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.

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.

are stocks overvalued?

data registering with market observers

frothy individual stocks For instance, Zoom (ZM), a stock I owned a while ago but have sold, reported a blowout quarter after yesterday’s close ($.20 a share vs. analysts’ estimates that averaged $.09, but ranged from a loss of $.16 to a gain of $.12). Thanks to this stellar earnings performance the stock’s PE, has shrunk to 1224x trailing earnings, according to Fidelity, or 38x its anticipated growth rate. ZM has tripled since February. Nevertheless, analysts are overwhelmingly bullish.

(Why have I sold? I’m a frequent user of the service and I like it. I imagine, though, that ZM will end up as a feature of someone else’s app. This could happen through a high-priced takeover, which would mean shareholders would make money from here …or it could happen by rivals making their services better, which would be a less happy outcome. And I didn’t have a strong conviction about which way things would go.)

the trailing (that is, based on pre-pandemic results) PE on the S&P 500 is a higher than average 23x+, even though earnings reports for index companies over the next six months or more are likely to be ugly

–the continuing economic, pandemic response and now civil liberties, train wreck of the Trump administration. My sense is that the stock market, which normally pays little attention to politics, is focused on the here and now of an inept leader beginning to channel his inner George Wallace. I don’t think the potentially disastrous long-term economic consequences of his policies are fully in today’s prices, nor the chillingly real possibility that he will be reelected in November. But his epic dysfunction is impossible to ignore.

So why is the market going up every day? More tomorrow.

looking for a bottom

A reader asked about my Monday comment on a possible “double bottom” in the US stock market.  I thought I’d elaborate.

 

What often seems to happen at market lows in the US is that stocks plummet sharply in a frightening way and then for no apparent reason other than that panic selling stops reverse course almost as sharply.

double bottom

Many times the selling stops at, or maybe slightly below a point where stocks bottomed before or where they have meandered around without much net movement for a considerable period of time.  For us, the two possible stopping points seem to be the point where stocks reversed themselves in December 2019 (just below 2400) and the period in 2015-16 when the S&P meandered around 2100.

Typically, the initial rebound lasts for about six weeks.   The market  then returns to–or somewhat below–the past lows before starting back up for good.

My observation Monday was that I’ve heard so many commentators predicting that we’re in a double bottom situation now that it may have become the consensus view.  That itself is a worry.  In my experience, the consensus view rarely comes to pass.  Sometimes everybody is wrong; more often by the time the news has passed down to TV talking heads, it has already been fully factored into stock prices and stocks will be influenced by something else.  I have no idea what the something else might be.

This shouldn’t be our most important concern as investors.

what we should be looking at/for, in my opinion anyway

The reality is that predicting the ups and downs of the US stock market accurately is very hard to do.  In 28 years as a professional investor, I never met anyone who could do it consistently–and plenty of people who lost their shirts–and their clients money–trying.

Market timing is riskier that it might seem, as well.  If I remember the number correctly, 40% of the gains in a market cycle come in 10% of the days–the lion’s share of that in the early stages of a bull market (which is just when the conventional wisdom is most bearish).

At a scary time like this, we all are getting a check on our risk tolerances.  If you can’t get to sleep at night, you now know you’ve taken on too much risk.  Not necessarily all at once, but over time you should readjust your holdings.

Everybody has stocks that blow up on them.  This is a good time to analyze clunkers you may have among your holdings, look for patterns in your decision-making that caused them and make changes.  This is harder to do than it sounds.  But it’s crucial.

If you own non-index funds, look at how well they’ve done versus the market.  Don’t just look at the past six months, look back at the fund record for as long as it has been around.  Be careful, though, to make sure that the long-term record isn’t just from a big bet that paid off a decade ago.

When I was training new analysts, I’d ask–“Suppose you bought a stock at $50 that you thought could go to $65 and it has fallen to $40 instead.  You’ve just found another stock with the same risk profile that you have the same level of conviction in.  It’s selling for $50 and you think it could go to $100.  But you have no extra money.  What do you do?”  Invariably the answer would be–“I’ll wait for the first stock to go back to $50.  Then I’ll sell it and buy the second one.”

That’s crazy.  Stock A can go up 60% and Stock B can double.  Why wouldn’t you sell some or all of A now to buy B?  The reason is that newbies don’t want to take a loss.  Their ego gets in the way of making money.  If your portfolio needs to be reshaped, in my experience the sooner you start the better off you will be.  Another reality is that the best professionals aspire to be right 60% of the time   …and they spend a lot of time trying to minimize the damage from the inevitable land mines.

the stock market now

The only thing I can see to hang my hat on is time.  I have no idea about the level at which stocks stabilize.  I think it’s reasonable to figure that the worst of the pandemic will be at least in sight by the end of June, particularly as China seems to be going back to work now.  Presumably the oil price war will still be on, which is bad for oil companies of all kinds, though particularly so for frackers, but probably a net plus for everyone else.

Three key questions:  will tech firms continue to lead the market during any recovery?  how will consumer behavior change in response to the fact of quarantine?  what struggling companies will be unable to survive a several-month shutdown?

 

 

 

 

dealing with market volatility

Beginning rant:  finance academics equate volatility with risk.  This has some intuitive plausibility.  Volatility is also easy to measure and you don’t have to know much about actual financial markets.  Using volatility as the principal measure of risk leads to odd conclusions, however.

For example: Portfolio A is either +/- 1% each week but is up by 8% each year; Portfolio B almost never changes and is up by 3% every twelve months.

Portfolio A will double in nine years; Portfolio B takes 24 years to double–by which time Portfolio A will be almost 4x the value of B.

People untrained in academic finance would opt for A.  Academics argue (with straight faces) that the results of A should be discounted because that portfolio fluctuates in value so much more than B.  Some of them might say that A is worse than B because of greater volatility, even though that would be cold comfort to an investor aiming to send a child to college or to retire (the two principal reasons for long-term savings).

more interesting stuff

–on the most basic level, if I’m saving to buy a car this year or for a vacation, that money should be in a bank account or money market fund, not in the stock market.  Same thing with next year’s tuition money

–the stock market is the intersection of the objective financial characteristics of publicly-traded companies with the hopes and fears of investors.  Most often, prices change because of human emotion rather than altered profit prospects.   What’s happening in markets now is unusual in two ways:  an external event, COVID-19, is causing unexpected and hard-to-predict declines in profit prospects for many publicly-traded companies; and the bizarrely incompetent response of the administration to the public health threat–little action + suppression of information (btw, vintage Trump, as we witnessed in Atlantic City)–is raising deep fears about the guy driving the bus we’re all on

–most professionals I’ve known try to avoid trading during down markets, realizing that what’s emotionally satisfying today will likely appear to be incredibly stupid in a few months.  For almost everyone, sticking with the plan is the right thing to do

–personally, I’ve found down markets to be excellent times for upgrading a portfolio.  That’s because clunkers that have badly lagged during an up phase tend to outperform when the market’s going down–this is a variation on “you can’t fall off the floor.”  Strong previous performers, on the other hand, tend to do relatively poorly (see my next point).  So it makes sense to switch.  Note:  this is much harder to do in practice than it seems.

–when all else fails, i.e., after the market has been going down for a while, even professionals revert to the charts–something no one wants to admit to.  Two things I look for:

support and resistance:  meaning prices at which lots of people have previously bought and sold.  Disney (DIS), for example, went sideways for a number of years at around $110 before spiking on news of its new streaming service.  Arguably people who sold DIS over that time would be willing to buy it back at around that level.  Strong previous performers have farther to fall to reach these levels

selling climax:  meaning a point where investors succumb to fear and dump out stocks without regard to price just to stop losing money.  Sometimes the same kind of thing happens when speculators on margin are unable to meet margin calls and are sold out.  In either case, the sign is a sharp drop on high volume.  I see a little bit of that going on today

 

more on Monday