And we thought 2020 was crazy…
This past January certainly had its fair share of chaos and confusion—most of it centered in the Greater Washington area. Many were predicting some sort of civil war and others even had premonitions that were apocalyptic in nature. As we know from experience, the world just does not end all that often, thank goodness.
Of course, the financial markets did not want to let the political arena have all of the limelight, so Wall Street threw its hat in the proverbial ring and saw some good old-fashioned mania develop in some unloved stocks. When the stock of a bricks-and-mortar videogame retailer, GameStop (GME), goes from approximately $18/share on January 8th and trades over $480/share on January 28th, you know there is something really astonishing occurring in the market. I will quickly summarize for those that have not been following.
It appears as though retail investors have been identifying the stocks of unloved companies, often targeted by hedge funds selling the stock short (a financial maneuver to bet against the stock), and pushing their stock price up by shouting from various social media mountaintops. While this type of behavior is not a new phenomenon, the catalysts and methods are a bit novel. Also, speculative trading seems to have ratcheted up during the COVID-19 pandemic as you have legions of people with more money and more time than they are used to having. Based on recent market action, it seems many of them are looking to make some quick profits at the expense of any sort of analysis.
While a lot of outside observers view this as proof that the stock market is just some sort of glorified casino, we take a different view. The reckless trading talked about above does not reflect any sort of economic or business reality. We always keep in mind the insightful Warren Buffett observation that in the short-term, market prices are a voting machine, in the long-term, a weighing machine. Sooner or later, a company’s stock will be “weighed” according to its fundamental value and future business prospects, not according to the value speculative traders determine and certainly not according to the value an internet chat board prescribes.
As long as markets exist, there will be irresponsible traders and those looking to get rich quick. Unfortunately for speculators, there is not an endless supply of greater fools to which they can sell. This is easily illustrated by a quick examination of GameStop’s closing share price over the past several trading days. GME closed at $325 on January 29th, $225 on February 1st, $90 on February 2nd and $53.50 on February 4th.
More than 10% of 2021 is already in the rear-view mirror
As we move through 2021, we are reminded that each and every year has setbacks and challenges. 2020’s trials and tribulations were certainly of greater magnitude, more devastating, and caused more despair than most years but that doesn’t mean other years are easy. I am reminded of a story an acquaintance told me regarding something his pre-school aged daughter said before she went to sleep on New Year’s Eve. His daughter asked, “Daddy, when I wake up tomorrow, we won’t have to wear masks and no one will get sick anymore, right?”
That innocent and heart-warming line of thinking would make sense because of everything this young girl had been hearing in the over-hyped lead up to the end of last year. I’m sure she heard something along the lines of “I can’t wait until 2020 is over. 2021 is going to be so much better!” countless times. Well, when we all woke up that January 1st, it was still remarkably similar to 2020. The virus still existed, the country was still divided, and many individuals were still getting sick.
Despite these negative issues still being present, we know that life goes on. We know that there are still new businesses launching and extraordinary, ingenious technologies being developed. Inherently, we all know we must continue to plan for what lies ahead despite facing an unknowable future. This brings us to our outlook for the remaining 90% of 2021.
While the majority are feeling uneasy about 2021 and beyond, no less an authority than the International Monetary Fund (IMF) just upgraded their GDP projections for the year. In their most recent World Economic Outlook, the IMF increased their forecast for global GDP growth to 5.5% and US GDP growth from 3% to 5%. These figures are significant, especially when considering the size of the denominator—the global economy now totaling more than $88 trillion and the US economy accounting for nearly a quarter of that figure at an estimated $21.4T.
Other reasons to be optimistic about financial assets include interest rates that are near zero and total stimulus approaching $6T. In addition, corporate earnings consistently surprising to the upside this earnings season points toward bullish scenarios. According to FactSet, more than 8 out of 10 companies that have reported, have beaten expectations. This number normally hovers in the 65-70% range so 82% is a sizable improvement over the average earnings season. As FactSet states, “if 82% is the final percentage, it will mark the second-highest percentage of S&P 500 companies reporting a positive EPS surprise since FactSet began tracking this metric in 2008.”
In terms of risks to our base case, we believe that taxes will eventually have to increase and there is a case to be made that inflation may creep in sooner than most market participants think it will. This would cause the cost of goods and services to increase and could possibly lead to central banks increasing interest rates sooner than anticipated. Market forces could also push interest rates higher.
Other areas of concern involve valuations in certain pockets of the market. One chart that highlights what many deem to be an ultra-expensive segment of the larger technology sector is the Goldman Sachs Non-Profitable Technology Index:
Based on the above, it appears many investors are extremely bullish on innovation and not overly concerned with metrics like profits. Certainly, some of the companies in the above index will be big winners, however, it is difficult to imagine all of them becoming household names. This is not to say innovative technology companies will all fail but does serve as a reasonable basis to temper any overheated enthusiasm.
The current economic and business landscape suggest that 2021 has strong potential to be an environment where risk assets will do well. One can also make the argument that there are many reasons why financial assets are overpriced and due for a correction.
In our experience as fiduciary advisors, when it comes to thoughtful portfolio construction, effort in the early stages is best spent on clearly defining our clients’ risk tolerances and expectations for risk and return. When capital market expectations are clearly defined and one is invested in a portfolio of assets that is well-aligned with one’s risk tolerance, it is much easier to stay fully invested regardless of the uncertainty that exists. Proper asset allocation and return expectations are the high-level portfolio management decisions we consider to be most important.
From there, through research and partnership with other asset managers, we identify underpriced securities and best of breed investment managers to navigate the uncertain markets. At Wolf Group Capital Advisors, we strive to build all-weather portfolios that remain durable regardless of business cycle stage or economic environment. This disciplined and prudent investment management approach allows our clients to focus on what matters most to them—living a fulfilling life and achieving their goals while enjoying the journey to financial freedom.
By Charles Verruggio, Chief Investment Officer & Senior Financial Advisor