FINANCIAL MARKET UPDATE 2.3.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

The Frenzy in Meme Stocks

Over the past ten days, I have fielded more questions from friends about stocks than I have in the past ten years. Generally, these are people that have never expressed any interest in the market (aside from the occasional Bitcoin inquiry). Over the past few days, the massive price gains in a handful of once overlooked companies, now popularly referred to as “meme stocks,” have captured the attention of the masses (my buddies included) and pulled a large swath of new investors into the fray.

There is a lot of nuance in the developing meme stock story, and I’m not going to dive too deeply into them (For a thoughtful summary, I highly recommend the link from Aswath Damodaran in the ‘Hot Reads’ section). Instead, we’ll keep it fairly high level and discuss some important investor implications.

The general narrative is the Covid-19 lockdown left many people with stimulus money and nothing to do. Those looking for entertainment, including sports bettors that exchanged their bookies for brokerage accounts, began day-trading. With the stock market staging an intense rally off of the March lows, making money by flipping stocks looked easy and more people joined in. According to a report by CNBC, well over a million people downloaded the popular Robinhood trading app on average each month in 2020. Last month, there were over three million downloads.

As the ranks of day-traders have grown, social media communities focused on the activity have rapidly grown as well. WallStreetBets (WSB), a popular trading forum on Reddit, is widely credited with coordinating the buying power that sent the first meme stock into outer space. Although WSB has been around since 2012, the growth in subscribers has exploded recently. Entering 2021, WSB had a few thousand new subscribers each day on average. On January 23rd, 65,700 new users joined, followed by another 147,000 on January 25th. In total, there were 6.3m users subscribed to the forum as of last Friday. Half of those joined since last Wednesday.

Apps like Robinhood have “democratized” investing by giving small investors a free platform to trade shares with no commissions. This is not the first time technological innovation and falling costs have attracted armies of new investors, however. In the late 1990s, discount brokers like Charles Schwab, eTrade, and Ameritrade made the buying and selling of stocks as easy as the click of a mouse. Prior to this advancement, you had to physically call a human broker and pay a commission that could easily rise into the hundreds of dollars.

At the time, advertising by the large brokers made it look as though trading was easy and fun. Amidst one of the longest periods of economic growth and stock market gains on record, day trading became something of a cultural phenomenon. Fueled by greed and the hope of building wealth quickly, investors exchanged shares at unprecedented speed. This contributed to the inflating of the technology bubble, and ultimately its bursting. From January 1995 to its peak in March of 2000, the tech heavy NASDAQ delivered a cumulative return (excluding dividends) of 579%. By the October 2002 bottom, the index fell nearly 78%. As it turns out, trading is not easy.

It is said that those who do not know history are doomed to repeat it, and many new investors are unfamiliar with the lessons learned from the technology bubble. Today, the message that day-trading is fun and easy is permeating on social media. People should view purchasing a stock as buying an ownership interest in a business, where its value (and ultimately its stock price) depends on its operating results. Instead, the aim of many buyers of meme stocks lay somewhere between inflicting pain on hedge funds, and selling the shares after a massive price gain. Of course, this strategy is predicated on the hope that some greater fool, who for some unknowable reason, will be willing to buy the massively overpriced shares from you. At least with Tesla and Bitcoin, there is a semblance of possibility that they will one day revolutionize electric cars, batteries, and/or money. GameStop is a shrinking brick and mortar retailer, battling Walmart and Amazon for survival, selling a product that is transitioning to digital distribution. Could you argue its shares are worth more than the $4 they sold for last March? Sure. Are they worth $500? Be serious.

Nobody knows exactly how all of this is going to play out, but I’m pretty sure I can tell you how it’s going to end. Market dislocations of this type can become much larger and persist much longer than people generally think is possible. So even after a 60% decline in trading yesterday (2/2/21), there could be another leg(s) up. Still, things that can’t go on forever… won’t. Like gravity, the fundamentals of the business will tug relentlessly on its share price. A stock that shot for the moon is destined to crash back down to earth.

Fortunately, while US stock market valuations are not cheap by any means, the circus appears to be contained to the small group of small meme stocks. For context, the largest three companies in the Russell 3000 index (a proxy for the US stock market) are Apple, Microsoft and Amazon. Together these three businesses comprised 13.79% of the total market value as of February 1. Three of the more popular US meme stocks, including GameStop, AMC Entertainment Holdings, and Bed Bath & Beyond, comprised just 0.05% of the index. As a result, when the meme stock bubble bursts, it won’t necessarily impact the broader market.

If you have considered buying some of these companies, there are a few things to know. First, this does not qualify as investing. With share prices so obviously disconnected from reality, this is a pure gamble and should viewed as such. There is nothing wrong with making a bet, as long as your wager is something you can afford to lose in its entirety. Fun-money activity should be kept separate from your long-term investments. Finally, if you do make some money, don’t forget about the taxes!

WEEK IN REVIEW

  • As of last Friday, roughly 37% of companies in the S&P 500 had reported their earnings results for the 4th quarter. 82% of reporting companies beat analyst earnings estimates, while 76% beat revenue estimates. The earnings growth rate for companies that have reported, blended with the estimates for companies that have not yet reported, is currently -2.3% YoY. This reflects an improvement over the -9.3% earnings growth rate that analysts were estimating as of 12/31. Not included in these figures is Amazon, where Jeff Bezos announced he was stepping down as CEO and will transition to the role of Chairman of the board later this year.
  • Last week the Bureau of Economic Analysis (BEA) published data showing US GDP grew at a 4% annualized rate during the fourth quarter, missing analyst expectations of 4.3%. The full year growth rate for 2020 was -3.5%, making 2020 the worst year for economic growth since World War II. Economists are expecting a weak start to 2021, with activity rebounding after the first quarter.
  • On Monday, the ISM published its index of manufacturing activity, which slowed from December and missed estimates. Today we will get an update on services activity, tomorrow we will get factory orders,  productivity, and jobless claims. On Friday, the jobs report will headline the week of data releases.

HOT READS

Markets

  • Why Did Robinhood Stop GameStop Trading? Everything to Know. (Barron’s)
  • U.S. Economy Closes Out 2020 With Lower Than Expected 4% Gain (CNBC)
  • Here’s the Average Net Worth of Americans Ages 35 to 44 (CNBC)

Investing

  • The Storming of the Bastille: The Reddit Crowd Targets the Hedge Funds! (Aswath Damodaran)
  • Why It’s Usually Crazier Than You Expect (Morgan Housel)
  • Why Reddit Loves Elon Musk, Cathie Wood and Chamath Paliphapitiya (Bloomberg)

Other

  • What’s Plaguing College Basketball’s Powerhouses? (Sports Illustrated)
  • Facebook and Apple Are Beefing Over the Future of the Internet (Wired)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

 

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

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JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

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