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?

 

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Sources:

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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

 

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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:

Traditional TV Stations ready to Sign Off?

Copying the Brightest Investment Ideas

Self-Directed Investors Get Unexpected Benefit from Lockdown

 

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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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Is Warren Buffett or Elon Musk Making the Right Bet?

Warren Buffett’s Berkshire Hathaway is acquiring the natural gas transmission and storage assets from Dominion Energy for approximately $10 billion. At the same time that Berkshire is investing in the carbon-based energy infrastructure, Elon Musk and Tesla are preparing for “Battery Day” (see Channelchek article on June 17, 2020, “Is Elon Musk’s ‘Battery Day’ Losing its Charge?” Many believe that Tesla is on the brink of announcing significant improvements in the capacity and life of car batteries and the ability to store power generated from solar electricity. This is technology that could reduce the value of utility assets such as those bought by Berkshire. The two have a long history of butting heads. To quote Elon Musk, Buffett “does a lot of capital allocation” and “we should have, I think, fewer people doing law, fewer people doing finance, and more people making stuff.” So, who is right: the reigning champ of value investing or the upcoming king of growth investing?

Source: Bloomberg Businessweek

 

The Case for Warren Buffett and Value Investing

Warren Buffet is an unabashed supporter of value investing. He favors taking passive investment in well-known brand names that have dominant market positions. He likes companies that are well run but are facing a weakened financial position due to external events outside of managements’ control. Berkshire has long favored the stability of utility stocks dating back to the purchase of MidAmerican Energy in 1999. Berkshire followed the MidAmerican Energy acquisition by acquiring PacifiCorp, Northern Powergrid, CalEnergy Generation, Kern River Gas Transmission, Northern Natural Gas, NV Energy, and AltaLink. With the acquisition of assets from Dominion Energy, Berkshire will now own 18% of the gas transmission assets in the United States. The purchase, which includes spending $5 billion in cash, will hardly put a dent in Berkshire’s cash position, which was $137 billion as of May. From management’s point of view, the acquisition is putting cash to use that is earning a low return. As such, the company’s return on investment will increase even if it is being used to buy low-growth utility assets. As you might expect, the shares of Berkshire Hathaway tend to trade in a manner reflective of its underlying assets. Analysts following Berkshire project a growth rate in the single digits, and the shares trade at valuation multiples similar to the broader market.

 

The Case for Elon Musk and Growth Investing

Elon Musk and Tesla, Inc. take a different approach to investing. Tesla designs develops, manufactures, and sells electric vehicles, energy storage systems, and solar products. Tesla is a product disruptor that is not interested in acquiring out-of-favor companies. The few acquisitions that Tesla has made, such as Maxwell Technologies or SolarCity, have been done to support its drive to make technological breakthroughs. It does not want to purchase utility assets; it wants to make utility assets irrelevant. Some believe its development of solar energy and Powerwall and electric car batteries is a way to create a virtual power plant (see Channelchek article on June 22, 2020, entitled “Virtual Power Plants and Tesla Car Batteries. Tesla is investing in the future, and the shares of Tesla reflect that strategy. Tesla has a market capitalization of $260 billion even though it does not report a profit or positive cash flow.

 

A Review of How Utilities Work

Utility operations can be broken down into three primary categories: generation, transmission, and distribution. Gas utilities are somewhat different from electric utilities in that the “generation” of natural gas is typically done by unregulated exploration and production companies. Natural gas prices can vary in different points in the country, depending on production supply and consumption demand. Different price points create the need for gas transmission pipelines to move natural gas from areas of low prices to areas of high prices. Natural gas is used primarily for space heating, creating the need for storage fields that are filled in the summer and drained in the winter. Natural gas prices are constantly changing as supply and demand changes, sometimes creating the need for new pipelines or storage to be built or sometimes, meaning existing pipelines or storage are not profitable.

 

So, is Warren Buffett or Elon Musk Making the Right Bet?

Are utility assets temporarily out of favor, or has their importance been permanently reduced due to changes in technology? It is probably safe to say that utilities will continue to be involved in the generation of power. The emergence of solar and wind power has gone a long way towards reducing the nation’s reliance on carbon-based fuels for generations. That said, solar and wind power have reliability issues that will only partly be solved by improved battery technology. Natural gas is often viewed as the bridge from a carbon-based energy system to a renewable-based energy system and will remain a primary source of power generation. As such, the need for natural gas transmission and storage assets such as that being purchased by Berkshire Hathaway is not going away anytime soon. What’s more, the need for natural gas to heat homes will continue. Yes, increased use of solar generations combined with battery storage may result in increased use of electric heaters. However, people typically do not change their furnaces until they are broken, meaning natural gas heating will be around for decades if not centuries. In the end, then, the real question to ask is not “who is the better investor?” but “what time frame are we talking about?”

 

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Sources:

https://www.cnbc.com/2020/07/06/why-warren-buffett-made-his-latest-blockbuster-deal-a-bet-on-electric-vehicles.html, Yun Li, CNBC, July 6, 2020

https://www.cnbc.com/2020/07/05/warren-buffetts-berkshire-buys-dominion-energy-natural-gas-assets-in-10-billion-deal.html, Becky Quick, CNBC, July 5, 2020

https://www.businessinsider.com/elon-musk-not-biggest-fan-warren-buffett-joe-rogan-interview-2020-5, Alex Wong & Rebecca Cook, Getty and Reuters, May 7, 2020

https://www.nytimes.com/2018/05/07/business/dealbook/warren-buffett-elon-musk.html, John Foley, The New York Times, May 7, 2018

https://www.bloomberg.com/features/2016-solar-power-buffett-vs-musk/, Noa Buhayar, Bloomberg Businessweek, January 28, 2016

https://www.youtube.com/watch?v=ZPgiBzJzR6M Elon Musk: I am not Buffett’s biggest fan, CNBC, May 7,2020

Self-Directed Investors Get Unexpected Benefit from Lockdown

The advantages of virtual roadshows and other virtual investor relations events are greater than anyone would have guessed prior to Covid-19. These events offer a high degree of flexibility, lower costs for all involved, allows for increased frequency of meetings, and much broader inclusion. With all the benefits, these virtual events should remain a staple of the business world long after the virus risk has passed.

Broader Inclusion

Up until earlier this year, executives regularly made the rounds traveling to major financial centers telling their corporations’ stories to potential investors. In order to get the most from their valuable time and travel costs, the number of cities visited was necessarily limited.  The typical roadshow stops may have included New York and Boston on the East Coast, Chicago in the Midwest, and Los Angeles and San Francisco on the West Coast.  The stops would never include small towns inside or outside the U.S. Now they present everyplace there is an internet connection, including your living room or mine, regardless of where we live. They can be attended by investors of any level that are interested. This is clearly positive for the presenting executive, but it is also a big win for the out-of-the-way professional asset manager – and also the self-directed investors who never would have been able to listen and ask questions of management before.

Saves Resources

Management can now be far more productive under the new process, where they’re no longer balancing travel and logistical issues. They can focus more on virtual meetings and interacting with investors from around the world. And since time is conserved by reporting from their home or office rather than catching planes from one meeting to the next, far more interactions can be had in fewer days. What’s more, the Interactions are often with people they would never have benefitted from meeting with in the past. 

Lower cost

Two executives traveling from the East Coast to the West Coast for a week of meetings could cost $10,000 or more. This takes into account flights, hotels, car rides, and restaurants. For the management of firms who regularly meet with investors, the cost adds up over the year. Under the new virtual roadshow model, the dollars that were wasted can now be more productive by going toward company-sponsored research or other priorities in the IR budget.

The cost of time out of the office is less of an exact measure, but could even be higher than what is spent on travel. Additionally, the time an executive is not away from home and family is also an intangible benefit. Time in transit can now be used toward more productive purposes at the company, with customers, or simply to rest and recharge.

Increased Flexibility

The pandemic has proven the importance for public companies to have a disaster recovery plan-B for investor communications.  Companies that had existing virtual capabilities in place or those that pivoted to them quickly have benefited from maintaining “face-to-face” contact during a period of heightened investor uncertainty.

Virtual roadshows are likely to remain the dominant means of meeting investors in-person, while traditional meetings are likely to be left for special circumstances. Both investors and executives understand the benefits of engaging in this way.

Take-Away

The need for management to maintain uninterrupted communications with investors has never been stronger as we manage through unprecedented disruption of businesses. The advantages to open communication is obvious. Executives can meet with more investors while their resources, including time and money, can be redeployed for greater gain. Companies waiting for conditions to change rather than adopting this technology or partnering with a firm that offers it are falling behind.

Investors, particularly those outside of the normal roadshow or conference centers, and self-directed investors that never received attention from management are the big winners. Virtual financial events place them on a more level playing field. This creates a situation where investors, companies, and the overall market is benefitting.

 

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Copycat Investing, Bright Idea or Dud?

 

“Risk comes from not knowing what you’re doing.” – Warren Buffett

 

There’s a scene in the 1992 movie “My Cousin Vinny,” which, unlike the rest of the classic, is not quotable. There are no spoken words, just actions that let the viewer know exactly what is going on. Many of us can relate.  The scene takes place the first day of an arraignment on murder charges. In the movie, Vinny is defending his nephew Bill and his friend Stan. The challenge is, Vinny just passed his bar exam and has never been a trial attorney. He figures out quickly, along with the audience, that he does not have enough experience to know even the basics to steer clear of the dangers of courtroom proceedings. He finds himself in a situation where the outcome is critical, yet he is very out of place.  To raise the stakes even more, he is surrounded by and competing with veterans of courtroom proceedings. Everyone else knows what they are supposed to do. In the scene I’m referring to, he tries to avoid trouble by mimicking the prosecutor — when the prosecutor sits, he sits, when the prosecutor places his briefcase by his chair, Vinny places his briefcase down, and so on. There are no words spoken to tell the viewer what’s going on. Still, it’s clear that Vince Gambini is determined to be successful, and the method he chooses is to become a copycat of the opposing attorney who is already a proven success.

If you’re familiar with the movie, you know that Vince Gambini does learn and eventually builds on his knowledge and then merges his own strengths and style with what he has copied. He is successful in the end, presenting his essential case. Many investors who are new and learning, or just more comfortable copying or riding the coattails of top money managers do something similar. It is called “copycat” investing, or “coattail” investing. The method and practice is done in many different ways. It certainly has its merits and its limits.

Copycat Investing:

The concept of copycat investing is simple: by mimicking investment picks of consistently successful large investors, smaller investors can possess a well-researched and thought out portfolio with little analysis and minimal knowledge of investing.

There’s no shame in mimicking investors who have a track record you’d like to enjoy. Copycat investing is a selection method, like many other popular methods such as index investing, Dogs-of-the-Dow, or long/short. These can be just as mechanical as replicating the investment moves of well-known professional investors or fund managers.

But is copycat investing a viable investment strategy? While the evidence of its success is somewhat mixed, there are certain techniques you can use to get you closer to being the perfect copycat investor.

SEC Filings

The Securities and Exchange Commission (SEC) requires investors who manage more than $100 million to disclose their holdings once every 90 days. This information is available on the SEC website as Form 13F; a link is included below for your convenience. When you determine the fund manager you’d like to mimic (Buffett, Ackman, Icahn, etc.), this is the first site to be updated. A secondary site worth looking at is holdingschannel.com.

A search here presents visitors with the most recent filings and the investment decisions of historically successful investors such as Berkshire Hathaway or Carl Icahn. The risk that individual investors and those who manage money for others should be aware of, is that with up to a 90-day delay in posting new information, coattail investors may be too late to participate in any early benefits the professionals enjoyed. 

Investors who wish to direct their decisions by copying others should understand the objectives of those they follow and make sure it fits with their own objectives.  For example, Warren Buffett is a long-term investor. He’s been quoted as saying: “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.” A long-term investor who doesn’t expect to always be transacting may be better suited to ride Warren Buffett’s coattails. Alternatively, Carl Icahn has an enviable investment record, but his intent is often to seek board seats or control and effect change within the company. This is not very straightforward, so it may not suit most smaller players.

Problems With Approach

The successful investors already have a portfolio. Their entry point in their current holdings may have been years ago and for a very different price. An investor purchasing shares in those companies now may be placing themselves in a holding that has already experienced its growth spurt. Therefore, future results may be limited. Yet, to ignore these holdings is to ignore the idea that any new positions (that you plan to mimic) may have been added as a compliment, hedge, or diversifier to what is already held. If your own portfolio only accumulates new additions, you may have lopsided risk. An identically weighted portfolio has you mis-timing transactions.

Sales are another consideration. Even long-term investors would have a hard time tolerating finding out about divestiture of a position 90 days later. Large successful investors do sell; when they do, they often help set a downward trend in the market.  Investors sitting tight in down-trending positions, only to find out months later the position is no longer in their copied portfolio, are doomed for occasional large disappointments.

Take-Away

If you are going to practice copycat investing, the filings on the SEC website will become an important source of information. The best investors to copy are those that hold much longer than the 90-days. This may limit you to successful buy-and-hold managers, but only if you desire a buy and hold portfolio. If you prefer to be more proactive and less patient, the copycat strategy may be impossible to fully realize.

One large benefit to copycatting is that by mimicking those that are successful, you can get started investing quicker while you learn your own way around the market following the experienced money with a track record. This gives you a starting point to develop your own strategies and investment style.  Success does not always come from blazing your own trail; sometimes it comes from directly copying the greats, often a mix of both creates the perfectly tailored portfolio for the individual. 

 

Paul Hoffman

Managing Editor

 

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Sources:

SEC Company Filings

Activist
Investors

Holdings Channel

Are we on the Verge of Acquisition-Mania?

While much of the world has been zoomed in on pandemic mitigation efforts, civil unrest, and an overreactive stock market, the change of fortunes in tech are worth paying attention to. Facebook, Amazon, Apple, Netflix, Google, and Microsoft have in hand the perfect ingredients of change along with the financial strength to scoop up companies with synergies that can lead to expanded services, higher profits, and fewer competitors. 

Based on the acquisition activity of these giants over the past couple of months, it seems management has adopted an aggressive pro-active posture similar to that of past recessions. Memorable examples of tech acquisitions from previous downturns include IBM in the 1990s that readjusted its business focus to software and service rather than mainframes and hardware. Some of the acquisitions they made during this period included Lotus, Tivoli, and Unison. During the dot-com bust after the turn of the millennium, two little known companies named Google and Facebook began to rise to the prominence they enjoy today. Another company that decided to get aggressive during the Y2K downturn was Apple. It doubled its research and development in 2001 and 2002. The outcome was the introduction of quickly adopted music storage technology, and later, smartphones. Big tech has been served well by aggressively planning to be even stronger when the economy recovers. 

What Big Tech has an Appetite For

The pandemic has pushed to the forefront new or expanded consumer needs that have provided clear demand and opportunity. Under the category of telecommunications alone, the requirements of companies to electronically meet with remote employees or even clients they’re building relationships with is worth billions. Couple that with entertainment technology and online retail needs, and the potential for massive leaps forward in business growth is possible, even for a current giant. But only for those companies positioning themselves to shape tomorrow’s standards.  Facebook’s CEO Mark Zuckerberg said in an investor call in May, “I’ve always believed that in times of economic downturn, the right thing to do is keep investing in building the future. When the world changes quickly, people have new needs, and that means there are more new things to build.” Facebook and the others clearly ramped up activity when the lockdown began.

Cash for transactions is not a problem for the largest tech companies. And their high stock valuations could provide additional “currency” for acquisitions. At the end of 2019, the combined six tech companies were sitting with $557 billion. This pile of cash allows each in the group to go shopping for the best fit for their projections of how the future will look. They can create strategies of how their business will provide for it, then build or buy the missing pieces. According to PricewaterhouseCoopers, these firms have been among the top spenders on research and development for most of the last decade.

Tech Activity

As Netflix, Amazon, and the other tech companies adapted to their own employees working remotely, they experienced a spike in their services from others in the country doing the same. The demand of messaging and other teleconferencing software and platforms had spiked.

The world is changing, and many of the new or expanded needs are already obvious. Since March, Microsoft has quickly acquired three cloud computing companies with a variety of capabilities to augment their current services of providing technology to business.

Amazon, which relies on its employees interacting with others, was at once overwhelmed with a surge of online orders. They dealt with the safety concerns of its workers first in part by investing in 175,000 new employees. Then they made their corporate shopping list. According to The Wall Street Journal, Amazon is now in advanced talks to buy an autonomous (driverless) vehicle startup named Zoox. The purchase price is estimated to be between $2.7 billion and $3.2 billion.  And, while air transportation dropped almost overnight in response to the pandemic, Amazon placed 12 Boeing 767s in its shopping cart and hit the “Buy Now” button. The online retailer is now equipped with substantially more capacity than ever — acquired at a discount.

Apple is sitting on $193 billion, they’ve scanned their business environment and found four attractive opportunities to swipe right on. In the past few months, they have acquired; DarkSky, a popular weather app for all make smartphones. They picked up Voysis, a digital assistant and speech recognition software company, and Xnor.ai, an artificial intelligence startup. Apple made an acquisition in NextVR that demonstrates their belief in the future. NextVR is a virtual reality (VR) provider that marries live sporting events with VR through various headsets.  An Apple virtual developer conference is in the works.  

Facebook’s activity skyrocketed in March as they were one of the first platforms people flocked to for voice and video chat to keep in touch with others. In April, Facebook said it was taking a $5.7 billion stake (10%) in India’s Reliance Jio, a streaming service where Facebook expects to set up a digital marketplace serving Asia. According to a June 17 Bloomberg article, the investment is being reviewed under India’s antitrust regulations. 

In May, Facebook bought Giphy for an estimated $400 million. Giphy will become part of its Instagram platform. Their expansion in Asia grew earlier this month as they made a large investment in digital payment app Gojek. Gojek now serves 170 million people in South East Asia.  

Also announced this month, Facebook has plans to create a new venture capital fund and is hiring seasoned tech investors. The plan seems to be to selectively fund startups and perhaps later have access or visibility of the firms that offer the most potential. Facebook recently posted this job opening:

Hiring: New Product Experimentation (NPE) team, ideally 10-years of tech experience.

“In this role, you will manage a multi-million dollar fund that invests in leading private companies alongside top venture capital firms and angel investors,”

“You will develop investment and impact theses, lead the execution of new investments, and support existing portfolio companies as needed.”

Facebook has confirmed they have hired someone to fill the role.

Google, too, updated products that people can use to work from home. In April, it said that its video chat service, Google Meet, would be available inside people’s Gmail window and free to anyone with a Google account. It also said it would bolster e-commerce searches by making listings in its shopping search results mostly free, rather than have merchants pay for all their products to appear in the results.

Non-Tech Activity

Tech isn’t the only industry strengthening or expanding their business offerings. Biotech, pharma, retail, and finance, are as well. In late May, Merck announced it would be acquiring Themis; a company focused on vaccines and immune-modulation therapies for infectious diseases.  Roche acquired Stratos Genomics to possess their one-hour DNA sequencing technology. Grubhub was picked up by Just Eat Takeaway.com, which creates new operations in the U.S. for the entry into online food delivery in the United States. Esports acquired the private company LHE Enterprises to capitalize on the surge in online gaming interest. As larger companies in different industries have more clarity of the future business environment, we may see even more non-tech acquisitions.

Take-Away

This period in history will likely be remembered for bringing an acceleration of change. Companies are looking to capitalize on clear trends that are expected to last well after the current challenges. Investors, for their part, can take their own steps to capitalize on new consumer demands. Research of smaller companies that may become acquisition targets could uncover investment opportunities.

Tech is the most notable group making acquisitions to reshape and benefit from a changing world, but there are others. Companies in any industry, which are aggressively seizing the opportunity and perhaps letting go of old ways, could find themselves more powerful when the pandemic resolves itself.  

Investors holding shares of firms targeted for acquisition may never see their company grow into the next behemoth like Apple. This is okay — finding the next “Apple” isn’t as easy as finding small innovative companies that Apple may become interested in owning.

Paul Hoffman

Managing Editor

 

Fin Tech is one of the Fastest Growing Tech Sectors

Emotions, Markets, and Mayhem (Faith in Cycles)

Are Dual Class Stocks a Mistake for
Investors?

 

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Sources:

Facebook establishing a venture arm to invest in startups

Facebook
Invests $5.7 Billion in Indian Internet Giant Jio

Building a transformative subsea cable to better connect Africa

Zoom’s Biggest
Rivals Are Coming for It

Top Innovators

Amazon in Advanced Talks to Buy Self-Driving-Car Tech Company Zoox

Facebook to
buy Giphy for $400 million

Microsoft acquires Softomotive to accelerate and expand its Robotic Process Automation capabilities

IBM Acquisitions 1990-1999

Zuckerberg Investor Call Tanscript

Facebook’s Deal With Jio Under Indian Antitrust Review

Would Anyone be Shocked if the Market Suddenly Capsized?

Is the market’s pricing mechanism temporarily broken, or is it now forever changed? Could it be that retail traders and investors are now the “smart money,” or will they be shown to be suckers? These are the debates taking place among veteran traders at their virtual “water-coolers” and among less-seasoned retail investors in online chat rooms and Facebook groups.

We’re approaching mid-year 2020, it’s a presidential election year that began with the stock-market breaking record highs while corporations were guiding earnings expectations lower. These were expected to be headlines that set the tone in the first half. These expectations have all but been overshadowed.  Since the new year opening bell on Thursday, January 2, 2020, we’ve experienced a rollercoaster record high in the S&P followed a rapid 30% drop, which rebounded in a “V-shaped” bottom to close even on the year.

Some of the most followed and admired investors, such as Warren Buffett, Stanley Druckenmiller, Jim Cramer, and others, famously missed the strongest rally in 90 years. At the same time, self-directed investors, mom and pop, and younger, less-seasoned newbies have been participating in some of Wall Street’s biggest and most unexpected moves. 

Hundreds of thousands of individual investors trading small positions online and from phone apps are pushing up prices of companies that have recently filed for bankruptcy protection or teetering on the edge of default.

In a market as different as the 2020 environment, it’s not surprising that the average daily trading volumes for some of the financially unsound names have been up as much as 30 times their 2019 average. The soaring companies are, in many cases, the same firms that have seen skyrocketing interest at brokerages popular with individual investors. 

The website Robintrack, which is not affiliated with the Robinhood trading application, downloads Robinhood’s trading data, then provides users with tools for analysis and allows downloads at no cost. Although Robintrack doesn’t capture data from other retail broker activity, the information can be used as a gauge of trends and popularity of the do-it-yourself investor.

Robinhood Favorites

Below are the top ten stocks (out of top 3000 by market cap) that have seen the largest increase in interest on Robinhood over the last month:

Out of the “Robinhood favorites,” all are household names that most people would recognize. With the exception of Invesco, all are experiencing severe financial challenges. The first on the list, American Airlines, lost $2.2 billion in the first quarter. The second most popular, Hertz, filed for bankruptcy protection on May 22.  The tenth on the list, Norwegian Cruise Lines, warned of a possible bankruptcy in late May. These three provide solid examples of retail popularity along with price movement that is helping to drive prices unpredictably.

 

American Airlines

Source: Robintrack, CNBC Data
Through 6/9/20

Despite the uncertainty in the airline sector, Robinhood users have gone from roughly zero holdings in American Airlines to almost 650,000 shares.  Shares are up 57.35% over the past five trading days, along with the increased volume.  Changes in data, activity, and increases in popularity on Robinhood may become additional indicators of short-term price movements for traders looking for trading plays.

Hertz

Source: Robintrack, CNBC Data Through 6/9/20

Robintrack’s data indicate that 159,000 of their users currently hold Hertz stock. That’s a record high and an increase of over 430% from 37,000 users a month ago. Over the past five trading days, the dramatic increase in volume has been accompanied by a 416% increase in stock price. Did the experts get this one wrong, or are smaller owners ignoring the risk of holding HTZ? Either way, there has been a large amount of money to be made by any standard.

 

Norwegian Cruise Lines

Source: Robintrack, CNBC Data Through 6/9/20

Norwegian Cruise Line’s growth in popularity from approximately zero to now close to 360,000 holders among Robinhood users ignores many of the challenges in the hospitality industry. However, the 39.61% increase in the stock price over the past five trading days has certainly been cause for many self-directed investors to feel their purchase is justified.

Taking from the Poor and Giving to
the Rich?

Are online self-directed investors ushering in a new era of profitable contrarian investing, or will the days ahead prove to be disappointing and costly? Despite the increase in activity, the average holding per user is small, even if Individually, their positions represent significant positions.  As far as Wall Street is concerned, retail is looked at as a block, despite the idea that the activity is hundreds of thousands of small investors rather than one or two institutions with billions taking a position.

The extraordinary movement in both stocks that are popular on Robinhood and in the market as a whole is still in the midst of a powerful move. Expectations among professionals are that historic unemployment and mounting corporate losses, along with a deep recession, will remove the giddiness among all market players. If the experts have it right, the upward movement across the major indexes cannot continue to attract new retail investors, and institutional investors are apt to stick with conventional valuations. These valuations suggest the market is overpriced. If these attitudes hold, it is a recipe for losses for those in the market. This may leave many retail investors battered.

 

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Source: Hundreds of Thousands of Tiny Buyers Swarm to
Insolvency Stocks

Robintrack

Robinhood
traders cash in on the market comeback that billionaire investors missed

Invesco Ltd. Announces May 31, 2020 Assets Under
Management

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

The pandemic shuts down the economy … and the stock market goes up.  People are rioting in the streets to protest racial injustice … and the stock market goes up.  The United States threatens to strip Hong Kong from special trade status, potentially reigniting trade wars with China … and the stock market goes up.  The rise in the general stock market seems at odds with the economic data being reported.  Granted, the market is supposedly a measure of future results, not current results.  But then how does one explain the market’s strength at the same time that management teams and analysts are racing to lower earnings and cash flow projections? The following three charts perhaps offer some explanation.

 

 

Personal income is up.    Personal income in the US surged 10.5% in April, the biggest jump since the US Bureau of Economic Analysis started compiling data in 1959.  Disposable income rose by 12.9%.  The increase is largely due to an increase in government spending.  Government social benefits accounted for $6.3 billion, or 30% of the personal income in April, almost twice the normal percentage.  One can debate the merits of the government bailout, but the impact is clear.  Government spending has put additional dollars into the hands of consumers.  However, consumers are not spending the increase in income, instead choosing to save it.

 

People are saving, and there is nowhere else to put
money.  People have responded to COVID-19 concerns by staying at home, which has reduced the money they spend on entertainment.  They are also foregoing other discretionary spending due to employment and economic concerns.  The personal savings rate has skyrocketed to historic levels.  The personal savings rate is a measure of savings as a percent of disposable income.  Brian Moynihan, CEO of Bank of America, tells CNBC that checking accounts have 30% to 40% more money in them than 12 weeks ago.  This comes despite historically low-interest rates.  Put plainly; the money must go somewhere, so why not the stock market?  And why not put those dollars in stock that are well known?

 

 

The stock market has become dominated by a handful of tech stocks.  Since bottoming out on March 17, most major indices are up approximately 20%.  Information Technology stocks have led the push with the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) up more than 30%.  Technology stocks are less affected by a reduction in consumer spending due to COVID-19 or racial tension.  In fact, Apple and Google could become major players in the fight against the virus through contact tracing apps, while Facebook and Netflix are seeing increased usage, and Amazon is benefiting from increased home deliveries.  Major stock indices such as the S&P 500 or the Russell 200 are meant to measure the performance of a broad group of stocks comprising all aspects of the economy.  In actuality, the performance of the indices is heavily influenced by a small handful of large companies.  Amazingly, five stocks (Apple, Microsoft, Amazon, Google, and Facebook) now comprise 18% of the S&P 500’s market capitalization, roughly equal to the market weight of the bottom 300 companies.  This percentage has grown steadily in the last ten years.  The strong performance by the stock market, then, does not necessarily reflect improving economic conditions but rather that of just one sector or maybe even only a handful of companies. 

Suggested Reading:

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Sources:

https://www.cnbc.com/2020/05/29/us-savings-rate-hits-record-33percent-as-coronavirus-causes-americans-to-stockpile-cash-curb-spending.html, Maggie Fitzgerald, CNBC, May 29, 2020.

https://finance.yahoo.com/news/looting-protests-and-covid-19-havent-pounded-the-stock-market-160426990.html, Brian Sozzi, Yahoo Finance, June 2, 2020

https://finance.yahoo.com/news/5-powerful-tech-companies-now-make-up-18-of-the-stock-market-heres-why-this-could-be-a-bad-thing-145710881.html, Brian Sozzi, Yahoo Finance, February 3, 2020

https://qz.com/1862614/personal-income-in-the-us-shot-up-a-record-10-5-percent-in-april/, Karen Ho, Quartz, May 29, 2020

http://arnerichmassena.com/blog/faang-phenomenon-sustainable/, Jillian Perkins, Arnerich Massena, June 29, 2018

https://www.yahoo.com/news/faang-stocks-defying-coronavirus-bloodbath-115111875.html, Ritujay Ghosh, Zacks, May 26, 2020

 

How High Can the Market Go?

The markets continued to defy gravity after NASA, with the help of Zoom, rang the Nasdaq opening bell from space on Tuesday, June 3.  The major indexes have continued to reach higher each day since the March 23^rd bottom, causing some to feel uncomfortable with the current level of the market. Nasdaq has been particularly ballistic. In just under six months this year, the Nasdaq 100 has gained 11.2%.

There are many economic, political, medical, and business concerns that would cause one to expect the market to be down. There are also various measures and valuation methods that suggest the most followed indexes are at their melting point. Rather than listing these concerns or rehashing the extreme valuations, it is helpful to understand the reason for the rise. In this way we are giving the market the benefit of the doubt. After all, successful investors know, the market is never wrong. To make money you must know where it is going, even if you don’t think it should go there.

 

The Sustainability
of Daily Market Increases

The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of U.S. consumer confidence levels conducted by the University of Michigan.  The current sentiment has not been this depressed in eight years. Obviously, with 14.7% now claiming unemployment, households are deciding which basic necessities they can afford and which they can put aside. For a large percentage of Americans, this makes discretionary spending out of the question.

With such a large population of consumers avoiding discretionary spending, corporate earnings will be squeezed in most sectors. Businesses already are going bankrupt at a record pace. Some of the more recognizable names that filed for bankruptcy in May included J. Crew, Neiman Marcus, Hertz, and Tuesday Morning. Airlines which had crew shortages in 2019 are laying off thousands this year.

Under even the best conditions, daily stock market increases are not sustainable. So it is safe to project they certainly will come to an end at some point. All rallies do. This latest rally has continued for three reasons. All three are positive expectations rather than actual experience.

1. Expectations of a quick cure and/or vaccine for Covid-19 will get us back to work
2. Expectations for built up post-pandemic demand will be highly stimulative
3. Expectations that Government financial support will be immense and ongoing

These three by themselves are likely just fuel for the current height of the financial markets. After all, at the beginning of this year companies were guiding expectations lower. Channelchek discussed this in an article titled Is
the Market Disregarding Earnings Results? which we published on February 14^th of this year. This was before the coronavirus lockdown and well before the riots that have spread out of Minneapolis. At that time it was easy to make an argument that markets were steamy and needed to cool off a bit. There are significantly more headwinds now, to say the least. Still, the Nasdaq 100 actually passed it’s February 19^th high in midday trading this week.

The University of Michigan also polls consumers on their expectations on improving business conditions. These numbers are quite positive. A higher percent of consumers than any time in the past ten years views the outlook as improving. This survey doesn’t ask “better than last year?”, it asks “better than now?” With this, it isn’t surprising that such a high percentage sees an improvement. Feeling that things will get better may have been the initial spark that stopped the fall in March.

University of Michigan Survey Data

Fear of Missing Out (FOMO)

The average daily growth in the S&P 500 over the past 50 days is 0.78%, while the return for owning a US Treasury 10-year for 365 days is 0.76%. That’s less than 1/365 in return. Risk versus return is one driver of investor behavior. Confidence is another driver. On the day after election day in 2016 the Dow hit an all-time after a dramatic late-day rally. Nothing had fundamentally changed in the market except increased confidence in business conditions. This stoked some buying which then prompted more buying.

It often only takes a couple of strong days before the attention of a larger pool of investors begins to want in on the rise in prices. This then feeds on itself as more and more see the movement and fear they will miss out. This happened when US stocks bottomed in March 2009. The economy was still bad and quite uncertain. The result, confidence in the future, and governmental support led to the longest bull market in American history.

Take-Away

There are some faint signs that the economy is bottoming. For instance, the number of unemployment claims has slowly declined, and mortgage applications, both refinancing and new purchases, are rising. Airline passenger activity and restaurant traffic are climbing as well.

The opposite of the fear of missing out is fear of staying at the party too long — not booking profits on the way up. This causes a downward movement that is often more rapid than the upward climb. The Fed and participants long the market certainly hope that after defying gravity amid so much uncertainty, that any reduction in pace leads to a soft landing.

                                                                     

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Sources:

University
of Michigan Data

https://www.nasdaq.com/articles/how-nasdaqs-opening-bell-defied-gravity-2020-06-03

Koyfin Market Data

Unemployment
BLS

Irrational
Exuberance, Chapter 8

Is the Repeated Outperformance in June of the Russell 2000 Random?

“Sell in May and Go Away” is an investment axiom that suggests investors would do better to lighten their positions in stocks during the summer months. Is this good advice? It doesn’t tell us when in May that we should take our chips off the table. Is it May 1, Memorial Day weekend, May 31? And, is one sector or index more impacted than others? This May, the Nasdaq hit its low for the month on May 3, right before its 800 point climb. The S&P 500 bottomed later on May 14 before shooting up close to 10%. Overall, May 2020 was an excellent month for the major market indexes. If you didn’t sell, there’s a good chance it gave a boost to your portfolio.

What will June and the summer bring? I don’t know of any market sayings for June. I guess you were supposed to have already reduced your positions in May. I do know, from my years on Wall Street, that the trading desks during the summer months are often controlled by the rookies and interns. They’re often trying to demonstrate their abilities while the veterans are out playing golf or lying on a beach in South Hampton. Could this be the root of the “sell in may…” advice?

Serious investors don’t care about sayings; they care about company data, economic numbers, trends, and probabilities. I decided to look back at the trends over the past 20 Junes to see if history provided a verifiable pattern across the most followed market benchmarks.

June
Results Since 2000

Out of the past 20 years, the Russell 2000 has returned positive results 13 times (65%). This doesn’t sound overly impressive until you compare it to the Dow 30 which had been up in June for only 7 of the years (35%), the S&P 500 was up 11 of the 20 (55%), or the Nasdaq that was up 9 Junes (45%) over the past 20 years. So, over the period, only two indexes were up during June more than half the time. I should point out here that this 20-year period was not “cherry-picked” to compare performance history.  A quick review of the data for the ten years prior to this, and the ten years prior to that only reinforced this June “trend” with the small-cap index exceeding the others. Here is a link for the Underlying Data.

 

Data Source: investing.com  

In terms of performance, the track record for the Russell 2000 is even more compelling. With a one-month return average of almost 1% (0.94%) in June since 2000, the Russell has returned more than double the next closest index which is Nasdaq.

 

There May Be a Reason

Rather than caution that past history is not an indication of future performance, I’ll instead make sure readers know that during this period, the best year was 6.89% (June 2019), and the worst June was negative 8.60% (June 2008). So any particular year has its own circumstances. But there is something at play during June with this index. The Russell Indexes are being reworked and this creates activity that could be providing a predictable tailwind. The added companies typically have a good amount of new interest surrounding them. This added interest causes fresh institutional buyers of the new stocks being included and often a rise in their value leading up to and for a short time after their inclusion.

Take Away

Channelchek wrote two informative articles on the impact on investors of index reconstitution. They are Opportunity When Stock Market Indices
are Reshuffled and The Russell Index Reconstitution. These two articles, coupled with the above data, make clear that investors should be aware of how the calendar impacts the index, which measures the lower 2000 stocks of the 3000 largest capitalized companies.

As far as selling everything else now that it’s the last day in May, normal market probabilities may not apply this year. The one thing certain in 2020 is that there are cross-currents that will continue to move markets dramatically. The normal drivers of stock price based largely on recent company performance, for now, are on hiatus. 

 

Paul Hoffman

Managing Editor

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Investor Relations in 2020 — Meeting the Needs of Investors and Companies

Is face-to-face communication gone forever? Are nimbleness and strategic plan more critical than financial reports? Is loyalty from the investment community on par with having the loyalty of customers and employees? Are reputable company-sponsored research firms protecting their reputation when “business as usual” is on hold? Does this leave both investor and customer base maintained? Has the current economic weakness strengthened investor relations firms? These are among the questions addressed in this well-thought-out, well-presented release posted May 4th in USA Today titled: The New Age of Investor
Relations by Stuart Smith, CEO, and Founder of SmallCapVoices.com.

The New Age of Investor Relations

So far in 2020, we learned with abject certainty that “business as usual” is an axiom of the past. COVID-19 continues to wreak havoc on the world, leaving in its wake total carnage of economies, businesses, communities, schools and health care systems. As world leaders and health experts attempt to define a semblance of the “new” normal, we’re all reminded that the future can only be forecast, not foretold. This means it’s time to adapt.

Established crisis management plans, from a global perspective, did not anticipate this crisis. Determining the full scale of impact will take decades, though the effect on America’s businesses, however, is closer at hand. As the pandemic peaks and plateaus, we will see which public companies successfully adopted a new-age strategy to retain, attract and communicate with the lifeblood of their existence: the investor community.

The game plan for many CEOs thus far has been to reduce overhead and adjust operations to minimize impact on the bottom-line and ensure continuity with customers. In the midst of these changes, temporary disregard of the financial community to focus on corporate survival is expected, though admissible for only so long and to a small degree. If broader market performance is any indication, existing and perspective stakeholders are watching to gain clear understanding of what measures are taken to manage liquidity. Qualitative information – the company’s new business model and strategic direction – may be more important to convey in the near-term than quantitative financial documents. In order to stabilize stock prices, shareholder performance-expectation must align with the actual decisions made by management.

Of extreme, immediate importance is timely communication that answers the most common questions of the investment community.

For instance: Are there pressures on demand for your goods and services? Are you able to meet this demand? What is the impact from supply chain disruptions? Are projects being delayed or cancelled? How are you managing your human capital? Are you eligible for government assistance?

There are many more questions, with relevancy based upon industry sectors, some of which are impossible to answer during this changing environment. Even so, investors are observing management’s ability to handle the current crisis and evaluating the longer-term merits of making or holding investments. In the absence of concise answers, it is critical that public companies communicate to shareholders how they are monitoring economic indicators and steps they are taking to manage relationships with suppliers and customers.

Is Face-to-Face Gone Forever?

Nothing beats face-to-face communication. The tactility of an in-person meeting can never be replaced, but with the current environment, roadshows, investor luncheons and equity conferences are no longer on near-term calendars. Businesses are forced to find new ways to communicate in both business and social settings. In many cases, the results are better-than-expected and more cost-effective than in-person arrangements. Innovative companies are redirecting their travel dollars to improve their digital presence and create virtual offices. Websites are being overhauled; benign investor relations (IR) sections are coming to life; and webinars and virtual meetings have exploded in both number and the richness of content.

When face-to-face contact is deemed safe, executives will be back on airplanes and checking into hotels. This new digital awareness, however, will not be lost. When the cost-to-benefit analysis is complete, it will gain a permanent place in the IR toolbox.

Planning for Better Times

While trust is a prerequisite for effective IR, it is now more important than ever. “I don’t know what or who to believe,” has replaced “How are you?” as the opening catchphrase. Skepticism is at least on par with optimism.

Fortunately for corporate executives, world governments and mass media have usurped and preserved the lead as those least trustworthy. Mistrust for corporate America, however, still provides a sizable hurdle for those given the task of telling the company story.

When the storytellers are the inside players, the hurdles become taller. Only the most skilled CEOs and CFOs can effectively maneuver through this unprecedented territory. Pure transparency of message – passion without promotion – has always been the bedrock of effective IR and it will be critical in the planning of post-crisis strategies.

Specialized and accredited IR firms – together with third-party, institutional-quality equity research – can help deliver, verify and validate internal messaging.

Think of this in terms of a restaurant. Who best to provide a recommendation: the cook or the customer? Investing in an uncertain future is immensely difficult. But it is the companies with emergent strategies, in the midst of crisis, that captivate the attention of investors. Even Apple was once on the brink of bankruptcy.

Picking the Best Players

Developing an effective IR program is not easy. CEOs and CFOs cannot just hire the solution; they must take an active role in its development. Many companies churn through IR firms, particularly when expectations are not met. Where consistency and clarity of messaging is imperative, churn is not good. Picking the “right” players the first time is imperative in developing a sustainable IR program.

So, what should be looked for in the selection of IR professionals? Specialization is a good start, particularly for companies in complex sectors. It’s akin to choosing a heart surgeon who has performed thousands of surgeries; specific experience will aid in the management of unforeseen circumstances.

Longevity is paramount, both as a firm and in the retention of clients. Longer-term case studies will provide insight into the IR firm’s methodology and how it establishes a rapport with the investment community.

Personnel is also key. Consider the employees of the firm. CEOs and CFOs will need to spend considerable time with the person or team assigned to their account. The chemistry of these relationships will often determine the success of the program. A mutual respect promotes an honest exchange of ideas and information, and a candid discussion of expectations is the kind of relationship that will result in a more cohesive execution of the plan.

Over the last 15 years, attracting the attention of sell-side analysts has become increasingly difficult for small and microcap companies. Independent research provides the foundation for IR initiatives. Through a combination of decimalization, regulation and radical changes in the trading paradigm, small, more illiquid companies struggle to get coverage. Sell-side providers have an equal struggle getting paid by Wall Street for microcap research, so many have moved to higher market cap securities. The evolution of company-sponsored, or “paid” research has provided hope for these companies. With reputable firms, however, the decision to initiate coverage remains with the research department. A rule of thumb: if you can simply “pick them and pay them,” you probably should not.

Company-sponsored equity research (CSR) was stripped of the promotional / propaganda stigma when regulated, licensed equity analysts started writing it. Regulators have clear rules by which this level of analyst must abide by or incur hefty fines, or even ejection from the industry. The broker / dealer that sponsors the publishing analyst is also held responsible for ethical breaches. The relatively small cost to issuers of between $4,000 and $6,000 per month provides little incentive to cheat. Except for the payment method, the CSR process of selection, initiation and coverage through a licensed broker / dealer has not changed. Initially, there were conflict of interest concerns with CSR. Ironically, CSR can reduce conflicts arising from pay-to-play schemes, wherein research is offered in exchange for investment banking arrangements. For a company that has little or no coverage, if CSR is offered, it should be considered using similar standards of specialization and accreditation used in the selection of an IR firm.

Delivering the Message

A balanced and comprehensive IR strategy can only be measured by how it is accessed and by whom. On the research side, CSR or otherwise, institutional investors prefer access through aggregators such as Bloomberg, FactSet, Refinitiv (formerly known as Thomson Reuters) and Capital IQ. Retail distribution is more complex and is usually managed through direct communication with investors or their representatives. A new service, Channelchek.com, offers institutional-quality research on small and microcap companies to anyone who registers on the site. This free service also provides advanced market data, webinars and webcasts, podcasts and news. There are more than 6,000 companies listed on ChannelChek.com, opening a new channel of distribution to individuals and groups who did not have access though the aggregators, which charge hefty fees to users. Family offices, investment advisors, independent brokers, private equity, high-net-worth individuals and the huge and growing group of self-directed investors now have a fighting chance to making more informed decisions like the institutions; plus, at no cost.

Stay Optimistic

Management of even the largest companies are suspending guidance through what should be called the “Uncertainty Pandemic.” The uncertainty, however, doesn’t alleviate the responsibility to execute effective IR with the investment community. Tomorrow’s survival is arguably contingent on today’s strategies. Business leaders must establish flexible, yet defined, crisis management standards – such as the selection of a quality, modern IR firm – and demonstrate their ability to adapt as needed.

While the stock market has seen plenty of volatility this year, the numbers prove that investors are rallying behind American business. At all levels of adversity – and yes, this is probably the highest level we have seen – opportunity exists for those who successfully adapt. One sure strategy is to reevaluate and reenergize IR practices and communication strategies. Investors need companies as much as companies need them. Get on their radar screens. Carpe diem. Seize the day.

About the Author

Stuart Smith is the CEO and Founder of 
SmallCapVoice.com, which is a recognized corporate investor relations firm, with clients nationwide, known for its ability to help emerging growth companies build a following among retail and institutional investors via c-suite corporate profiles.

About Channelchek

Channelchek is among the services that have experienced a growing fan base through the pandemic. The online platform provides company-sponsored research and data on small and micro-cap companies alongside pertinent articles, virtual roadshows, CEO discussions, podcasts, and information on over 6,000 companies. For answers to your questions, please contact Channelchek here.

 

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Source:

USA Today, May 4, 2020 — The New Age of Investor Relations