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January 2021 review

Summary

The final week of January saw financial market headlines dominated by the trading activities of online community traders.

Mind GMEs

In a month that initially focused on rising Covid-19 infections in the UK and elsewhere, the trials and tribulations in Washington from attempted insurrection to inauguration, the final week of January saw financial market headlines dominated by the trading activities of online community traders.  Online forums on TikTok, Discord, Facebook and Reddit’s WallStreetBets, caused sufficient trading volatility to attract the attention of the highest authorities in the US, the Securities and Exchange Commission (SEC) and the Federal Reserve. Even Bitcoin became old news until Elon Musk’s hashtag reference to it gave it a short-lived shot in the arm (topical pun intended).

The stock that gained the most headlines among many was GameStop, a struggling retail game company.  By now you may well have heard or read many versions of what happened so here is a brief share price history (courtesy of Yahoo Finance) in January followed by a graphic depiction (courtesy of The Daily Shot) on the basis that a picture tells a thousand words:

2021 opening price on Jan 4:           $19.00

Closing price on Jan 29:                  $325.00

Intraday high on Jan 28:                 $483.00

Source: The Daily Shot

Because of its struggles as an old-fashioned, store-based game retailer, GameStop had long been a favourite short of some hedge funds to the extent that there were more shares shorted than actually existed.

When the maths points to an over-shorting situation, it’s time to cover your short.  Indeed, it is possible to determine where the biggest short positions exist in certain stocks and that information should form a part of a hedge fund’s strategy as to when to cover their short position on a stock.

Hedge funds caught out by GameStop’s short squeeze have some explaining to do about their risk management processes to their investors. It would seem that information on shorts, as a percentage of a company’s available shares, drove the price recovery in a few other struggling companies that suddenly became darlings of the aforementioned online communities – AMC Entertainment and BlackBerry (remember them?) being two examples.

Mistaken Identity

Like any scenario that has the feel of a frenzy or mania, there are the odd mishaps, as this Australian company with the same GME ticker but listed on a different exchange, demonstrates.  The end month spike in this resource company being attributable to retail traders picking the wrong company.

An Australian company with the same ticker as GameStop

 

Capitalism or manipulation?

The small, but substantial in numbers, crowd of buyers in GameStop and other low-priced stocks had a material influence on price movements and in the process caused losses at the hedge funds that shorted those companies.  Some brokerage firms suspended the ability to trade shares in some of the companies affected – fuelling frustration among many market participants, few of them having sympathy for hedge funds.

Whatever you think about the shenanigans of January, and the last week in particular, what happened does spark a debate as to whether this is just capitalism at work, market manipulation, large investors fending off smaller investors or anti-establishment’s attempts to ‘punish’ Wall Street. Let’s see what the US SEC think.

 SPACS

Also known as Special Purpose Acquisition Companies, a SPAC is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.

Also known as “blank check companies,” SPACs are not new but have recently become more prevalent as investment vehicles for high-profile investors. SPAC takeover activity can also be viewed as late cycle frothy activity which, when allied to some of the lofty valuations in some largely US large-cap companies, stokes ‘bubble’ fears.  Investor expectations seem to be reflected in the opening day performance of SPACs, as evidenced in the chart below (source: The Wall Street Journal).

Cash

What could be a factor in markets and supporting market behaviour is the savings buffer as depicted in the following chart.  Some of the shaded area could be playing the market in a David vs Goliath, young vs old, retail vs professional investor scenario. The YOLO (you only live once) generation are seeing use of their cash balances to trade as a way to earn money to make lifestyle changes.

Source: The Daily Shot

Cycles

Monetary – the end of the interest rate cycle, interest rates are headed higher but when and by how much?  As inflation picks up, will the expectation that central banks remain on the sidelines hold true?  A steeper yield curve where longer-term interest rates rise further than short rates is a consensus view.  Central banks have the ability to finesse the shape of their yield curves through continued quantitative easing (QE).

Fiscal – the spending cycle continues and President Biden’s ‘build back better’ programme will add to Government stimulus in the US.  Elsewhere in developed markets, a ‘do whatever it takes’ mentality remains in play.

Economic – are we nearing the end of the beginning? Economic growth rates are being revised upwards. Vaccine success and roll-out beating new variants is the consensus view.

Covid-19 – the turning point of the infection cycle? Vaccines expected to be winning the battle.

Leverage

The low cost of debt and availability of cash can encourage leverage.  What happened in the general equity market sell-off at the end of January could be a by-product of leverage and some de-leveraging as a consequence.

The Investment Mix

Expensive assets, demand assets, contagion from stock specific lofty valuations arising from narrow breadth in US equities. Inflation creeping higher.  Negative real interest rates. Whatever you think about equity valuations, debt markets are expensive and could be described as being a bubble, one created by central banks activity since 2008. A borrower’s market – which again could be seen to promote leverage.

Earnings

So far so good, many beating consensus expectations. More to come in February but overall, consensus forecasts have been surpassed again.

ESG – Due Diligence

One story that isn’t changing is the momentum behind the label that is ESG, which as a reminder stands for Environmental, Social and Governance.  There continues to be a veritable tsunami of flows in to ‘ESG’ strategies, but many investors are rightly wary of ‘greenwashing’ by asset gathering investment management businesses.

As a fund of funds manager, we see one of our roles as reviewing the underlying holdings of managers we have investments with from a governance perspective.  In January, we have sought clarification from managers viz their holdings in the following companies to ensure their governance is both appropriate and transparent:

  • Compass Group
  • Danone
  • Kingspan

Summary

There are undoubtedly some areas of froth in companies yet to post a profit and where significant passive inflows have caused an increase in the size of a few large, predominantly US, companies.  Clean energy has had an impressive run but could be at the foothills of a long and rewarding journey.  Debt markets, mostly yielding sub-inflation unless significant credit risk is absorbed, are unattractive.  Diversifiers are hard to come by.

The monetary and fiscal policy mixes around, coupled with economic growth prospects, favour equities in demand themes that are not overbought. We continue to hold and discover good conviction themed funds investing in exciting, not overbought, good value growth stories.

While the anti-establishment community’s short covering squeeze on hedge funds plays out and garners financial media headlines, it is not bubble behaviour – more a forced de-leveraging on parts of the investment community.

 As one of our key providers quoted recently:

Short term share price movements are driven by speculators but in the long run, share prices are driven by how well companies execute the opportunities they have.

Investors should be focused not frantic.’

 Or as another put it:

For equity investors, the best opportunities lie not in seeking broad-based leverage to a rising economy but in anticipating and participating in the positive secular changes within economies.’

 We agree with both.

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