power of original research, the fact that healthcare has been a key performance driver and that the real performance stars this year have been (as usually is the case) in less headline-catching names.

a note on risk

The ARK ETFs are not for everyone, however. The overall group has a narrow focus; the ETFs are highly concentrated, with the top ten positions in the Innovation ETF, for example, comprising just under half the fund; and what the firm considers to be key names can be top holdings in more than one ETF. So holders should be able to tolerate their higher than average level of risk.

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