The most important events recently are all macro-related, and hence this issue of Tidbits is very light on company-specific news…
Change is always an uncomfortable thing. In stable times, existing power structures resist change…hence progress is often slow, and incumbents often do not see or feel the sand shift beneath them. But in chaotic times, incumbent power structures are weakened and cannot hold back change. What starts as invisible, slow, seemingly stasis, suddenly becomes tectonic shifts.
COVID-19 has weakened existing power structures. And tectonic shifts are happening, both good and bad.
Here are some of the shifts that are worth monitoring.
#1 Retail Mania
Back in March, Capital Flywheels felt with strong conviction that the market was severely mis-priced. While the future was uncertain, the businesses that make up the stock market (as opposed to the general economy) was unlikely to have as negative of an outcome as small businesses across the US. So far, this has largely been the case.
However, while the market was severely mis-priced in March, the stock market has now fully recovered its losses. But more importantly, the marginal investor (retail investors) is now incredibly sloppy and are engaging in significant risk. This should be a very heavy sign of caution…
For example:
Everyone knows retail investors dived back into the market as stocks rebounded. Now, evidence is starting to build that their buying has become a key driver of the beaten-down shares that are dominating the rally.
Companies that have been soaring are in many cases the same firms that have seen skyrocketing interest at brokerages popular with individual investors. Turnover is surging: average daily volume for these stocks has occasionally been 30 times what it was in 2019.
…
Fascinated with industries that fell most in the coronavirus crash — airlines, cruise operators, auto sellers — and egged on by Twitter impresarios and in chat rooms, tiny day traders are betting big on the recovery. And their trading has been at the very least prescient. Lured by zero trading fees, a historic selloff and probably boredom while stuck at home, the group often viewed as “dumb money” opened record new trading accounts in the first quarter. While Wall Street icons denounced the rally, retail traders kept on buying — a decision that’s paid off as the S&P 500 jumped more than 40%.
Source: Bloomberg
And, perhaps, even more concerning is that many retail investors are getting involved in companies that have already declared bankruptcy:
Investors are piling into stocks of bankrupt companies, wagering against a court process that routinely wipes out shareholders.
Car renter Hertz Global Holdings Inc., oil driller Whiting Petroleum Corp.and retailer J.C. Penney Co. are among companies that have seen their shares more than double in recent trading sessions despite being in Chapter 11 bankruptcy, a process that allows companies to keep operating while working out a plan to repay creditors.
“I have always thought people have a psychological urge to buy stocks at a low price,” said Kirk Ruddy, a former bankruptcy claims trader. Retail investors may be buying big names they recognize without realizing how rare it is for shareholders to get anything back in bankruptcy, he said.
Source: Bloomberg
Capital Flywheels may be a few days late in pointing this out since some of this excess has started to reverse in the last few days, but the fallout is unlikely to be over. This is because putting money into a bankrupt company isn’t just putting money into a bad company that someone can wait out with hope…all bankrupt companies have an expiration date. In a few weeks, all of these bankrupt companies will almost certainly be zeroes. The excess is reversing now, but the shock, the utter shock of complete loss of money for a large swath of retail investors is still to come.
A close friend sent this clip over recently:
For people like Dave Portnoy, reality has likely not set in, yet. Retail investors caught up in this trades are likely in the “denial” phase rather than “accepting reality”.
While the Paper Portfolio is safe in the sense that almost every holding is well capitalized and truly is benefiting from both secular change and change forced by COVID-19, market reversals generally spare no one. Capital Flywheels is somewhat concerned from a near-term returns perspective, but the bigger concern is whether this could lead to a bigger tectonic shift – Retail investors’ labor income is likely shot at the moment…a significant setback in capital income would further widen the divide between the common citizen vs the capital class.
#2 Platforms Taking a Stand
After years / decades of stasis around racial progress, the Black Lives Matter movement suddenly accelerated following George Floyd’s death. Once, again, shifting sand that almost seems invisible becoming a tectonic shift because existing power structures have been weakened (by COVID-19).
While the changes that are starting to take place because of the Black Lives Matter movement are worth discussing in their own right (which Capital Flywheels is optimistic about), there are already many views on that front, and Capital Flywheels has limited insight to offer. What Capital Flywheels thinks is being overlooked is the likely permanent shift in behavior by the platforms towards a more active stance on many politically sensitive subjects.
And it all started with this:
While voting fraud concerns is not directly related to the Black Lives Matter movement, President Trump’s prior arguments have always insinuated that minorities are the ones that are likely perpetrating voting fraud.
That Twitter warning was followed-up by this a few days later:
Near-term, this increases the risk for platform businesses, many of which are held in the Paper Portfolio. While Capital Flywheels believes platforms taking a stronger stand on extreme views is good and necessary, there is risk and there are trade-offs. These are all worth monitoring.
#3 Reforging Relationships
In stable times, things change slowly not only because incumbent power structures resist change but because agents of change are often divided by wide variety of opinions. Part of the value of life-altering events is that it creates shared hardship, shared reality, and shared consensus. Therefore, crises tend to unite.
And the world is seeing this in action in a number of ways.
For example: The world is increasingly coming to a consensus that Trump is on the wrong side of things, especially amongst the US’ traditional allies:
Intelligence and law-enforcement officials among America’s allies in Europe and the Middle East told Insider they were aghast at the heavy-handed tactics and rhetoric used by US police generally, and by the president specifically, to suppress demonstrations against police abuses of African Americans.
“It has been chilling watching the United States devolve into the same strongman-style policing and rhetoric we have been opposing together as allies in the Middle East and Eastern Europe,” a NATO military intelligence official who has deployed to the Middle East, Africa, and Afghanistan in support of various anti-terrorism campaigns told Insider.
The source’s view is widely held.
Some European officials have started to side openly with the protesters.
Source: Business Insider
However, while Trump has pushed the US further from allies, what’s interesting is that allies are not moving away from the US. In fact, US allies are reaffirming their belief in core US values around democracy and liberty. Many educated US citizens fear that Trump has largely destroyed US standing in the global stage, but the Black Lives Matter movement is surprisingly showing how strong the ideas that underpin the US are to US allies, and that these ideas will survive Trump.
Many US allies have seen their own Black Lives Matter protests in solidarity with those in the US (for what is completely a US domestic issue), including even a country like New Zealand:
Another way that relationships are being reforged is the potential uniting of Europe.
While Europe has had a currency union for two decades, Europe has not been united fiscally or politically. But this appears to be changing:
For decades, even when the 2008 financial crisis threatened to blow the bloc apart, the European Union’s wealthier nations resisted the notion of collective debt. But the coronavirus has so fundamentally damaged the bloc’s economy that it is now forcing European leaders to consider the sort of unified and sweeping response once thought unworkable.
The European Commission, the bloc’s executive branch, on Wednesday proposed that it raise 750 billion euros, or $826 billion, on behalf of all members to finance their recovery from the economic collapse brought on by the virus, the worst crisis in the history of the European Union.
Source: New York Times
A united Europe is a stronger Europe. The world’s largest economy is currently the US, followed by China. But the Eurozone is larger economy than China and is on par with the US. The uniting of Europe could dramatically shift the economic and investment landscape in the coming years.