Image Credit: Third Way Think Tank (Flickr)

SEC Proposes to Tighten Rules on Fund Labeling Including ESG

Investment fund names are part of investor education and need to be true to the fund’s objective and strategy. This is according to two SEC proposals that would require fund managers to use caution, and a dictionary, when titling funds. A fund with a name that suggests growth or value would have to maintain 80% of its investments in that category, under one of the proposals. Another example is funds titling themselves green, low-carbon, or sustainable would have to define how they achieve their environmental objectives.

“Investors should be able to drill down to see what’s under the hood of these funds.” SEC Chair Gary Gensler said in remarks at a commission meeting on May 25^th. “A fund’s name is often one of the most important pieces of information that investors use in selecting a fund,” the Chairman noted.  

The SEC has been increasingly focused on ESG (environmental, social, and governance) investing. There are many funds that label themselves as ESG without disclosing or defining the label. The SEC is questioning these undefined labels. And they are willing to fine those they view as misleading. This week, mutual fund manager BNY Mellon Investment Advisers paid $1.5 million to settle SEC charges that it misrepresented the ESG review it made of investments.

SEC Proposals

The SEC endorsed two proposals on May 25. The first proposal updates a rule implemented in 2001, which states that 80% of a fund’s holdings should be invested in the type of assets suggested by the fund’s name. The “Names Rule” requires for example a biotech fund should hold biotech stocks, while an exchange-traded fund (ETF) named for an index must be 80% invested in the indexed stocks. Since 2001 when the rule was adopted, its application has become less stringent.

The new updates specify the Names Rule also cover fund names which seem to define strategies. Names reflecting a focus on environmental, social, and governance-related concerns could soon be required to maintain 80% of their holdings in assets chosen by a defined ESG criteria.

The second proposal governs disclosures by ESG funds. Gensler said that according to one estimate the universe of U.S. sustainable investment vehicles has grown to $17 trillion. Many investors are affected by these funds.

ESG strategies vary widely, said the SEC chairman. Under the ESG disclosure proposal, fund companies or investment managers that claim to consider ESG factors would have to detail the factors they consider as well as how they are implemented. For example, an ESG-focused fund that aims to affect greenhouse emissions would have to report emission metrics for its portfolio, and annual progress toward its ESG goals.

Image: SEC Chairman Gary Gensler (Twitter, March 1,2022)

Compliance

Mutual funds and ETFs would have to identify which holdings fall into the 80% required bucket. When positions fall below the 80% required, the fund would have 30 days to fill the gap. “Names matter,” said Chairman Gensler.

The Names Rule update could affect 75% of SEC-registered funds. For many funds, it will mean an extra cost upfront to rebrand or recreate the funds, and an ongoing cost from a compliance standpoint.

The reporting requirements are expected to discourage “greenwashing” by funds that claim to focus on ESG factors but may not. “What we’re trying to address is truth-in-advertising,” said Gensler, in a news conference after the meeting.

What’s Next?

Both SEC proposals now go out for public comment over the next 60 days. If fully adopted, money managers would have a year to comply. Compliance may require renaming funds, bolstering sales materials with specifics, changes to prospectuses, and the addition of analysts and compliance staff within the fund management industry.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.wsj.com/articles/sec-to-propose-more-disclosure-requirements-for-esg-funds-11653498000?mod=markets_major_pos10

https://www.barrons.com/articles/sec-gensler-greenwashing-esg-funds-51646166625?mod=article_inline

https://www.barrons.com/articles/sec-tighten-rules-esg-funds-51653498277?mod=Searchresults

https://twitter.com/GaryGensler/status/1498708322677149700

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Image Credit: Daniel Mennerich (Flickr)

A Close Look at Michael Burry’s Plane Crash Comments

Michael Burry tweeted, “Fads today (#BTC, #EV, SAAS #memestocks) are like housing in 2007,” in March of this year. For almost a year now, the famed hedge fund manager has been predicting market tragedy, as he correctly did before the great recession. On Tuesday (May 24) he again warned that his feelings about the economy and various markets are the same as they were in 2008. He indicated he isn’t cheering for it, but he’s warning that people should prepare for it.

Image: Michael Burry’s May 24 Tweet

While Burry is regularly warning others to run for cover and prepare for doom, there is little in his company’s filing of public investment
positions that would indicate that he has any doomsday positions. In fact, he had added long positions in energy (OVV) which could weaken during a receding economy, and consumer discretionary goods (SPWH, STLA), which are by definition an area where households can cut back in hard times. One of these may have been a temporary dividend play, not a longer holding. His hedge fund held puts on one large technology company (AAPL) and was long two others (GOOGL, FB).

The assets reported on form 13F to the SEC is not necessarily his entire portfolio. After all, when he used credit default swaps as part of his “big short” they were not at the time overseen by the SEC. His company may be employing another method that is off the regulatory radar. The SEC has not yet regulated pure cryptocurrency.

The Big Question

The Scion Asset Management founder posted his tweet this week (then
deleted it) after data for new single family home sales for April were released. The report showed home sales fell an unexpected 26.9% over the previous April.— well off the consensus forecast. On the same day, the S&P 500 index tumbled 2.5%, bringing its YTD slide to -18%.

If Michael Burry is so perturbed by his own forecast of economic problems and markets like housing, stocks, and credit instruments, why is he warning people? Burry is famous for his prediction and his ability to capitalize on having been right in 2007-2008. This fame attracted many followers. His public tweets of warning could become an impetus to weaken asset prices. He could become part of the fuel that brings his prediction of doom to reality.

To say he is brilliant economically is an understatement, he must know the power of his words. And his words can serve to alter investor actions. (Share your thoughts under this article on Twitter).

Take-Away

Burry has predicted the next market crash will dwarf the 2008 bust, That event sparked a global financial crisis. He seldom gives interviews and when he does it is typically through a Bloomberg terminal with Bloomberg News.

As head of Scion Capital Management Burry became one of the most followed hedge-fund managers after predicting and making his clients a fortune betting on the housing-market crash in 2007/2008. He has repeatedly drawn parallels between the run-up in asset prices during the COVID-19 pandemic and the bubble that made him famous. The warnings he now is giving don’t seem to add up with his portfolio positions, unless he is involved in non-securities like real estate, cryptocurrency, or some other asset type.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.thestreet.com/technology/is-the-financial-crash-of-2008-about-to-repeat

https://www.sec.gov/opa/Article/press-release-2012-67—related-materials.html

https://mobile.twitter.com/burrydeleted?lang=en

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Market Bifurcation Can Confuse Investors

Market bifurcation happens when relative moves between stock groupings that usually trade in semi-tandem, branch into different directions. A classic example would be energy stocks and the travel industry. When energy prices are stable, the two typically move up and down in rough synch with the overall market. When energy costs quickly rise, travel stocks may become weaker and even move in the complete opposite direction. This disconnect, branching in different directions, is called bifurcation.

Other bifurcation possibilities could include growth stocks and value, tech and industrials, and consumer cyclical vs. non-cyclical.  The move in different directions, typically ebbing and flowing together, can be long-lived and last for months, or short-lived lasting only days.

Soruce: Koyfin.com

The graph above demonstrates a bifurcation between large industrial stocks represented by the Dow 30, and large tech stocks represented by the Nasdaq 100.

While this only shows three trading days (May 20, 2022-May 24, 2022) The bifurcation between the two, which had previously tracked in the same direction, is extreme. Investors may play bifurcation by expectations that the two will eventually revert to their mean. Shorter-term traders should recognize the split early since the two major benchmarks are acting in complete contrast to the other.

There is no telling how long a bifurcation will last. As with most market anomalies, expectations of how long the cause of the trend will exist dictates the future. The Nasdaq, over the past three years (May 2019- May 2022) has trounced the Dow 30 performance, earning an additional 35%.  The two typically tack closer. This may indicate the beginning of a rotation and money flows out of the high PE Nasdaq 100 and into more conservative dividend-paying companies.

It is unclear if a long-lived trend has developed until entrenched (three days does not make a trend). But an astute trader will pick up on early signs of strength and weakness in order to recognize market rotations. They may choose to take advantage of – or steer clear of these. Active investors may benefit by reallocating with a larger percentage in the stronger areas of a bifurcated market and reducing allocation in the weaker. 

Paul Hoffman

Managing Editor, Channelchek

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Small-Cap Insider Buying Ratio Could Mean a Market Bottom is Near

There are more insiders buying at small-cap firms than there are insiders selling. This wasn’t the case in April and is still not the case for large-cap stocks where there are far more inside sellers than there are inside buyers. Insider buying is the purchase of company shares by a director, officer, or other executives with insights from the “inside.” And, it can be a good indicator of future results.

According to Verity, an investment research & data platform, as reported by Barron’s, insiders at S&P 500 firms are acting the same as they had in the first quarter, laying low and playing a game of wait and see. But this is not the case for small-cap insiders.

Large-Cap
Insider Ratio vs Small-Cap

There were 272 insiders selling shares at S&P 500 firms during April compared with 32 buyers (11.8%), according to Verity. Looking at month-to-date, there have been 225 sellers and 42 buyers (18.7%). Put another way, within the large-cap index, for May; there have been more than five sellers for every insider buying company shares.

According to Ben Silverman, Director of Research at Verity, large-cap “Insiders are, by and large, not buying,” adding “More positively, we are still seeing lower-than-typical levels of selling. There’s this unwillingness to accept the current valuations and generate liquidity at these valuations.”

Silverman sees more positive signs for small-cap stocks included in the Russell 2000. During April, there were 388 sellers and 105 buyers at firms included in the Russell Small-Cap index. For May, this has turned around. Over the past weeks, there were 327 sellers to 395 buyers. If this ratio holds, it will be the first month with more buyers than sellers since pandemic lows in March 2020.

For the week ended May 17, there were 281 buyers—the most since the week ended May 19, 2020. Even more promising, according to Verity, was the ratio of buyers to sellers, which was 2.8 to 1. The one-year average is 0.7 to 0.8, representing that there had been more sellers than buyers. Silverman says he’s encouraged that insiders at small-cap firms are buying. He noted that we’re in the early stage of insider season when most firms open their quarterly trading window.

Small-Cap
Interest

Could this indicate a market bottom is near? Referring to the small-cap insider interest, Silverman said, “We’d like to see this number continue to grow or at least not decline significantly because historically we’ve seen buying momentum either sustain or build over a three-to-five week period near market bottoms.”

With a more refined look at the sector, Silverman sees buying momentum in the industrial goods space, including transportation, machinery, and electronic equipment firms. His view is the upswing in buying activity at regional banks is a positive sign since he believes they generally have a good pulse on local economies.

Take-Away

The knowledge that insiders are purchasing company shares can signal they have confidence in the future share price of their company. It may even indicate a market bottom is near. During the month of May, the small-cap stocks captured within the Russell 2000 index saw a far higher ratio of buyers to sellers than the S&P 500 large-cap index. What’s more, the last time this confidence indicator was positive was over two years ago.

Channelchek is a small-cap stock, data, and information resource, specializing providing users a means to explore and discover opportunities among smaller companies. Start your small-cap company
research on Channelchek.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://verityplatform.com/insights/

https://www.barrons.com/articles/stock-market-recession-inflation-federal-reserve-51653328257

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Image Credit: Third Way Think Tank (Flickr)

Has the Crypto Crunch Accelerated SEC Plans to Regulate the Market?

The Securities and Exchange Commission (SEC) Chairman Gary Gensler says he’s concerned and expects other crypto tokens will fail, and it could undermine overall faith in financial markets. The comments came after May’s implosion of TerraUSD, which was the third-largest stablecoin by total value. The SEC chairman was speaking before the House Appropriations Committee on May 18.

“I think a lot of these tokens will fail,” Gensler told reporters after the Committee panel hearing. “I fear that in crypto…there’s going to be a lot of people hurt, and that will undermine some of the confidence in markets and trust in markets writ large.”

Assets in the cryptocurrency markets have shrunk by more than $1 trillion in value since December as signs that the Federal Reserve would unwind its accommodative policies became accepted. Around the same time, regulators began placing crypto under a spotlight with the intent to protect speculators by providing rules and constraints. The use of crypto by Russia cast the tokens under an even darker light for much of the world. The accelerated crypto selloff came after the U.S. central bank raised interest rates. TerraUSD, a token whose price was supposed to remain 1:1 with the $US, suddenly crashed. It’s sister coin, Terra Luna, that was meant to back it, also fell apart.

The token price action has caused concern about the possibility of other asset classes getting spooked. Chairman Gensler said that exposure to crypto by SEC-registered asset managers isn’t significant but that the agency has less knowledge of family offices and other private funds.  Back in January, the SEC proposed a rule that would increase the speed and quantity of confidential information that private-equity and hedge funds provide the Commission through Form PF filings.

SEC Standing  

The SEC
announced in early May that it plans to add 20 investigators and litigators to its unit dedicated to cryptocurrency and cybersecurity enforcement, nearly doubling the unit’s size. During the House meeting, which concerned budget items, Gensler said he wished he had more to work with for oversight. “We’re really outpersonned,” he said.

Most cryptocurrencies likely meet the legal definition
of a security that should be registered with the SEC, both Mr. Gensler and his predecessor, Jay Clayton, have said. No major cryptocurrency issuer or trading platform has proactively opted into the commission’s oversight. If there is going to be more oversight, it will be forced.

Gensler’s is a former MIT professor that taught blockchain and cryptocurrencies. As the top SEC cop, he has been working on persuading trading platforms such as Coinbase to be regulated as exchanges, saying many of the assets they provide trading in are securities. The platforms take a different stance. From a legal point of view, it isn’t clear how an SEC-registered exchange could allow trading in securities that have not been registered with the commission.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.wsj.com/articles/more-crypto-market-turmoil-is-predicted-by-sec-chairman-gary-gensler-11652906029?mod=markets_minor_pos1

https://www.sec.gov/news/press-release/2022-78

https://corpgov.law.harvard.edu/2022/05/18/testimony-by-chair-gensler-at-hearing-before-the-subcommittee-on-financial-services-and-general-government-u-s-house-appropriations-committee/

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Initial Public Offerings (IPO) Can be Considered a Ground Floor Opportunity

When a private company, one not yet traded on any stock exchange, first offers shares of its company for purchase, this process is known as an initial public offering (IPO). It is a transfer of ownership which provides a method for the company to raise capital by selling all or part of the business by becoming a publicly traded corporation.

The IPO process is sometimes referred to as “going public.”

To bring a company public through an IPO, management chooses a lead underwriter, often an investment bank. The underwriter provides expertise with the securities (stock shares) registration process and distribution of the shares to the public. The lead underwriter then assembles a group of investment banks and broker-dealers (a syndicate) that is responsible for selling shares of the IPO to institutional and individual investors.

Participating in an IPO

To participate in an IPO, you agree to purchase shares of the stock at the offering price before it trades on the secondary market. Your indication of interest as a potential investor helps set the initial offering price.

Your broker will require standard guidelines to be met to determine if you meet SEC rules to qualify as a “qualified investor.” If you are eligible, you may be asked if you’d like to be signed up for new IPO alerts. 

If an investor has done their own due diligence and has been allocated shares in an IPO, it is important to understand that while they are free to sell shares obtained through an IPO whenever they deem appropriate, many firms will restrict eligibility to participate in future offerings to those that sell within the first several days of trading. The practice of quickly selling IPO shares is known as “flipping,” and it is something most firms discourage.

Considerations

Before investing, be sure to do basic research. This can be challenging because of the lack of information on non-public companies. The company’s preliminary prospectus is provided by the issuer and lead underwriter. It includes information on the company’s management team, target market, competitive landscape, recent financials, who is selling shares in the offering, who currently owns shares, anticipated price range, potential risks, and the number of shares to be issued.

Qualified Investor

The overall guidelines as to who qualifies to participate in IPOs are fairly standard. One way to determine if you may meet the guidelines is by providing confidential information here.

Paul Hoffman

Managing Editor, Channelchek

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Sustainability and ESG Investing May Not be a Top Priority for those Hiring Portfolio Managers

A few of the winning categories in the stock market over the past two years have fallen from grace. The slide suggests that they had either been overbought or the demand changed for their products; it’s also possible they are now oversold. For example, high tech and disruptive tech were high flyers; they now are underperforming and seem to be “out of the rotation” of where investor money is flowing. Another category that saw money piling into it was ESG (Environmental, Social, Governance). This is a relatively new category that was so much in demand that many new funds were created to capitalize on the flow of cash. Many publicly traded companies even altered their business and their branding to capitalize on the expanded demand for stocks in these funds.

With the overall market declining and investors challenged to find companies on an upswing, are ESG labeled investments still getting attention?

ESG Scores

ESG scores are based on environmental, social, and governance factors that take into account corporate energy use, land use, emissions, employee satisfaction, business practices, and executive compensation. The popularity of funds that invest in ESG ranked companies had escalated as the new administration entered the White House in 2021. This is in part because there were big plans to recover from the pandemic-related slowdown with financial support for green or sustainable projects. ESG funds then experienced large and growing inflows of assets. With the increase in assets and a limited field of stocks to choose from, the category outperformed. As the above-average performance was recognized and reported on, it attracted more assets.

This caused companies that didn’t fit into the category to make changes that would provide them a decent ESG score. The list of acceptable companies from which fund managers can choose is still growing.  This creates a situation where there is an increasing number of names, while the amount going into these funds has slowed.

The ESG ratings themselves are provided by private companies that have earned a reputation in the business. They wield a lot of power as they dictate who can be included in a fund and who cannot. The better-known firms are MSCI (MSCI), the largest ESG rating company, Standard & Poor’s (SPGI) and Sustainalytics, owned by Morningstar (MORN). Investors, including fund managers, use these as a guide to screen stocks for inclusion in ESG and sustainable portfolios.

Performance

The year-to-date (YTD) S&P ESG Index (308 stocks) and the S&P 500 performance have tracked pretty close since the beginning of the year. There has only been a slight benefit to those earning the ESG index which is down 18.7% vs. 19.4% for the S&P 500.

Source: Koyfin

The YTD performance difference of just over 1%  represents a narrowing of the performance spread for the two indexes. As the graph below indicates since August 1, 2021, (one year after launch of the index) there is more than a 5% difference in return, favoring the ESG fund.

Source: Koyfin

Mood Change?

ESG funds and ratings have been under fire in 2022. This is in part related to the attention the Russian invasion of Ukraine brought to the category. Some critics question why ESG-labeled funds own companies such as Russia’s state-backed energy company Gazprom.

In a recent study by Seeward & Kissel they surveyed funds-of-funds, family offices, endowments, seeders, and other investors, the law firm discovered ESG considerations rank low as a priority when hiring managers. The Seeward & Kissel’s 2022 Alternative Investment
Allocator Survey indicated, that overwhelmingly the main criteria used are investment strategies and a track record of performance.

According to the survey over 40% said ESG and investment team diversity were the least important issues when sourcing portfolio managers. A full 90% answered that investment strategy was the most important factor and track record also ranked high on the list.

Daniel Bresler, a partner at Seeward & Kissel said, “We don’t think ESG is going away anytime soon, but it has been placed on the backburner because of concerns with Ukraine and markets going crazy.” Bresler also indicated he was surprised by the results showing how low the ESG category ranked in importance.

This week’s announcement that Tesla (TSLA) was ineligible and therefore cut from the S&P DJI ESG, has also caused confusion among onlookers who viewed the electric car company as the ESG “poster child.” At the same time, the strong position of Exxon Mobil (XOM) which moved up within the same S&P index has raised questions about methodology.

Take-Away

ESG is maturing and will have its place. The attention it received as the Biden Administration was laying plans for greener projects while helping rebuild infrastructure provided a high level of enthusiasm for the category. The overall market has turned somewhat sour and returns are now a stronger driver than an often misunderstood ESG and sustainability category. Along with the market weakness, the nature of rewarding some companies with a high ESG score and other seemingly less destructive companies with a lower score has reduced enthusiasm.

These perceived problems are likely just part of the growing pains of a category that will likely ebb and flow as the other investment categories, sectors, and companies do.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.investmentnews.com/major-outflows-hit-most-asset-classes-as-recession-woes-mount-221753

https://etfdb.com/esg-channel/how-long-will-esg-funds-rake-in-capital/

https://www.buyoutsinsider.com/strategy-and-performance-outpace-esg-and-diversity-in-manager-selection-survey-finds/

https://etfgi.com/news/press-releases/2022/04/etfgi-reports-esg-etfs-listed-globally-gathered-net-inflows-7-billion

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One Way to Keep the Investor Focus Needed to Succeed When Markets Turn

Keeping a clear head while all around you are losing theirs is key to trading and investing. I have a habit that helps with focus that I learned from my years as a chief investment officer responsible for the success of several billion invested in the public markets. I’ll share this with you. As I combed through headlines this morning, all of them pushed doom and gloom, this can cause partial investor “blindness. I didn’t bother to turn on the TV as I’m certain the emotionally charged market pundits are doing all they can to keep viewers engaged. They do this by emphasizing things that create fear.

Fear sells, and selling benefits their shareholders whether or not the information helps your investment decision-making or not. And making decisions to grow and protect your money is the essence of successful investment management.

Where You Could Look Instead  

I mentioned I didn’t turn on the TV this morning. For me, much of the TV market news are shows designed to keep you tuned in all day. They do this with emotional broadcasts and “breaking news” stories. It makes sense for them, they sell advertising, and the industry increases revenue by building viewership. But I admit I did tune in yesterday to watch my friend Eddie Ghabour, the author of The Commonsense Bull to see what he had to say. To his credit, Eddie owned Apple (APPL) and other tech stocks when everyone else thought they had no more room to run. To me, his is the voice of calculated reason. The two were discussing the comments Fed Chair Jay Powell made at a Wall Street Journal event concerning their resolve to fight inflation. I was surprised to hear the self-described commonsense bull stoking fear by saying, we’re in the “largest bubble of our lifetime,” and it’s going to burst as the Federal Reserve is “going to suck liquidity out of the system.” Whether this comes true or not, immersing oneself in this kind of talk will begin to prevent you from uncovering opportunities. And in every situation, there are opportunities.

It may seem obvious to say that data is unemotional. But it is less likely to create the kind of bias that prevents an investor from seeing what could be when viewed in black and white. Whether it’s TV journalists or professional headline writers, there’s a bias in reporting, a bias that is absent in raw numbers, and when done right, absent in genuine investment research.

Fortunately, we now all have systems, software, platforms, and computers to sort through technical data. We can learn quickly what stocks are trading counter to the market, what’s trading up on volume, what’s moving above its 50-day average, etc. These are the kind of things I like to look at,  finding what’s strong when everyone else is talking about the world falling apart. Then I make sure its normal performance isn’t a natural mirror image, in other words, it isn’t likely to go negative when the market turns positive. An example would be bond ETFs going up when stocks go down. Looking for companies that are strong and may have gained even more on a positive day is built in to most platforms and can isolate, without emotion, candidates to review while everyone else is being told we are doomed.

May 18, 2022, for Example

Within Channelchek there is a section to the left of the screen called Movers and Shakers. On a real-time basis, it filters through the 6000+ small and microcap stocks on Channelchek and provides users with those that have the largest gains, largest losses, and relatively most active. On this big down day, I wanted to see what was holding up and if they were all centered around a specific industry. It turns out there was no industry preference, but there was a long list of companies up 7% or more while the market was down over 4%.

Screenshot of Channelchek Movers and Shakers after close
May 18, 2022

From the quick list, I started with names I am most familiar with. In fact, I had just gotten research in my email on Garibaldi Resources (GGI:CA, GGIFF). As an added plus I am not opposed to increasing my exposure to gold. 

Then I looked at the most recent, decidedly unemotional, third-party research on this company. It stands to reason that letting a FINRA licensed analyst that specialized in the industry and knows the company through-and-through, is the best person to kick the tires and show what they are expecting.

Using this one company as an example: Garibaldi is a gold mining company that just released very positive exploratory results on one of their mines.  The indepth report explained that out of nine holes drilled to test for gold mineralization, eight came back with positive results. This could explain the strength of this stock, particularly in the gold sector which also outperformed on this day.

As a side note, I found it interesting that on a day that the U.S. markets were falling, all the overperforming stocks were listed (some co-listed) on a Canadian exchange. This isn’t insight you’re likely to get on CNBC or Fox Business News.

Sidelines

Money in the market should continually be swapped out for better opportunities, this is an especially good practice with tax-deferred accounts like IRAs.  Money on the sidelines, when inflation is running above 8%, is losing a lot of buying power. While dry-powder is helpful to have on-hand when you think the market has hit bottom, keep in mind that money is always moving someplace. And there are many companies with performance not-correlated to the companies that are driving index averages.

Take-Away

Sell-offs will always cause scary headlines and fearful hype from newscasters and publications. Individual and professional investors alike can lose focus when surrounded by doom and gloom forecasts. One way around this is reviewing mostly data and reading full stories from the more reputable sources, also look for quality research. Market research and equity research —  if done right it is devoid of emotion.

The example above is simple and basic, using only one tool to see where money is flowing to, rather than allowing myself to be bombarded with where it is flowing from. To be sure your brokerage account has an array of very sophisticated tools to bring ideas to the surface.

Register for Channelchek to receive equity research in your inbox before the opening bell each day.

Paul Hoffman

Managing Editor, Channelchek

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The Battle Between Bull and Bear Has Become Intense

A bull facing off with a bear is among the most entrenched icons and lore in stock market trading. Bull vs. bear icons can be found in almost any office that is involved in the stock market. Long ago, people came to use the terms “bullish” and “bearish” to reflect their thoughts on market direction, and the meanings are universally understood. In 2022 the memes of bulls and bears struggling with each other have reached a crescendo. After an incredibly long and strong market from Spring 2020 until year-end 2021, there has been no question we were in a bull market. As we entered 2022, the sentiment which drives markets has been less confident and decidedly more negative.

The terms are based on direction and overall sentiment, but over time, analysts have attempted to define what a bear market is. In recent years, a bear market has been defined as having fallen 20% or more from recent highs.

Source: Koyfin

The chart above shows the volatility index (%) against
the S&P 500 index (%). Since December 2021, the index has hit higher highs
and higher lows as the markets are wrestling with more negativity than prior
periods.

Bull and Bear Facing Off

In a bear market, share prices are on average dropping each week. This results in a downward trend that investors believe will continue; the belief, in turn, snowballs into an entrenched downward trend.

To date (May 18), none of the major indices have fallen 20% or more from their high. But for many in the markets, it feels as though they have. Investors had been velocitized by the swift gains over the prior years, so even sideways movement for a period would feel negative. The current 16% decline of the S&P 500 feels much steeper than it is. It has been held up by many strong up days showing there are still plenty of bottom-fishing bulls. This is the essence of the bull and bear facing off.

Bullish Position

The economy may seem to have the ingredients for a reduction in growth that could lead to a reduction in corporate earnings, but the most followed measurement, employment, isn’t showing signs of faltering. Confidence is created by knowing if one wants a job, they can get a job. Job growth and wages have been marching higher through most of 2022. So much so, that wage inflation is becoming a concern.

There is still ample stimulus in the system as a result of quantitative easing and low-interest rates. The Fed has discontinued adding stimulus in the form of bond purchases and has begun raising rates, but real rates are still negative, and the mopping up of money injected into the system is scheduled and will follow a slow timeline.

Consumers are still spending. Retail sales for April rose a seasonally adjusted 0.9% in April. Demand is strong for most goods and services, especially those involving leisure activities. With the consumer still looking to spend, the markets may hold up well.

Bearish Position

Fed Chair Jerome Powell gave a talk yesterday at the Wall
Street Journal’s Future of Everything Festival. During his talk, he discussed his resolve to bring down the 40-year high inflation rate and bring it in line with their 2% target range. He admitted that the landing might be bumpy, but he believes it can be done without causing a recession. A recession is generally defined as two consecutive quarters of negative growth (GDP). We are now halfway through the second quarter of the year. The first quarter, which came off a very strong 4^th quarter, showed the economy had negative growth of 1.6%. So we may already be in a recession. If job growth falters, it will become a problem.

The Fed is raising rates and draining stimulus with an eventual target of 2% inflation. This would seem to argue for aggressively applying of the economic brake pedal.

Higher rates increase costs for businesses that borrow money and slow down purchases for households that were planning on making a purchase on credit. For businesses, higher rates could cut into profits, and households may decide to curtail purchases because of the high cost of money (borrowing costs).

Take-Away

By definition, it is premature to call this market a bear market, yet it has ceased to be a bull market. On up days, the bulls come out in force and have driven the markets up by 2% or more in a trading session. This shows that there are many positive participants buying in at these lower prices. The bearish sentiment is in large part based on future expectations, not economic reports. The feeling is based on previous Fed tightenings and the heightened probability of entering a recession.

This market has continued to surprise over the previous decade, and the future won’t be any different. In addition to overall growth or recession, there is the potential for a rolling recession. This could play out where it affects companies that rely on low interest rates such as housing, while at the same time those that still prosper while the job market is good and continues to grow. Examples of this are sectors where people spend disposable income on things such as leisure, entertaining, or clothing. In the meantime, the bulls and bears are thrashing to determine how 2022 will play out in the markets.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.bea.gov/data/gdp/gross-domestic-product

https://www.wsj.com/articles/feds-powell-to-take-wsj-questions-on-inflation-and-economic-outlook-11652779802?mod=Searchresults_pos7&page=1

www.koyfin.com

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The Big Price Impact on Stocks After Warren Buffett’s Most Active Buying Spree

Warren Buffett and Berkshire Hathaway (BRK.A, BRK.B) were actively spending down the company’s large pool of cash last quarter, just as they promised during their recent annual meeting. This makes sense as some stock prices are lower than they have been in years, and a few sectors are showing they could have plenty of upside potential. It makes even more sense when you consider that Berkshire Hathaway was sitting on $144 billion in cash. The inflation rate is now running above 8% and eroding the value of every unearning penny.

Jumping into the market can be costly if wrong, but investor’s ‘dry powder’ is being eroded with increased costs by the day – finding a place for money to grow by at least the inflation rate would seem prudent. The analysts at Berkshire Hathaway are certainly aware of this.

The positive impact of Berkshire showing confidence in a company is often all that is needed to exceed the near non-earnings holding a cash position. Below we look at three Berkshire Hathaway changed positions as reported on May 16, and then compare the stock’s price moves versus the overall market.

Where Did They Gain Exposure

As revealed by the companies 13F filed on May 16, as of March 31 Berkshire Hathaway added Citigroup (C), Paramount Global (PARA), and sold Verizon (VZ). There were older positions added to as well, such as Chevron (CVX), and Activision Blizzard (ATVI). But for the purpose of showing the power of Buffett’s believing a stock is attractive, or in Verizon’s case, no longer attractive, we’ll take a look at the market moves of these companies as of 1pm the day after the 13F was made public.

Source: Koyfin

The above chart of Citibank, Paramount Global, and
Verizon from the beginning trading on Monday compares the stocks to the S&P
500 performance during the same short period.

The S&P, as reflected during the short period in this chart, beginning on the date of Berkshire’s 13F filing, shows the S&P 500 up 1.60%. This is substantial in a year when the index has mostly been delivering red to investors. Verizon was the most noteworthy sale of Buffett as they brought their position near zero. The company’s stock rose only 0.11%, well below the S&P benchmark performance.

As for the positions opened during the first quarter by Berkshire Hathaway, Citicorp shot up 8.28%. Paramount Global reacted even more strongly, rising double digits to 13.95%. 

Lessons

While an SEC-registered portfolio new holdings are kept close to the vest before reported in order to avoid insider trading problems, listening to what someone like Warren Buffett is saying at annual meetings and at other times can allow you to get a sense if they have been active, and in what industries. More important, is whether they are active buying or selling. For an investor that is holding a stock which a well-followed investor has decided to sell, can cause significant underperformance for at least the near term.

Other Pertinent Info from the 13F Filing

During the first quarter of 2022, the value of Berkshire’s US stock portfolio rose by 10% to $364 billion. Buffett had indicated the firm he manages has been struggling to find bargains in recent years. He blamed this on stocks swelling to record highs, fierce competition from private equity firms, and SPACs which increased competition and costs of acquisitions. Even Berkshire’s own rising stock price made it unappealing as a company stock buy-back.

A change of appetite took place in the first quarter of 2022. Berkshire bought $51 billion worth of equities and sold less than $10 billion in stocks. Its net cash reduction of $41 billion helped slash its cash pile by 28% to $106 billion. Q1 2022 marked one of the most active buying periods in Berkshire Hathaway’s history.

Take-Away

Well known, successful investors can either make a winner out of your holding or cause it to trade at a pace below the market. While knowing and trading on information before it is made public can get you in trouble, investors like Buffett do provide guidance. These hints as to their thinking and likely direction may help investors somewhat. This is why it always makes sense to know what they’re saying – it isn’t fun holding something they just reported sold, and the tailwind they create when you’re long the same company can be profitable.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.sec.gov/Archives/edgar/data/1067983/000095012322006442/xslForm13F_X01/primary_doc.xml

https://whalewisdom.com/filer/berkshire-hathaway-inc#google_vignette

www.koyfin.com

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Michael Burry’s Latest Portfolio Brings the FAANGS Out

On Monday, May 16, Michael Burry filed his company’s holdings report with the SEC. Relative to the previous quarter, there was significant reshuffling. While it’s rare to get an explanation of his thinking beyond an occasional tweet of warning or tweet of frustration, his quarterly positions report is worth reviewing. It lends a rare clue as to what the celebrated hedge fund manager is expecting.

Michael Burry’s thinking, reflected in Scion Asset Management’s 13F holdings (a/o March 31), are shown below. Following the holdings we offer company descriptions and some thinking related to a few of the holdings.

Source: WhaleWisdom

Why it Matters

The positions in Scions portfolio are usually few, quite deliberate, and not the result of herd thinking. During the prior quarter (Q4 2021), among the scant positions were two public prison stocks ($GEO and $CXW). While many pundits and YouTube “gurus” hazarded a guess as to what Burry may have expected to occur with crime, the positions may have had nothing to do with an expected need for jail cells. Following the stock tickers links above to the Channelchek reports discloses that public policy on for-profit prisons is in flux. The positions may have just been a play on policy direction.

Burry’s investment universe is broader than the average self-directed investor and even deeper than the average hedge fund manager. The positions report reflect just those required to be disclosed in an SEC 13F filing. With this in mind, out of the entire universe of public securities Scion could hold, there are only a dozen that Burry’s portfolio felt were worthy at the end of the first quarter. One is a Put position which effectively makes him short the stock and possibly expecting more red than green, but not necessarily.

Holdings Breakdown

Scion has a Put on Apple (AAPL) with contracts to control 206,000 shares. The portfolio is also long shares of two other megacap high-tech stocks adding to a similar notional amount. Of the three, based on price earnings ratio, Apple is by far the most expensive. Apple’s P/E is at 23.7 earnings, while Google/Alphabet (GOOGL) is trading at a much lower PE of 20.7x, and Facebook/Meta (FB) is even lower yet at 15.1x price to earnings. This AAPL Put may not be a bet against Apple as much as it is a play that FAANG stocks should trade with multiples more in-line with each other. If this is the case, he’s not looking to hit a home run, but instead looking for movement either down by Apple, or up by the two other FAANG stocks to net incremental capital gains.

Since the 4Q of 2021, he has held Bristol Myers Squibb (BMY).  Year-to-date 2022 the biopharmaceutical company is up 19% vs the S&P 500 which is down 9.8%. Discover Network C shares (DISCK) is his fourth largest by market value. The C shares of Discovery allow no voting rights. Discovery’s A shares allow one vote per share, and B shares 10 votes per share.

Moving down the list shows a very diversified portfolio of long positions including Cigna (CI) a health care insurer, Ovintiv (OVV) a Canadian based fossil fuel company trading at 8x earnings, and Nexstar Media (NXST) which is a media company that owns television broadcast networks not unlike DISCK.

Stellantis NV (STLA) is a Dutch automaker trading on the NYSE and London exchanges. It owns the Chrysler and Jeep brands as well as Alpha Romeo, Peugeot, and Maserati. STLA pays above-average annual dividends. It declared a dividend on February 25, with an ex-dividend date of April 19. The period covered in Scion’s 13F is through March 31. 

In the consumer discretionary category Scion’s portfolio held two companies month-end that stand to benefit as consumers fill their need to travel and play outdoors. Bookings.com (BKNG) which is a huge online travel website and retailer Sportsman’s Warehouse (SPWH) which is a small-cap value stock trading at only 3.75x earnings.

The last is a payment tech company called Global Payments (GPN). The company’s product line runs the full gamut of electronic merchant payment products.

 Take-Away

Dr. Michael J. Burry has an excellent record of spotting investment opportunities before the rest of the market. His picks are as disparate as the mortgage market in 2008 and GameStop (GME) in 2020.

The portfolio reported by the SEC on May 16, reflecting March 31 quarter-end holdings does not have a strong theme. The most talked-about position has been the Puts on Apple. As mentioned, that play may be more complicated and be a hedge involving other long holdings.

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Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.sec.gov/Archives/edgar/data/0001768023/000156761922010751/xslForm13F_X01/primary_doc.xml

https://whalewisdom.com/filer/scion-asset-management-llc#tabholdings_tab_link

www.koyfin.com

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Better Your Risk Management Investing Strategy with Protective Puts

The year 2020 and 2021, despite the coronavirus-related selloff, left most stock market investors with outsized gains. From January 1, 2020, through today (May 13), the S&P is up 20%. So while this year’s moves may be negative, many investors still have gains to either realize or protect. Realizing gains is easy; you pick your spot and sell out of your position. But what may not be easy is the taxes that may accompany those gains or parting with a position that you believe over the long term will excel. If you are confident the best place for your assets is your current position, protecting it with an options strategy may be the best way to protect against your downside, and only curtail your upside potential by the price of the protective options used as insurance.

Hedging Against Downward Moves

If you have unrealized capital gains, you are probably glad but may be an anxious trader or investor. Volatility, as measured by the VIX is at a level that is considered negative for stocks. Yet, if you believe stocks you own still have upside once we get through this period where covid, crypto, low unemployment, higher interest rates, and war can cause the prices on your holdings to swing in an unpredictable fashion, an options strategy may make sense for you.  

One method experienced investors employ is the protective put.

Image: Koyfin

What is a Protective Put?

There are two main types of options: put and call options. The buyer of a call has the right to buy a stock at a set price until the options contract expires. The buyer of a put has the right to sell a stock at a set price until the contract expires.

If you own a stock, a protective put position is created by purchasing put options on the name or something highly correlated to the stock. And, at a quantity that will roughly trade one to one with your position. The put allows the owner to sell the underlying stock at the price predefined in the options contract. This is the mirror trade to a covered call which involves selling the right to buy a stock owned. Investors that are more comfortable with covered call options can think of purchasing a put to protect a long stock position, much like a synthetic long call.

The benefit of a protective put strategy is it helps protect against losses during a price decline in the assets name, while still benefitting from capital appreciation if the stock increases in value. Of course, there is a cost to any insurance against big losses: in the case of a protective put, it is the price of the option. Essentially, if the stock goes up, you have unlimited profit potential (less the cost of the put options), and if the stock goes down, the put goes up in value to offset losses on the stock.

Removing the Mystery

Assume you own 100 shares of ABC Company at $50 per share from April 2020. The cost of this trade was $5,000.

The stock is now trading at $65 per share, and you think it might go to $70 or more. However, you are concerned about stablecoin problems and the Fed putting the kibosh on growth.

A protective put reduces risk if you maintain your position in the stock so you benefit if it reaches your $70 price target. At the same time, the put offers protection in case the market weakens or there is an unforeseen event with the company you own.

Example

Let’s say the stock is trading at $65, and suppose you’re tired of seeing your gains erode so you decide to purchase the 62 ABC Company October put option contract (the underlying asset is ABC Company stock, the exercise price is $62, and the expiration month is November) at $3 per contract (option price) for a total cost of $300 ($3 per contract multiplied by 100 contract shares).

If ABC continues to go up in value, your underlying stock position increases as normal and the put option falls “out of the money” (it can’t be exercised). For instance, if, at the expiration of the put contract, the stock reaches your $70 price target, you might then choose to sell the stock for a pretax profit of $1,700 ($2,000 profit on the underlying stock less the $300 cost of the option) and the option would expire worthless. It the stock went to $74, your overall net would be $2100. And you could realize it without having concerns about a sinking price.

But what if the price did get beaten up? If your fears about the market were realized and the stock was negatively impacted, your capital gains would be protected against a decline by the put.

Here’s how:

Assume ABC Corp. common shares declined from $65 to $55 prior to the option’s expiration. Without owning the put, if you sold the stock at $55, your pretax profit would be just $500 ($5,500 less $5,000). If you purchased the 62 ABC October put, and then sold the stock by exercising the option, your pretax profit would be $900. You could then sell the stock at the (put) exercise price of $62. As a result the profit from the put position would be $900. To calculate, use the $500 profit on the underlying stock, plus the $700 from the in-the-money put profit, less the $300 cost of that option. Compare this with a profit of $500 without the option contract.

The cost of the option doesn’t take much away from upside potential, by it protects against downside losses. If you think your stock price will not move in either direction, a put option may not benefit your strategy.

Circumstances to Consider Put Protection

Protective puts can be a useful strategy for traders and investors that expect a short- or intermediate-term decline in the price of a stock they own and have reasons not to sell. The reasons could be tax related, you may be somehow restricted from selling the shares, fierce volatility in the share price, it is exposure to the company you work for and selling is not yet permitted, building the position in thinly traded shares took time, etc.

Any one of these reasons might make it prudent to consider a protective put. Additionally there may be an event such as an earnings report that you expect will drive the price in ne direction or another, and you want to protect against the downside risk of that report.

Take -Away

Option protection in the form of puts comes at a cost that the investor needs to factor into their overall strategy. However, in volatile markets, knowing you’ll capture a large part of the upside if your stock moves up, and are protected from profit erosion if the stock declines allow for more overall comfort with the limited risk in the position.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.nerdwallet.com/article/investing/put-options

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