It has now become clear that the sudden bull that followed the sudden bear was primarily due to retail investors, first buying “cheap stocks”, then buying “momentum stocks”. What we have learned in recent days:
- Online brokerages have seen a record number of new accounts opened this year, and the big four — E-Trade, TD Ameritrade, Charles Schwab and Interactive Brokers — executed as many trades in March and April as in the whole first half of last year, per public disclosures.
- About 1.2 million retail clients started new brokerage accounts at Fidelity Investments between March and May, a 77% increase from the same period last year. TD Ameritrade Holding Corp. reported 608,000 new funded accounts in the three-month period ending March 31, a 249% increase from the year-earlier period. In March alone, new and existing retail clients opened 426,000 funded accounts, the company said.
- TD Ameritrade said it is registering growth in customers younger than 35. Online broker Robinhood Markets Inc., which said the median age of clients is 31, has increased its customer base 30% through the first four months of the year.
- The brokers are reporting more trading as well. TD Ameritrade is averaging 3.5 million client trades a day so far in June, for example, more than four times as many as in June 2019.
- Public data from Robinhood has revealed a surge in the total number of positions held in customer accounts — doubling to 30+ million in early May after the lockdowns began. Meanwhile, Charles Schwab and TD Ameritrade reported a record number of account openings in their latest earnings report.
Dave Portnoy, founder of the popular website Barstool Sports, found a following doing pizza reviews but, because of the pandemic, flipflopped to day trading, sharing slices of his regular moves to his 1.5 million Twitter followers as he scans his portfolio.
In an interview with the WSJ, Mr. Portnoy said that in early June, when Warren Buffett said he sold his airline shares, Mr. Portnoy, who reportedly called Warren Buffett “an idiot”, bought those stocks, a move that has led to big profits for himself and, likely for some of his followers.
“I’m the new breed. I’m the new generation,” he crowed. “There’s nobody who can argue that Warren Buffett is better at the stock market than I am right now. I’m better than he is. That’s a fact.”
“I tell people there are two rules to investing: Stocks only go up, and if you have any problems, see rule No. 1.” (…)
“I do not necessarily miss sports that much because there are other things that entertain me far more, i.e. the stock market,” he said.
Funny that Mr. Buffett also claims there are only two rules to investing: rule #1: don’t lose money; rule #2, never forget rule #1. Funny also that George Soros once said that “Investing should not be entertaining. Good investing should be boring”.
Younger, inexperienced people seem to have taken this market over, pushing aside too cautious, “have been” billionaire investors as well as most other not so well known pros who have also proven very wrong per numerous surveys which revealed that these people, earning their living managing money, are very pessimistic on the economy, corporate profits and financial markets.
From my lens, only Lowry’s Research saw the trading tsunami coming as it smartly measured the rise in “buying power” in early April against waning supply pressure.
But how did that start? Some clues:
- Professional investors have largely abandoned the stock market amid the coronavirus pandemic, but sports bettors and bored millennials have jumped into the retail stock trading market with both feet. (Axios)
- Robinhood, whose easy-to-use app makes the transition between sports betting and trading seamless, boasts a similar customer base to most sportsbooks, notes Marc Rubinstein in his newsletter, Net Interest.
- “43% of North American men aged 25-34 who watch sports also bet on sports at least once per week, and that’s the same group that has flocked to Robinhood,” Rubinstein writes.
Coincidentally:
Dayanis Valdivieso, who was laid off during the pandemic, is tapping an unlikely source of money for her first foray into stocks: the government’s $1,200 stimulus check. Ms. Valdivieso, a 22-year-old in Louisville, Ky., used a portion of her check to trade stocks, using a Robinhood account.
“It was basically free money, so, you know, I decided to play around with it,” she said. “You might lose some, you might win some. It’s like a gambling game.” (…)
She currently holds positions in United Airlines Holdings Inc. and the ProShares Ultra Bloomberg Crude Oil ETF, a leveraged product that seeks to track twice the daily return of an index of crude-oil futures. (WSJ)
Then there is this 29-year-old electrician in Seattle who, acknowledging Hertz is saddled with debt, faces intense competition and could have its shares delisted, rendering them worthless, figures “the Hertz brand name holds value and the company operates a huge fleet of cars. The stock was cheap enough to roll the dice”.
The trading surge pushed Hertz shares up nearly 500% after billionaire Carl Icahn dumped his stake in the company at 72 cents a share last month. (…)
However, “there can be no assurance that the NYSE will grant the company’s request for continued listing at the hearing and whether there will be equity value in the company’s common stock,” Hertz said. (WSJ)
So, Carl Icahn, who knows a thing or two about bankruptcy and equity valuation, but also fits right in with the “have beens”, bails out of Hertz at $0.72 only to watch illiterate newbies push the stock back to $5.00.
Yes, “the Hertz brand name holds value and the company operates a huge fleet of cars” but the above quoted electrician forgot the negative wire, the $17 billion debt load on its fleet of some 500,000 cars, a $34k average liability per car.
Hertz creditors would rather get more cash than cars, so they saw an opportunity to tap this un-hoped for demand for HTZ shares. From the U.S. Bankruptcy Court petition recently filed in Delaware last week:
The recent market prices of and the trading volumes in Hertz common stock could potentially present a unique opportunity for the Debtors to raise [up to $1 billion in] capital on terms that are far superior to any debtor-in-possession financing. (…) The Debtors bring this motion on an emergency basis given the volatile state of trading in Hertz’s stock and to ensure that the Debtors are in a position to capture the potential value of Hertz’s unissued shares.
Note that the petition comes from the debtors, not the company, the board or its shareholders. In plain English, this translate into a request to transfer speculators’ money directly into Hertz creditors’ bank accounts.
The senior unsecured, 6% notes due 2028 last changed hands at 40.5 cents on the dollar (though up from 15 cents on May 26) for a yield-to-worst of 22.65%, implying that the common stock is worthless. Yesterday, Hertz filed a motion to wiggle out of lease commitments on 144,000 vehicles, claiming that it cannot afford to pay them.
According to data from Robintrack.net, 166,000 accounts on the Robin Hood trading platform held Hertz shares as of June 10, up from less than 2,000.
These 166,000 folks are obviously not aware of their odds. At around $40, the historical equity return is -85% according to Verdad’s director of credit Greg Obenshain:
Other zombies are benefitting from the free money sent to bored sports bettors and millenials.
- Whiting Petroleum filed for Chapter 11 on April 1st and the stock price has soared 532% since that time, and reportedly 47,000 Robinhood investors are long.
- Chesapeake Energy Corp., which said in May that it is considering a bankruptcy filing, rose more than 500% during that time frame.
Ms. Valdivieso, quoted earlier, has turned her attention to an even riskier form of investing: options trading. “You can make a pretty good amount of money in one day,” she told the WSJ.
She apparently has company in the option speculative arena:
Over the past few weeks, we’ve looked at the high and increasing amount of speculative activity among options traders, particularly the smallest of them that transact 10 contracts or less.
As stocks rose 3% or more each week, it was kinda-sorta understandable. But last week, stocks suffered high volatility and a big decline on Thursday, coupled with a mostly-failed rally attempt on Friday. That did not put off speculative traders – in fact, it emboldened them.
Last week, the net speculative activity (calls bought to open minus puts bought to open) of the smallest of traders was more than twice as extreme as it was at the peak in February. (SentimenTrader)
This is a truly amazing chart:
Using relative percentages, small traders spent 52% of their volume on buying call options to open. This is a record high, tied with the most extreme weeks in 2000. (…)
Among all traders, there were approximately 22 million more calls bought to open than puts. This is astounding. (…)
The Options Speculation Index, which is the most comprehensive look at how traders allocated their volume across speculative versus hedging activity, moved to the highest level since a few weeks in the year 2000. (…)
More likely, it’s a hoard of new traders stuck at home who have seen stocks only go up for months on end. This has never ended well and remains a large risk over the short- to medium-term.
Jason Zweig in last weekend WSJ:
(…) At the WallStreetBets community on Reddit, the online platform, users are encouraged to “show off a brutal, crushing loss.” When a user claimed to have lost roughly $750,000 trading options in just a few weeks last year, others posted such comments as “Goat” [greatest of all time] and “YOLO” [you only live once].
Jaime Rogozinski, who founded WallStreetBets in 2012, says the group has nearly 1.3 million members, up from 577,000 last June and 314,000 in June 2018.
“They don’t know what they’re doing,” he says, “and they don’t care that they don’t know what they’re doing.”
Where is Allan Greenspan when we really need him?
But don’t think the pros crowd is much more rational. Bank of America Fund Manager Surveys (FMS), a monthly poll of 212 investors managing $598 billion in AUM, reveals that 78% of respondents reckon that the stock market is “overvalued.” This is the most bearish they have been since at least 1998.
And yet, the June FMS cash level precipitously dropped from a high 5.9% in April to the 10-year average of 4.7%.
The FMS hedge fund net equity exposure jumped to 52% from 34%. FOMO is clearly at play!
At least, the retail investor bets with his own money.
Richard Bernstein, president of Richard Bernstein Advisors LLC, has been one of the most astute investors during the last decade. Richard is a true fundamental investor who constantly ponders the pros and the cons:
We continue to manage our portfolios during this totally unprecedented period based on fundamentals, and not on market momentum or guessing. The US government has so far provided adequate cushioning of the economy, and economic data is starting to improve. As mentioned, this improvement argues for increasing cyclical exposure.
However, the US response to COVID-19 has been woefully inadequate when compared to other major economies’, and the risk of a reacceleration in cases is real. The risks argue portfolios should maintain some defensive exposure. (…)
Cornerstone Macro, a leading independent economic research firm, succinctly described the dilemma investors currently face. The US has led the world in fiscal and monetary stimulus, but it has lagged the world in COVID-19 response. Only some emerging markets now have infection rate trends worse than the US’s. The entire developed world has passed us in recovery trends. Chart 3 (Courtesy of Cornerstone Macro) shows the “curve” of COVID-19 cases in major economies. It is clear the US’s response has been quite poor relative to other G-7 economies.
(…) As of this writing [June 14], 21 states (up from 14 two weeks ago) have increasing COVID-19 cases. The path to COVID-19 recovery still appears more challenging than is generally thought. The risk of a negative surprise seems meaningful to us. (…)
The extraordinary multi-black swan environment makes it difficult to be an ardent bull or ardent bear. Extreme positions seem based largely on guessing an outcome or market momentum rather than a thoughtful analysis of the fundamentals.
Fundamentals are improving from miserable levels and remain horribly depressed, but they are indeed improving. However, the reality of the US’s inept response to COVID-19 should temper investors’ enthusiasm at least to some degree. (…)
Believe it or not, we are only 5 months away from the U.S. elections. Odds are high that President Trump, whose approval rating has fallen from 47.8% in late January to 40.8% per FiveThirtyEight, will seek to boost the economy as hard as he can. That means strong pressures to re-open as much and as quickly as possible, potentially resisting any negative C-19 trends, right into flu season.
It also means intensified blaming on China and possibly new trade “initiatives”.
New polls from major polling organizations show a healthy 8-point lead average for Biden over Trump in the general election. A new CNN poll shows the biggest lead so far for Biden, with a 14-point lead over Trump, while the Hill/Harris poll shows a 10 percent lead and the IBD/TIPP shows a 3-point lead. (Statista)
But, Both Candidates Are Widely Disliked (Again). This Time, Biden Could Benefit.
It’s a truism of politics: When you’ve got an incumbent on the ballot, the race will be a referendum on her or his leadership — probably more than it’ll be about what the challenger is offering. So with President Trump’s approval rating stuck deep in the red, there’s little doubt that he is facing an uphill battle.
But there’s a wrinkle to this situation: His likely Democratic opponent, Joseph R. Biden Jr., also has a favorability problem. (…)
One key difference between this year and 2016 jumps out: In that election, people who saw both candidates unfavorably broke in favor of Mr. Trump, seeing him as the better of two bad options. This year, Mr. Biden holds an advantage — by a mile — among these ambivalent voters.
In a Monmouth University poll released last week, roughly one-fifth of voters did not express a positive view of either candidate (Mr. Trump’s net favorability rating was -19 in that poll; Mr. Biden’s was -7). Those voters broke hard for Mr. Biden, 59 percent to 18 percent. (…)
The latest Quinnipiac University poll contains evidence that Mr. Biden has room to grow. Unlike most, that survey offered respondents the option to say they hadn’t heard enough to make up their minds on whether they saw him favorably or unfavorably. Twelve percent of respondents said they needed more information about Mr. Biden before they decided. Just 3 percent said so about Mr. Trump.
Whether they will be voting or not, investors will need to start to focus on mundane things as David Rosenberg recently reminded us:
Here is what is at stake — from the current Biden platform:
- The top personal income tax rate goes back to 39.6% from 37%
- Capital gains tax rates go to a 28%-35% range from the current 23.8%
- The top corporate rate goes to 28% from 20%
- The tax on foreign income will double
- The Biden plan calls for the Social Security payroll tax cap to be lifted from 15% of payroll tax to the 39.6% top rate
- All in, the top marginal rate from all sources of income approaches to 50% — Canadian-style! — on incomes over $300,000
Finally, ponder the pros and the cons of a Democrat sweep.
Democrats are seeing a much better chance of retaking the Senate in 2020
(…) Democrats need to win back at least three seats to reclaim the majority, but they are also defending Sen. Doug Jones in deep-red Alabama — a state where President Donald Trump has a 28-point net approval rating. If Jones loses, that means Democrats need to win four seats and the White House (where their party’s vice president could vote to break ties in the Senate), or net five seats without the White House advantage.
Overall, Senate Republicans are defending more turf. Republicans have 23 seats (mostly in red states) to defend, compared to the 12 Senate Democrats who are up for reelection. (…)
“There’s no denying that the Senate is very much in play, and I think a lot of Republicans are in denial about taking that for granted at this point,” Tim Cameron, a Republican strategist and a former chief digital strategist at the National Republican Senatorial Committee in the 2014 and 2016 cycles, told Vox. (…)
If you don’t care much about fundamentals, you can ride with the many technicians who are bullish because of the “inherent strength” in numerous technical measures. Maybe a problem with many of these indicators is that they are being conned by all these retail speculators and their heavy trading with many pros chasing them to protect their relative performances.
In this tug of war between the people and the virus and between the pros and the cons, I tend to side with science and objective probabilities.
The Rule of 20 P/E is currently 21.3 at 3150 on trailing EPS of $158.70 which are on their way to $140 (23.9 R20 P/E) after Q2 and $125 (26.6) at the end of 2020.
The bullish thesis asserts that the world gets back to “normal” sometimes during the next 12 months so we should value equities based on normalized earnings. Sure thing…if one we can reasonably confidently project normality in 2021 or 2022.
This high-wire exercise involves predictions on crucial factors such as employment and consumer behavior in a deconfined world, corporate costs in a deglobalizing world and personal and corporate taxes in a deeply indebted world. The debates will go on until the fight against the virus ends and we can actually see life the day after (see my May 5 post THE DAY AFTER…).
The glass-half-full vision embeds profit estimates of $164 in 2021 (they were $162.93 in 2019) and $187 (+14%) in 2022. The S&P 500 Index is already at 19.2 and 16.8 times 2021 and 2022 estimates respectively. Valuation history remains unfavorable using conventional P/E ratios.
Using the Rule of 20 which incorporates inflation in the valuation equation, the R20 P/E is 20.7 with EPS of $164 and inflation at its current 1.4%. Using 2022 “normal world” estimates of $187, the R20 P/E declines to 18.3. Buying currently at this level and assuming that the R20 P/E is at its 20.0 neutral level at the end of 2022 would return 9.3% over the next 30 months or +3.7% per year.
Considering the numerous heroic assumptions required in this likely best case scenario, such return does not strike me as attractive even with a riskless 3Y Treasury yield of 0.22%.
The charts below present the historical returns on the S&P 500 since 1927 at various R20 P/E levels:
This chart shows the probability of losses 6 and 12 months out:
In all, both the pros and the cons are scary.
If I have to choose between Dave Portnoy’s two-rules of investing (stocks only go up, and if you have any problems, see rule No. 1) and Warren Buffett’s (rule #1: don’t lose money; rule #2, never forget rule #1), I would go for the has been’s.