Eagle, CO
Since peaking on February 16th, the S&P 500 was down about 5.7% at its lows on Thursday. The NASDAQ was down 12% over the same period and is fully in correction territory (down more than 10%.)
The S&P’s outperformance of roughly 6% is notable even if you know that the NASDAQ is more volatile (because it is full of technology and biotechnology companies.) The tech-heavy index has been leading the market higher for several years, and it is really no surprise that it would lead the markets lower on a pullback.
The questions now are whether the S&P 500 will follow, and if the NASDAQ might bottom first and then resume its leadership position by rallying out of this correction.
In any case, we have been looking to tighten our trailing stops and lock in gains. Yes, that will lead to realizing some gains and paying some taxes (for taxable accounts), but I would rather pay a % of our gains to Uncle Sam, than give a similar amount or even substantially more, back to Mr. Market.
For all the new clients we have added since March of 2020 – you have not yet been with us through a correction, let alone a bear market. And for long-time clients, a refresher is probably worth a few words.
We use trailing stop loss rules to limit our risk and protect our gains. We also carry a fair amount of cash to take advantage of opportunities that arise during these periods.
We do not enter our “stops” into the market with our custodians. Rather, we track them in an online database and then manually close our positions the following day if our stops are triggered on closing basis. It is important to note that we don’t use intra-day prices in our rules. So, if a position closes the end of the trading day below our stated stop-loss price, we exit the following day when the market opens.
These rules give us the confidence to hold positions for a very long time, so long as they “behave.” The biggest misconception about trailing stops is that they cause us to actively trade in and out of positions, but nothing could be further from the truth.
For example, right now, our average holding period across all long positions in both the Appreciation and Income Strategies is currently 399 days. And that is with consideration that the bottom of the last bear market we experienced was less than 365 days ago (March 23, 2020). The oldest positions were part of the original allocations for these strategies back in July of 2018 and we’ve already held them for almost 1,000 days.
Nearby is a snapshot of all our open positions across both the Appreciation and Income Strategies (sorted by days held):
You might notice that we entered several of our open positions very near to the date of the bear market putting in its bottom. That would not have been possible without cash. And having cash wouldn’t be possible without selling something (…or asking you to make a deposit 😉).
In another snapshot nearby, you’ll find the positions we sold during the last bear market from 2/21/20 – 3/26/20 when the market was down 35% or so (sorted by date sold):
Open long positions
Positions closed between 2/21/20 and 3/23/20
Our favorite holding period is “forever.”
But it doesn’t always work out that way and we aren’t getting married to these names. There is no shortage of big ideas in which to invest these days -even if the valuations leave a lot to be desired. When we hit a stop rather than be disappointed, I am generally excited to invest in the next big thing. And sometimes, the best thing to do is buy back one of the names we stopped out of, even if it is a little higher than where we sold.
The idea isn’t that we know what is going to happen and to exactly pick market tops and bottoms – the idea for trailing stops is to protect against catastrophic losses, from which you may never recover.
During the current pullback, we have stopped out of a couple positions (WPM and AMT) and tightened our stops on some of our highest-flying names. We also sold half of our position in MercadoLibre (MELI) and we are very close to stopping out of several more names. That said, we have a stable of ideas that we would love to buy, and they are getting cheaper by the day as the market sells off.
February Performance
I guess all I had to do was call out the Income Strategy in my last letter, to wake it up. Last month the Income Strategy was up about half as much as the S&P 500, which is its stated objective. Meanwhile, the Appreciation Strategy was up slightly more, but still only about half as much as the S&P 500 which was up 2.6% in February.
What really drove performance in the Appreciation Strategy was the NASDAQ though, which was down more than 2.5%.
Unfortunately, the slide has accelerated early in March as the NASDAQ and Appreciation both remain under pressure.
Outlook
$1.9 Trillion more stimulus was approved over the weekend while vaccinations and economic re-openings including movie theatres continue to gain steam. With all that new money sloshing around, I continue to believe that if people go out and spend it, stocks will rally, and inflation will rise.
No market goes straight up forever though. There are always pullbacks and sector rotations that happen along the way. There is no telling how severe the current one will get but we are highly disciplined, and we will follow our stop losses and (re)entry signals when they hit.
The driver of the current drop in stocks is a rise in interest rates. Higher interest rates reduce the present value of future revenues when conducting fundamental time value of money calculations. This is the first fundamental driver of markets we have seen in quite some time. I think that is part of the reason for the resurgence in some “value” stocks. (That, and me “jinxing” the Income Strategy last month.)
I wonder how long it might last. Billionaire hedge fund manager, David Tepper, was out this morning saying that the move in rates has already gone too far, too fast… and the stock market is rallying higher on hopes that he may be right.
In Barron’s over the weekend, I read:
“…a one-percentage-point rise in Treasury yields would increase Uncle Sam’s annual interest expense by the equivalent of double NASA’s budget. Interest costs one percentage point above the Congressional Budget Office’s baseline estimate would add $9.7 trillion—more than 10 times the annual U.S. defense budget—to the deficit from 2021 to 2030.”
So, I do think there is a limit to how high interest rates will be allowed to go.
One last thing before I go, a quick victory lap if you will… Last month, I said:
…[GameStop] management never created new shares of their company to sell to the public when they were going for $500/share… they didn’t do it at $400, $300 or $200 either. And now, the shares trade for $65.
If you had something that was worth $10 and for some strange reason you could sell it for $65 right now, what would you do?
This doesn’t take a savvy businessperson to figure out.
You sell as much as you can sell as fast as you can sell it until the price goes back to around $10! Then, you buy it back if you like.
GameStop needs to raise money to invest in converting their business from a place where people simply go to buy video games in person. They just missed the opportunity of a lifetime.
The management team at GameStop is incompetent. They have demonstrated it in several ways over a number of years as their stock price fell from $57 in 2013, to around $2.50 in 2020.
Current management has presided over the destruction of around 96% of the value of GameStop over the past 6 years, meanwhile the stock market more than doubled in value and other companies in the video game space did much better than the market. They should be ashamed.
That said, they did recently add Ryan Cohen, the founder of Chewy, to their board after he bought a substantial number of shares and started agitating for changes. Mr. Cohen has been very quiet about his plans for the company, but I would venture to guess that it involves making GameStop the “online destination” for ordering video games and accessories.
Well, since then, GameStop’s CFO has “resigned” and the company has (as of this morning) appointed Mr. Cohen to “lead its e-commerce shift.”
You can’t make it up.
As always, thank you for reading!
Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisor
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