Jon Manchester, CFA, CFP®, Senior Vice President, Chief Strategist - Wealth Management, and Portfolio Manager - Sustainable, Responsible and Impact Investing
March 31, 2021
Online trading platform Robinhood launched in 2013 with a mission to “democratize finance for all.” The Menlo Park, CA-based firm offered free trades, no minimum balances, and one share of a stock to sign up. A year later, the app debuted on Apple’s App Store with a waitlist of reportedly one million users. The colorful, intuitive interface catered to millenials. “People like us can trade just like the big guys,” said their introductory video.
Millennials—the first generation to grow up with widespread access to video games—readily embraced the app, which until recently celebrated a user’s first trade with confetti animation. Daily push notifications aim to keep users engaged, and an ecosystem of (mostly) merry men arose around Robinhood on sites including Reddit and TikTok, with influencers touting their trading acumen. A TikTok video earlier this year went viral in which a user named Chad explained his sophisticated strategy: “I see a stock going up and I buy it – and I just watch it until it stops going up and I sell it.”(1)
The app’s popularity soared with its target demographic and, by 2019, Robinhood boasted six million users. The sheriffs of the brokerage forest could no longer ignore this upstart. Within a two-day span in September 2019, E*Trade, Charles Schwab, and TD Ameritrade matched Robinhood with free trading. The little guy had triumphed; finance was more accessible to all. A neat story, if the credits were to roll then. The featurelength film, still in production, offers a more nuanced view of Robinhood’s business model as well as the role of retail investors in setting stock prices.
Marooned at home by the pandemic last year, and with social media fanning the flames, predominantly young investors flocked to Robinhood. By the end of 2020, the app had exploded to around 20 million users.(2) Its fervent followers spawned a new phrase: meme stocks. This refers to investments hyped on social media, with GameStop as the poster child. It was a natural fit, a video game retailer for the video game generation. It was also heavily shorted, a trait shared by some other meme stocks like AMC Entertainment. This made it an even more attractive candidate for the band of traders. The fat cat hedge funds, like the Sheriff of Nottingham, sat on the other side of the trade.
The GameStop saga has yet to find its punch line. In January, the stock rocketed 1,625% higher before plunging 69% in February, only to shoot back up 87% in March. To say the price volatility is disconnected from fundamentals would be stating the obvious, but the meme stocks seem to be following their own peculiar logic. The strange machinations within certain slices of the investment world prompted The New York Times to issue a “March’s maddest markets” bracket that included meme stocks (GameStop, Tesla), SPACs (blank check companies), penny stocks, nonfungible tokens, and a few digital currencies.
Break Out the Bubbly?
For Bailard’s investment strategies, these wild meme stock swings are largely a sideshow, but retail traders seem to be having real impacts on markets. A recent Bloomberg article noted individual traders now represent nearly a quarter of U.S. volume on any given day.(3) In January, Goldman Sachs calculated that the 50 most heavily-shorted Russell 3000 stocks had rallied 98% over the prior three months, which they dubbed the most extreme short squeeze over the past 25 years.(4) Elevated demand for penny stocks, companies with negative earnings, and extremely high-growth, high-valuation equities may also be at least partly attributable to the retail segment.
With COVID-19 still very much a threat to economic activity (and human life), speculative trading outbreaks do put us on bubble watch. In late March, news that a largely unknown investment fund called Archegos Capital Management overextended itself with leverage did not help. With details still a bit murky, it appears Archegos had assets of roughly $10 billion, but via borrowing had levered up to owning positions worth nearly $30 billion.(5) When some of those investments went south, Archegos and the banks that lent the firm money had to essentially fire sale those securities. It brought back some unpleasant memories of past leveraged implosions (Long Term Capital Management, Bear Stearns, etc.) but, at this point, Archegos appears to be a cautionary tale, not one indicative of a broader problem.
One reason for cautious optimism is that households and corporations are in reasonably good fiscal shape despite the enormous stresses incurred from the pandemic. U.S. households have accumulated an estimated $1.5 trillion in excess savings since the onset of the pandemic, and Goldman Sachs economists think that number could be $2.4 trillion—or 11% of Gross Domestic Product (GDP)—before “normal” economic life resumes around mid-2021.(6) Of course, this is in aggregate, with many Americans mightily struggling and our woeful inequality picture only exacerbated by events of the past year. At the corporate level, low borrowing costs have immensely helped, and the bond market shows little signs of fear regarding credit risk.
High valuations, a hallmark of stock market bubbles, remain worrisome in certain segments. In some cases, investors have bid up stocks enthusiastically as COVID-19 recovery plays, and the stocks seem richly priced for even a “normal” economic environment. Growth stocks have come under some pressure recently with interest rates on the rise, but this is after an extraordinary run. Over the 2017 to 2020 timeframe, the S&P 500 Technology sector returned 30% annualized, double the overall market’s return. That has left a number of tech stocks stranded, at least temporarily, at higher valuations as the tide moves slowly out.
According to Bernstein Research, the most expensive quintile of tech stocks are trading at 17x revenues on a market-cap weighted basis, the highest level since the tech bubble.(7) This is not to suggest that all tech stocks are historically pricey, but there are pockets of the market carrying valuations we may ultimately deem as irrationally exuberant, in retrospect.
Spend Money to Make Money
On the economic front, the U.S. recovery continues apace, albeit with COVID-19 as a governor of sorts. Fourth quarter 2020 real GDP growth of 4.3% capped a pandemic-plagued year in which real GDP contracted 3.5%. Economists are projecting nearly 6% growth in 2021 however, and some think it will end up being significantly higher than that due to various stimulus measures. The residential housing markets remain strong: the S&P CoreLogic Case-Shiller National Home Price Index was 11% higher year-over-year in January, its largest gain since February 2006. In the labor markets, the rapid improvements experienced last summer have slowed considerably, but reopening should bolster the employment ranks. As of quarter-end, total nonfarm payrolls remained approximately 4.5% lower than a year prior.
Meaningful economic tailwinds will continue in the form of fiscal and monetary policies. President Joe Biden’s $1.9 trillion American Rescue Plan boosted direct aid via higher stimulus checks and an expanded child tax credit. Eligible households with children are due to receive $6,600 on average, with the largest families receiving more than $10,000.(8) The Center on Poverty and Social Policy at Columbia University estimates the relief package could cut child poverty in half this year. Next on the agenda is an ambitious $2.3 trillion infrastructure bill, which looks likely to face stiff political opposition. And, in fairly short order, Biden intends to introduce another spending package focused on education, childcare, and other social programs.
It is unclear how far these proposals will get on Capitol Hill, but they seemingly increase the upside risk to economic growth estimates for 2021, given the already strong backdrop. On the other hand, taxes will need to move higher to foot the bills, which would weigh on corporate profits. Goldman Sachs strategist David Kostin estimates that full implementation of Biden’s tax plan would reduce the earnings of S&P 500 companies by around 9% but believes the actual drag on 2022 profits will be closer to 3% if Congress only takes the corporate tax rate up to 25% instead of the 28% proposed. Higher taxes will mostly be background noise if corporate earnings follow their projected path. Per Standard & Poor’s, the 2021 estimated operating profits of $172 per share would represent nearly 10% growth over the 2019 pre-pandemic level and a 41% increase versus last year.
On the monetary policy front, the Federal Reserve remains committed to its new “average inflation targeting” policy. This essentially enables the Fed to let inflation run moderately higher than its 2% target for some time before feeling compelled to raise the Fed Funds target rate. Combined with quantitative easing and the fiscal spending spree, market participants are identifying higher inflation as a growing concern. The Fed believes any near-term inflation will be transitory, but bond investors—and digital currency enthusiasts—are not so sure. After bottoming at just 0.55% in March 2020, the 10-year breakeven U.S. Treasury rate (implied inflation) has steadily risen, reaching 2.38% by the end of the first quarter.
According to Raymond James Chief Economist Dr. Scott Brown, economists view inflation as driven primarily by two factors: inflation expectations and the degree of economic slack.(9) Inflation expectations are on the move higher, yet still well contained. We know slack (a description of unused resources in an economy) remains in the broader economy in part by the number of unemployed or underemployed in the working-age population. Federal deficits do not seem to be a root cause of inflation (Japan, for example). Nor does growth in money supply, despite Milton Friedman’s well-known statement that “Inflation is always and everywhere a monetary phenomenon….” Inflation remains a credible threat we will be monitoring closely but, in the meantime, it doesn’t hurt to dust off the inflation playbook in case the genie slips out of the bottle.
1 “Robinhood Couple in Viral TikTok Discover Momentum Trading,” bloomberg.com, 1/19/2021
2 “Robinhood’s Reckoning: Facing Life After GameStop,” wsj.com, 2/5/2021
3 “Nothing the Stock Market Does Ever Scares Its Retail Daredevils,” bloomberg.com, 3/6/2021
4 “Anatomy of a short squeeze,” Goldman Sachs Research, 1/29/2021
5 “What Is Archegos and How Did It Rattle the Stock Market,” wsj.com, 3/30/2021
6 “Bubble Puzzle: A guide to bubbles and why we are not in one,” Goldman Sachs Research, 3/22/2021
7 “Expensive tech is still expensive,” Bernstein Research, 3/22/2021
8 “Which Families Will Receive the Most Money From the Stimulus Bill,” nytimes.com, 3/12/2021
9 “Weekly Economic Monitor – The Inflation Outlook,” Raymond James, 2/12/2021