Category: Markets

 

Small-Cap Stocks Have Shifted into Outperformance Mode

 

The behavior of drivers I witnessed while driving south from New York to Florida after Labor Day reminded me of reactions prevalent among market participants. Behaviors that literally drive travelers; from the professional (truck driver) to the guy in the sports car, or the family cruising in the SUV, also impact investor behaviors. There are people in the markets and on the road,  especially professionals, that always seem to know things first and how to respond. There are also impatient drivers and investors, those that want fast results, and safer people just trying to be prudent. They’re all on the same road, but their level of expertise and reason for being there is different, so is their ability to change when needed.

My personal driving style is risk-averse; I just want to arrive alive. My normal pace is about 7 miles per hour above the posted speed limit. This is often a little slower than those around me, but not so slow as to annoy others on the road. During this most recent road trip, while just south of  Annapolis, there was a significant number of cars on the road, yet the pace was brisk. We were all making good headway (just as investors in large-cap, especially tech, have over most of the summer had been). Like these investors, I let my guard down with everyone else who had grown comfortable with the velocity that we were moving. I was startled from my comfort when a car came past exceeding the average speed by 15-20 mph. I then noticed that a few of the cars around me increased their own pace.  People are inclined to increase their risky behavior when they see others less cautious and benefitting from it. As far as I can tell, the truck drivers didn’t change their behavior.  As professionals, they learned from experience and training what was best for them. A few miles past where the cars sped up, I saw a number of vehicles, mainly trucks exiting the interstate. This got my attention, and I considered doing the same as these drivers are often more in the know than the occasional vacationer like myself. Without a known alternative route to take me where I wanted to go, I decided not to.

It did not take long before I realized why the professional drivers exited. The car that startled me as it raced past earlier had just gotten into an accident. It was left overturned with steam coming from what I assume was the front.  The cars around me quickly slowed their pace to the speed limit. I reduced my speed as well; I also lowered the volume on my music and placed my hands firmly at 10 & 2 o’clock on the steering wheel. Seeing what could happen caused us all to be safer drivers. For some of us, that lasted about ten miles. After that I saw people begin to resume their speed. For others, they shook off the reality of the possibility of crashing sooner and resumed their pace quickly. This wreck wasn’t the only one I witnessed on my 1200-mile drive. Each time I saw caution temporarily increase among those around me. The stock market has behaved the same way throughout 2020. On two occasions we’ve experienced severe and sudden downturns; after each, people have quickly resumed their pace.

Stock Market Highway

Leading up to the late February 2020 record-level highs in the major indexes, we saw many investors speeding into the market. Tech stocks were especially popular, but many sectors had continued strength as we ignored warnings of an overextended market, sorted out pandemic risks, and the idea that the pace may be dangerous. The markets did come screeching to a halt after President’s Day  as some participants exited out of equities and others took alternative routes to stocks most likely to benefit from a response to the pandemic.

The 30% crash ending in March caused many to head to the sidelines as the reality of what could happen became reality. Some of these investors stayed cautious and missed opportunities as the market rose again. Others pivoted to companies that eventually proved to be the darlings of the situation. This included big tech, pharmaceuticals, and online retail.

 

Source TradingView.com – NASDAQ 100 E-Mini as Proxy for NASDAQ 100 Stocks (1 year)

In the past few weeks, these darlings, the companies that had been speeding the most after the earlier crash, have hit another rough patch. During the last 14 days (Since September 4) the NASDAQ 100 is down 5.9% as investors move money out and find different avenues.

Taking an Exit

On September 2, thanks to tech stocks and other COVID related plays, the large-cap indexes had reached a new all-time high. In the short time since then, they have given up more than 10% (NASDAQ 100). Although this rapid selloff is not currently as large as the 30% route in March, it was rapid and exceeds the psychological 10% level that investors react to.

The question now is, is this a pause before large tech investors begin “bargain” hunting, or have they shifted their focus. Chart comparisons for popular indexes may be able to answer this. If the pattern holds, it looks like investors may have exited the large-cap tech highway and found an alternative route in small-cap investments. This is starting to become visible when comparing major index results over the past 14 days, and money flows among ETFs.

While the three most quoted large-cap indices are down over the past two weeks, the small-cap stocks, which weren’t getting much attention during the race to the new peak, have significantly outperformed as money was taken off the table in the high flying large caps and placed instead in companies with lower market caps. This may prove to be a smart detour as the economy gets on a stronger footing.

 

 

From Friday, September 4 through Friday, September 18, the Russell 2000 index showed positive results while the DOW 30, S&P 500, and NASDAQ 100 were down meaningfully.

 

 

Fund flows into ETFs with performance that tracks small-cap indices have outpaced flows into large-cap funds. This change suggests that market participants selling out of large-cap have not left the market. They have just adjusted the road they believe is now safer and could offer a better return.

 

Shifting Gears

The small-cap companies represented in the Russell 2000 rely less on profits from doing business overseas than the large-cap indexes. As the U.S. pace of recovery is strong, it makes sense to look domestically for value. Larger corporations with stable and stronger financials were the “flight-to-quality” trade early in the pandemic. Unwinding these trades also has the effect of cash moving back into a more diversified position.  Domestic small-caps also have less international exposure, they are more shielded from sovereign and other geopolitical risks. The U.S. relationship with China, Brexit concerns, and a Presidential election may complicate global investing. This bodes well for companies that primarily have their operations in North America.

Though far from the “best-ever” economic levels we saw pre-pandemic, data has been improving. The unemployment rate is at 8.4%, this is much better than what many economists had forecasted for the remainder of the year, manufacturing has also expanded, and confidence is high

Take-Away

The relative increase in small-cap stock interes shows that investors think the run-up in companies that benefit from social distancing are low on gas.

Small-cap stocks are providing somewhat of a refuge from the rout that tore through equity markets this month. This signals that investors see brighter days ahead for the economy as pandemic lockdowns are lifted.

Not unlike highway driving, market movement is the cumulative effects of all the behaviors of those involved. It makes sense that there are some investors who have already begun leaving the large-cap companies that had treated them well and are now taking other routes. The conditions are changing, it may be time for investors to take it off autopilot and adjust once again for what may be called for.

Paul Hoffman

Managing Editor, Channelchek

Suggested Reading:

Do Analyst Price Targets Matter?

Fear of Missing the Next Apple

A Virtually Perfect Time to be in This Business

 

Enjoy Premium Channelchek Content at No Cost

 

Each event in our popular Virtual Road Shows Series has a maximum capacity of 100 online investors. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

 

Sources:

Nasdaq, tech stocks coming out of correction

Small Caps Emerge Relatively Unscathed in Megatech Bludgeoning

ETF.com

 

 

Half the Analysts Following Apple Have a Buy Rating Even Though the Stock is Above Their Target

 

The shares of AAPL have surged above $500 per share after having risen 70% year to date.  Most of the surge has come since the company announced a four-for-one stock split on July 30^th.  Since the stock split announcement, the shares of AAPL have risen approximately 30%.  Sixty-one percent of the analysts following the stock have a positive rating on the shares of AAPL despite the shares trading above price targets.  The highest price target is $520 per share, and the average price target is $430 per share.  Whether or not analysts following AAPL raise their price targets or lower their ratings remains to be seen.  The current disparity, however, raises a bigger picture question: do analyst price targets matter at all?   In theory, an analyst’s price target is an indication of where an analyst thinks the stock will trade at a future date (usually twelve months).  As such, the difference between an analyst’s price target and the current stock price is a measure of how much an analyst believes the stock is under or overvalued.  In reality, price targets do not fully reflect an analyst’s sentiments regarding a stock for reasons discussed below. 

Bull Case (price targets are useful)

Price targets are regulated and can not be arbitrary. Following the collapse of Enron in 2002, regulators added additional restrictions regarding the use of price targets.  FINRA rules 2241 and 2241 require that price targets have a “reasonable basis” and include a disclosure of risks that may impede achievement of the price target.  Most analysts will justify their price targets mathematically, perhaps by applying a price-to-earnings ratio, a sum-of-the-parts calculation, or a discounted cash flow estimate.

Price targets imply direction more than magnitude.  As mentioned earlier, price targets represent an analyst’s estimated value of a stock.  That value, however, is not static.  It may be based on many factors that are constantly changing, including company fundamentals, its competitive environment, overall stock market conditions, interest rates, and many other factors.  In theory, an analyst should be changing his or her price target every day if not continuously.  This, of course, is impractical.  As such, investors should pay more attention to the direction of price targets, especially when they are updated.  A study by researchers at the University of Waterloo and Boston College found that analyst target price revisions are more accurate predictors of future stock price performance than the actual price target.

Price targets lag behind changes in fundamental company developments but will adjust. Analysts will typically review their price targets whenever they write a report.  They will take into account all changes that have occurred since their last report.  However, they will probably not make a change to their price target unless the change is significant.  If a drop in interest rates warrants raising a price target by $0.50, they may decide to wait until conditions warrant a larger change.  Consequently, price target levels typically lag minor changes in company fundamentals or other data points.

Bear Case

The analyst just raises their targets when they are hit.  Although analysts tend to think of price targets as a way to communicate their feelings on a stock, some investors and traders view them as a price limit for buying the stock.  Investors and traders get frustrated when analysts simply raise their price targets when stock prices reach their target. The chart below shows the stock price of Apple shares (yellow line graph) and the median twelve-month price target for Apple (white line graph).  As you can see, the two lines mirror each other, with the gaps growing during periods when the stock price has stagnated.  As indicated earlier, this may be a function of the fact that analysts are not constantly changing their targets, instead of waiting until the fundamental change is large enough to make a major move.  Often, such a move occurs when a company releases earnings or other news.  Of course, such an announcement often is associated with an increase in the company’s stock price.  Analysts try to stay ahead of the stock price, but that is not always possible when there are sudden moves.

 

 

Price targets are sticky on the downside.  Price targets typically increase over time.  If an analyst used a P/E ratio to set a price target, the price target would increase each year, assuming the company is growing earnings.  Occasionally, company fundamentals or other factors deteriorate, causing an analyst to lower high price targets.  This is certainly true in situations where a company makes a major negative announcement.  It is less true when a company’s fundamentals deteriorate slowly.  It is not unusual for an analyst’s price target to become outdated under such a scenario.

Conclusion

Price targets are a second tool (in addition to a stock’s rating) for analysts to communicate feelings about a stock’s value.  Price targets can become outdated when a stock’s price moves quickly.  However, that does not mean it is not important.  Investors and traders need to be cognizant of the limitations of using price targets for making investment decisions when making decisions regarding buying and selling stocks.  Price target changes may provide more information that the price target level.  Often, the magnitude of the change or the reasons behind the change tell a more complete picture.

Suggested Reading:

Investors Should Pay More Attention to ATM Offerings

Investment Journalists Would Make Horrific Fund Managers

Fear of Missing Out on the Next Apple

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Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

Sources:

https://www.barrons.com/articles/wall-street-analyst-stock-price-targets-51561597085, Al Root, Barron’s, June 27, 2019

https://realmoney.thestreet.com/articles/08/03/2013/why-price-targets-matter, James Deporre, Real Money, August 3, 2013

https://www.theglobeandmail.com/globe-investor/investor-education/what-every-investor-should-know-about-analysts-price-targets/article627565/, John Heinzl, The Globe and Mail, March 29, 2012

https://financialpost.com/investing/analysts-target-prices-rarely-accurate-global-study-finds#:~:text=%E2%80%9CWe%20find%20that%20analyst%20target,subject%20to%20conflicts%20of%20interest.%E2%80%9D, David Pett, Financial Post, March 07, 2013

https://www.finra.org/rules-guidance/rulebooks/finra-rules/2241, FINRA

https://osboncapital.com/price-targets-are-obsolete-why-are-they-still-a-thing/, John Osbon, Osbon Capital Management, September 12, 2018

 

SPAC Candidates, Blank Checks, and Leaving More to Investors

Former House Speaker Paul Ryan knows a lot about being a candidate. The former Speaker of The House was Mitt Romney’s vice-presidential running mate. He won elections for The House of Representatives eight times by defeating challenger Jeffrey C. Thomas in 2000, 2002, 2004, and 2006 elections. In the 2008 election, Ryan defeated Democrat Marge Krupp. He just announced he’s creating a special purpose acquisition company (SPAC). The IPO shell will be among the latest in the torrent of SPACS popping up this year. Paul Ryan will soon be aggressively looking for an acquisition candidate as part of his newly formed business.

 

Organization of the SPAC

Ryan is expected to serve as chairman of the soon to be formed Executive Network Partnering Corp. (ENPC).  ENPC will look to attract roughly $300 million in an initial public offering (based on demand).

 

The new vehicle’s ticker symbol will be ENPC. Relative to traditional shell IPO vehicles, ENPC will provide longer-term incentives for its stakeholders and scaled-down fees for underwriters. Founders of ENPC won’t be permitted to sell any of their shares for three years after any merger. Similar vehicles allow for sale when shares trade above a certain level or after a year from closing.

 

SEC Filing

ENPC is expected to file documents with the Securities and Exchange Commission in the coming days. This filing will outline the structure specifics. They’ve chosen the acronym CAPS to refer to the vehicle whose terms are supposed to be more investor-focused. The underlying reason for choosing “CAPS” is it is a palindrome for SPAC and can mean “capital which aligns and partners with a sponsor.”

 

 

More Competitive

Management competence and what their experience brings to getting a worthwhile deal completed is the main component investors look for when investing in this form of IPO. Terms are also high on the list of what should be analyzed before any monetary commitment.

 

Typically, SPAC founders are awarded shares equivalent to roughly 25% of what is raised when the initial IPO closes. As you might imagine, that becomes an above-average payday for their efforts. Under the expected ENPC terms, Ryan and the other creators will have the right to buy roughly 5% of the shares and then reap another 20% of the stock appreciation if share price increases by more than 10%.

 

They also plan to slash fees to Wall Street banking organizations. Evercore Inc. is the sole underwriter of the blank-check fund. They agreed to be paid 1% of the size of the vehicle; this is half of the usual 2% upfront of other SPACs. When a merger deal is struck, the same underwriters typically receive another 3.5%. With Paul Ryan’s SPAC, Evercore will get a separate, smaller advisory payment. ENPC is free to work with other advisers on any subsequent merger deal.

 

 

The Year of the SPAC

So far, in 2020, 75 new SPACs have been listed, with a total raised adding to $29.9 billion.  This is more than twice what was raised during all of last year. There is no telling when or why this pace may begin to slow, but over the past eight months, SPACs have already attained the highest volume ever in one year.  They have accounted for approximately 43% of IPO volume in 2020.

 

Earlier this Summer hedge fund billionaire William Ackman raised $4 billion for the largest SPAC ever created.  Last month, health-care-services provider MultiPlan, Inc. announced it was merging with a blank-check company run by Michael Klein in the largest transaction ever at $11 billion.  

 

Take-Away

The appetite for investors eligible to participate in a SPAC is still very high. The sheer number of “blank check” companies being formed is starting to push their founders to provide more to investors and negotiate better deals with banks and other service providers and consultants. “Big names,” including Paul Ryan, who sits on the board of FOX Corp., which owns The Wall Street Journal and other large media outlets, help bring attention to their intended deals.

 

Suggested Reading:

Special Purpose Acquisition Corporations (SPAC) Attracting Investors

Can AI Skyborg Technology Create Unpredictable Yet Consistent Military Aircraft?

Are Dual Class Stocks a Mistake for Investors?

 

Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

 

Sources:

Will 2020 Go Down as the Year of the SPAC?

https://en.wikipedia.org/wiki/Paul_Ryan

Paul Ryan Becomes Board Member of FOX News Corp.

Former
House Speaker Ryan to Chair Blank Check Company

Wall Street Banks Are Cashing in on the Boom in Blank-Check Companies

 

 

Investing, Gambling, and Trading (Which are you Doing?)

 

“Oh, that’s gambling,” my mom said. We were talking about an investment I recommended to her two months earlier. She had followed my recommendation to purchase the security, which closely follows gold prices. It went up. In fact, I checked it while on the call and saw it was up 13.7%. The last time I had a conversation with my mom, it was even higher at 19.2%. Gold then retraced a bit after its strong run. For those that pay attention to these markets, the recent dip was not unexpected. I was happy with the position, mom was confused. “Why didn’t you have me sell it,” she asked?”

 

I had recommended the security purchase as an investment, not as a trade. The added diversity it brought to my parent’s portfolio, and perceived downside risk was why I suggested it. Those elements hadn’t changed. It still represents a good position relative to all the factors that went into this decision for them. Additionally, in my mind, there is no asset with a more compelling story that I’d replace it with right now, including cash. Especially considering the joint account owners are both in their eighties. As an investment, there is always a risk of loss, but it is not a gamble in the way rolling dice is. I should mention that the position wasn’t put on as a trading play. There have been and will be future transactions (trades) involved, but we weren’t trading this stock, they are invested in it. After all, these are retirement assets.

 

Today, many people use the terms investing and trading interchangeably. They’re both different activities and gambling is completely separate from each of them. There is a bit of overlap. All three seek to increase wealth. Two try to increase wealth by price movement, these two are investing and trading, they are not the same and require different skills and knowledge.

 

Investing

Accumulated capital that has been allocated to assets with the intent of growth and producing profit is financial investing. The return on investment is generally expected to come from income or price appreciation. The expectation of a return over time in excess of the initial outlay is key to investments. At times this return will be positive; if the investment goes as expected, the return can, of course, also be negative. Seldom will it be unchanged.

 

There is risk with investing. This risk is commonly linked with potential rewards and is measured against a time horizon.  Using real estate as an example, before purchasing an investment property, the investor may try to determine what the risk is that the property sits unrented, what is the risk of the value declining, what are the risks that cost of ownership increases beyond expected rental income, etc.. Investments in stocks, bonds, and funds have their own sets of risks. The primary investment risk is, “what if the investment is worth less than the cost at the time when I anticipate using the money for non-investment purposes.” Within that risk are all the nuances driving the market up and down, the impact of all the elements affecting the sector, and the time you will hold the investment. There is also the consideration of the universe of other options and which would create the best risk-adjusted return over the expected holding period.

 

Maximizing return at the end of the holding period should be the primary goal of investors. If they find themselves in the position, as many gold investors just did, where the asset jumps 10-20%, it then deserves to be reevaluated with the question, “Is there now a better place for this capital?” This is the same for investments that are not performing or underperforming. Part of investing is looking at nonperforming and holdings that are underwater and asking if it is still the best place for the capital. Seeking return by evaluating holdings, understanding alternatives to each holding, and working to maximize risk-adjusted return is investing.

 

Trading

More frequent transactions, such as the buying and selling of stocks, commodities, or even flipping houses, fall under the category of trading. The trader could be using the same vehicles as the investor to attempt to increase wealth. But the decision to buy has a limit in that they are looking for quick short-term moves in the asset. Traders of stock, commodities, and real estate are looking for these faster price moves with a goal of returns that outperform buy-and-hold investing. The skill includes awareness that the money committed is not an investment; it is instead the most important tool to generate income. The “tool” needs to be protected through risk management. A trader without money is no longer a trader; they are out of business. This is one reason a good trader has a time horizon – a bad trade should never become a long-term investment.

 

High-frequency traders look to earn incrementally over many trades during the course of the day.  They have a plan to manage the winners to exceed the losers in dollars they generate. Low-frequency traders may monitor the market for long periods of time before uncovering a setup they believe fits their description of a high probability trade.

Trading can potentially return much more than investing. Deciding when investments are most likely to move, rather than ride ups and downs, is often from a series of calculated speculations which fit a tested methodology of that trader. The trader, like the investor, has to be aware of changes that increase risk without adequate reward adjustment when comparing one trade over another.

 

Gambling

Wagering, betting or gambling, means risking money on an event that has an uncertain outcome and relies more on chance than does investing or trading. One big difference from investing is that gambling very often has a known outcome probability, both direction, and magnitude. These are called odds (50/50, 1,000,000/1, etc.). There are no firm odds for investors or traders. There could be a history of performance, but no mathematical outcomes that all participants are subject to.

Investors and traders, like the gambler, may also benefit from luck, but when done right, trading and investment decisions are based on expectations that don’t in any way include chance.

 

Take-Away

Whether you’re investing, gambling, or trading, it is important to have a plan. The plan should involve money management skills. For the investor, they should seek to move into another position when their holdings no-longer offer the best risk-adjusted return expectation. Traders should execute when the trade needs to be entered or exited. Win or lose, money management is key to a trader’s survival. Without capital, there is no trading, that would put them out of business. This can be said of gambling as well. Professional gamblers are able to continue only as long as they have money in which to play their game of choice. The average person that gambles by purchasing a lottery ticket is spending a few bucks, writing off the entry fee almost immediately as they spend it. They’ve purchased a fantasy that can last until they check their success. A raffle ticket, lottery, or spin of the wheel at a Church picnic is viewed as a donation. There are few who view their own gambling as investing and trading. Alternatively, there are many who transact with brokerage accounts acting on hunches and guesses who are leaving too much to chance. Successful investors and traders are more deliberate, more methodical. Hunches are not part of their evaluation.

 

As an aside, the account my mom spoke to me about is an investment account. She is going to hold onto her gold position until something else makes more sense to replace it.  She is not a trader. However, her gambling luck is top-notch. Last year she won a $50,000 Mercedes in a Church raffle.  Perhaps her exclaiming “that’s gambling” was intended as a positive.

 

Paul Hoffman

Managing Editor, Channelchek

 

Suggested Reading:

Contango, ETFs, and Alligators

Trading vs Investing vs
Tomorrow

Millennials Could Use Help With
Investing

 

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Stocktwits

Actively Managed Funds are No Guarantee for Beating the Market

 

According to Dimensional Fund Advisors, while the types of businesses most prominent in the market vary through time, the fact that a small subset of companies’ stocks account for an outsized portion of the stock market is not new. Given the difficulty of predicting which companies will outperform or underperform supports the importance of having a broadly diversified portfolio.  Are individual stocks or index funds the best path for gaining exposure to the market?

 

The Case for Index Funds:

Index funds offer a low cost means for diversified exposure to the market or segments of the market. Index funds help minimize company-specific risk that can dent returns. During the March 2020 market sell-off, many individual stocks performed substantially worse than the S&P 500 index, including those vulnerable to travel restrictions and social distancing, including cruise lines, airlines, and hotel chains and experienced a slower recovery as the market rebounded. The main argument against owning an index fund is the inability to outperform the market. However, the broader market has provided respectable returns over time. For example, during the period January 1970 through June 2020, the S&P 500 annualized return with dividends reinvested was 10.4%. Excluding dividend reinvestment, the annualized return was 7.3%.

 

The Case for Individual Stocks:

Owning individual stocks can be a good choice for investors with ample funds and the ability to own enough equities across industries to be appropriately diversified. Due to low trading costs, a portfolio of individual stocks can be bought at relatively low cost, and the investor can easily track what he/she owns, dividends received, and can vote their shares on company matters. However, there is still the issue of monitoring holdings, rebalancing when appropriate, and staying up to date on market trends and/or company developments. Importantly, for investors that have time to make informed choices, there is the potential to outperform the market or spot that next Apple, Amazon, or Facebook that will accelerate the path to wealth.

 

The Take-Away

Investors should choose investments that are appropriate based on return objectives and risk tolerance. This likely encompasses a mix of active and/or passive funds, individual company equities and/or other asset classes. While actively managed funds can be a great option for certain strategies, S&P Global Indices found that many actively funds underperform their respective benchmarks. Because actively managed funds are by nature constrained from owning broader benchmarks, they risk missing out on the stocks that drive broader market returns. As a result, many investors may elect to own individual stocks at relatively low cost for the actively managed portion of their portfolios. Selecting a subset of individual micro or small-cap stocks for a portfolio that may include large cap index funds for broad market exposure and diversification, may offer more opportunity to capture alpha due to smaller cap companies being underfollowed by the analyst community and the potential for higher growth. For micro and small cap investors, www.ChannelChek.com may be an excellent resource for generating investment ideas.  

 

Investors Should Pay More Attention to ATM Offerings

Trading vs Investing vs Tomorrow

Channelchek Experiences Meteoric Activity Increase

Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

 

Sources:

Large and In Charge? Giant Firms atop Market Is Nothing New, Dimensional Perspectives, Dimensional Fund Advisors, 2020.

Index Funds vs. Individual Stocks: What Does the Coronavirus Market Collapse Teach Us
About Both Investing Strategies?, USA Today, Adam Shell, March 23, 2020.

S&P 500 Return Calculator, with Dividend Reinvestment, DQYDJ, 2020

SPIVA U.S. Year-End 2019 Scorecard: Active Funds Continued to Lag, S&P Global, S&P Dow Jones Indices, Berlinda Liu, April 8, 2020.

Capital Raises by ATM Equity Offerings, Combined with Good Stewardship, Can Serve Companies and Investors

An at-the-market (ATM) offering is a type of follow-on offering of stock used by publicly traded companies to raise capital over time. Under a typical ATM offering program, a listed company incrementally sells newly issued shares on the exchange through a designated broker-dealer at prevailing market prices rather than employing a traditional underwritten offering at a fixed price.

According to Bloomberg Law, 79 ATMs were completed in the first quarter of 2020 representing proceeds of $10.1 billion.  In 2019, 266 ATM offerings raised over $31 billion.  The chart below summarizes ATM offerings on U.S. Exchanges from 2014 through the first quarter of 2020.

 

Advantages:

Greater control – A company has more control over the timing of sales, the amount and the price received. Additionally, a company can more precisely match the sources and uses of funds.

Less disruptive to the stock price – Unlike a managed public offering, ATMs are less disruptive to the stock price because sales are limited to a specific percentage of trading volume and mask the seller.  Additionally, selling shares into the existing trading market can result in a lower cost of capital relative to other financing alternatives where the shares are sold at a discount.

Can be set up quickly – Generally, ATM offering programs can be implemented in relatively quickly for issuers that are eligible to use a short form S-3 registration statement and have an effective shelf registration statement.

Disadvantages:

ATMs may be used indiscriminately – Given their ease, managements may use ATM offerings to raise capital indiscriminately and cause dilution to existing shareholders.

Investors may be unaware – Unlike a public offering that may be more visible to investors, shareholders need to pay attention to filings, such as the Form 10-Q, to be aware of the company’s intention to use an ATM offering program and to track shares issued under the program.  

Not suited for lump sum capital raises – Because sales are limited to s certain percentage of daily trading volume, ATMs are best suited for raising capital over time and not suited for raising large amounts of capital in a short time frame.

The Take-Away

ATM programs can be an effective tool for management to use for managing working capital needs and raising capital in advance to fund specific capital projects. However, management teams should use ATM programs effectively and efficiently to avoid unnecessary shareholder dilution.  Investors should also pay attention to company filings to monitor such programs and assess whether management teams are good stewards of capital.  

Suggested Reading:

Will 2020 Go Down at The Year of the SPAC

Will there be an
Explosion of New Acquisitions?

Can the Market
Continue to Defy Gravity?

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Channelchek Content at No Cost

Sources:

At the Market Offerings Raising Equity Capital in Volatile Markets, Goodwin Law, December 29, 2008.

Analysis:
At-the-Market Offerings Trend Upward in Q1 2020, Bloomberg Law, Preston Brewer, April 10, 2020.

At-the-Market
Offerings, Journal of Financial and Quantitative Analysis, Vol. 54, No. 3, Matthew T. Billett, Ioannis V. Floros, and Jon A. Garfinkel, June 2019.

 

 

About Virtual Investor Day 2020

 

Welcome to the inaugural Virtual Investor Day Conference (VID) – a conference that is focused on you, the investor!

Jointly hosted by Follow the Money Investor Group and IR.INC Capital Markets Advisory, and sponsored by Noble Capital Markets, VID is a two-day, invitation-only event featuring nine resource-focused public companies that have recently attracted market attention.

VID differentiates itself by offering our featured companies an opportunity to meaningfully share their story with you. Featured companies will present a full 30 minutes in order to better outline their investment opportunity, and we will provide you, the investor, 15 – 20 minutes to ask live follow up questions after each presentation.

During VID, you will have the chance to interact with other investors and we encourage you to engage and take part in the numerous polls and other features that will be live during the conference.

In these turbulent times, characterized by uncertain global economies and significant central bank stimulus, many people are perhaps feeling unsure about how to manage both the opportunities and risks that are being presented . To that end, we have three guests joining us to speak on this exact topic:

Frank Holmes, CEO of US Global Investors

Nico Pronk, CEO of Noble Capital Markets

Rick Rule, CEO of Sprott US Holdings.

See you at Virtual Investor Day on August 11th and 12th!

 

Meet The Presenters

Rick Rule Rick Rule has devoted over 35 years to natural resource investing. His involvement in the sector is as broad as it is long; his background includes mineral exploration, oil & gas exploration and production, water, agriculture, and hydro-electric and geothermal energy. Mr. Rule is a sought-after speaker at industry conferences, and a frequent contributor to numerous media outlets including CNBC, Fox Business News, and BNN. He founded Global Resource Investments in 1993 and is now a Senior Managing Director of Sprott, Inc., a Toronto-based investment manager; and CEO and President of Sprott US Holdings, Inc., where he leads a team of skilled earth science and finance professionals who enjoy a worldwide reputation for resource investing. Sprott U.S. Holdings Inc. is a holding company made up of three separate and distinct companies: Sprott Global Resource Investments Ltd., a FINRA Registered Broker/Dealer; Sprott Asset Management USA, Inc., an SEC Registered Investment Adviser offering managed accounts; and Resource Capital Investment Corp., an SEC Registered Investment Adviser that manages Limited Partnerships. These three companies make up the U.S. Subsidiaries of Sprott Inc., and are active in securities brokerage, segregated account money management and investment partnership management involving both equity and debt instruments, across the entire spectrum of the natural resource industry. Trey Wasser Mr. Trey Wasser, brings over 33 years of experience in capital markets, brokerage and venture capital structures, and has specialized in equity/debt re-structuring and cash management. He was a corporate finance specialist with Merrill Lynch, Kidder Peabody and Paine Webber. He is the President, founder and Director of Research for Pilot Point Partners LLC and is the founder of Due Diligence Tours organizing analyst tours to hundreds of mining properties in North America.

Virtual Investor Day Sessions

Keynote Speaker Frank Holmes – CEO/CIO US Global Investors Tuesday August 11th @ 10:00 AM Eastern

Feature Company Day 1 – Presentation Ely Gold Royalties Tuesday August 11th @ 10:30 AM Eastern

Feature Company Day 1 – Presentation Chakana Copper Tuesday August 11th @ 11:30 AM Eastern

Feature Company Day 1 – Presentation Golden Predator Tuesday August 11th @ 12:30 PM Eastern

Feature Company Day 1 – Presentation Warrior Gold Tuesday August 11th @ 1:30 PM Eastern

Feature Company Day 1 – Presentation Palladium One Mining Tuesday August 11th @ 2:30 PM Eastern

Keynote Speaker Guest Speaker: Nico Pronk – Noble Capital Markets Wed August 12th @ 10:00 AM Eastern

Feature Company Day 2 – Presentation Blackrock Gold Presentation Wed August 12th @ 10:30 AM Eastern

Feature Company Day 2 – Presentation Jaguar Mining Presentation Wed August 12th @ 11:30 AM Eastern

Feature Company Day 2 – Presentation Regulus Resources Presentation Wed August 12th @ 12:30 PM Eastern

Feature Company Day 2 – Presentation Comstock Mining Presentation Wed August 12th @ 1:30 PM Eastern

Keynote Speaker Closing Speaker Day 2 Wed August 12th @ 2:30 PM Eastern

 

Disclaimer

Follow the Money Investor (“FTMIG”) is an online investor community that connects investors and public companies. Both FTMIG and IR.INC are not registered as a broker, dealer, exempt market dealer, or any other registrant in any securities regulatory jurisdiction and will not be performing any registerable activity as defined by the applicable regulatory bodies.

Both FTMIG and IR.INC and their affiliates do not endorse or recommend any securities issued by any companies identified on, or linked through, this conference. Please seek professional advice to evaluate specific securities or other content discussed during this event. Links, if any, to third party sites are for informational purposes only, and not for trading purposes. FTMIG and IR.INC. and their affiliates have not prepared, reviewed or updated any content on third party sites and assume no responsibility for the information posted on them.

What’s Moving the Market: Explained in Three Charts –  Part 2

The market continues to rise despite the negative impact of a pandemic and remediation efforts that have slowed down the economy.  In an article written on June 5, 2020, What’s Moving the Market: Explained in Three Graphs – Part 1, we explained the rise in three graphs.  The first graph showed a significant jump in personal income in April related to the government stimulus.  The second graph showed a large spike in personal savings in April as home-bound consumers decided to invest the money instead of spending it.  The third showed the increased weighting that a handful of tech stocks are having on the major indices implying that the market movement is due the success of a few companies that are less affected by the pandemic and not a broad-based representation of the economy.  These three trends witnessed in April have continued into the summer months.  But there is more to the story, as explained in the next three graphs.

Reason #1 – Retail investors have become active participants in the stock market. 

Households have been taking their stimulus money and putting it directly into the stock market.  Joe Mecane, the head of execution services at Citadel Securities, said that retail investors make up 20% of the market currently, up from 10% in 2019.  Retail online brokerages such as E-Trade, TDAmeritrade, and Charles Schwab have reported robust business activity in recent months in response to the stimulus and the erasing of commission fees.  The activity has created a FOMO (fear of missing out) among retail investors, which serves to push the share of retail-favored stocks even higher.  Goldman Sachs shows this outperformance graphically in the chart below.

Reason #2 – Investors have nowhere else to go

Valuation multiples have climbed as management and analysts lower expectations for 2020.  True, investors may be looking beyond 2020, expecting a strong rebound in 2021.  Still, multiples of 2021 results are high relative to historical levels.  So why do stock prices keep rising? Frankly, there is nowhere else for investors to put their money.  Bank deposits offer little return.  Government bonds, as shown in the graph below, provide returns below 0.5% unless you go out past ten years.

 

Reason #3 – Earnings reports for the second quarter are coming in above depressed expectations

It’s early in the reporting season, but results are generally surpassing expectations at a higher rate than we have seen in past quarters.  This may reflect increased caution by management and analysts given uncertainty.  Nevertheless, better-than-expected results will lead to higher expectations for future quarters.  John Butters of Factset provides the below scorecard for S&P 500 companies who have reported second-quarter results:

 

The three graphs presented above help explain why the market continues to rise.  However, they do not offer much insight into whether the market will continue to rise in the future.  There are just too many unknowns.  Will the stimulus that put money in investor pockets be extended? How will retail investors react when the market faces a downturn? Have management and analysts overestimated the downside of the pandemic, or were they just being overly cautious?  Only time will tell.

 

Suggested Reading:

What’s Moving the Market: Explained in Three Graphs – Part 1

Equity Markets Give a Lesson in Behavioral Psychology

Copying the Brightest Investment Ideas

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Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

Sources:

https://financialpost.com/investing/how-the-new-retail-investor-mania-is-changing-the-stock-market-game, Victor Ferreira, Financial Post, July 06, 2020

https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_072420.pdf, John Butters, Factset, July 24, 2020

https://markets.businessinsider.com/news/stocks/retail-investors-quarter-of-stock-market-coronavirus-volatility-trading-citadel-2020-7-1029382035#, Ben Winck, Markets Insider, July 9, 2020

Special Purpose Acquisition Corporations (SPAC) Attracting Investors

“So, we’re looking to marry a unicorn. So we’re prettying ourselves up for the most attractive possible partner…” – Bill Ackman, July 22, 2020

 

On July 21, Pershing Square Tontine Holdings raised $4 billion by offering 200 million units at $20 per share in the largest IPO of a special purpose acquisition corporation (SPAC). Several high-profile companies, including Nikola, Fisker, and DraftKings, agreed to merge with a SPAC as a means of going public instead of pursuing their own initial public offerings. According to SPACInsider, 59 SPAC IPOs raised $13.6 billion in 2019 with an average IPO size of $230.5 million. In 2020, 50 SPACs have gone public that raised $19.0 billion with an average IPO size of $380.1 million. During the period 2009 through 2020, there have been 274 IPOs that raised $65.7 billion.

What is a SPAC?

A special purpose acquisition corporation (SPAC), also known as a blank check company, is generally sponsored by an investor (i.e., Pershing Square Capital Management) and/or a management team and raises capital in an initial public offering (IPO) with the intention of completing an unidentified acquisition that meets the SPAC’s investment objective. The IPO proceeds are held in trust that can only be accessed to consummate an acquisition. If the SPAC does not complete an acquisition within a specified time frame, it must liquidate and return the trust proceeds to its stockholders. Once the SPAC finds a company to acquire, investors have the choice of staying invested in the SPAC or redeeming their shares, if they do not like the transaction, for the amount for which they were acquired.

The Rationale

SPACs offer an alternative to a traditional initial public offering as a way for companies to go public. For some companies, it may be difficult to go public due to size, lack of investor interest, or a challenging IPO environment. Some companies in a “hot” sector may chafe at the prospect of their stock price taking off after a traditional initial public offering meaning that they might have left too much money on the table. For some, merging with a SPAC may offer a less costly and/or burdensome means of going public. Importantly, SPACs offer an alternative for private equity and/or venture capital firms to exit their investments. Because sponsors include providers of private equity, some may view it as a sign of asset managers’ growing influence in the capital markets.

The Take-Away

Judging from the data below provided by SPACInsider, the number of special purpose acquisition corporation IPOs accelerated in 2017.

Source: SPACInsider and Noble Capital Markets

With no shortage of private companies capitalized by private equity and venture capital firms, coupled with well-recognized sponsors like Apollo Global Management and Pershing Square Capital Management launching successful SPAC IPOs, it is likely the trend may continue.

 

Suggested Reading:

Will Broadcast Mergers and Acquisitions Surge?

Will there be an Explosion of New Acquisitions?

Can the Market Continue to Defy Gravity?

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Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you  here.

 

Sources:

Bill Ackman and Tontine Holdings Rewrite the Terms for SPACs, CNBC, Kenneth Squire, July 22, 2020.

Nikola and DraftKings Stock Started As ‘SPACs.’ What Investors Need to Know, Barron’s, June 22, 2020.

SPAC IPO Transactions – Summary by Year, SPACInsider, July 2020.

Go SPAC Yourself, Techcrunch, Alex Wilhelm, July 22, 2020.

Bill Ackman’s blank-check acquisition company to begin trading on Wednesday after Raising up to $4 billion, Markets Insider, Ben Winck, July 21, 2020.

SPAC-and-Span: A Clean Exit?, Harvard Law School Forum on Corporate Governance, Carol Anne Huff, Daniel Wolf, Kirkland Ellis, July 9, 2015.

Electric Car Maker Fisker to Go Public Through SPAC Deal at $2.9 Billion Valuation, Reuters, Ben Klayman, July 13, 2020.

Big Blank Checks, The New York Times, Dealbook Newsletter, July 14, 2020.

Ackman-backed Blank Check Company’s Units Rise in NYSE Debut, Reuters, C. Nivedita and Joshua Franklin, July 22, 2020.

Why Robinhood Traders May Never Find the Next Apple

“I encourage people to educate themselves, but short-term
trading is more risky than long-term investing and I do worry about this risk
investors take…” Jay Clayton, SEC chairman, July 22, 2020

 

Are you growing weary of officials at different levels of government telling us how
they think we should protect ourselves? In the first half of 2020, it seems a record number of authorities, at times, openly ignoring their own advice, told us what’s “safe” and what’s “unsafe.” The advice is all worth considering before determining if you agree or not, but when it involves risk tolerance, that’s a very personal choice. So, if you disagree with the advice, it may be that you know what’s better for you when it comes to your own risk/reward tolerance. One recent warning that is worth considering occurred on July 22 on CNBC Squawk box. The Chairman of the U.S. Securities and Exchange Commission discussed what he thought was risky behavior, and the precautions retail investors can take to reduce their risk. What was said involves self-directed investors’ choice of stocks. The SEC does restrict the sale of unregistered securities to accredited investors, but commenting on investor’s valuation methods and holding periods seems barely within the purview of the SEC’s Congressional mandate.

The SEC’s stated mission is threefold:

• Protect investors
• Maintain fair, orderly and efficient markets
• Facilitate capital formation.

Based on the interview, it seems the activities of the latest crop of market participants are causing the SEC chair, Jay Clayton, to sprout some gray hairs. He’s concerned that individual investors are using assets for risky, short-term trades.  These are primarily younger market participants, taking full advantage of free online trades. Recently, according to him, they’ve been causing the price of “certain stocks” to skyrocket. If his concerns are accurate, the SEC may further address it as part of one of the three stated roles they serve. 

Protect Investors

The primary means the SEC “protects” investors is their disclosure rules and transparency requirements. These regs are designed so all investors, large institutions, or dabbling individuals will have access to basic facts about an investment prior to deciding whether or not they should transact. This is why the SEC requires public companies to regularly report specific financial and other pertinent information. The stipulation provides a base of knowledge for all investors so they may use it to judge for themselves whether to buy, sell, hold, or avoid an offering. It’s through the scheduled flow of timely, comprehensive, and accurate information that investors have a uniform basis for judgement.  

Chairman Clayton seems to have concerns beyond company reporting requirements. His worry is with the investor side, not the issuer side. Clayton specifically expressed concerns for smaller investors with very short holding periods. His words during the July 22^nd interview are:

“What we are seeing is significant inflows from retail investors, and they have the hallmarks of short-term inflows. And does that concern me? Sure. Because that’s more trading than investing…”

He continued by expressing:

“Short-term trading is much more risky than long-term
investing, and so I do worry.”

There will always be investors and traders looking to beat the market. This reality guarantees that there will always be people who find different methods than those that came before. Certain “styles” will seem to some to be unconventional, others risky, and to some just reckless. There seems to be a new “style” every few years. SOES trading, Japanese pairs, Tech funds, Bitcoin, Index funds, Leveraged CMOs, etc. Some of these blew up on participants while they were involved, others blew up later, and some methods, like many of today’s Robinhood traders, Bitcoin investors, and some Index fund buyers are still rewarding participants.

Should the Chairman of the SEC allow himself to be openly concerned for those involved so as to  “protect investors?” Probably not under this part of their mandate. Should he be concerned because it impacts the commission’s second mission; to maintain “fair, orderly and efficient markets?” Let’s explore further.

Maintain Fair, Orderly and Efficient Markets

The SEC oversees securities broker/dealers, exchanges, investment advisors, and mutual funds. A primary concern is “fair” dealing, protecting against fraud, and disclosure of important market-related information to investors. With this, they make rules, after all, fairness amongst all involved dictates that regulators act with clear guidelines, not arbitrarily. 

“Orderly” and “efficient” speaks to the manner and speed in which the commission handles all of the items on its plate. The markets are continually coming up with new products.  Over time each of the new products usually has variants. The variants eventually have offshoots. The broad spectrum of investment options the SEC oversees doesn’t just grow, it compounds. Similar to how investors are creative in their methods, those that serve buy and sell-side players also are inventive. Newly engineered investments require review. The SEC expedites these reviews for the benefit of all. An easy to understand example is their review of the Spyder ETF, which was a unique security in the 1990s. This product was quickly mimicked and also expanded to include many other specific indexes. After the SEC became accustomed to the product and quickly approving other transparent ETFs, they had to review and make determinations on novel ETFs such as the actively managed, non-transparent ETF. The SEC knows the markets work best if there are no bottlenecks to the approval of newly securitized offerings or exchange tools, but they must all be reviewed.

Are no-transaction-fee online trades a new invention. No. They seem to be an evolution of lower and lower fees that began since brokerage commissions became competitive in May of 1975.  The same (or better) service has been offered at lower and lower prices since then. Do the no commission brokers impact the market? Not in as large a way as “program trading” did when it first began or the introduction of computers or the reduction of brokerage commissions from $100 to $10 by Charles Schwab and others. So this is not of much consequence to the SEC. It provides even more access to the markets.

Although he did not name companies, Clayton spoke of stocks far exceeding normal valuations, which make them expensive by historical standards. He’s concerned the stocks may be rising more on emotion than prudent valuation processes. In his discussion, Clayton added that the SEC had issued guidance to brokers and investment advisors on how to give individuals proper warning about the risks they face when allocating capital in select equities. He did not suggest which equities, it is presumed he was thinking about companies like Tesla, which is up 240% YTD and 521% over the past 12 months. Tesla is the 10^th most popular stock on Robinhood. Many renowned investors are short this stock (TSLA), in fact current short interest in TSLA is $28.5 billion. So this is a very real battle of well-known investors with huge short positions and tens-of-thousands of Robinhood accounts impacting price movement.

The guidance he suggested is a further explanation of risks to investors. This, of course, is within the mandate of the SEC, and is fair in that it may help the understanding of risk, while not setting guidelines that would directly impact companies or individuals.

Facilitate Capital Formation

When Congress included the consideration of “capital formation” in the SEC’s mandate, it did not define the term. However, it is not an unfamiliar concept. It is generally understood that capital formation is a macro benchmark that measures changes in productive capital available in the economy. This includes enhanced infrastructure as the economic base of capital formation. It is however, most often defined as the ability for entities to raise funds. If funds are more available for the same or an increase in purposes, this constitutes capital formation. To reiterate, it is not the act of raising capital as much as it is the availability of capital that is capital formation.

Surely individuals trading in their Interactive Brokers, Robinhood, or All of Us accounts are not creating more capital. At the same time, it is not hindering capital formation. So, as it relates to the SEC mandate, this is not adding to why SEC Chairman Jay Clayton is so concerned.

How to “Protect Ourselves”

Referring to the inflows of assets into accounts from investors and the holding period, Clayton said this during the CNBC interview:

“Here at the SEC, when we think about that investor, we think about someone who’s investing for the long term: investing over time, doing it on a monthly basis…”

As a result of the concern very short holding periods (trading not investing), the SEC has issued guidance to brokers and investment advisors on how to give individuals proper warning about the risks they face when allocating capital in select equities, and statistical risk to overtrading. The active trading language is not new; the language on specific equities is not defined but presumed to mean so-called “Robinhood” stocks.

“I hope people are heeding that,” he said.

The age group most associated with online trading apps are “the millennials.” This generation takes a lot of criticism from the generations that are older than them. Their sanity is again questioned as they trade shares of stocks under $5, or load up on bankrupt companies like Hertz, and JC Penney, and when the online traders drive the price up on Tesla while Wall St. giants are short the stock. What is the right way and wrong way to invest is measured by results.  Today’s lack of transaction fees eliminates what had been a very large drag on results in the past. Perhaps it is the veterans relying on past performance to indicate future results that have it wrong. Time will tell.

These disagreements as to value are what makes markets. Investing goes through regular incarnations and reinventions. The use of technology has provided an environment where one need not be a Wall Street professional to have access to information and top execution. This latest generation that is comfortable with technology now finds themselves with discretionary investment accounts. They will make good trades and bad trades and we’ll all learn from each other. 

Paul Hoffman

Managing Editor

 

Suggested Reading:

Investment Portfolios are Checked Twice as Often by Millennials

The Supply of Cash and Stock Prices

Has Robinhood, the Online Brokerage Disruptor, Been Disrupted?

 

Enjoy Premium
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Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you  here.

 

Sources:

The Role of the SEC

The New Age of Investor Relations

SEC Chief Worries About Retail Investors Trying to Get Rich Quick

SEC Chair Speech

The
Genesis of Discount Brokerage

Bets Against Telsa Stock Approach $30b

SEC Chair Clayton on Squawkbox Transcript

SEC Investor Objectives

Investment Journalists would make Horrific Fund Managers

Tomorrow I’m going to pack a lunch before I head to work. I’ve learned that I can predict with a high degree of certainty that between 11:30 and 12:30, I’m going to feel hungry enough to benefit from lunch. That isn’t the only forecast I’ll make tomorrow. I’m going to estimate my car ride to the office will take 25 minutes with a 10% margin of error, and that the air conditioning in the office will be set at a temperature requiring something warmer than I’ll wear in the car. There are several other predictions I’ll make before heading to work that will make my day more rewarding, but I’m not going to predict the stock market. That would be a waste of time.

As a former mutual fund manager, I had my finger on the trigger of $50B. I’d head into Manhattan before dawn and determine how best to react if/when certain events occur. I wouldn’t try to predict or make a call about the event. Instead, scenario analysis and if-this-then-that planning kept the fund among the top five performers in its category. This lack of prediction (or predicting various scenarios and reactions) included economic numbers, Fed testimony, earnings reports, everything. After all, if these were predictable, the market would have already built them into prices. So the reaction was what I focused on, that’s where prediction for me was most profitable. I made sure I had a firm understanding of the expectations of others. If a majority of investors was sure of something, then there could only be two outcomes. They could be right, or they could be disappointed; either way, profit was usually found leaning in the opposite direction of the masses. This is the root of the axiom “
buy the rumor and sell the fact.”

Buy the Rumor

The current “rumor” is that the pandemic will not last forever. There are multiple ways it may end; vaccine, therapeutics, a high percent of immunity, or it could die of natural causes. The market has been trading higher based on the eventual return of business without distancing. How coronavirus meets its demise doesn’t matter to the professional or individual investor. They only need to know that it is a widely held belief that it won’t be with us forever. The timing is uncertain, so until there is more clarity when it will disappear, the uptrend in stocks may continue. The clear end to the virus may wind up being the end of the relentlessly positive equity market.

This thinking is, in large part, how successful contrarians execute their strategy. It’s also why forecasters are often more wrong than right. They haven’t accepted that there is the human factor that buys and sells on future expectations. They still retain the notion that believes the market will react off news as though investors were blindsided by the event.  We see it on CNBC and other major outlets all the time when one of the regular talking heads is stumped because a company reports higher earnings and the stock trades off, or a payroll number is below the prior period, and the market rallies. These are not people who accept that when an economic release or event comes out as positive as expected, profit-taking usually ensues. Instead, they are professionals with a large audience that expect that if a pharmaceutical company finds a much-anticipated cure, that its stock will always go up. It is far from a given. Rumors, if resolved on expectations, become an opportunity for profit-taking, this tends to change the direction of the stock prices for a period as profit-takers undermine any strength.

Sell the Fact

Once information becomes public, it is by definition too late to be early in taking a position. Contrarian traders or “news” traders like to trade against the tone of the report. This sounds daring, but the market has been building the forthcoming set of facts into prices. If one believes the stock market is currently priced for a perfect scenario, you should consider if it will be more likely to be disappointed, even in the rare case that perfection occurs.

Traders and investors that have gone against today’s economic gloomy forecasts and been long stocks should decide on scenario strategies now, before the eventual full return to work. The market sentiment leading up to the eventual “all-clear” sign on the pandemic has been extremely positive. Even as the rate of infection rotates from state to state, the market has climbed higher. The climb has been dramatic in some industries like pharmaceutical companies in different phases of testing.  Holders of these stocks should also pre-think a plan, especially if the market price seems to have built-in a win. Some of these companies, whether they are part of the solution or not, may face severe downward pressure.

Make a Plan

Buy the rumor and sell the fact doesn’t mean to act on any half-baked expectation. It means to buy in anticipation of almost certain news/events to come, and then sell once the news has been presented, preferably with a pre-thought out plan.

It isn’t difficult to forecast the eventual end of a pandemic. The world has a long record of surviving and thriving each and every one. With this in mind, develop a plan. This is true of any Covid or non-Covid related exposure, but it’s especially pertinent today in the Covid stocks. If tomorrow a therapeutic is shown to have complete efficacy, what repositioning will you take? Both the beaten-down sectors such as hospitality and energy and so-called “Covid stocks” like communications and online retail will react sharply.

The resolution of the pandemic should quickly change investors’ buy and sell lists dramatically. Determining now what the lists will look like will reduce hesitation to act later.  The headlines of major papers have been telling us the market is overbought since the first uptick after the final March 23 route was completed. We have been in rally mode most of that time. The Nasdaq has even made new all-time highs. If the pandemic abruptly shows signs of abating, the major news outlets will be more positive about the market’s prospects. What are the chances it won’t defy these forecasters again? 

Managing Editor

Paul Hoffman

 

Are Individual Investors the Smart Money?

The
Risk of Economic Confidence Waning

Virtual
Roadshows are the New Normal

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Channelchek Content at
No Cost

 

Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

ESG Investing: Is Everything Else Irresponsible?

Responsible investing dates back as far as investing itself. In the 18th Century, Quakers and Methodists had both laid out clear guidelines to their followers over the types of companies in which they should invest, as did a range of other religious groups. Responsible investment became more formalized in the 1960s around the time the mutual fund industry started to gain acceptance. Questions around responsible investment reflected the social issues of the day, including the rise of the civil rights movement. It has continued to evolve as those demands from society have changed.

ESG (Environmental, Social, and Governance) investing refers to a class of investing that is also known as “sustainable investing.” “Sustainable Investing is an umbrella term for investments that seek positive returns and long-term impact on society, environment, and the performance of the business.

Notably, there are several different categories of sustainable investing, including impact investing, socially responsible investing, ESG, and values-based investing. Investors typically assess ESG factors using nonfinancial data on environmental impact (such as climate change and carbon emissions), social impact (including items such as employee satisfaction), and governance attributes (such as board structure). A key question is whether investors can “do well” in their investments while at the same time “doing good” from a societal perspective.

 

How Big Is ESG Investing?

Globally, the percentage of both retail and institutional investors that apply environmental, social, and governance (ESG) principles to at least a quarter of their portfolios jumped from 48% in 2017 to 75% in 2019. Reportedly, the largest amount of sustainable investing assets is in Europe, totaling $14.1 trillion, followed by the United States with $12 trillion. According to various sources, from 2014 to the beginning of 2018, assets under management with an ESG mandate held by retail and institutional investors grew at a four-year compound annual growth rate of 16% in the United States.

The Deloitte Center for Financial Services (DCFS) expects client demand to drive ESG-mandated assets to comprise half of all professionally managed investments in the United States by 2025. According to the DCFS, investment managers are likely to respond to this demand by potentially launching up to a record 200 new ESG funds by 2023, more than double the previous three years.

The International Monetary Fund estimates there are now more than 1,500 equity funds with an “explicit sustainability mandate.” These funds control nearly $600 billion in assets, up from roughly $200 billion in 2010. Overall, ESG-listed funds still have some way to go before becoming mainstream, representing less than 2% of the total investment fund universe. A hurdle to making sustainable active management funds more widespread is anecdotal evidence that their fees are often higher than those of other active funds, according to the IMF research.

 

Issues with The ESG Approach

While adopting an ESG approach and investing in ESG funds sounds laudable, there are some concerns about the transparency and quality of ESG disclosures. For example, from the company perspective, most ESG reporting by US companies is voluntary, and the content of those reports is left to company

discretion. According to research by Christensen, Hail, and Leuz (2019), a review of accounting and finance academic work showed that there currently is substantial variation in disclosures. This situation makes objective comparisons of companies’ ESG practices quite difficult for investors.

Looking at investment managers, a large number of them commit to such initiatives as the Principles for Responsible Investing. Still, the extent of actual implementation is not clear, as the large majority of asset managers do not disclose precisely how ESG factors inform their investment decisions.

Finally, there is considerable divergence in the metrics and methodologies used among ESG data providers. There is no list of agreed-upon ESG issues among the data providers. Research by Gibson, Krueger, Riand, and Schmidt (2019), highlights that ESG ratings diverge considerably. According to the research, the average correlation between overall ESG ratings of the six major providers of ESG data was less than 50%.

Morningstar has found that ESG implementation has not been defined consistently, partly because ESG investing is evolving. In the asset management industry, where active management faces competitive pressure from index investing, ESG strategies have been the bright spot in terms of new funds being launched and receiving inflows. This raises the question of, are funds labeling themselves as ESG in order to attract assets?

 

Does ESG Investing Outperform?

So, the $64,000 question is, can one do well by doing good?

Recent research demonstrates that ESG metrics may, in fact, aid the quest for alpha. The study backtested ESG metrics for materiality and found that a strategy that solely based its investment decisions on these metrics outperformed a global composite of stocks, strengthening the case for an active ESG investment strategy. In its October 2019 Global Financial Stability Report, IMF researchers found the performance of “sustainable” funds is comparable to that of conventional equity funds. “We don’t find conclusive evidence that sustainable investors underperform or outperform regular investors for similar types of investments,” Evan Papageorgiou, an author of the research, and deputy division chief in the Monetary and Capital Markets Department of the IMF told CNBC Wednesday.

Morningstar found that 41 of the 56 Morningstar’s ESG indexes outperformed their non-ESG equivalents (73%) since inception. Morningstar noted that performance across the range tends to be strong. ESG indexes also favor companies with healthier balance sheets, stronger competitive advantages, and lower volatility than their mainstream counterparts.

In summary, while what makes an ESG company appears to be in the “eye of the beholder” today, it does not appear that investors give up a potential return by adopting ESG investing principles.

 

Sources:

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ESG And Responsible Institutional Investing Around The World

What is ESG Investing?

Advancing environmental, social, and governance investing

‘Sustainable’ investors match the performance of regular investors, new IMF research finds

ESG investing is a ‘complete fraud,’ Chamath Palihapitiya says

A short history of responsible investing

Coronavirus, Stock Market Strength, and Elevators

Back in 1962, the TV show Candid Camera used its hidden cameras as part of a scientific study to learn about human behavior. Along with three of the show’s actors and some unsuspecting passersby, what they discovered was both revealing and entertaining. It also provides an essential understanding of human behavior that impacts investment decisions. In a black and white episode, the show helped in one of a series of trials called the Asch conformity experiments. Candid Camera’s episode was titled “Face the Rear.” Dr. Solomon Asch had been conducting different tests at Swarthmore College as part of his research for over six years. Through his various social behavior trials, he was able to gauge the apparent human disposition to conform. The different scientific experiments yielded some useful results for understanding what may be driving the stock market 58 years later.

In “Face the Rear,” the Psychologist had two actors enter an elevator and take the abnormal position facing the back wall (not the door). They then waited for an unsuspecting test subject to enter the elevator; at this point, a third actor would board the lift and also face the back wall. With no encouragement, other than “fitting in,” the test subjects would, consistently, look around, then decide “by themselves” to also turn and face the back wall of the elevator. This information about human behavior may shed light on the strength of today’s equity markets.

Investors are Facing the Rear

Over the past few months I’ve been speaking to self-directed investors, fiduciaries, fund managers and other market players whose analysis I respect. Our discussions have struggled to uncover the reason for this years relentless upward climb in stocks. Most of these experienced investors and traders agree; all factors considered, they’d expect the market to be, at best, cautiously optimistic. At worst, searching each day for a new bottom. We’re all guessing at what does not, given what we all know, make sense. The conjecture offered includes high savings rates,  supportive Fed policy, “it’s all big tech,” “the vaccine is near,” forward-looking investors, etc. However, we all believe there is nothing in recent market highs that conforms to past market behavior.

The other day I tried a different approach and got different results. I thought, perhaps we’re all asking the wrong question. We’ve been asking why the market is going up in spite of some of the most negative and uncertain economic conditions in history. We actually already know the answer; the stock market goes up when there are more buyers than sellers. It’s that simple. So the better question, what we really are trying to learn is, why the heck are there more buyers than sellers?

Everyone’s Going Up

The science of economics pays a lot of attention to statistics that measure hard data. It’s a social science, but it can only count what can be counted. And it can only count that after the fact. It’s a discipline with its predictive basis in supply and demand, and a portion of demand is driven by crowd psychology. The herd doesn’t always face in the direction you’d reasonably expect.  But the human need to conform, as Dr. Salomon Asch proved with six years of various experiments, is a part of being human. Additionally, follow-through of market trends is driven largely by what is “working” at the time. Investors’ expectations of other investors’ future actions is how money is made. There is no right or wrong; if the crowd is moving in one direction, that is the right direction (for now). Herd behavior is the best answer I’ve found for the question, “why are there more buyers than sellers?”

The main ingredient and action from investors that create speculative bubbles, even when many investors feel the sentiment is incorrect has always been the desire to do what other investors are doing. At the extreme, price bubbles then grow, and acceptable valuations get redefined. Then the fear-of-missing-out behavior creates worry, even among contrarians. Logic can be found, but it isn’t driving behavior any longer. One by one, logical investors may move in a direction that they are not comfortable with because that has been the easiest path, despite concerns.  

Let’s Blame the Media

It has become fashionable to blame the media for everything.  In the spirit of herd behavior, for this section, please allow me to join the blame-the-media herd. Rest assured, to be even more convincing, I’ll quote experts – which is always in fashion.

Nobel Laureate in economics, Professor at Yale University, and co-creator of the Case-Schilling Index of House Prices recently wrote:

“…most people have no way to
evaluate the significance of economic or scientific news. Especially when
mistrust of news media is high, they tend to rely on how people they know
respond to news. This process of evaluation takes time, which is why stock
markets do not respond to news suddenly and completely, as conventional theory
would suggest. The news starts a new trend in markets, but it is sufficiently
ambiguous that most smart money has difficulty profiting from it.” – Robert J. Schiller, Understanding
the Pandemic Stock Market

Mr. Schiller believes people look to their peers rather than blindly follow talking heads on TV. We’ve seen this occur with peer groups on message boards and social media as they have bought stocks of bankrupt and near-bankrupt companies. Previous logic and methodology would suggest these companies should have been avoided. The mainstream news sources have continually poked fun at this group of online investors, but the short track record thus far has validated their actions. In a June 15^th conciliatory article, CNBC quoted the head of Quantitative Research at Societe Generale:

“For all the mocking of Robinhood investors, their timing back into the market looks impeccable, with a
significant pick-up in holdings as equity markets bottomed in mid-March” – Andrew Lapthorne

When it comes to financial markets and other, more dubious, money-making plots like chain letters and Ponzi schemes, money continues to be made as long as there is new money to be found. So, for as long as market participants are following each other, the current bullishness will persist. There is, of course, a finite amount of US Dollars, so in theory, upward movement cannot last forever. However, with interest rates near zero, there is still plenty of investable cash returning less per year than stock market participants earn in a day. That is a strong incentive to consider equities when you may not otherwise have.

Artificial Markets

Price discovery of all kinds is, in part, based on consumer or investor alternatives. When the masses are choosing one item over another, their decisions impact price direction, and price direction depends on the environment. A bag of popcorn at a movie may cost three times the price of making and eating it at home, but the alternative is not eating popcorn at the movie or eating other more expensive items available. So the current price works. No one would pay $6.50 for a bag at home. Should people suddenly not buy it at current prices, the theater has plenty of room (over their cost) to lower what they charge movie-goers until they hit the price where it is again being purchased. The same is true for wine at a restaurant, soda at MacDonald’s, and everything else. That is everything except a large portion of the bond market. The Fed is controlling a large swath of prices of the bond market; they are not market-priced. The central banks promise to keep rates at zero and flatten the curve by setting a yield target over which they may have a running bid to all sellers, prevents this area of the curve from being market-priced. It is instead artificially priced.

There has been an increased demand for borrowing, individual loans, and small business loans. Corporate loan demand is still strong, but weaker than earlier in the year. This increase in borrowing demand, especially with weakened credit ratings and scores, should put upward pressure on the cost of money. Interest rates would be expected to rise. Yields are below what typically can be expected in the bond market. The higher price of bonds is different than the higher price of stocks. The difference is that the Fed admittedly is rigging the bond market prices. Crowd behavior and other inputs have been replaced with government fine-tuning.

Stock prices are not overtly rigged, but they are tied to interest rates and other alternatives to investing. This impacts investor decisions across all assets.

Take-Away

In the TV episode discussed earlier, people entering the elevator, clearly befuddled, slowly turned around and faced the rear of the elevator. But the experiment did not stop there. In one of the elevator rides, the Candid Camera actors onboard removed their hats (it was 1962). The unwitting rider did the same. When they placed their hats back on, the strength of following the crowd caused the rider to then place their hat back. Crowd psychology, whether it is fitting in, or following peers you trust, is powerful. No amount of looking at lagging and leading indicators, P/E ratios, stochastics, or logic can compete with that.

For now, crowd behavior is the freight train driving the market upward. It may last months; it may change tomorrow. This behavior, like elevators, runs in two directions. Those entering near the top may be putting more at risk than those who entered at ground-level.

Paul Hoffman

Managing Editor

 

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