Posts tagged ‘spaq’
Return to Rationality?
As the worst pandemic in more than a generation is winding down in the U.S., people are readjusting their personal lives and investing worlds as they transition from ridiculousness to rationality. After many months of non-stop lockdowns, social distancing, hand-sanitizers, mask-wearing, and vaccines, Americans feel like caged tigers ready to roam back into the wild. An incredible amount of pent-up demand is just now being unleashed not only by consumers, but also by businesses and the economy overall. This reality was also felt in the stock market as the Dow Jones Industrial Average powered ahead another 654 points last month (+1.9%) to a new record level (34,529) and the S&P 500 also closed at a new monthly high (+0.6% to 4,204). For the year, the bull market remains intact with the Dow gaining almost 4,000 points (+12.8%), while the S&P 500 has also registered a respectable +11.9% return.
The story was different last year. The economy and stock market temporarily fell off a cliff and came to a grinding halt in the first quarter of 2020. However, with broad distribution of the vaccines and antibodies gained by the previously infected, herd immunity has effectively been reached. As a result, the U.S. COVID-19 pandemic has essentially come to an end for now and stock prices have continued their upward surge since last March.
Insanity to Sanity?
With the help of the Federal Reserve keeping interest rates at near-0% levels, coupled with trillions of dollars in stimulus and proposed infrastructure spending, corporate profits have been racing ahead. All this free money has pushed speculation into areas such as cryptocurrencies (i.e., Bitcoin, Dogecoin, Ethereum), SPACs (Special Purpose Acquisition Companies), Reddit meme stocks (GameStop Corp, AMC Entertainment), and highly valued, money-losing companies (e.g., Spotify, Uber, Snowflake, Palantir Technologies, Lyft, Peloton, and others). The good news, at least in the short-term, is that some of these areas of insanity have gone from stratospheric levels to just nosebleed heights. Take for example, Cathie Wood’s ARK Innovation Fund (ARKK) that invests in pricey stocks averaging a 91x price-earnings ratio, which exceeds 4x’s the valuation of the average S&P 500 stock. The ARK exchange traded fund that touts investments in buzzword technologies like artificial intelligence, machine learning, and cryptocurrencies rocketed +149% last year in the middle of a pandemic, but is down -10.0% this year. The Grayscale Bitcoin Trust fund (GBTC) that skyrocketed +291% in 2020 has fallen -5.6% in 2021 and -48.1% from its peak. What’s more, after climbing by more than +50% in less than four months, the Defiance NextGen SPAC fund (SPAK) has declined by -28.9% from its apex just a few months ago in February. You can see the dramatic 2021 underperformance in these areas in the chart below.
Inflation Rearing its Ugly Head?
The economic resurgence, weaker value of the U.S. dollar, and rising stock prices have pushed up inflation in commodities such as corn, gasoline, lumber, automobiles, housing, and a whole host of other goods (see chart below). Whether this phenomenon is “transitory” in nature, as Federal Reserve Chairman Jerome Powell likes to describe this trend, or if this is the beginning of a longer phase of continued rising prices, the answer will be determined in the coming months. It’s clear the Federal Reserve has its hands full as it attempts to keep a lid on inflation and interest rates. The Fed’s success, or lack thereof, will have significant ramifications for all financial markets, and also have meaningful consequences for retirees looking to survive on fixed income budgets.
As we have worked our way through this pandemic, all Americans and investors look to change their routines from an environment of irrationality to rationality, and insanity to sanity. Although the bull market remains alive and well in the stock market, inflation, interest rates, and speculative areas like cryptocurrencies, SPACs, meme-stocks, and nosebleed-priced stocks remain areas of caution. Stick to a disciplined and diversified investment approach that incorporates valuation into the process or contact an experienced advisor like Sidoxia Capital Management to assist you through these volatile times.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 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, SPOT, UBER, SNOW, PLTR, LYFT, PTON, GBTC, SPAK, ARKK 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.
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.
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