First Quarter 2021 - Boredom, Margin, SPACs, NFTs and RetirementSubmitted by Alsworth Capital Management, LLC on April 27th, 2021
Boredom, Margin, SPACs, NFTs and Retirement
Stocks in the US and around the world continued to advance this past quarter, as vaccines have promised to free us from the grips of the global pandemic and enormous stimulus spending has provided ample money to the economy to induce spending. Since the pandemic low in stocks on March 23, 2020, we have witnessed US stocks, developed international stocks, and emerging-market stocks advance an astonishing 80.6%, 74.8%, and 74.6%, respectively. Clearly, it paid not to panic and get out of the markets last spring. This last quarter has seen a “reflation rotation” out of the high growth technology names that led the recovery and into the lower priced more economically sensitive value stocks like banks, real estate, energy and manufacturing. Small companies have outperformed in recent months and have recovered as well. The prospect of higher growth and higher inflation has caused interest rates to jump higher. Bond prices, which move opposite interest rates, have dropped with the core bond index falling 3.6% this quarter.
It has now been just four months since the FDA approved the Pfizer and Moderna vaccines and over 148 million doses have already been administered. Reported infections, hospitalizations and deaths have been declining precipitously in the developed world and the economy has been opening back up as people are slowly resuming normal activities. The pace and manner of reopening has been nearly as haphazard as shutdowns, but the overall trend is encouraging. It is easy to assume that the pandemic is over, but regional spikes persist and we remain far from “herd immunity” in the US, let alone globally. As travel resumes, vulnerability to regional spikes spreading to more controlled areas of the world remains a concern. The stock market is weighing these factors and is clearly forecasting that vaccinations will win over the risks heading into summer months when transmission is greatly reduced through more outdoor activities. Maintaining this outlook will require achieving herd immunity before the fall season. It will also rely on the effectiveness of the vaccines in protecting against new mutations and variants of the virus that develop in regions where the spread is high. We have learned through this experience that it is impossible to avoid the ramifications of viral activity in far flung regions of the world, in even our most rural communities. Herd immunity will require a global vaccination effort. Economic reopening will also require the distribution and use of life saving treatments to keep death rates low, so that we can remain confident in coming out of our homes and resuming normal activity.
The rise in stock prices has come very quickly, far ahead of a recovery in employment or economic growth. Investment markets typically price securities based on expectations of the future about twelve months in advance. Prices are volatile because nobody can consistently predict the future and expectations always meet unexpected events and changing conditions. Current unemployment remains very high and it will likely take another year or two before normal hiring resumes. Stimulus checks, unemployment funds and forgivable loans have provided a buffer for small businesses and labor to get through the pandemic, while avoiding another Great Depression. It has been a victory for economists and globally coordinated central planners in manufacturing a likely “V” shaped recovery. Nobody is talking about “double dip” recessions anymore. It has really been better than the most optimistic strategists could have hoped for. We believe that the consensus view of economic recovery over the next twelve months is probable. The power of the Fed to create very low interest rates to induce borrowing and investment is palpable. The power of lawmakers to stimulate the economy is undeniable. These factors have overwhelmed the forces that repress economic activity and we have learned that aggressive action can yield immediate results. We also believe that current prices fully reflect the expectation that corporate earnings will be strong in the months ahead. We didn’t panic during the depths of the pandemic recession and it has paid off. Now the work gets much harder.
The economy and investment markets are determined as much by psychology as they are by analyzing financial figures. The psychology of processing an unexpected pandemic led to a drop off in spending, layoffs, plant closures and the hoarding of toilet paper, as well as cash. Markets are predicting that the psychology of vaccinations and free money will lead to a surge in spending, reduction in savings and a spike in corporate earnings. So far, this looks to be a correct assumption. However, history has shown us that there are always unintended consequences to major events and humans are not always rational in our behavior. There are clear signs of excess and mania in current markets that bear watching. The prices paid for stocks today exceed those paid in past peak markets by most metrics. There is reason to be optimistic about corporate earnings, but expectations should also be bound by fundamental analysis around how much to pay for probable future income earned on those investments. Even if you assume high growth in sales for a company for the next twenty years, you have to figure out how much you are willing to pay today for that company and how long it will take you to recoup your investment, let alone earn any excess income. The alternative is to plan on selling the asset to a “Greater Fool” that will pay an even higher price in the future for the asset regardless of the income it produces. There isn’t an endless supply of greater fools with money to burn for no economic reason.
There has been a substantial increase in the amount of margin being used to purchase assets today. Margin is the ability to borrow money using your stocks as collateral. You might have a $100,000 in stocks, which allows you to borrow another $50,000 to buy more stock, with the hope of growing the portfolio value to a point where you can sell off some stocks to pay your margin debt and reap the growth on the entire $150,000. This works until the value of your portfolio declines and you have to sell stocks at a loss to pay off the debt (margin call). Some investors buying on margin today haven’t experienced managing this strategy during a market correction, let alone a bear market (20% or more decline). At present, margin debt is the highest in history. On an inflation adjusted basis, it is nearly two times the levels of the dot.com bubble. This doesn’t mean that stocks are going to crash, but it is a sign of speculation in the markets.
There has also been an explosion in the creation and purchases of a new asset called Non-Fungible Tokens (NFTs). These are “digital assets” that give someone unique and singular ownership (limited supply) of an asset. The ownership is verified through blockchain technology and can’t be easily stolen or manipulated. It also doesn’t require any government entity to verify or assign ownership through copyright. Artists have been creating NFTs to sell ownership in artwork that is created digitally. If an artist creates something digitally or has a copy of artwork stored digitally, it could be easily copied online and replicated a billion times by anyone that wants it. However, if you own the NFT code, you can claim that you are the rightful sole owner of it. That doesn’t prevent anyone else from using it, but you can stake claim to the ownership, much like owning a star that anyone can see with a good telescope. An artist named Beeple recently sold an NFT for $69 million. The founder of social media platform, Twitter, sold an NFT for his first ever tweet for nearly $3 million. The NBA sold an NFT for ownership of a short video of basketball player Lebron James dunking a ball for $612,000. Anyone can watch the video online, but only one person owns it.
Wall Street bankers have been attracting unbelievable amounts of money for new investment vehicles called a Special Purpose Acquisition Company (SPAC). These are a shell company that is created to attract investment dollars to be used toward finding a private company to merge with at some point in the future (typically within 2-3 years). They have attracted billions of dollars, which all need to be deployed in a short period of time to merge with some other company. Celebrities and athletes are putting their names on some SPACs to attract investment money, despite rarely having any experience investing in or managing companies. Investors are pouring money into shell companies before they even know what they will be investing the funds in.
I’m not casting judgement on people that buy on margin or people that buy cryptocurrency, NFTs or SPACs. There may well be unimagined future utility in these investments. Borrowing money to buy these new assets, or to buy old assets at high prices, might prove profitable. What is noteworthy to me is the speed at which new assets are being created and the eagerness to buy them, which translates to skyrocketing prices being paid. It reminds me of twenty years ago and the parabolic rise in prices paid for future bankrupt companies that had no sales, no proof of viability, but had a “.com” after their company name. Speculation, like gambling, can be very profitable. If you can afford speculation and enjoy it, no harm, no foul. Investing for future income, however, should be approached with caution, calm reasoned fundamental valuation, and a heavy dose of “show me” skepticism. Once cold hard cash is converted to ownership of an asset, there is no guarantee that the ownership will lead to future cash when it is needed.
I believe in the adaptability of humans to persevere and thrive in any environment. I’m also mindful of the propensity towards panic and mania. Through it all, we can manage to come out ahead, if we can avoid succumbing to the extremes. We will do our best to keep a cool head and stay centered, while continuing to be curious about new developments.
After much deliberation, research and listening to more knowledgeable people, Jacqueline and I have chosen to receive the Pfizer vaccine. Everyone in our office is also vaccinated. A more difficult decision was deciding to have our children get the same vaccine. Our youngest child is not yet eligible. We are awaiting the final results and reviews regarding vaccinating children age 12 and above. If all goes well, we anticipate resuming our travel schedule to meet with out of state clients, which represent the large majority. It’s a personal choice, but part of our decision was based on the need for us to maintain engagement with our clients, while also providing for the safety of our family. If you are comfortable meeting in person, we will be happy to schedule a meeting. We also continue to do a lot of phone meetings and web meetings (computer screen share, as well as Zoom). As tax season winds down, we will be catching up with more financial planning meetings and we look forward to connecting for updates.
Please feel free to contact us anytime. Also, if you really like this commentary letter, maybe we can create an NFT for exclusive ownership of the digital copy!
Shane M. Alsworth, MBA, CFP®, CLU®, CIMA®
The views and opinions presented in this article are those of Shane Alsworth only
Investments are subject to market risks including the potential loss of principal invested.
Asset Allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
Sources: Morningstar/Ibbotson data, Ned Davis Research, BCA Research, Litman Gregory Research