A VIEW FROM THE TOP END

Markets:

The rally in US share markets has continued under President Biden as his first two weeks in the top job has seen a flurry of executive orders. The market has appreciated the Covid recovery plan that Biden has set out. The Aussie share market over the same period has been relatively flat. With an increase of Covid cases forecast in China, Chinese resource demand has taken a step back and blown some cream off the top of commodity prices. By the numbers, the SP500 returned 1.40%, the Nasdaq posted 4.76% and the ASX200 finished 0.78% down.

Apes vs. Snakes

Mainstream news outlets became fascinated with the behaviour of a group of retail traders that congregate on the sub-Reddit “wallstreetbets”. With the increased coverage we have received a number of questions around short selling, GameStop shares (GME:NYS) and the Robinhood traders, so we thought we’d address it.

First this is not the first time that we have come across the famous/infamous (depending on the side of the trade you are on) traders at wallstreetbets. This is a sub-Reddit dedicated to one-upmanship when it comes to “yolo”-trades (yolo = you only live once). Basically, the wildest, craziest, and biggest payoff (or loss) wins. Posters will post screen shots of their accounts in an ever-increasing attempt to impress their fellow sub-Redditors. Originally, post-Covid crash, this crowd of retail traders was responsible for the rally in cinemas, airlines, and cruise ship operators. Fundies around the world took notice, and either got onboard or missed out on the initial stages of the recovery.

After the rally, several institutional investors began to follow the data set produced by Robinhood. Robinhood was the no fee trading platform of choice that the wallstreetbets crowd was using to weaponize their latest strategies, and they produced data with a leader board (now disconnected) and trading volume for the day on each security. Patterns began to emerge that institutional investors took notice of. Instances like the June 2020 rally in Hertz rent a car shares, after an announcement they were filing for bankruptcy were some of the “never seen before” behaviour that was being driven by retail traders…and it drove professional fund managers nuts.

A bankruptcy in Hertz would make equity shareholder’s positions nearly worthless. As a sign of the times, Carl Icahn, the billionaire, and famous corporate raider was a holder of $1.8bn in Hertz shares (pre-pandemic) ended up selling his holding for a mere $40m as the business had $19bn in debt and a fleet of 700,000 vehicles idle with no known end in sight to the virus’s effects. Two weeks later Hertz shares rallied from $0.72/share to over $5.00/share as the traders from wallstreetbets using Robinhood took a punt. Some made money on the speculative pump and dump, but the majority would lose out as Hertz was unable to avoid bankruptcy and had its shares delisted in October 2020.

Fast forward to today and the group from wallstreetbets is at it again. This time in their sights has been the owner of EBGames here in Australia, GameStop (GME:NYS). Savvy posters on the sub-Reddit noticed that the strategy of crowding into a stock pumped up its value, but ultimately the buying would dry up and share prices would eventually succumb to downward pressure. However, there is a way to cause a surge in buying without having to be the ones doing all the buying and that is by causing a short squeeze.

For those that might not know, or need a refresher on short selling, we will give an example:

Let us say 5 bananas currently cost $10. One ape on the market has 5 bananas and a snake asks to borrow 5 bananas for a bit and instead sells the 5 borrowed bananas thinking prices will go down soon (shorting). The snake thinks he can buy bananas later for less and give them back to the ape, so the snake makes a profit on the difference.

Now the wallstreetbets crowd has made this example their own, embracing the role of ape, against the snakes (hedge funds). Building on the case above, the squeeze occurs when the group of apes notice what the snakes are doing and decide to buy ALL the bananas on the market until the snakes have no other choice than to buy their bananas from the group of apes to return the original bananas they borrowed. If the group of apes stay strong and do not sell, then prices will go up quickly.

The squeeze was on in GME:NYS this month as the apes took control of the stock after noticing the amount of short interest from hedge funds betting that the troubled game retailer would see its shares lose value. Fundamentals in the gaming industry point to headwinds for GameStop as gamers move more and more online for their purchases. These carefully justified short positions were blown up in a series of days when retail traders started buying, with hedge fund Melvin Capital singled out as losing billions. GME shares rocketed up 700%+ from Jan 21st to Jan 26th, as shorts tried to cover their positions by buying shares on the open market. At the end of the week Melvin Capital and others were on the hook for enormous losses.

Now short squeezes are nothing new to the market (we benefited from one in URW:ASX in November 2020 on positive vaccine news). They happen a few times a year, but usually are news driven and not a result of collusion. There have been instances in the past where what has gone on with wallstreetbets has been tried. Famous examples include Piggly Wiggly grocery stores in the 1920’s where the owner walked into the NY stock exchange and tried to buy every available share so shorts could not ultimately cover their positions. Or Porsche trying to buy Volkswagen in secret causing VW shares to rise from $180/share to $912/share in Oct 2008 when the Porsche unveiled that they owned all but 6% of the freely traded shares and shorts quickly realized that there were twice as many shorts as there were shares available. The ensuing chaos as shorts tried to run for the exits pushed prices up rapidly and cost hedge funds $30bn. Our favourite example is from India, where Reliance used a 14-day settlement window and a few friends to buy up all the shares of Reliance and held short sellers’ hostage. The ordeal shutdown the Mumbai exchange for 3days as government officials tried to broker a deal between the two parties.

Common between the historic shorts squeezes is the need for regulators to ultimately step in to stop the squeeze. In the past all three of our examples resulted in action to resolve the trades, and already trading platforms have begun to restrict trading into GME:NYS. It is a story in progress, something that we are watching, it is an interesting development, but do not expect TFM to be jumping on the speculative bandwagon and abandoning our framework.

Updating our checklist:

• Valuation: ASX & S&P500 levels: February is a big earnings month, so we will see some changes to the current PE’s over the next six weeks as results are absorbed, and analyst estimates revised. Currently the S&P is trading at 22.7x fwd PE and the ASX is at 20.7x fwd PE. We expect these ratios to move downwards (improvement) as earnings are expected to rise this year.


• Global PMIs: It is the start of a new month and we have fresh PMI data to dig through. China underperformed estimates, but still saw expansion in both their manufacturing and services sectors. In the US we saw beats in both the manufacturing and services figures, as the American economy continues to improve. Continuing jobless claims (an indicator of current unemployment) and initial jobless claims (an indicator where unemployment is expected to go) both beat analyst expecations, which is positive for markets. European figures were much the same, with Germany seeing a surge in their manufacturing, with only Spain in contraction. The producing regions of the world are rising again as economic conditions rally.



• Downgrades on guidance: It is a busy month for earnings and future guidance, as just over 2/3rds of our holdings will be reporting this month. Expectations are high for most sectors coming off a low year, with industrials, real estate, communication services, and energy expected to rebound to join the fast-moving stories from tech and consumer discretionary. We have summarised the analyst consensus for the next 12months below.




• Infection rates to slow globally: Western Australia is the latest state to go through a snap lockdown after the emergence of the new fast spreading strain within their borders. It was a short 5day period but emphasises the nature of the pandemic we still face, despite vaccines on the near horizon. In Europe and the US, the third wave of the virus is beginning to break. The UK themselves have vaccinated 16% of their population with the first jab of the two-dose vaccine and 0.8% are fully inoculated. The war was never going to be won in a day. If you want to follow the vaccination status globally please check in on our TFM vaccine tracker. It is live data and we have added a map for easy reference.
  
  TFM Vaccine Tracker




• Monetary and Fiscal stimulus announcements globally: Stimulus is still in negotiation in the US at time of writing. Despite the delay to the latest round of cheques we can say that consumer confidence in the US is rising, US unemployment is falling, and that savings continues to be at highs. In Australia, the story is similar. Central banks remain supportive of the current state. The Reserve Bank of Australia governor Philip Lowe mentioned that he had no concerns of property or share bubbles forming, and kept the official bank rate low, and will keep the money supply expanding until 2024. This is more of the same that we have seen since the Covid crisis began, so no one is ready to stop the music, and the party rages on.

Economic data in the global context continues to march upwards and the market is melting up with the improving news. We are still in the early upswing of the business cycle where asset prices are rising. If you do find yourself with extra capital our advisors are trained to help you deploy those funds to meet your financial goals. They know our strategies and the portfolios and are well placed to implement a plan that meets your needs. We encourage you to set up a meeting. Till next time take care and we will be in touch in two weeks.

Regards,