Archive for 2021
Market Drops as GameStop Pops
The stock market started with a bang this year with the S&P 500 index at first climbing +3% in January before ending with a whimper and a monthly decline of -1%. This performance followed a strong finish to a wild 2020 presidential election year (the S&P 500 rose +16%). There has been plenty of focus on the coronavirus health crisis and vaccine distribution (100 million doses in 100 days), along with debates over a $1.9 trillion proposed relief package by newly elected President Joe Biden, but there has been another story stealing attention in the financial market headlines…GameStop.
If a global pandemic and a populist attack on the Capitol were not enough for investors, the Reddit (WallStreetBets) and Robinhood revolution coordinated a mass attack on privileged hedge funds and short sellers by squeezing out-of-favor stocks like GameStop (Ticker: GME) to stratospheric levels (up +1,625% to $325/share in January alone) causing an estimated $20 billion of losses for many wealthy elites. To put the meteoric rise into perspective, before GameStop shares reached $325, the stock was valued below $20/share last month and has climbed more than 100x-fold from a low $2.57/share nine months ago (see chart below).
What Exactly Happened?
Well, millions of users on the social media platform Reddit banded together on a forum called “wallstreetbets” (see graphic below). WallStreetBets was established in 2012 and had approximately 1 million subscribers at the beginning of 2021 – today it has more than 7 million subscribers. Millions of these anti-establishment WallStreetBets followers effectively colluded together to inflate the share price of GameStop by ganging up on the many short sellers who were betting that GameStop share price would drop. In other words, Reddit-Robinhood buyer gains led to short seller losses. One hedge fund in particular, Melvin Capital, lost billions of dollars on its GameStop short bet and saw its fund performance decline by a whopping -53% in one month…ouch!
The Reddit WallStreetBets forum may have served as the match in this wildfire, but in order to trigger an inferno, a brokerage account is needed. A trading platform allows individual traders on Reddit to level the playing field against the hedge fund professionals and short sellers. The fuel for the GameStop detonation was Robinhood, a fintech (Financial Technology) brokerage firm founded in Silicon Valley in 2013 by two Stanford University graduates. The mission of the company is to “democratize finance for all.” But let’s not forget what Thomas Jefferson noted, “A democracy is nothing more than mob rule, where fifty-one percent of the people may take away the rights of the other forty-nine.” The Reddit-Robinhood mob certainly proved this point.
Although Robinhood was initially seen as a saint in the free trading revolution, eventually many of the brokerage company’s disciples became disenfranchised. Many users subsequently turned on the company and considered Robinhood a villain that was rigging the system when CEO Vlad Tenev halted the ability of its 13+ million users to buy GameStop shares.
Many traders came to the conclusion that Robinhood was working to save the perceived hedge fund bad guys by the firm temporarily terminating user purchases in GameStop stock. Mr. Tenev blamed regulatory capital requirements as a reason for disallowing Robinhood-ers to buy GameStop last week, which was a major contributing factor to why the stock price plummeted by -44% on January 28th. The following day, Robinhood partially reversed its stance and subsequently allowed minimal daily purchases of one share.
How Does Short Selling Work?
In the stock market, you can make gains by buying shares that go up in price, or you can make profits by short selling shares that go down in price. If you buy a stock, the most money you could lose is -100% of your original investment. For example, if you invest $1,000 into GameStop stock by buying 50 shares at $20 each, if the stock price goes to $0, the most the investor/trader could lose is 100% of their $1,000 original investment.
On the flip side, if you short a stock, the potential losses are limitless. For example, if you (or a hedge fund manager) shorts $1,000 of GameStop stock by selling 50 shares short at $20 each, if the stock price goes to $60, the short seller just loss -200% of their original investment [($20/shr – $60/shr) X 50 shares] = -$2,000. If GameStop goes to $100, the short seller loses -400%, and if GameStop price goes to $220, the short seller loses -1,000%. As you can see, the higher the price goes, there are infinite potential losses of the investor, trader, or hedge fund manager.
If a stock price continues to move higher, the only way for a short seller to stop the bleeding (i.e., close their short position or “bet”) is to buy shares. As a reminder, a buyer of stock closes their position by selling shares after they originally buy shares. A short seller closes their position by buying shares after they initially sell shares short. So again, if GameStop share price continues to move higher, the only way for GameStop short sellers to stop their losses is to buy more GameStop shares. This is the equivalent of pouring gasoline on a blazing fire because as millions of Reddit/Robinhood-ers are pushing GameStop’s share price higher almost every day, short selling hedge fund managers are left scrambling for the exits and forced to close their positions at even higher prices (i.e., larger losses).
What Does This All Mean?
Whether you are talking about speculation in Bitcoin, the rise of SPACs (Special Purpose Acquisition Companies), the increase in the number of IPOs (Initial Public Offerings), or the Reddit-Robinhood Revolution, risk appetite has been on the rise and long-term investors should proceed very cautiously. Just as many have experienced on trips to Las Vegas, big winnings can quickly turn to huge losses. Although it’s certainly fun to watch the individual Davids take down the hedge fund/short selling Goliaths, if the Reddit-Robinhood community gets too aggressive in its speculation, history shows us they will end up being the ones swimming in their tears or stoned to death.
If you need assistance navigating through all these land mines, please give us a call at Sidoxia Capital Management (949-258-4322) for a complimentary portfolio review.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (February 1, 2021). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in GME, AMC, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
New Year’s Resolutions and Vaccine Distributions
Many people were ready to flush 2020 down the toilet after the novel coronavirus (COVID-19) global pandemic dominated the daily headlines, but panic eventually turned into optimism. With last year and a new year celebration now behind us, the annual tradition of creating a New Year’s resolution to better one’s life will be a challenge for many in 2021. Why? Well, from a financial perspective, the stock market, as measured by the S&P 500 index, finished the year at another mind-boggling, all-time record high (+16% for the year), making 2020 a tough act to follow.
One area of the stock market performed exceptionally well. With millions of employees, students, and bored Americans locked down for much of the year, demand for computers, mobile phones, and internet-connected televisions swelled. Due to a flood of sales into devices, gadgets, equipment, and software, technology stocks became huge beneficiaries in 2020. The performance of this sector can be gauged by the results of the tech-heavy NASDAQ index, which skyrocketed an astounding +44%.
Countering the Confusion
Given this unexpected surge in stock prices, many casual observers are asking how is it possible the Dow Jones Industrial Average capped off a year above the 30,000 level (best ever) after a year when 80 million people contracted COVID-19 and almost 2 million humans died from the virus?
This month, we will try to answer this confusing question. We shall explore the factors behind the unprecedented collapse early in the year and the subsequent recovery in stock prices surrounding this perplexing virus.
We’ve experienced a lot over the last year: death, destruction, an emotionally divisive presidential election, social distancing, face-coverings, Amazon deliveries, Netflix binging, DoorDash food deliveries, hand-sanitizer stocking, toilet-paper runs, and endless pants-less Zoom video sessions. After all this insanity, here are some reasons for why your and my investment accounts and 401(k) balances still managed to appreciate significantly last year:
- A COVID Cure: Although roughly only 4 million doses of the COVID-19 vaccine have been administered to date (after a 20 million goal), the government has contracted for the delivery of 400 million vaccine doses from Pfizer Inc. (PFE) and Moderna Inc. (MRNA) by summertime. With these two FDA (Food and Drug Administration) approvals alone, these doses should be enough to vaccinate all but about 60 million of the roughly 260 million adult Americans who are eligible to be inoculated. Even better, each of these cures appear to be over 90% effective. What’s more, in the not-too-distant future, additional relief is on its way in the form of further vaccine approvals by the likes of Johnson & Johnson (JNJ), Novavax Inc. (NVAX), AstraZeneca (AZN), and the Sanofi (SNY) / GlaxoSmithKline (GSK).
- Fed Firemen to the Rescue: As the COVID flames are blazing with record numbers of cases, hospitalizations, and deaths, the Federal Reserve firemen have come to an economic rescue by providing accommodative monetary policies. By effectively setting the benchmark Fed Funds Rate to 0% (see chart below), our central bank is not only stimulating loan activity for businesses, but also lowering the cost of mortgages and credit cards for consumers. In addition, the Fed has been providing support to financial markets and invigorating the economy through its asset purchases. More specifically, the Fed outlined its activities in its most recent December statement:
“The Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.“
- Economic Recovery is Well on its Way: In addition to the unmatched monetary policy stimulus from the Federal Reserve, we have also experienced an unparalleled $4 trillion in fiscal stimulus to trigger a sharp rebound in economic activity (see red line in chart below). There have been multiple rounds of PPP (Paycheck Protection Program) loans given to small businesses, millions of direct checks distributed to unemployed individuals, along with a host of other programs covering the healthcare, education, and infrastructure industries. As a result of these measures, coupled with the vaccines unleashing massive amounts of pent-up demand, pundits are forecasting above-trendline economic GDP growth in 2021 approximately 4% – 5% (e.g., Merrill Lynch +4.6%, Goldman Sachs +5.9%, and the Federal Reserve +3.7% to +5.0%).
As part of the recovery, the banner year in stocks has also helped catapult consumer household balance sheets to over $120 trillion dollars, while simultaneously reducing debt (leverage) ratios (see chart below).
Flies in the Ointment
It’s worth noting that not all is well in COVID-land. Unemployment rates remain at elevated recessionary levels and industries such as travel, leisure, and restaurants persist in devastation by the pandemic. Politically, the hotly contested 2020 presidential election has largely been resolved, but a Georgia runoff vote this week for two Senate seats could swing full control of Congress to the Democrats. With the stock market at fresh new highs, a Democrat sweep in Georgia would likely be interpreted as a mandate for President-elect Biden to increase taxes for many people and businesses. Under this scenario, a temporary downdraft in the market should come as no surprise to any investor. However, any potential tax hikes on corporations and the wealthy should be accompanied with more infrastructure spending and fiscal spending, which could offset the drag of taxes to varying degrees.
Although Sidoxia Capital Management is still finding plenty of opportunities in the stock market while considering these record low interest rates (yield on 10-year Treasury Note of only 0.92%), areas of vulnerability still exist in recent high-flying, money-losing IPOs (Initial Public Offerings) such as Snowflake Inc. (SNOW), Airbnb Inc (ABNB), and DoorDash Inc (DASH).
Other cautionary areas of excess speculation include the hundreds of SPAC (Special Purpose Acquisition Company) deals totaling more than $70 billion in 2020, and the reemergence of Bitcoin froth (up greater than +300% this year). The recent rush into Bitcoin has been fierce, but industry veterans with memory greater than a gnat recall that Bitcoin plummeted more than -80% from its peak to trough in 2018. Suffice it to say, Bitcoin is not for the faint of heart and buyers should beware.While there was a lot of pain and suffering experienced by millions due to the COVID-19 global pandemic, there was a lot to be thankful for as well, including vaccines to cure the global pandemic. Even though we had another record year at Sidoxia Capital Management, there is always room for improvement. At Sidoxia our New Year’s resolution is always the same: Provide superior investment management and financial planning services, as we build sustaining, long-term relationships with our clients.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 4, 2021). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AMZN, NFLX, MRNA, ZM, PFE, NVAX, and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in DASH, JNJ, AZN, SNY, GSK, SNOW, ABNB, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Investing Caffeine 
