Iron Capital Insights

  • Iron Capital Insights
  • July 23, 2015
  • Chuck Osborne

The Summer Sillies

“Sell in May and go away.” That used to be the motto on Wall Street – just cash in and go on vacation for the summer. Of course that is not the best long-term retirement strategy, and for taxable accounts that could increase the tax bill quite a bit. But there is something strange in the water this summer that is almost making us take that silly advice seriously. My children have a case of the summer sillies, and the market seems to, too.

We had the Greece scare earlier this summer. I’m always fascinated with the news coverage of such events. Every investor, fund manager, Wall Street executive, etc., who could be found to do an interview pretty much said the same thing: Greece isn’t the story, it is China. Yet the media outlets sent their roaming reporters to Athens, not Beijing. It bordered on the surreal – Greece voting “no” to get a better deal, only to learn that no such deal existed.

To the extent that China has been discussed it is described as a market meltdown, yet it is seldom noted that the domestic stock market in China was up more than 160 percent before this “meltdown” occurred. I used to joke about no client ever complaining about upside volatility, but it really is true. People do not seem to understand that rapid movements up are just as abnormal and usually just as temporary as rapid movements down. China’s government has stepped in to stop the carnage; anyone found selling short will be placed in jail. That will put a stop to a free fall.

Now the focus is back home and on earnings. Last week Netflix reported:  huge customer growth, still can’t make money but no one seems to care, stock went up over 16 percent. Google reported the next day: beat expectations on earnings but missed expectations on revenues, stock went up more than 16 percent. Apple reports, beats all the way around; stock goes down. Microsoft reports, beats all the way around; stock goes down. Oil supplies are down by 1.5 million barrels over the last two weeks as gasoline demand is “unusually high,” according to the EIA. So the price of oil is again in free fall.

So let’s sum up:  If you are a company with a really cool product that you have yet to figure out how to make profitable, or if you are a cool Internet name with less-than-expected revenues, your stock is up dramatically. If you’re a commodity whose supply is down and demand is up, your price is down dramatically. If you are a company with real tangible products that are insanely profitable, and you do better financially then anyone thought possible, then your stock price is down dramatically. What is wrong with this picture?

Some might say it is the direction of these movements. Companies who do not make money are not supposed to have stocks that go up in value and vice versa. However, Wall Street has always been a little silly this way in the short term. A company is a darling and no matter the reality traders and analysts find something to like, or a company goes out of favor and they find something to hate. That has always happened and always will. The real, long-term issue with what is happening now is the word dramatically. Individual stocks are moving huge amounts on a daily basis.

Happy Birthday Dodd-Frank. Five years ago the massive regulatory pile-on was passed. Proprietary trading of Wall Street firms was a bee in the bonnet of Paul Volcker so he got a rule named after him. No more trading for Wall Street firms. Forget that this had nothing to do with the financial crisis, or that much of the proprietary trading that happened was to serve clients. If one wishes to buy, someone has to sell, and Wall Street firms often would just do it themselves and look for someone on the other side later. That made implementing the rule a little difficult. But this summer it is finally here and in full effect.

Those proprietary trading desks added a lot of liquidity to the market and smoothed out a few rough days. Yes the big firms often made money off their trading desks, but they also made the markets work more efficiently by adding volume and liquidity. It is very difficult to quantify the exact impact, but my experience over the last few years as firms one by one got out of the trading business is that volatility has increased. It is not necessarily higher in the aggregate, as losers and winners still cancel one another out, but the individual movement is much different.

Summertime has always been slow, which means less liquidity and therefore bigger daily price movements. More volatility. It has gotten worse and will likely continue to do so. All the more reason for a prudent investing approach, patience and the understanding that as with our children, so goes the market – summertime is often silly time.

Chuck Osborne, CFA
Managing Director