Is GameStop the Missing “Event”? - Weekly Blog # 666

 

Mike Lipper’s Monday Morning Musings

Is GameStop the Missing “Event”?

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

In the “Bubble”, Seeing the Trees and Not the Forrest

In recent blogs, I examined evidence of a stock market bubble about to burst. Is this week’s explosive coverage of the short squeeze battles of a handful of relatively small stocks, the classic unrelated event that leads to actions triggering the rapid deflation of general market prices? Could be, and it is worth thinking about.

Markets regularly fluctuate between high/low prices and valuations. Most of the time, they stay within an envelope around a loosely defined center. This is the type of period where stock and fund picking produces relative good and bad returns, getting the attention of both individual and institutional investors. The game dramatically changes at the two extremes. At both ends the driving force is the actual level of liquidity in the marketplace. The relatively few stocks that have high, two-way market volume get most of the action and attention. The others either don’t trade or have significant price gaps between trades. The deflation of a bubble is when prices rapidly collapse.

In the prelude before the bubble breaks, there are often signs of structural deterioration preceding some seemingly unrelated event, which spurs reactions. This can be the telltale sign of a bubble breaking. Two examples of these events come to mind. The assassination of the Austrian Archduke and the passage of the US Smoot-Hawley Tariff Act of 1930. In both cases, from a global standpoint, they were not earth-shattering events, but the reactions to them led to World War I and the global depression of the 1930s. 

In both cases, various political leaders used the event as an excuse to make aggressive moves, resulting in tragedy. The murder of the Archduke and his wife became an excuse for aggressive, militant nationalism and an attempt to change the political structure in central and eastern Europe. It in turn eventually brought the US reluctantly into the war and was a contributing impetus to WWII. 

The Smoot-Hawley Tariff was a political attempt to bail out the highly leveraged farm sector in the US. It raised import tariffs on agricultural and industrial products by 20% and was quickly followed by 20 other countries.

Possible Application to the GameStop Short Squeeze

Very little of the popular media coverage on the short squeeze of GameStop and a small number of other stocks starts with the recognition that short selling requires a margin (loan) account, funded by cash and/or securities. The buyer of the shorted shares looks to the selling broker, or in some cases a bank, to supply the shares. This requires the broker to borrow the shares from other shareholders or purchase them to make the delivery. If the broker borrows the shares, the firm must pay a rental fee or find another customer who owns the shares. To facilitate the trade, margin accounts permit the broker to loan out shares in margin accounts, using them as collateral to raise capital to support transactions. 

The broker is often forced to buy shares in the market to make delivery in less liquid stocks. The mere fact of the broker buying pushes up the price, turning the broker into a short seller, having delivered the newly purchased shares. The broker must recapture the money it spends and occasionally if it borrows too much it may face forced liquidation of the firm. If this becomes the experience of many, there can be an effort to get the regulators to declare a “corner” in the stock, where they order the cancellation of all trades above a given past price. It thus wipes out some of the gains of the short sellers and reduces the losses of the brokers. (This has not happened in many years.)

How Did this Happen?

1. In a period where there are large operating business losses, there is a political impulse to bail out the unfortunate to secure their future votes. To the extent the bailout is not quickly repaid with interest, it is in effect socialized, making the profitable portions of the economy pay the losses and any shortfall in repayments.
2. Payments to individuals during the current pandemic where in many cases saved and not immediately spent.
3. Many states have legalized both sports and casino gambling to tax it. This probably enlarged the gambling population and transferred public wealth to gambling interests.
4. Currently, many are working from home (WFH) and sitting in front of their computers. Some have temporary cash to spend and in the absence of their normal sports betting vehicles they have developed trading relations with electronic brokers. 
5. Our educational process in schools and at home does not distinguish between gambling and investing. Furthermore, people and many politicians don’t differentiate between borrowing to meet current expenditures and capital invested in long-term assets. Long-term assets, like new plant or other capital expenditures, create new earning assets which in many cases become new collateral.  

What May Happen?

1. The popular media will likely produce numerous stories of individuals with losses. This will provide politicians with an excuse to produce more regulation, which will be expensive and send more investment overseas, and/or into non-public activities.
2. The future “Debt Bomb” is now in the hands of the government, but with the shrinking share of the loan market at banks, credit conditions will loosen and the private sector debt burden will grow. Underlying every major collapse is the extension of too much credit and the resultant leverage. 
3. We live in a dynamic globe. Most financial systems are quite extended, with little room to handle medical, weather, technology, military, and political surprises.

What to Do?

For those portfolios structured to meet payment responsibilities over the next five years, this would be a good time to prune portfolios. The following actions may be appropriate.

1. Create a schedule to recognize all loses serially between now and June 30. Thus, create a capital gains shelter for sales of winning positions.
2. Examine winning holdings that need a current bull market to reach the investors’ price objective.  Sell at least half.
3. Sell at least half of all positions in stocks where current management’s decisions seem inappropriate.
4. Build an opportunity reserve for two new purchases.
5. Increase exposure to stocks that trade beyond your home market.
6. Expect surprises and usually invest against the first identified decision.
7. Read carefully what companies say. One Dow Jones Index company expects earnings in 2021 to equal those reported in 2019. Even if that happens, the company will not have produced sufficient earnings to cover the then expected growth rate for the two-year period, leaving their growth at least 10% behind the original plan. This should cause one to make some changes, either to the portfolio or to expectations.

Working Conclusion

Become more engaged and start managing your portfolio, holding a collection of investments that can both absorb some losses and find new opportunities. 

What Do You Think? 

 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/01/are-we-strolling-promenade-deck-of.html

https://mikelipper.blogspot.com/2021/01/contra-messages-weekly-blog-664.html

https://mikelipper.blogspot.com/2021/01/the-wisdom-of-3-wise-men-weekly-blog-663.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Stud Poker, The New Swamp Game - Weekly Blog # 661

 

Mike Lipper’s Monday Morning Musings

Stud Poker, The New Swamp Game

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

The never-ending battle between Principles and Principals for the swing votes is entering a new phase that will impact investors. Since ancient Greece’s limited democracy, historians have described the battle between Principles and Principals for political control in capturing a relatively small number of swing votes. Most historians put us at a disadvantage in analyzing the conflict, as we do not have a useful understanding of what really happened. Most historians rely almost exclusively on after-the-fact comments from those supporting various uplifting Principles, because there are easily available texts joining the believers in the nice sounding principles. The other side, regardless of winning or losing most of the time, leave evidence of the tactical moves that led to their success. Very few people produce a contemporary tale of the emotions that drove them to their decisions. At best we have an incomplete outline of what they did. Human Principals are by nature executors and at best leave a history of their successful deeds.

“Where Are We Now?” 

Regardless of the final result of the two Georgia Senate races, we will be in an era of divided government. Beneath the surface we are likely to see deep splits within both parties, with different factions positioning for 2022 and 2024 elections. In addition, various members need to build or rebuild the “mother’s milk” of politics, contributions. Many need to be seen as advocates for various local interests, which may conflict with the views of the national parties. It is worth remembering that the last national elections were fought primarily over unattractive personalities rather than uplifting principles. (Remember, US voters often express their negative views by voting for the opposition.)

Elected vs. Unelected

The number of elected representatives in Washington are under 600. The number of decision makers in various government departments and agencies are clearly many multiples of the elected people. Additionally, there is the political crowd, including official lobbyists and so-called “think tanks” following questionable principals. For the most part they are permanent residents in what is known as “the swamp”. Not only will they outlast most politicians, they are experts at manipulating the dictates of elected government.

Despite the egocentric nature of those in the capital, outside forces occasionally impede the political will of the elected leaders. The pandemic is just one such influence. Also both technology and economics increasingly have an impact. But let us not forget what is probably the most powerful force impacting almost everything, demographics. 

“The Game”

To understand the game, look at the page count coming out of the so-called “Stimulus Package”. The Democratic Leadership put out a single page of what they believed were their accomplishments. The senate driven bill was in excess over 5500 pages, a clear example of a negotiation by Principals. 

The incoming administration looks to this legislation as an example of bipartisan cooperation. The President-elect’s history in the Senate was not based on initiating legislation but working on compromises. The main bargaining chip in the likely compromise with the Principals is often identified with the letter “C”, or a passing grade. Three of the C compromises, often delivered outside of specific legislation, are Contracts, Clauses, and Circuits and Federal departmental judgeships. Large government contracts with sweetheart provision clauses are often favorable in terms of taxes, tariffs, and regulations. They also regularly secure contributions and votes. Circuit or department judgeships are worthwhile endeavors to instill a “friend” in the court.

Stud Poker Model

Watching legislation go through Congress and the White House is similar to the progress of a single game of stud poker. Stud poker, a seven-card game among a handful of people, was popular among political types for many years. It starts with each participant receiving two cards face down and one face up, followed by a round of betting with some players dropping out. It is followed by three rounds of getting a face up card and additional rounds of betting and/or folding with each card. The seventh card is dealt face down, again followed by a round of betting. One can win by being the sole survivor if all others drop out due to seeing both the exposed open cards and their own cards. You can also win by evaluating the face down cards and interpreting the betting and actions of others. The skill in the game is first assessing one’s own likelihood of getting a good hand, by knowing your own cards compared to the possible hands of others and the impact of their betting. There are two ways to win, have better cards than others or convince them that you have better cards where they fail to match your betting. You buy the pot of all that was waged without turning over your face-down cards. Poker is simple compared to Washington politics, with known and unknown cards.

In seeking a legislative compromise it is important to identify the strength of conviction that a useful benefit can be secured in reasonable time and determine what has been promised to others. Often, the more experienced legislators or their top aides can create an advantage that more junior Congressional members are unable to. 

Let the games begin!!  

What to Do?

As with more questions, it depends on your goals, measurements, and tolerance for disappointment. The answers for most of these questions is very dependent upon the time-period and measurement applied. The shorter the time-period, the less influence of timing decisions. Based on past experience, there have been 25% declines in one year and 50% declines in a couple of years or more. It is the measurement method which causes the most trouble in my opinion. In choosing between a very limited number of alternatives it is easy to measure absolutely, although with a large number relative performance is often more realistic. Most measure by comparing against a mathematical average, which is heavily influenced by the extreme performers. The more mathematically oriented may use the middle result or median in an array, which is preferable to me. With a large universe of competent players I prefer to subdivide performance into quintiles, avoiding the knife edge of quartiles.

I tend to view the performance within any quintile and particularly the third quintile as almost random, with a small number of extreme results being difficult to repeat. When managing in a competitive league that encourages shifting managers frequently, data from the current best performers is often used, not by me. For accounts having stringent absolute payments requirements, I prefer to measure against absolute and relative capital preservation. 

Now?

I prefer to work with long-term investment horizon accounts, where demographics, discipline, savings habits, intellectual-honesty and productivity of the labor force tend to structure my working framework. I don’t make any strategic changes, as some tactical changes will be required due to fundamental changes within the specific investments themselves.

As distinct from the long-term accounts, those that have effectively fixed or semi-fixed payment requirements need to balance the risk of reduced actual or anticipated payments with the generation of future sources of income production. Depending on the specifics of the account and our perspective, the mix between the two motivations is within a 30-70% mix. (This is not an essential prescription to the standard balanced fund’s stock/bond ratio, because both bonds and stocks may have capital risk and appreciation opportunities.)

As we enter the new year, the first of a radically different administration and a shifting power base, investing for the short-term in a competitive environment is going to be difficult. At times investments are priced cheaply in terms of their fundamentals, whereas at other times markets price securities near their probable top. In the last week of 2020 I don’t know whether we are closer to one extreme than the other.

As often the case when I am faced with a decision, I attempt to follow a sales prescription from Ben Franklin’s commercial activities and make a list of positives and negatives. Some salespeople convert these lists into a form of a balanced sheet, which surprisingly almost always has more positives than negatives. Before producing my lists I should identify my anti-momentum bias. Much like at the racetrack, I don’t have to bet on every race or market condition and the bulk of the money I am responsible for is long-term. (Think beyond this decade.)

The US stock market has fluctuated in a relatively narrow trading range this autumn/early winter period. Only after a material market move will we be able to determine if this was the distribution of risk from smart investors to less smart, or an opportunity for smart investors who perceive the near-term future as being materially better than what we have seen in the last four years. Thus, one can say that the current market brings together sceptics and believers. 

As the volume of transactions compared to the number of shares outstanding is low, one can see that there is not an overwhelming consensus view by market participants. Most of the money is invested for the long-term, at least beyond the incoming administration’s period in office. In the last two weeks of 2020, sceptics are selling to protect their capital gains from possible changes in tax rates on income and estates. s Buyers perceive an expanding domestic economy and a less turbulent world.

Positives (Random order)

1. The crowd at The Mall at Short Hills appeared to be larger on the first shopping day after Christmas than the days before the holiday. We guess the crowd had to line up and be temperature tested before entering big brand clothing and jewelry shops. The longest lines were at the Apple (*) store. Restaurants were busy and had lines, indicating that shoppers were committed to spending hours shopping.
2. I believe we are in a somewhat new investment era because of COVID-19 and global technology’s impact on consumption, suggesting our favorite numbers are out of date or out of scale. Key relationships between risk and reward probably remain reasonably constant, but not their number identifiers like P/E, yields, stock/bond ratios, turnover rates etc.
3. Shortages permit big price increases e.g., intra-Asia shipping container prices being up 450%. On a broader base JOC-ECRI Industrial Price Index is up 23.87% year over year. 
4. Long overdue stock leadership rotation in favor of small and midcap stocks will bring more capital into a needed sector. Tech focused stocks have returned temporarily to leadership.

(*) Personal position

Negatives

1. 62% of this week’s WSJ roster of prices declined.
2. A consumer confidence survey, expecting a +97% reading, came in at 88.6%.
3. Some strategists see meaningful risk in the Middle East and China. In the former case, strained budgets will force risky expansions. In China’s case, a further crackdown on debt creation is expected.
4. The Biden administration relying on people for material economic expansion based on their Obama Presidency experience.

Subscribers, please remember the two iron clad rules of investing:

1. The only guaranteed product of the market is to create humility.
2. Surprises happen because most don’t expect them.  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/12/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/12/searching-for-surprises-weekly-blog-659.html

https://mikelipper.blogspot.com/2020/12/an-investment-dilemma-with-possible.html

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Confidence Deteriorating Normally, Recession Unavoidable - Weekly Blog # 579

Mike Lipper’s Monday Morning Musings

Confidence Deteriorating Normally, Recession Unavoidable

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

One investment trap is having extreme faith in historical statistical norms. This week’s numbers basket has the following negative indicators:

1. McDonald’s was the only stock to be up in the Dow Jones Industrial Average
2. There were 38% more Puts purchased than Calls
3. The Delta Market Sentiment Indicator is bearish, recommending 100% cash
4. The American Association of Individual Investors is only 25% bullish and 40% bearish
5. The Barron’s Confidence Index favors best quality bonds over intermediate quality, a bearish signal for stocks
6. Only 22 of the 72 weekly price indicators rose in the week
7. Stock prices are breaking down from triple top formations, a reversal signal
8. Of the 25 best performing mutual funds, only 5 are invested in developed markets, 10 in emerging markets, 5 in India, 4 in Latin America, and 1 in China. Of the 10 poorest performing funds, 4 are invested in Natural Resources and 3 are invested in alternatives
9. Money Market Funds, particularly institutional funds, and other short-term funds were big beneficiaries of flows

Reactions:
Not because I am a contrarian, but I learned at the racetrack that heavily backed horses win only about one-third of the time and pay very little in exchange for their exposure to “racing luck”. Something market analysts refer to as “surprises”. With pundits generally being very responsive to the echo chamber, it is likely that there will be an increasing volume of bearish proclamations, with some of these politically motivated. They will all see a recession ahead.

They will undoubtedly be correct, there is a recession ahead. I have close to 100% confidence with that statement. Why? Because since recorded time there have been recessions, even before governments and central banks thought that they controlled rather than influenced markets. I have much more faith in the rules that govern all human and other animal behavior. Greed and Fear are two motivators embedded on the same coin. Greed is essentially the desire to acquire enough assets and/or power that one can escape the fear of insufficiency.

Recessions Are Needed
Almost every expansion, if it continues, will lead to an excess of supply and speculative behavior. When these excesses become too great, they are brutally eliminated. The emotional rule is that if my neighbor is out of work it is a recession, but when I am out of work it is a depression. (To the best of my knowledge the term depression was first used in the US in the 1930s. It is a term from psychology that describes how people feel rather than an economic condition.)

Are Excesses Big Enough for a Major Recession?
One of the lessons of history is that the many changes in fundamental condition are not generally identified before there is a decline. Today, one must look hard to find the growing imbalances that could set off a chain reaction that would bring down the economy. I don’t currently see the growth of imbalances sufficient to set off the reaction. However, the so-called immediate cause for the beginning of World War I was the assassination of the Austrian Archduke by a crazed person. Even then, it took another six months before hostilities started.

As a prudent investment manager and investor, I am always scanning for future problems that could grow large enough to start a major recession, or even a depression. There is one element that could lead to a smaller reaction. Much like the prime mortgage crisis, it has been identified by a minority of watchers, including some at the Federal Reserve. The element of concern is the growth of credit extensions by non-bank financial institutions, which have provided loans with light loan covenants. If that area blew up unexpectedly it might conceivably take 5% or less off our GDP, or one year’s growth.

Others in my cast of possible but unlikely horrors are medical, weather, or technological tragedies that we have not seen before. In this scenario actuaries have no data to guide them. I could see such an event taking a low double digit hit to global prosperity. Possible yes, but the odds are very small.

What to Do?
Because others are worried, I am less so. I view any sort of major market drop as an opportunity to find new leadership at fair prices. In the past I have missed some of these opportunities because I was waiting for truly bargain prices. I was not sufficiently aware of Charlie Munger’s fair price doctrine. There is always the risk of being too smart and out-smarting oneself. Thus, I am generally maintaining my equity positions. I will be willing to sell some of my positions in order to buy what I believe to be the new leaders when there is a double-digit breakdown.

Question of the week:
What is your intended strategy when it becomes clear to you that we are in a market breaking recession?


      
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/05/memory-traps-judgement-weekly-blog-578.html

https://mikelipper.blogspot.com/2019/05/probable-view-of-next-decline-weekly_19.html

https://mikelipper.blogspot.com/2019/05/probable-view-of-next-decline-weekly.html



Did someone forward you this blog?
To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.