Category: Markets

An Investment Tool That’s More Important than Ever

The overall stock market performance during April was one for the record books. The Dow 30 (+11.1%) and S&P 500 (+12.7%) put in their best one-month performance since January 1987. The Nasdaq (+15.4%) delivered its greatest one-month gains since June 2000, and the Russell 2000 (+16.22%) outperformed the other three major market indicators.

The April rally was a welcomed reversal from March, which was the worst month since the height of the financial crisis in 2008. The question most stock investors are trying to discern now is, will stocks reverse again in May?  And How best to determine value?

Where to Now?

The economy and its impact on the stock market are in extraordinarily uncertain waters. Any previous trends have all been derailed. This is not just true of the market overall, but also true for both companies that will benefit from the pandemic and the majority which will be hurt by it. One fact that will keep many self-directed investors active is the reality that, during times like these, opportunity is at its highest. It is also true that at times like these the risk of short-term realized or unrealized losses are also at a high level. Volatility, truly is a double-edged sword.

Many market participants are accustomed to companies earnings guidance and earnings forecasts, especially in highly capitalized corporations that are widely covered by sell-side analysts. The quarterly forecasts of these companies are so broadly covered by mainstream news outlets, that they’re sometimes treated and delivered to investors like they’re an event themselves. The problem now is, over the past few weeks analysts along with one company after another have pulled their guidance and stated, “we just don’t know.” This takes away one of the valuation tools investors use in their decisions to buy or sell.

For the companies part, they can not offer the earnings insight into the near future which they do not have. This is safe for them to not offer numbers with far less confidence than the market is accustomed to. Without the companies insight, analysts from both sell-side Wall Street firms and company-sponsored research have placed many companies near-term projected revenue in a wait-and-see mode. The analysts, oddly enough, probably have better visibility out a year or more when the crisis is presumed to be behind us, than they have out three months. This may not be as much of a drawback for investors as it feels.

Investors, enjoy experiencing immediate gratification and reassurance after investing in a company. However, it is long term results (longer than 90 days) that is most often the reason an investment is made in the first place. Similarly, as far as selling,  a long-term negative outlook makes more sense than ridding your portfolio of a company because they are having a one-time hit to EBITDA.

Perhaps the economic lockdown will usher in an era of companies managing for long-term results. An era where analysts don’t feel a need to be as precise about their immediate estimates of income as opposed to longer-term prospects for the company and space in which it does business. Investors for their part could serve their future financial growth better if they look at companies through a longer-term lens. This would allow corporate management to create strategies with a longer-term focus.

Determining Value Now

Lower expectations of forecasting precision over the next two periods from the company’s investor relations or research analysts will be important for investors that want to stay involved and feel comfortable. By definition, people invest for the future, value expectations over a more appropriate time horizon may be the answer to this lack of information. Even during ideal times, it would be foolhardy to invest cash in a stock if you need that cash in a few months. A longer-term focus is more prudent for investors, and if companies are given leeway to focus long-term they should be able to make decisions that drive better results. This is better for investors and there are still forecasting tools. In fact, there are plenty of other fundamentals to review as a measure of future positive performance.

One thing the pandemic has done is cause us to see shifts in the economic landscape that may change industries. Some areas have earned a lot of buy-side interest because of the virus and lockdown and what it might usher in. Recognizing these changes early could be the key to finding performance and benefiting from the new paradigm. These could include industries providing work from home solutions, medical solutions, and safe havens such as precious metals, among many others.  Once industry expectations are recognized, sort through high-caliber industry reports to make sure you aren’t missing anything. From there, find companies within the space and check the recent price trend; you don’t want to chase after a stock that perhaps has already received too many speculative investors. Then comb through institutional-quality research analyst reports to get a clearer picture of the inner workings of the business model and growth prospects. Narrow down the list of possibilities and hope to find the deserving company that has been overlooked in all the other noise.  

Time Horizon Adjustment

The regularity of earnings projections with what had been a short feedback loop provides a sense of control and precision regarding accuracy, but perhaps not usefulness of these forecasts. Even with today’s murky conditions, wide estimation error, or lack of short-term guidance should not be a problem for investors. We know there is a temporary problem. If it were possible to forecast next quarter’s earnings per share for every stock in the S&P 500, any partially astute investor would assume that each companies profits this year are not representative of their longer-term potential. To put it another way, the accuracy of any earnings forecast during the first half of 2020 does not make it a valid measurement for determining normal expectations for the company. Companies that miss estimates can still have great earnings prospects. Conversely, companies that exceed expectations could still face difficulties. Within the past two months, and looking through next quarter, what is going on within the company books, within the various industries, and management goals to drive better performance can hardly be fully assessed by most self-directed investors or small RIA firms. They need more information and deeper insight on industries and company-specifics. The business model itself could be more telling than the numbers. 

Without a crystal ball, we don’t know how “normal” next year will be. However, as an investor, we should try to take advantage. We know the focus should be longer-term. As far as Wall Street analysts are concerned, the direction of future numbers and ability to resume normalcy down the road provides a very good start to discerning where assets should be deployed and which investments are best sold now. Looking out beyond the immediate quarter reduces short-term “noise.”  It also creates a longer-term horizon for management to measure success. Three years, five-years, ten years, these seem like an eternity in a world where immediate expectations drive stock price, and stock prices are available and rapidly changing throughout the day.  But if your investing for a future measured in years, you may be surrounded by opportunities that you’re afraid of taking advantage of because you aren’t as certain what will happen over the next 90 days. This will work against your success in the new paradigm.

 

Paul Hoffman

Managing Editor

 

Suggested Reading:

Stock Index Adjustments and
Self-Directed Investors

The Case for Silver

Small-Cap VS Large-Cap Investing

 

Register for Channelchek Premium Content and Tools at No Cost!

Sources:

Strategies
for Quarterly Earnings

Has Warren Buffett Already Shown His Hand?

Market participants, of all levels, have been wondering aloud about Warren Buffett’s low profile. Shortly after other wealth destroying market events, the “Oracle of Omaha” tended to step-up and calm fears early in the financial turmoil. The orchestrated economic stoppage of today’s lockdown has left investors wondering. They’re wondering if and when they’ll get a glimpse into the thinking of the highly respected Chairman of Berkshire Hathaway. Well, they don’t have to wonder much longer. His “silence” will end Saturday (May 2) at the Berkshire Hathaway shareholder meeting (held virtually).  The discussions from that meeting have the potential to set the market tone in a number of industries and even the overall mood.

Has He
Already Shown His Hand?

Reviewing his actions and experience after the financial bubble burst late Summer 2008 may lend clues into his current focus. There was an excellent op-ed article written by Buffett for The New York Times just one month after the recognized start of the 2008 financial crisis. The piece was titled “Buy American – I Am” and contains one of his most famous quotes; “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.” The article uses market history to make compelling arguments for ignoring fear and to confidently move cash from the sidelines and into the market. The only problem with the article, at least according to the author himself; is, he was wrong.

The Oracle of Omaha used the op-ed to “cheerlead” for the country and the markets. He wrote about taking his personal account from 100% U.S. Treasuries to making significant investments in U.S. Companies. The piece helped calm fears and served to inspire others to be comfortable investing while the extent of trouble was not fully clear.

Berkshire Hathaway, in 2008/2009, for its part, took large positions in beaten-up companies with excellent brands and excellent histories. The investments back then included Harley Davidson, General Electric, Tiffany & Co, and construction materials giant USG, among others. When discussing the crisis many months later, Buffett had lamented his timing and said he wished he had written his op-ed later than he did. He had spoken too soon.

This (jumping in early) by itself could easily explain his now shying away from making any bold statements. He is famous for confidently investing when others are fearful, but it is difficult to know when fear is near its peak. In 2008 he expressed extreme optimism only one month after the start of the market crisis. He was reminded that one month is too short to assess a new and highly unusual situation.

Charlie Munger, Warren Buffett’s business partner and Vice-Chairman of Berkshire Hathaway, spoke with The Wall Street Journal a week ago. He was very clear as to what was going on in the Berkshire Hathaway investment mindset and the deals coming their way. In short, he made clear, “The Phone Is Not Ringing Off the Hook.” 

The Vice Chairman also said, “Warren wants to keep Berkshire safe for people who have 90% of their net worth invested here. We’re always going to be on the safe side. That doesn’t mean we couldn’t do something pretty aggressive or seize some opportunity. But basically, we will be fairly conservative. And we’ll emerge on the other side very strong.”

Munger also noted that they generally don’t go out searching for deals with companies. In the past, corporations looking to discuss their situation came to them. He said large corporations are most likely having those conversations with the U.S. government. Certainly, the U.S. has deeper pockets and greater ability to help than Berkshire Hathaway. 

What Others are
Saying

The speculation and consensus among investors is that he is quietly deploying capital and selectively buying shares of companies that are the backbone of America. In a podcast for The Knowledge Project titled “Getting Back Up,” Bill Ackman, CEO of Pershing Square Capital Management, discussed what he thinks Berkshire Hathaway may be doing and should be doing. In the podcast, Ackman is heard saying: “I’m surprised they haven’t done anything yet that’s visible, but my guess is they’ve been buying stocks a lot…” The hedge fund manager added,   “The big opportunity for Berkshire is Berkshire itself.”  He explained it was a “cheap stock” before the market route and now is a “real bargain.” Class B shares of BRK (BRK-B) closed Wednesday at $189.61.

Rest Assured He Will Be Comforting

If history offers any indication, Warren Buffett believes markets always come back. As an “oracle” his projections usually have a soothing mood of confidence. This is not to suggest that anyone should believe the markets have seen their worst, or that everything will perform equally. Instead it would suggest there are many bargains within the equity markets, but the strength of the overall market may have gotten a bit ahead of itself.

As far as thoughts he shares on sectors and industries within the market, the investors will be listening for tips relative to performance spreads between stock classifications, which industries he sees value within, and if he is more likely to be looking offshore this time.

The normally lavish Berkshire Hathaway Annual meeting will be held virtually for the first time. It has been announced that Charlie Munger, who is 96, will not be attending. You can “attend” yourself on Saturday with this live stream this link.

Suggested Reading:

“The Big Short” Dr.
Michael Burry’s Views on the Shutdown

Why Index Funds Could be
a Mistake in 2020

What Now? Post Pandemic
Stock Market Investing

Register for Channelchek Premium Content and Tools at No Cost!

 

Sources:

Berkshire Hathaway 2020 Meeting Press
Release

“Buy American – I Am” NYT, 10/16/08

Charlie
Munger: ‘The Phone Is Not Ringing Off the Hook’

Bill Ackman:
Getting Back Up

Your Move – Three Investment Ideas to Consider Now

(Note: companies that
could be impacted by the content of this article are listed at the base of the
story [desktop version]. This article uses third-party references to provide a
bullish, bearish, and balanced point of view; sources are listed after the
Balanced section.)

Stock market indices have gained a large portion of their value back after having been down as much as 34% over the past month. The major market averages are now off their high less than 20%. The unpredictable massive rally in these benchmarks included record moves that will surely be studied in history books – as will the selloff that took place the month earlier. 

The magnitude of this upward index bounce is very misleading. Have you noticed that most sectors have not participated in any meaningful way? In fact, some of the more deflated stocks are still near their lows, others have fallen further. Here’s why.

Stocks With
the Most Pull

“The top five companies in the
S&P 500 have never occupied a greater share of the benchmark’s total market
capitalization.”  – Mike Bird, WSJ, April 20, 2020

Companies that have added the most to the rise of the Nasdaq and S&P 500 over the past month are tech giants such as Amazon, Intel, and Microsoft. Today, just five stocks MSFT, AAPL, FB, GOOG, and GOOGL account for 20% of the market cap for the entire S&P 500. That exceeds their concentration during the dotcom bubble of 2000.  The entire IT sector now accounts for a 25.4% weighting in the S&P 500 (a/o 4/17/20). None of the other ten major sectors even come close. While technology, which does not have a reputation of being defensive, has contributed most to index returns, some other individual companies have also held up well, especially in healthcare and consumer staples — two more traditional defensive sectors.

 

The performance of the entire S&P is in
large part because of participation by a few stocks.

Where Do We Go From Here

The market seems to be past the “blood in the streets” stage, where investors were tripping over themselves to unload stocks indiscriminately. The extreme rise in the tech sector looks to have been the standard kneejerk reaction by speculators trying to get in early and by those that followed the move and chased stocks behind them. The next move, if the worst is behind us, is typically more rational. That soberness may carry the overall market sideways to down as some participants wait for confirmation that indeed the economic road ahead will be positive.

While the overall indices may simmer, this will likely be because of cooling of the tech stocks while more traditional plays begin to heat up.

Strategies
for Low-Risk Exposure

The crisis fell upon us fast, but we learn fast. The follow-up in the investment markets is likely to be quick. In the same way, everyone quickly learned how to put on a mask, have Zoom meetings, and food shop for longer than a week at a time; investors are going to become more adept at crisis investing.

In the past, crisis investment strategies have always had three strong tenets:

1). Be very selective (not major market investing)

2). Be more defensive (base decisions on worst-case scenario)

3). Be among the first (don’t chase)  

The best risk/return opportunities for investors will likely present themselves from long-term secular trends. The pandemic and the coinciding stay-at-home policies have accelerated many of these trends in tech usage. Look to capitalize on the old strong sectors that could experience a tailwind from the revised world we’re entering.

The old trends that had been worth watching in stocks, that will be enhanced once most of the economic lights are turned back on, include; a world that is more digital, a world that is more in debt and a world that values medical miracles.  

Three
Investment Areas that Should get Warmer

1). Stable and
defensive stocks– This may seem obvious, but many people still get caught up in “sexy” stocks and chasing what is most highlighted on CNBC or Fox Business News. Invest in stocks that display earnings growth trends that are less likely to be negatively impacted by “sheltering in place.”  Many people saw the TP shortage as an inconvenience; investors should have researched it as an opportunity. Consumer staples and healthcare products are always in demand without regard to economic conditions. This places them on stable ground for a defensive position. In many cases, the increased hours people stay at home has placed further demand on items such as soap, and paper products, while possibly lowering demand for items like hair gel and deodorant. This is why specific companies, rather than a consumer goods ETF, is preferable.

Many of these stocks pay dividends. This not only adds to return, it helps make the equities more attractive as yield investors are bumping up against sub 1% government bond rates. Dividends cause the stocks to be less volatile overall.

2). Cyclical stocks– Ahead of a firm-footed recovery, selective investing in cyclical companies that thrive as people open up their wallets, may look different than in the past. Discretionary spending will likely increase in areas that have pent-up demand. These could include household appliances, recreation, online dating, fitness, etc..

3). Long-term trends- We’ve already had a taste of the accelerated structural changes that could define this decade. There has been a digital transformation. This has set much deeper roots in the past month than it has in the past three years. The momentum is not likely to slow. Technological disruptors that improve work and home life seem to be in a position to maintain their above-average growth. Any dip in stock prices allows entry at a reasonable level as renewed activity should once again prove rewarding longer term. E-Commerce also got a boost from the lockdown’s effect on brick and mortar stores. The boost in popularity is likely to stick at a higher level than pre-crisis, thus providing a new base for these products.

Pharmaceutical and biotech companies with pipelines for drug and genetic therapies will continue to garner attention as the population has the pandemic fresh on their mind and now shows increased support for more rapid discovery, clinical trials, and FDA review.

Take-Away

The bounce that we have seen in the major indices is not representative of the movement in the various components of the underlying index. The split or bifurcation likely has sectors overbought while others that should get attention have been overshadowed by these “stars.” The coming recovery is likely to unfold slow but sure. Focusing on the surest beneficiaries of the eventual recovery is less speculative and more prudent. Chasing relatively high-flyers, or owning them by default because you have invested in an index fund may be less profitable. There is still much uncertainty moving forward. Picking your short, medium, and long term positions with more rationally will allow participation in moves upward with comfortable risk-adjusted returns in volatile times.

Suggested Reading:

Why
Index funds Could Be a Mistake in 2020

Stock
Index adjustments and Self-Directed Investing

Additional
Balance in 60/40 Asset Mixes

Sources:

The
Winner Takes All Stock Market Rally

Titans
Dominate Stock market

Twitter- @Birdyword

The 2020 Investment Buzzword No one is Using Yet!

(Note: companies that
could be impacted by the content of this article are listed at the base of the
story [desktop version]. This article uses third-party references to provide a
bullish, bearish, and balanced point of view; sources are listed after the
Balanced section.)

Today when investors say they are “in the market” or “out of the market,” they most often are using shorthand to discuss the stock market. This is understood, even though there are many other active investment markets.  The others don’t get as much attention. In fact, because of current investment practices, the term “in the market” usually implies exposure to one of the major index averages.

It wasn’t always this way. Not too long ago, investors would build a portfolio working with a broker and buy a small basket of stocks. Commissions were high, but a good broker was worth the price because of the in-depth research they conducted. Back then, “in the market” didn’t mean broad exposure to 500-2000 holdings.  Far fewer. The reason for the change, of course, is an evolution that gained momentum around 1980. It was then that mutual funds started to become understood throughout households, many of which had never been “in the market” before.  Mutual funds allowed investors, even small ones, to benefit from what has been a cyclical but rising market, but with much lower entry fees.

The combination of the ease with which large mutual funds allowed an investor to gain or reduce exposure to equities, the comfort of being extremely diversified, the rising trend in stock prices, and the painless built-in fee made mutual funds an easy sell for fund companies.

Once invested, to determine if the fund manager was doing a good job, marketers began benchmarking their funds against major market indexes on the futures exchange (Dow, S&P, and later Russell). Investors were taught that good returns were “index” returns. Investors began to measure if their fund performed satisfactorily by how it stacked up against a broad index.  When this became the standard by which investors measured success, mutual fund companies created index funds with the objective of meeting or beating a specific index. Here is where they ran into some problems.

Matching an index, which has no fees, no slippage, and no flow of assets in or out (often at the worst times), is mathematically impossible for a fund manager without taking on additional risk. Index mutual funds often fell short of their benchmark. It wasn’t their fault. When markets are rising, investors put money into the fund, this adds to the average price of the underlying holdings. When markets fall abruptly, investors often pull money out. This locks in lower performance and prevents the fund manager from buying at lower prices. Also, managing fund flows requires a cash position; this dampens fund performance. Innovative financial engineers then addressed the issues and came up with a product that was more capable of tracking a major index return. The product was exchange-traded funds, and these became more popular to people whose goal was “market” returns.

Lower Cost Options

With the goal of index investing and tracking much closer to index returns,  exchange-traded funds (ETFs) made their debut in early 1993. State Street Global Advisors created the first which was the S&P 500 Trust (SPDR). This new fund type had lower fees and held a set amount of the underlying stocks. As a result, the fund trades virtually tick for tick with the S&P 500 index. SPDR gained popularity very quickly and is still the most actively traded ETF. Investment advisors have been able to lower the cost to their index fund invested clients as they moved them into this new innovation.  

Today there are ETFs that cover all the major indexes. What’s better is they now also cover all the underlying sectors within an index. So if you don’t like Financials but feel Energy is undervalued, you are no longer limited to just receiving broad index returns. You can pick and choose the categories within the equity markets and focus more heavily on one sector over another.  Building a custom portfolio using indexed sectors has become a more refined way to give investors above-average potential.

Sector Bifurcation

Market sector movement at the start of 2020 is a solid example why those that maintain an active investment portfolio should do more than just sit idle with broad market index funds.

The graphic below demonstrates how the Spyder defined sectors deviate drastically from each other. The economy is going through a period where the markets are bifurcated. There are sectors that are strong and rising while there are sectors that are weak and sinking. This is different from recent experiences where we saw all sectors generally moving in the same upward direction. The markets are likely to remain bifurcated and volatile until the pandemic crisis is history.

For investors looking to “pick their spots” in what is a more difficult market, they now have the ability to target sectors they deem superior and avoid those with low probability of satisfaction. The six-month chart below (Red is S&P 500, SPDR) shows that back in November Healthcare began outperforming the major index while Energy was falling off quite a bit. That trend continued and accelerated during the pandemic. Investors in the Healthcare ETF are up 10% over the past six months, Energy sector investors are down over 40%.

 

 

Investors should consider a bias in their holding toward sectors with a more positive outlook and away from those with more negative using targeted ETFs.

Further Bifurcation

Within investment categories, especially during the current crisis, there is further bifurcation. Investing strictly in ETFs, even sector ETFs,  means still accepting the bad with the good. The pandemic has clearly altered the direction of individual company earnings. Sector funds don’t take this into account. Here is an extreme example:  Midway through last quarter investors began to flee from the category of hospitality. This was wise, the sector includes hotels, travel, restaurants, and event services. Poor performance within this sector was all but guaranteed.

Avoiding an ETF focused on hospitality certainly turned out wise as forecasted. But what was also easy to forecast is that within the sector there would be opportunities in meal-kit companies like Blue Apron (APRN). The conclusion from this is, not only should investors no-longer just “buy the market” they should not just buy sector funds either. Having a core in the broader market is fine, weighing that more heavily with some sector funds is also good, but stock-picking is becoming more important than ever.

 

Here’s another example, Energy was one of the worst beaten down sectors. Even within the energy sector there were huge gains to be found in companies like COG. Fortunately, investing in individual positions is no longer as expensive per transaction. Picking targeted companies makes more sense than ever.

ETF investing is still a low-cost way for a small investor to benefit from overall market growth without experiencing brokerage fees cutting into their results. They have had their reign and are now just another option to keep in the mix. This has become extremely apparent over the past few weeks, and it appears it will be an issue for a while. Investors may now be entering a new investment cycle where a wider variety of vehicles are implemented.

Just like with other cycles, we seem to be moving back toward where we started, individual stocks.

Finding Opportunity

Looking back since the beginning of the year and looking forward to the foreseeable future, we are seeing some sectors of the market doing substantially better than others. The market is bifurcated and no longer finds most industries, sectors, or even segments within sectors moving in-synch. The differences within each category and within each company will impact a portfolios performance more than it did just nine months ago.

The low and no cost of trading today all but eliminates the cost of commissions from things investors worry about. This cost was a big reason that investors moved to funds, to begin with. The other concern was expertise. As mentioned earlier, investors moved to funds in part to not have to rely on a broker and their research. Today, the internet has brought the cost of quality research down to approximately zero. Just logging on to your computer can put any level investor in touch with more information than any full-service broker ever had in 1980. It also can flood you with bad information and pseudo- research and even schemes to artificially pump stocks. Make sure you can trust where you’re getting your information from. Providers of quality research such as Morningstar,
Channelchek, or Standard &
Poor’s are either partially or completely no cost to subscribers. These, along with information from an online broker, should be plenty for most self-directed investors or even advisors. Sites that promise the next hot stock should be viewed with caution.

Take Away

There are more investment vehicles, low-cost options of transacting, and choice than ever before. Investors that lazily place money in the overall market are not trying to enjoy the best possible returns. The bifurcated market of today is likely to continue. Sectors that will win are often being spelled out for us as we listen to how various stimulus packages are being created. Individual stocks can have extreme performance if they have a unique characteristic that puts their product or service in high demand in changing times. The various research companies offering top-tier information on equities is indispensable as you look for potential opportunity.

Suggested Reading:

Where
Investors Found Double-Digit Growth in Q1

There’s
Opportunity When Market Indexes are Adjusted

Michael
Burry Says Covid-19 Cure Worse that the Disease

 

Channelchek Community:

Unlimited, no cost subscription to company
research and premium features

Sources:
SPDR Sector Tracker

There’s Opportunity When Stock Market Indices are Reshuffled

(Note: companies that
could be impacted by the content of this article are listed at the base of the
story [desktop version]. This article uses third-party references to provide a
bullish, bearish, and balanced point of view; sources are listed after the
Balanced section.)

After the close of regular trading on Monday, April 13, it was announced by S&P Dow Jones Indices that they would be moving LHC Group (LHCG) out from the SmallCap 600 index and into the MidCap 400 index. The release also informed that they would fill the open spot in the S&P 600 with YETI Holdings (YETI).

It’s not uncommon for an index to change and adjust the underlying measures by listing or delisting companies used as a component. It’s something they often must do.  Listed corporations merge or are acquired, companies like LHC grow out of their market cap definition, and industries may gain or lose relevance as technologies change. One major index that does a thorough scheduled rebalance is the Russell 2000.

As you might expect, being listed or delisted causes out-of-the-ordinary price action around the stocks that are moved in or out of an index. The first rule of investing is; only where there is movement is there opportunity. Being listed or delisted causes price movement. As with most trading and positioning, if it were a sure thing, everyone would be doing it. Let’s look at some history.

Typical Activity for Newly Listed

The announcement of YETI being added let investors know that the companies price action will be represented in the S&P 600 as of the market open on Friday, April 17. The graph below shows the price and volume activity since the announcement (note that major market indices were also up 3-4%). The companies price rose while volume spiked the day after the unscheduled surprise announcement.

The reason a company becomes more active and sought after when it’s included in an index is simple. With the popularity of index funds and indexed ETFs, whenever a company is added, the mutual funds that are looking to mirror the index will act to develop a position with a similar weighting near the date of the change. And an ETF is required to own the index they represent, ETF administrators have no choice but to hold the stock, based on their prospectus.  Conversely, when a stock is dropped from an index demand may fade as interest by the index fund managers disappears.

This is one example of what price activity often looks like after a new listing announcement and before the inclusion date. Price often improves and trading volume is typically much higher than average. The index will begin measuring YETI Friday, April 17; it will be interesting to see how it performs on that day and over the coming weeks relative to the market.

 Activity Immediately After Listing

In late June 2019, FTSE Russell reconstituted its indices, including the Russell 2000. Presented below is a table of all 12 Biotech firms added. The table lists the price at close (two hours before the announcement,) the percent increase/decrease as-of the open on the date included in the index, and lastly, the percent change for there three days after it was inserted into the index.

Included at the top of the table is the percent change of the Russell 2000 (RUT) during this period. On the very right side two columns of the table the RUT change is netted out of each companies’ price movement. This allows you to view movement from the baseline of where the market was on that day.

On Friday, June
28, 2019, twelve stocks were added to the FTSE Russell 2000 and/or Russell 3000
indices. As with most reconstitutions, the shares of the companies did show
inordinate activity and movement.
Affimed N.V., Axsome
Therapeutics, Eyepoint
Pharmaceuticals, Apyx
Medical, Organogenesis, Strongbridge
Biopharma,
Zynerba Pharmaceuticals, Misonix
Inc., Urogen
Pharma, PhaseBio
Pharmaceuticals, BioXcel
Therapeutics, V
B Industries.

Analysis

The price from announcement date to open on inclusion date was up on 9 of the 12 included stocks. The increase in price beat the index in 8 of the 12. The average of all 12 increased by 2.26% as compared to the RUT, which only increased by 1.78%.

Three days after inclusion in the index, 11 of the 12 stocks beat the index, with only one showing a negative return. The average return for the 12 companies over the three days was 5.73% (RUT gained 1.19%).

Opportunity

These examples demonstrate that finding plays as indexes reshuffle their underlying stocks is possible. In fact, if price increases before inclusion date are the norm, this could actually have the effect of the index listing the company at a higher than average or inflated price. This would weigh down the index performance and give the advantage to the investor seeking individual opportunity outside index investing.

In June, FTSE Russell will once again be adjusting the underlying listed securities. It’s always smart to watch the activity surrounding this, even if you’re uninvolved. A link to the schedule is below under “Sources.”

 

Suggested Reading:

Do
Market Scares Provide Uncommon Opportunity?

Taking
The FDA Shortcut

Additional
Balance in the 60/40 Asset Mix

 

Channelchek Community:

Unlimited,
no cost subscription to company research and premium features

 

Sources:

FTSE Russell 2020 Reconstitution Calendar

YETI Holdings to
Join S&P SmallCap 600

New
Additions to Russell Indexes

Sorry We’re Open – Pros & Cons of Closing Equity Markets

Any Face-to-face discussion has been rare for me the past couple of weeks. But, my conversations with many people that have passed through my life, is at an all-time high. Last Sunday I received a Facebook message, with an attached article, from an intern who had worked for me years back. Advay was a sharp kid when I met him, he had a healthy sense of humor and an amazing capacity for statistics. His grasp of numbers always came in handy when we’d discuss baseball, less helpful when I’d assign him a project. Over time, he’s done quite well for himself as a mutual fund manager.

The last time I heard from Advay was when his son was born, that was four years ago, so we haven’t been in touch. The article he forwarded to me was from Bloomberg. It mildly suggested that the stock markets should be closed until the economy gets its grip. His own message, along with the article read, “This needs to happen now!”

I hadn’t given much thought to the markets closing for the pandemic. At my core, I’m a free-market believer that trusts there is a danger when markets of any kind are manipulated or the rules are otherwise changed. In my mind, to restrict trading would cause less certainty and more panic selling. I know I’m not alone in my thinking. Some expect that even the whisper that a market closure might happen could spark a total route. On Oct. 19, 1987—the day of the “Black Monday” market crash, the SEC chairman, David Ruder told reporters that trading might be halted. He never did follow through and pull the plug on trading, but having mentioned it, probably caused deeper panic selling.  He regretted even suggesting it. Ruder, years later said that closing markets is a mistake, “You could actually be causing more chaos by trying to close the U.S. markets down,” Ruder said.

Some Argue That Open Is Best

Before responding to my old intern’s IM on Facebook, I decided I’d learn a little more about the current discussion on the topic. I found, on the side of the debate to keep the markets open are key decision-makers like Treasury Secretary Mnuchin who said, “We think it is in the best interest to keep the markets open,” He said this at a meeting of the Financial Stability Oversight Council, which includes the heads of the Treasury, Federal Reserve, and the Securities and Exchange Commission.  The Trump Administration is even more resolute. They have continually vowed to keep the stock market open.  Terrence Duffy, chairman and chief executive officer the CME Group Inc., told The Wall Street Journal in an interview. “I think it’s a horrible idea. You could actually be causing more chaos by trying to close the U.S. markets down.” The Nasdaq head of North American Markets, Tal Cohen has said, “The markets are functioning well,” he added, “The direction of stock prices is another question.” Representatives from the New York Stock Exchange,  have also said they are committed to keeping their exchanges open.

Some Argue That Closed Is Best

Among those that think it best if the exchanges close to let the market catch its breath during the pandemic are Senator Manchin of W. VA who told MSNBC “Maybe close a day or two…Calm the waters if you will.”

Some in the financial industry agree. Although not a majority, Executives from some of the world’s largest asset managers told the Bank of England’s governor in a call earlier this month that they believe the markets should close for two weeks.

Closing the stock market has been done before. In 1888 it closed for two days for a blizzard, in 1914, the NYSE closed for about four months when World War I broke out, stock exchanges also closed for more than a week in March 1933 when President Franklin D. Roosevelt declared a bank holiday to stop financial panic,  again in 1985 after hurricane Gloria, then in 2001 after the World Trade Center attack, and then for two days in 2012 after hurricane Sandy.

These are Emotional Times

I decided to respond to Advay by first understanding that he personally may be down quite a bit in the market. This could impact one’s thinking (and one’s mood). I also kept away from politics or my laissez-faire philosophies related to this wealth depleting (hopefully temporary) selloff. Lastly, I decided to call him rather than write. I wanted him to know from the tone of my voice that I was not against him personally, but instead may differ in my thoughts on the merits of closing equity markets.

I also dug a bit into my own thinking, then called him. I asked about his son and his wife and the delay of the baseball season. Then after a brief polite conversation, I explained that companies need access to capital and individuals need access to their investments. Neither can do this well with the markets closed. To limit either would further worsen the challenges both people and corporations are feeling. It isn’t about greed at all, it’s about having more options.

 

 

 

Paul Hoffman

Managing Editor

Suggested Reading:

Where Investors Found Double-Digit
Growth in Q1

Unemployment, how high can it go

Is there a gold lining among the
clouds?

 

Sources:  

Close the
Markets? Data and Psychology Say Maybe

Venues
may close. Trading should remain open

Authorities are being pressured to close markets

Some Top Asset
Managers Argue Financial Markets Should Close

U.S. Rebuffs
Calls to Close Stock Market

Deciding on the Best Course for when the Storm Clears

Investors must be able to trust the aids on which they rely when navigating financial markets. If they can’t, they’re putting a lot at risk, themselves, and all who are depending on the performance of the assets. When market squalls arise, there must be confidence in decision methods and surety in your own ability to carry them out. A feeling of being way off course, for some, can cause clouded decisions and perhaps lead to the wrong actions. Complete confidence in where you are and how to proceed is required. To act or even not to act is a decision. Market storms cause us to lose trust in our strategies and question ourselves. People often freeze, some just start panic buying or selling. If you feel your methods and aids for navigating the market have taken you far off course, it’s hard to trust them. But, without having something to rely on, deciding what to do next is a shot in the dark.

There is nothing in this educational piece about deadly viruses, quarantines, or business closures. That’s intentional. The suggestions you’ll find as you scroll down are things I’ve learned over three-plus decades of all types of market storms. There is no need to point to a specific disruption; because there is one thing that is constant through all of them, human behavior. I will, however, warn you that the next section may be uncomfortable for some.  Uncomfortable because it has you looking a bit into your reaction to adverse events. We’ll quickly move past that and provide some positive ideas for you or the accounts you manage, information that will make for better conversation during quarterly performance quarterly reviews. 

Correct
for Deviation

Before checking on the accuracy of your decision-making tools, check on the fitness of the decider. You. Your aids for navigating the market may be in working order and just as useful as ever, but your ability to read them may be skewed.

There’s a fear center in our brains called the amygdala (/e’migdele/). The processing speed of the amygdala is 12 milliseconds (twelve-thousands of a second) if I convert this to a unit of measure to make it easier to understand, it equates to instantly. For example, if a bug lands on us (or if we see the words “market crash”) this fear center reacts and can instantly cause tense muscles, increased pulse rate, released hormones, and heightened sensitivity to anything else around that can be perceived as risk or danger. Have you ever experienced someone sneak up on you and cause you to jump? Your heart, breathing, and the rest of your body are instantly revved up. It takes a while to “recover” even after you know you’re okay. Your reaction processes changed in 12 milliseconds or instantly.

Think about all the information about health, markets, and economic collapse that has been heaped on us recently – within a short span of time. There are many reasons to expect our fear centers are doing what they were designed to do to serve our cave-dwelling ancestors. It’s taking over or, at the very least, weighing in on our decision making. When our amygdala is our co-pilot, we tend to question everything. The problem with this as an investor is it may not be measuring the next course of action rationally. It may be overriding our ability to measure one possible outcome over another. Prior to being hit with recent shocks, there may have been gloom and doomsayers that we could easily dismiss. This could have been TV News or other media that we knew was just trying to keep viewers’ attention, so we ignored any hype. We may have more easily accepted that there is always disease present in our lives, yet mankind has survived and thrived. We probably weren’t spending every day thinking, I better do something and I better do it now.

If you believe you are in the heightened fear mode and you’re concerned about the risk of your next move, try this: Turn off your TV and do these four things to help your mind reappraise the situation.

1. Remove the personal side. Pretend you’re advising someone else. What advice would you give them? Then weigh the advice for yourself.
2. Look at other times you or others were in similar positions. For the most recent stock market moves I brought myself back to the October 2002 plunge. This market event is the least talked about because it is the least remembered. It felt devastating at the time. I thrived afterward.
3. Write down the three most upsetting things you feel about the future. Now mentally write a story, using actual acts available, that now develop into a bright future.
4. Don’t immerse yourself in triggers. The most important quarantine for investors right now may be from others who are afraid. Fear is contagious and can fire up your amygdala.

Intelligent investors act out of patience and courage, not panic. If you are temporarily questioning your ability to act using your trusted tools and strategy, the focus should be on regaining that confidence, not acting despite it.

Move Forward Before it’s Completely Clear

I had read a New York Times article with the headline: Stock Market
ends its Worst Quarter Since 1987 Crash.  The date on top of the newspaper was September 30, 2002. After the paper printed, over a couple of weeks, the market went even lower. Flash forward to this week, I have taken a lot of calls from investment advisors and even some big firm money managers. These are all veterans in the business, yet when I mentioned the Fall of 2002, very few had a recollection of those brutal few months. Storms pass.

The least popular advice anyone, especially with an activated amygdala, wants to hear is common sense.  Investment axioms like: “Stay the course,” “The best time to buy is when there’s blood in the streets,” “if you liked it at $40 you should love it twice as much at $20,” are hard to swallow when you want quantitative reasons for your next move. Investors should base their decisions on hard data, not people just repeating what sounds good. 

Here is hard data for you to review, not fluffy sayings: Statistically, as stocks decline, they become more dangerous. But, only in the short run. In the long-run, every leg lower equates to a higher probability of high returns later. On the surface, anecdotally, this makes sense, but it’s easier to get comfortable with if you see the data.  

S&P Avg. Performance Since 1950 After Market Decline

The first column of the above table lists the stock market declines from their highs broken down into 5% increments. The next column shows where the market bounced to after three months; the next column lists 6-month results; this is then followed by average annualized returns for one, three, ten, and 20-year average annual return. Periods highlighted in green are above average; those in red indicate some decline from the previous period.

At the 20%-25% market decline level, and all further declines from there, there is a significant improvement in returns after one year. The average annual returns for all periods afterward are inline or better than returns expected by investors in the overall market. Based on this information, if you are in the market today, stay in. If you have cash, a better argument can be made for you to commit some of it than to stay away.

The above data is encouraging. It is important that I remind you that these are averages. Probabilities are nice, but what has happened in the absolute worst case is largely hidden in the data. The worst that has happened to any of these investors is information I would also want to review before committing capital.

S&P Worst-Case Since 1950 After Market Decline

This new table is the same as the one above except it’s showing the single worst case of return as time went on. One take-away is stocks can go a lot lower over the short-term, but over the long-term, the situation starts to improve dramatically. With this as a guide, the worst-case scenarios have investors increasingly more at risk if they entered the market after only a small decline. In other words, since 1950, even in the worst-case scenario, investors have been better off when they have invested after substantial selloffs.

Checking the S&P level this Friday (3/20/20) I see the broader market is down 29.41% from its February 10^th high. A Return to that level will require a mathematical increase of 41.70%.  In the past, when we have been in this situation, the market has returned 8.5%-9.5% to investors after just one year. There is, however, the risk that history teaches us that we may have to wait longer than a year just to break even.

 

Paul Hoffman

Managing Editor

 

Suggested
Reading:

Exposure to these Sectors Could Enhance Risk-Adjusted Return
During the Recovery

Will Interest Rates Test Negative for Coronavirus

Bear Market Cycles, is it “Different” this Time

 

Sources:

 Amygdala

Expressing
fear enhances sensory acquisition

Perception of
Risk

Effects of
stress on decisions under uncertainty: A meta-analysis.

Stock
Market ends its Worst Quarter Since 1987 Crash

The bulls have their day

Exposure to these Sectors Could Enhance Risk-Adjusted Return During the Recovery

(Note: companies that
could be impacted by the content of this article are listed at the base of the
story [desktop version]. This article uses third-party references to provide a
bullish, bearish, and balanced point of view; sources are listed after the
Balanced section.)

The bull market that began in 2009 ended in 2020 when both the Dow Jones Industrial Average and S&P 500 posted greater than 20% declines from their highs.  After years of economic prosperity and rising stock prices in the United States, the sell-off in stocks has been swift as investors brace for the possibility of a deep recession.  Year-to-date through March 16, the SPDR S&P 500 ETF is down 25.5%, while the iShares MSCI EAFE ETF, a product capturing the large and mid-cap performance of developed markets outside the U.S. and Canada, is down 31.7%.  The iShares MSCI USA ETF, a product capturing large and mid-cap performance of the U.S. market, is down 25.3%.  While domestic equities have fared better than those abroad, should investors consider diversifying investments globally to better position portfolios for an eventual post-Coronavirus recovery? 

Arguments in Favor

Foreign markets may offer better valuations.  As of March 16, 2020, the yield on the iShares MSCI EAFE ETF is 3.48% compared with 1.90% and 1.43% for the SPDR S&P 500 ETF and iShares MSCI USA ETF, respectively.  With the S&P 500’s recent outperformance, some believe international equities may offer superior value and appreciation potential.  According to Yardeni Research, the EAFE and USA forward P/E multiples were 13.5x and 18.0x, respectively, as of March 11, 2020.  Increasing exposure to international equities could provide greater upside when global markets stabilize and recover. 

Lower volatility.  While every country has its own set of risks, portfolio diversity among various asset classes and international versus domestic equities may reduce overall volatility.  According to Vanguard, while most investors prefer to maintain significantly larger allocations to their home country, exposure to international equities helps to reduce portfolio volatility. 

Greater risk-adjusted returns.  Diversifying investments globally may enhance risk adjusted returns since investments are not tied to a singular business cycle.  For example, if the U.S. economy is slowing, other countries’ economies may be expanding.  According to an article by Ford Donohue, CFA, while international stock allocations up to 20% of a portfolio may enhance returns without increasing volatility, any increased international allocation is a trade-off between risk and return.   

Possible Downside

Lack of transparency.  While the United States has a well-established legal and regulatory framework applicable to capital markets and corporate governance and disclosures, other countries may not provide the same level of assurance for investors.  Additionally, with a heightened focus on ESG, U.S. companies may appear to be more focused on investor concerns.  According to an article in the Financial Times, while Chinese companies have made progress in addressing environmental issues, corporate governance is still a sticking point.   

Global markets are increasingly correlated.  Due to globalization, diversification benefits may be decreasing as economies are increasingly linked and changes in the business cycle in one country can have a global effect.  During periods of crisis when global markets experience greater volatility, the correlation between international and domestic investments may increase.  

Domestic multinationals offer ample exposure.  Many investors seek to gain exposure to international markets by investing in domestic companies that do business abroad.  While this does provide exposure to international markets, investors limit return potential by not investing in leading global companies that may be headquartered outside their home country, or may benefit from greater diversification by investing in international companies that are more segregated and less global in scope.   

Big Picture

Following the March 2020 declines in the market, now might be a good time for investors to review their portfolios and think ahead.  Enhancing portfolio diversity to include exposure to various asset classes, industries and markets, may position portfolios to deliver better risk-adjusted returns over the long-term.  International equities could offer portfolio diversification benefits and enhanced return potential, especially for those countries at a weaker economic starting point.  However, because most investors lack the time to assess political and country risks outside the United States, investing in a mutual fund or exchange traded product that offers exposure to international equities may be desirable.  A mutual fund that invests internationally have better resources than the average investors to assess investment risk and return potential.  Whether individual stocks or a managed product, now might be the time to think about adding international exposure to reap the benefits of diversification during the journey ahead.

Sources:

Understanding
and Managing Political Risk, The Balance, John Christy, October 28, 2019.

Time
to Put Some Money into Overseas Stocks, Forbes, Larry Light, January 25, 2020.

Global
Index Briefing: MSCI Forward P/Es, Yardeni Research, Dr. Ed Yardeni and Joe Abbott, March 11, 2020.

Foreign
Stocks Are Looking Cheap. 5 Ways to Take Advantage, Barron’s, Darren Fonda, October 22, 2019.

Global Equity Investing: The
Benefits of Diversification and Sizing Your Allocation, Vanguard Research, Brian J. Scott, CFA, Kimberly A. Stockton and Scott J. Donaldson, CFA, February 2019.

5
Myths of International Investing, Fidelity International Update, June 2019.

Chinese
Governance Raises Red Flags, Financial Times, Siobhan Riding and Jennifer Thompson, June 1, 2019.

International
Equities:  Diversification and Its
Discontents, Enterprising Investor, CFA Institute, Ford Donohue, CFA, November 19, 2019.

Emotions, Markets, and Mayhem (Faith in Cycles)

In a crisp white shirt, charcoal pinstripes, and yellow “power tie,” I turned to leave the crowded deli near Federal Hall off Wall Street.  This hole-in-the-wall was my daily breakfast stop. Here the counter clerk would spot me through the crowd  and know to wrap up a jumbo bran muffin and regular coffee, medium — then I’d continue down to the corner of Williams and Wall. The date was October 23, 1987. Just four days earlier, the Dow Jones Industrials had suffered its largest one-day loss in history, 22.6%. Minutes before, unspoken concern had brought an eerie quiet to my subway ride from Penn Station to Trinity Church. Commuters stayed hush while immersing their brains in newspapers shouting bold doomsday headlines. 

Most mornings, this deli was lively and filled with boisterous overachievers enthusiastic about starting their day. Not on this Tuesday — it was tense and quiet. The quietness was broken after one man began chuckling for no apparent reason. His laugh quickly annoyed the guy in the green trading smock standing in front of him, who asked: “what’s your problem?” Before I reached the door, the laughing man was shoved into a corner payphone hanging above a news rack that spilled papers onto the floor. This brawl escalated as three more Wall Streeters lost their cool and jumped into the fight.

I made it out and down to 48 Wall, here the elevator man knew to take me to the trading floor on three. At 25-years old, I had never experienced anything like this. I felt a bit shaken.

I didn’t have any of my own money in the stock market. Professionally I was trusted to manage a little over a billion in US Treasuries; this pool was earning over 9%. Back then, I was a Fed analyst and a fixed income guy, but I had been around financial markets enough to wonder, is the Dow dropping 508 points last Friday a buying opportunity?

At lunch, I headed down the street and opened a trading account while simultaneously funding it with a check. Two days later, when the check cleared, I bought 200 shares of a utility — A familiar company that mailed me a bill each month. Less than a week after the stock certificates arrived in my mailbox, I sold the position for a $322 gain. My very first “round-trip” in equities. I earned enough to pay my electric bill for the next four months. More valuable than that, I learned a lesson in market moves.

Psychology
of Market Moves

If you’ve been in the investment world for a while, you’ve learned a few lessons yourself. You’ve certainly been through a few bull and bear cycles. First, the stock market behaves well for a while. The returns become better than available in other liquid asset classes, it attracts new cash from the other markets, and the equities prices continue upward. At some point, the sentiment changes, slow and uncertain at first, then people throw in the towel and sell at a fevered pace. Over the past 20 years, the equity market moves downward have been fewer and much more abrupt than the marches upward.

20 Year History, S&P 500        Source: Macrotrends

So far, I’m sure I’m not telling you anything you don’t know. The markets are moving (in either direction) based on the combined expectations of the participants in the marketplace. The study of Behavioral Economics, which combines many disciplines, interprets market psychology. That is the psyche of the combined participants that puts in place direction, momentum, and then turns in sentiment. Behavioral scientists hold that emotions are the main driving force behind market fluctuations.

When prices are rising consistently, and sentiment is good, market activity leads to a bull market. Consistent declines and poor market sentiment place us in a bear market. Bear markets tend to be less gradually sloped than bull markets (steeper declines). Negative sentiment (fear) tends to react with more urgency than optimism.

Price discovery of most anything is largely set by buyers and sellers deciding where they can both agree to transact. For this reason, the higher the number of active market participants interested in transacting shares in a company, the tighter the bid-offer spreads become.

Beware
the Ides of the Upward March

When stocks are marching higher (expansion phase), there is eventually a peak to the optimism. Blind confidence, fear of missing out, and fantasy control the direction. This strong buying activity usually accompanies the middle through the end of bullish sentiment. Some say the bull market ends when all the buyers are involved. With no new buyers to enter, there is no price support and no place left for it to go but down. At times it will move within a narrow band sideways; this is called the distribution phase. During distribution, some holders of stock begin to slowly take profits by selling shares into a market that still has a buying appetite.

Sparse numbers of buyers and the appearance of sellers begins to cause more down days than up, the mood shifts from very optimistic to complacent or confident. By now in the cycle, participants have grown accustomed to expecting the market to act in a specific way (rising values), so they wait, comfortable in the unrealized profits they’re holding.

As prices continue to trend lower, confidence gives way to the feeling of regret that they didn’t book profits when they had them. When the pain of the new downward trend builds to the point of realization that it will only get worse, then a feeling of not being able to get out fast enough takes over. As mentioned above, declines are often steeper than climbs as anxiety quickly turns to panic. At first it’s hard for many investors to sell and take a loss, even when the loss is likely to deepen. Plus, there’s ego involved that causes many to sit and try to wish the price back up.  Then, seemingly all at once they give in and sell.

As the price drops become even deeper, the pain becomes too much, and the hold outs give up and sell. This is referred to as capitulation. At this point, the market is probably close to the bottom. Volatility is high at this stage, and the market may again trade sideways within a narrow band as buyers begin to show some optimism and maybe even “bargain hunting.” 

Source: Dictionary.com

How to
Benefit from Market Psychology

Investors and traders should trust that historically, the broader market has done three things. These three movements demonstrate a cycle which, similar to what is mentioned above, sets up fearful investors to lose. They buy after the market has risen and finally become convinced that the direction is up, and they hold while it’s going down as they either fail to recognize the new trend or have already counted how much the position was once were worth — even though they never booked the profit. For those that mentally count earnings they never take, selling at lower prices is uncomfortable.

These are the three things the market has always done:

1. Gone up
2. Gone down
3. Gone up even more

Through the end of 2019, markets have reached new highs 100% of the time after going lower. We know this, the chart below demonstrates it, yet buying on the way down is very difficult for even the most seasoned investors.

Source: Yahoo Finance

For those that find buying on extreme weakness hard, the key is to make believe the stock market is a store.  When prices are higher than you’ve ever seen them, you should avoid buying. In fact, you can lighten up some, perhaps sell the weaker stocks first. When the market is cheaper than recent averages, use it as you would a Groupon to your favorite event. Don’t wait until it expires and then pay full price.

Cognitive
Bias

This bias suggests a thinking pattern that can lead to unwise or wrong decisions. One of these biases is confirmation bias. This is the tendency to overvalue information that confirms our expectations. We only see or recognize what we want to. At the same time, confirmation bias will cause the trader to ignore information that runs counter to their expectation.

Loss
Aversion

Aversion to loss, causes the trader to fear losses more than they enjoy gains. Investors feel the pain from a loss as higher than the joy of a gain, so they miss good investment or trading signals.

Endowment
Effect

The endowment effect is common, it’s the mindset that values those things already owned more highly than those not owned. The problem lies in the idea that if one owns a stock that is no longer likely to rise, and they hold it, the investor misses the opportunity to redeploy the funds into a better prospect.  The stock with dim prospects should be sold, and the higher probability stock should be purchased.

This Time
it’s (not) Different

Fading refers to a contrarian investment strategy that suggests trading against the prevailing trend. The idea is the market has already factored in all information and is going to change direction. For those with a short-term time horizon, fading the direction of the market could be dangerous. For longer-term investors fading a declining market by buying has demonstrated itself to be safer than shorting an upward market. The reason is that the long-term market direction has been upward. The ceiling on a stock or market price rise is infiniti, this makes fading the market by shorting a riskier proposition. Fading the downward market is safer, however, investors aren’t going to time this perfect, but markets have rewarded those that are patient. The proof of this is in the all-time highs we registered this quarter. The market has always bailed out long market positions (eventually).

Mayhem
Happens

We can all learn from 1987 (two years to full recovery), or from September 11, 2001 (one month to recover), or the 2008 financial crisis (followed by a 10-year bull market), and almost certainly 2020 will not be the markets undoing. The U.S. economy is legendary for its strength and ability to climb back. Americans’ national optimism is hard to shake; the desire to win and find opportunity never stops.  

 

Paul Hoffman

Managing Editor

 

Suggested Reading:

Market Selloffs and
IRA Contributions

Will the Stock
Market Survive COVID-19?

The Economic
Symptoms from Epidemics Have Been Felt Before

Equity Managers can Shine after a Good Shellacking

Steep market selloffs have historically provided opportunity for investors.  The most successful have been contrarians who are selective in what they add to their positions. They analyze which industries and which companies within those industries have been dragged down with the stampede of selling.  Like a sniper, they select their target and take sharp aim at those companies they expect to outperform.

 Stock
Index Contrarians

Other investors, instead, jump into the overall markets with a blanket approach, as most investors are still rushing for the exit.  They’re also often rewarded with outsized returns. For example, 11- years ago, this week, investors were buying into a selling frenzy. Their confidence in cycles paid off.  The washout peaked on March 9, 2009. The low levels have not been revisited since. Their confidence paid off.

 Historically, buyers of the overall market into huge selloffs have eventually been rewarded.

 

Source: CNBC

 Stock-Picker
Contrarians

After September 11, 2001, air travel came to a halt. There were not many people who were looking to load up on Boeing stock. Those that owned it wish they hadn’t and let their anxiety take over as they sold. On the other side of this fear were far fewer buyers than sellers.  These investors saw only value in an industry they did not expect to go away.  Perhaps some of these buyers ignored the headlines and realized Boeing is also a military contractor. Others may have purely looked at the BA balance sheet to see that it was priced well. Whatever caused some to buy this aircraft manufacturer after the attacks in 2001, if they held for only a month, they far exceeded the returns available from the S&P, which also rose during that time. Since then, Boeing has returned almost 600% to The S&P’s 80-85%.

Source: CNBC

We simply attempt to be fearful when others are
greedy and to be greedy only when others are fearful. -Warren Buffet

 Opportunity

For those that have been in the market for more than a few of these rollercoaster rides, there is very little new in these scenarios. When everyone is selling, look for opportunities. When the overwhelming consensus is that it can only go higher, take some cash out to be used for when that sentiment changes (sell high). We all know to “buy low,” it’s difficult for most when we’re in the midst of a wash-out.

 It’s also good to be reminded that it takes patience to wait to be near the bottom, and you aren’t likely to time it perfectly (ever). The market is surely presenting great deals right now. Look for companies that are acquisition targets, dragged down with the surge, maybe start at those that were in the best sectors before the wave of selling. The market has provided participants a good shellacking, relax, and shop smart.

Suggested
Reading:

IRA
Thoughts: When Market Selloffs and Tax Season Collide

Black Swans, Falling
Knives, and Market Corrections

Lower Rates, Lower
Markets, Higher Expectations

Lower Rates, Lower Markets, Higher Expectations

The S&P 500 has fallen 13.8% after hitting an all-time high 10 trading days ago.  The markets jumped this past Monday on the hope that central banks will respond by lowering interest rates. They gave most of the gains back on Tuesday when the Federal Reserve did exactly that by cutting the overnight target rate by 50bp. This leaves little room for further stimulatory cuts.  Does the government have enough ammunition left to combat a slowdown in the global economy, have the markets become weary of government stimulus after ten years of a boom market?

The Fed May Have the Right Tools  

• Who says interest rates can’t go negative?  The Fed lowered its benchmark fund rate target by 50 basis points to a target of 1.0-1.25%.  Some analysts expect an additional cut at the Fed’s next meeting on March 17-18.  The bond market responded with many shorter-term bond yields dipping below 1.0% and threatening to turn negative.  The thought that we are approaching a point where investors would have to pay lenders to hold funds seems hard to grasp.  However, there are several examples of foreign government bonds trading at negative returns.  Germany, Japan, France, Spain and the Netherlands all sell bonds with negative yields.  In fact, Bloomberg estimates that negative-yielding bonds make up about a quarter of the investment-grade debt globally.
• It’s not the level of the rate cut that
  matters, but the percentage.  When the Fed cut rates by 50 basis points, many investors yawned because they’ve seen 50 basis point cuts before.  However, the cut represents a large percentage reduction in rates.  The 29%-33% reduction in rates is the largest since 2008, right after Lehman Brothers went bankrupt.  The move is a clear signal that the government will do whatever it takes to combat the effects of the virus.
• The U.S. is taking the lead but is not acting
  alone.  In conjunction with the Fed action, on Tuesday morning G-7 finance ministers issued a release indicating that they are ready to act, including taking fiscal measures to support the global economy.  A single nation rate cut shifts investment funds from one country to another.  A consolidated rate cut encourages idle funds to become invested.  While the G-7 statement stopped short of supporting coordinated rate cuts, the call for a joint coordinated action is meaningful.

 

Economic Stimulation May be Battling More than a “Stay at
Home” Consumer

• The economic expansion is long in the tooth.  The market and companies are weary of continued expansion after ten years of economic growth.  Management has expanded factories, built up inventory and hired more employees.  The idea that they will take advantage of lower rates to expand further seems unlikely given lowering consumer confidence and growing uncertainties surrounding the virus.
• It’s a global economy and China has been
  beaten down.  The days of viewing the U.S. as an independent country that trades with partners is over.  In today’s global economy, products have inputs coming from all over the world and products that are sold all over the world.  China is an important supplier of parts and products to the U.S.  Unfortunately, China has been severely weakened in the most recent trade war.  While the U.S. has been able to shift some trade to other countries such as South Korea and Vietnam, it remains dependent on China to maintain a healthy economy. 
• Don’t look for fiscal expansion to offset
  weakness.  After cutting taxes in 2018, federal debt has risen from $19.5 trillion to $22.7 trillion.  The Congressional Budget Office projected an annual deficit in excess of $1 trillion, and that was before the coronavirus outbreak.  A slowdown in the economy will negatively affect receipts and could mean deficits that are much larger.  Debt as a percent of GDP will rise. 

Balanced

The economic impact of the coronavirus is unknown.  However, the resolve of governments to respond to any impact is hard to question.  Sure, it is easy to say that the government should have done more to prepare for such a disrupting event while economic conditions were better (lower the deficit, raise interest rates, etc.), but such commentary is Monday morning quarterbacking. 

 

Source

https://www.cnbc.com/2020/03/03/fed-cuts-rates-by-half-a-percentage-point-to-combat-coronavirus-slowdown.html, Jeff Cox, CNBC, March 3, 2020

https://www.bloomberg.com/graphics/2019-negative-yield-debt/, John Ainger, Bloomberg, July 24, 2019

https://www.washingtonpost.com/business/2020/03/03/economy-coronavirus-rate-cuts/, Heather Long, Washington Post, March 3, 2020

https://www.politico.com/news/2020/01/28/federal-deficit-one-trillion-trump-107901, Caitlin Emma, Politico, January 28, 2020

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Thursday, February 20, 2020

1-800-Flowers.com (FLWS)

Gets Into A Personal Space

1-800-FLOWERS.COM, Inc. is the leading provider of gourmet and floral gifts for all occasions. For nearly 40 years, 1-800-FLOWERS® has been helping deliver smiles for customers with gifts for every occasion, including fresh flowers, premium, gift-quality fruits, and other gourmet items from Harry & David®, popcorn and specialty treats from The Popcorn Factory®; cookies and baked gifts from Cheryl’s®; premium chocolates and confections from Fannie May®; gift baskets and towers from 1-800-Baskets.com®; premium English muffins and other breakfast treats from Wolferman’s; carved fresh fruit arrangements from FruitBouquets.com; and top quality steaks and chops from Stock Yards®. The Company’s BloomNet® international floral wire service provides a broad range of quality products and value-added services designed to help professional florists grow their businesses profitably.

Michael Kupinski, Director of Research, Noble Capital Markets, Inc.

Refer to the full report for the price target, fundamental analysis, and rating.

Adds A Personal Touch. The company announces plans to purchase PersonalizationMall.com from Bed, Bath & Beyond for $242 million. The transaction is expected to close in early April, 2020. We view the acquisition favorably as it expands its everyday gifting platform, further distances itself from its peers that a narrow gifting offering.

Reasonable purchase price. The purchase price is estimated to be 1.7 times trailing revenues and 10 times estimated fiscal 2021 EBITDA. a fair price for a business growing revenues in the high-single digit to low-double digits and for cash flow margins in the 15% range. Tax benefits bring the purchase price to…

Get the full report on Channelchek desktop.

This Company Sponsored Research is provided by Noble Capital Markets, Inc., a FINRA and S.E.C. registered broker-dealer (B/D).

*Analyst
certification and important disclosures included in the full report. 
NOTE: investment decisions should not be based upon the content of
this research summary.  Proper due diligence is required before
making any investment decision. 

Thursday, February 20, 2020

1-800-Flowers.com (FLWS)

Gets Into A Personal Space

1-800-FLOWERS.COM, Inc. is the leading provider of gourmet and floral gifts for all occasions. For nearly 40 years, 1-800-FLOWERS® has been helping deliver smiles for customers with gifts for every occasion, including fresh flowers, premium, gift-quality fruits, and other gourmet items from Harry & David®, popcorn and specialty treats from The Popcorn Factory®; cookies and baked gifts from Cheryl’s®; premium chocolates and confections from Fannie May®; gift baskets and towers from 1-800-Baskets.com®; premium English muffins and other breakfast treats from Wolferman’s; carved fresh fruit arrangements from FruitBouquets.com; and top quality steaks and chops from Stock Yards®. The Company’s BloomNet® international floral wire service provides a broad range of quality products and value-added services designed to help professional florists grow their businesses profitably.

Michael Kupinski, Director of Research, Noble Capital Markets, Inc.

Refer to the full report for the price target, fundamental analysis, and rating.

Adds A Personal Touch. The company announces plans to purchase PersonalizationMall.com from Bed, Bath & Beyond for $242 million. The transaction is expected to close in early April, 2020. We view the acquisition favorably as it expands its everyday gifting platform, further distances itself from its peers that a narrow gifting offering.

Reasonable purchase price. The purchase price is estimated to be 1.7 times trailing revenues and 10 times estimated fiscal 2021 EBITDA. a fair price for a business growing revenues in the high-single digit to low-double digits and for cash flow margins in the 15% range. Tax benefits bring the purchase price to…

Get the full report on Channelchek desktop.

This Company Sponsored Research is provided by Noble Capital Markets, Inc., a FINRA and S.E.C. registered broker-dealer (B/D).

*Analyst
certification and important disclosures included in the full report. 
NOTE: investment decisions should not be based upon the content of
this research summary.  Proper due diligence is required before
making any investment decision.