What Goes Up…
February 3, 2021
Well, I guess we have to talk about GameStop. First, let’s give a little history about how GameStop got here. The company has been struggling for years as gaming businesses moved to online distribution and relentlessly away from the business model of selling hard copies at local brick and mortar stores. GameStop had gone from a price of $57 a share in 2013 to less than $3.00 in April of last year. Revenue has declined over 40% in less than three years. Earnings have been negative in five of the last six quarters. GameStop actually bought back about one-third of their stock in late 2019 and early 2020, but was unable to move the price of the stock out of the single digits. Needless to say, this is not a company you will find in a Dana portfolio.
GameStop being a favorite of the short crowd is nothing new; the amount of shares sold short was above 60 million in 2015, moved back above that level in mid-2019, and has been at that level ever since. This is a large amount of shorting based on the amount of shares outstanding. Why hasn’t a short squeeze taken place over the past five years? Nobody knows. We would expect GameStop to retrace most of its move and head back below $40 per share, and probably lower, although it may take a few months. No value will have been created in an economic sense, just gains transferred from those who bought high and sold low, to those who bought low and sold high.
The overall markets still appear to be in recovery phase. Bond yields drifted slightly higher as vaccine distribution continued. The Fed stated that they will continue to remain accommodative, putting a lid on overall yields. Value sectors of the market continue to keep up with growth sectors of the market. This rotation began in the fourth quarter and has continued in the first, another healthy sign for the market when a broader number of companies participate on the upside.
We are in the middle of earnings season, and the results have been very encouraging so far. It is always difficult for market analysts to gauge the speed and magnitude of both earnings declines and recoveries, so we cut them a break on accuracy. Both earnings and revenue beats are running above their recent averages. These positive results are responsible for the market averages holding near all-time highs. We remain optimistic and forward looking, as these results were generated in the middle of a third discrete spike in COVID-19 cases and deaths that took place during the fourth quarter.
COVID-19 vaccines are being distributed and administered at a rate near one million per day. The rate of new cases, hospitalizations, and deaths have all begun to decline in most areas of the country. The CDC recently declared 26 million cumulative cases in the U.S., and 31 million doses of vaccine administered. We are hopeful that an increasing rate of vaccinations could put COVID-19 concerns in the rearview mirror towards the end of the first quarter, earlier than many suspect. This could provide a significant boost to both consumer confidence and spending. We will continue to hope for the best while preparing portfolios for potential challenges and opportunities.
Random thought: “If we merge mercy with might, and might with right, then love becomes our legacy and change our children’s birthright” – Amanda Gorman, Inaugural Poem
Is It Safe?
The New Year is often a time for people to reflect and make resolutions. Some reflect and wish they would have sold their equities in September. Others make resolutions never to buy bitcoin or cannabis stocks again. The fourth quarter reminded everyone participating in the equity market that after many ups, there will be some downs and to enjoy the benefits of the ride you have to deal with both. Volatility, which has been low for so many years, reared its head high in 2018. Nearly all asset classes had negative returns through November and domestic and international stocks stayed that way. Bond investors saw rates drop and treasuries rally in December, helping generate slight positive returns for the year if they avoided long maturities and low credit quality.
Like most of you, we are uncomfortable with what happened in the fourth quarter. Yet, trying to sort through it all is like trying to put together that 3,000 piece jigsaw puzzle you received for Christmas. Also, like that jigsaw puzzle, it will take time for the dust to settle, the markets to sort overblown reactions from facts, and for investors to erase this from their mind. 2018 will go down as the first negative calendar year for the S&P 500 Index since the financial crisis in 2008. In the seven trading days before Christmas, the S&P 500 Index was down over 11%. In the eleven trading days after Christmas, the same index is up over 10%. Recovering a part of the fourth quarter losses is a good thing, but so far, it only fits into the bounce category, not the recovery category. Most indexes have recovered about 50% of the peak to trough decline from late September through late December. Some additional gains along with quarterly earnings announcements would be more reassuring.
The good news is that the volatile market has brought valuations down to levels that are as low as they have been in five years. The current multiple on 2019 S&P 500 Index earnings is only about 15X. Although earnings growth will slow from 2018 levels, growth is still expected to continue. In the past, when the market multiple has fallen 5X (from about 20X to 15X this time) the subsequent twelve-month return from the bottom has averaged slightly over 20%. Selling or reducing equities at the bottom is not a good long-term strategy. Our portfolio management team has taken this opportunity to make some adjustments to our portfolios while maintaining a high-quality bias to our holdings.
The fixed income markets also experienced heightened volatility and finished 2018 nearly unchanged. Shorter maturity bond returns were positive, while longer maturity bonds were negative. Corporate bonds generally underperformed government bonds. The Fed is expected to significantly slow the pace of rate increases, and this should be a positive for fixed income. In our fixed income strategies, we are reviewing our positioning based on expected changes in the Treasury yield curve. We hope the Fed heeds the market’s message that it wants a pause in the rate increases. While we don’t expect any rate change this month, we will learn much more from the Fed after their meeting this week.
Many times, investing seems easy. In periods of rapid change, it can seem frustrating or impossible. We accept the challenge of difficult periods, and we have faced our share of them over the last four decades. We learn from every experience, and our accumulated experiences are guiding us through the current market challenges.
Tact is the knack of making a point without making an enemy.
-Sir Isaac Newton