“The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only.”
~ John Maynard Keynes, “The General Theory of Employment, Interest and Money”

I have to tell the truth: I wish I were writing about almost anything else. I find last week’s big story regarding Gamestop and the battle between young, inexperienced hedge fund traders and young, inexperienced day traders a boring distraction from real investing. I share this quote from Keynes as a testament to the fact that if one believes that this is somehow new or unprecedented, then he is gravely mistaken. In fact, I am going to go out on a limb here and say that regardless the subject, if one believes something is truly new, she is wrong. There have been approximately 4,000 years of human history. Whatever it is, it’s been done before. The only thing unprecedented about our era is that we now have too much free time to obsess on the trivial. But I digress.

The story of Gamestop is not complicated. Gamestop sells video games and gaming merchandise much the way Blockbuster used to rent movies. Its future, unless it can completely reinvent itself, is to follow the path of so many companies before into oblivion; to become an answer to trivia questions, and one day be highlighted in a movie where some kid goes back in time.

With this in mind it is certainly a company whose stock should be sold – and sold it was, by not only those who owned it, but also those who did not own it, the short sellers. Here is where a major regulatory disfunction becomes highlighted, once again I might add. To sell short (which is the term used to describe selling a stock one does not own), investors used to have to wait until some other investor bought the stock and caused the price to move higher. This was called the uptick rule, and was the way short selling worked from 1938 until 2007 when the SEC, in their infinite wisdom, removed the rule, and … well, do you remember 2008?

In 2010 the SEC wrote a new, watered down, far-too-complicated (which is another way of saying it’s easy to get around) version. Since then, short sellers have given us the flash bear market in 2018 and last year’s road to misery. The problem, in terms of fixing this, is that the impacts are short-lived and they actually create opportunities for longer term investors. We bounced back very well in both of those cases.

What is less noticeable to lay investors are the micro-disconnections that occur on individual stocks often. We see this almost all the time; there is a compounding effect whereby most hedge fund trading today is run by computer models and all the models are the same, so every professional trader is on the same side of all of these trades, and the daily volatility on individual stocks is hugely amplified.

Some day traders (that’s what we called them when I was their age, so that is what I’m going to call them) figured this out and saw an opportunity. The rest of the story is just color; this is the essence of what has happened. Is it a problem? Not really, but to the extent it is a problem, it is all due to the fact that the SEC has allowed short sellers to run amuck for more than a decade now. Bring back the uptick rule and this story goes away.

For the rest of us, times like this are a good reminder of why we invest prudently. We are owners of companies, not traders of stocks. These things do not happen to quality companies with solid futures. We are bottom-up investors; we invest in companies, not the “stock market.” The market is exactly what its name says, a market. I don’t care if they are price gouging on Captain Crunch, I’m buying eggs and bacon because we eat a real breakfast and the prices for eggs and bacon are fair.

We are absolute return-oriented. In other words, we do not participate in competitive investing. If some day trader made a lot of money on Gamestop, then good for her. That does not hurt me in the least. If some hedge fund rookie trader loses his boss a lot of money, well, welcome to Wall Street. These things do not impact us in the least, except that the time I spend thinking about this is time I can’t use finding actual investments.

We are risk-averse. While I put all the blame, if that is even the right word, for this fiasco on the short selling culture, this day trading trend will not end well. Those who make a lot fast, lose a lot fast. Las Vegas wasn’t built because gamblers are successful. There is a brass card holder and clock on my desk which I refer to as my “Purple Heart.” The last time we had a day trading craze, the technology required serious traders to come to offices where they could access trading terminals. One such place was down the hall from my office when I was a young team leader at what was then Aetna Retirement and is now part of Voya. One of those traders lost everything. In his desperation he took a gun, killed his wife and children, then came to our building. He killed several people that day, and my team members saved the life of one of his victims who was shot in the back. He eventually committed what they call suicide by cop, forcing the police to shoot him. Our bosses at Aetna Retirement came to Atlanta, took us to an expensive lunch, and gave us those card holders – our “Purple Hearts.”

Those who do not learn their history are doomed to repeat it. Trust me, there is nothing new, and nothing good, in this Gamestop story. This will not end well for any who get involved.

Warm regards,

Chuck Osborne, CFA
Managing Director

~The Games Children Play

“To everything there is a season, and a time to every purpose under the heaven.”  ~Ecclesiastes 3:1

Yes, that is right, this is not just a song by The Byrds, it is scriptural wisdom; whether one learned it in Sunday school or by singing along to the radio, it is just as true. For what seems like years now, we have been talking about the market’s unhealthy skew toward large-growth companies. Since the financial crisis the “market,” as judged by most, has gone up considerably, but this is really just the large U.S.-centric indices, like the S&P 500, which are dominated by technology firms. The rising tide has not lifted all boats, and investors who buy value stocks, or the stocks of smaller companies and those headquartered overseas, have seen little in the way of growth.

These trends happen in the market all the time. The decade of the aughts saw the exact opposite occur; the rationale was that we were coming off of the tech bubble. In response to the tech bubble and the economic downturn triggered by the 9/11 attacks, the Federal Reserve (Fed) lowered interest rates to levels that seemed very low back then. This had the effect of inflating a housing and commodity bubble, which brought on the financial crisis in 2008.

Since the financial crisis and the policy aftermath, we experienced an incredibly slow economic recovery with overall economic growth at almost half of historic U.S. levels. The result was that investors sought companies who could grow even if the economy did not. At some point in market behavior momentum takes over, and as always, the market overshoots. Recently, the unprecedented reaction to the COVID-19 pandemic exacerbated this already-entrenched trend, and the differential between growth stocks and value stocks approached record levels.

Some of our clients have even taken to making fun of me (to my face – they always make fun of me behind my back) because of my insistence that this will pass. The season will change, value is coming.

Not only has my tune not changed, but we may have already seen the change. In the fourth quarter of 2020, large-growth companies as represented by the Russell 1000 Growth index were up 11.39 percent while large value stocks as represented by the Russell 1000 Value were up 16.25 percent. Small-company stocks, as measured by the Russell 2000 index, were up 31.37 percent. The stocks of companies headquartered outside the U.S. also outperformed, as did companies from emerging-market countries.

In other words, diversification away from large U.S.-based technology companies worked for the first time in a long while. That trend has thus far continued into 2021. Through last Friday, January 15, our custom-blended global equity index, which is fully diversified in stocks of all shapes sizes and nationalities, was up 2.7 percent while “the market,” a.k.a. the S&P 500, was up 0.39 percent.

The trigger for this season of change appears to be Wall Street’s hope for stimulus. For what it is worth, the day of our new president’s inauguration, we had a reversal: the focus on the word stimulus was translated as economic growth, but then the reality of stopping pipelines, raising minimum wage, and regulating everything in sight momentarily put everything on hold. That is what happens in the market: Nothing happens in simple straight lines. There is always a trend and then a wait-a-minute moment.

We have seen false starts in this transition before, and it is possible that is all the last four months have been. These larger trends do, however, go on for years, and lately a decade seems to be the life span. “To everything there is a season…a time to plant, and a time to pluck up that which is planted.” We appear to be in the time to plant some diversification, while we pluck up those U.S. technology profits. To put it in terms of The Byrds, it may be time to “turn, turn, turn.”

Warm regards,

Chuck Osborne, CFA
Managing Director

~Is It Value Season?

We have a new ornament on our tree this year: a roll of toilet paper which simply says, “2020.” What a year it has been. It actually has been a positive year in the markets, although as we have said before, those gains are not equally distributed. However, even the unloved value stocks have made a recent comeback and will at least finish the year where they started, if not a little ahead. How can that be?

Life is not really about the events or circumstances that impact us. No, life is about our reaction to those events and circumstances. Once upon a time, when children actually went to school and schools actually cared about education, we learned these lessons through classical literature. This time of year we would read “A Christmas Carol,” by Charles Dickens. Scrooge was a miserly old man, but we learned that he wasn’t always that way; the events of his life hardened him. One such event was the premature death of his sister.

His nephew Fred also experienced that same loss, but it did not affect him in the same way. He was full of love and happiness, especially during the Christmas season. His uncle treated him badly, but Fred’s response was to feel pity for his Uncle Scrooge. Two men, living in the same world and sharing many of the same events, but with two totally different reactions.

This is the story of 2020: same year, same pandemic, many different reactions. If you live in California or New York, then you have lost almost all of your freedom and ironically been ravaged by the virus anyway. On the other hand, if you live in Georgia or Alabama, your life has pretty much gone on with the exception of wearing masks and working more from home, and while the virus is here it has stayed relatively under control.

We see it as well with our friends. I have friends who sadly have lost parents to COVID-19, yet they maintain a positive outlook even while grieving their loss. I have others who have been spared, yet every word out of their mouths is gloom and doom and fear. It isn’t what happens, it is how we choose to react.

So why is the market finishing this year in positive territory? Because more people see the glass as half full than those who see it as half empty. 2020 has been hard, but life is hard. It is supposed to be hard; life tests us. Those tests make us stronger and more resilient, and help us have greater appreciation for the good times.

What will 2021 bring? I believe most of us are looking at 2021 with optimism. Although I did hear a joke recently, “Just wait until 2020 turns 21 and starts drinking.” While I admit that I laughed, I also have to admit to being firmly in the camp of optimism.

More importantly for my day job and your portfolio, I believe most market participants share that optimism. 2021 will likely be a good year for the market. The odds are that the gains next year will be heavily weighted toward the areas that were left behind this year, and that some highfliers will come back to earth. When all is said and done, it should be positive. Of course, those are just the probabilities. Ultimately, 2021 – like every year, even 2020 – will be what we decide to make of it.

As for the next few days, I know in my house, and I hope in yours, Santa is still coming. Merry Christmas and Happy New Year!

Warm regards,

Chuck Osborne, CFA
Managing Director

~Santa Is Still Coming, Even in 2020

“Everything in moderation, including moderation.”  ~ Oscar Wilde

We have heard the advice so often: everything in moderation. This advice is repeated so often probably because we are so bad at following it. Today’s motto is closer to “everything in hyperbole,” and perhaps that explains the election and aftermath. We have been living with extremes so long that we just need some good old-fashioned moderation.

President Trump represented extreme behavior, and the country rejected it. The Democratic Party adopted an extreme platform and the nation rejected it, with Democrats losing seats in the House and making little ground in the Senate, despite winning the White House. The market has mostly celebrated that outcome, which we had predicted.

The market has also begun the process of moderating. We have spoken often about the outsized returns of technology companies and the fact that many parts of the market have not kept up. Over the last month we have witnessed those ignored areas making up ground, while the technology firms have seen their stocks go nowhere. It is a short time period, and it may or may not be lasting, but it seems to go along with the prevailing mood.

This year we have experienced a global pandemic and an extreme reaction to that pandemic. We have seen extreme social unrest in our cities. We have heard extreme ideas put forth by what are supposed to be serious people. Even in sports, the NBA evidently got together and had a championship that no one watched. College football is on-again-off-again every week, and even the Masters was played in November. Azaleas do not bloom in November for anyone, not even the powerful membership of Augusta National.

We long for normalcy, for moderation. We don’t often think of moderation during this time of year, because it is Thanksgiving after all. However, even in a year when all we want is some normalcy, there is still much for which to be thankful. In keeping with our tradition, here is my list:

~ I am thankful for the perspective of 2020, for it is in the challenging times that we are reminded of what is important.

~ Having said that, I am thankful 2020 is coming to an end.

~ I am thankful for positive vaccine news, which assures us that there is a light at the end of this tunnel.

~ I am thankful for my wife, who has always been a loving mother but who has also become teacher and tech support.

~ I am thankful for my children who are growing and learning every day, even if they are wearing pajama pants to their zoom school classes.

~ I am thankful for my family, immediate and extended.

~ I am thankful for all of my friends.

~ Of course, I’m always thankful for Mama’s pumpkin cheesecake and for my loose-fitting pants, which make enjoyment of said cheesecake possible.

~ Finally, I am thankful for you, our clients and friends. Your trust in Iron Capital is our greatest asset and we value it every day of the year.

Happy Thanksgiving!

Chuck Osborne, CFA
Managing Director

~Everything in Moderation

Prudent investing is risk-averse. You have all heard me say that at least a thousand times. Coming into this election, the market had been on a big run since bottoming in March. Valuations were getting a bit high and we now have political uncertainty.

We said there was a good chance that we would not know who the next President would be on election night. That was not exactly a brave prediction, but as expected, this is indeed the case. We did not know how people would react, and given the summer of incredibly violent “peaceful protests,” we hoped for the best and planned for the worst.

Thankfully the post-election time has thus far been peaceful (knock on wood). The market has surged after dropping dramatically last week. We took protective measures heading into the election and as a result, lost less than the market last week and have gained less this week. We still lost value last week and have still had big gains this week, we have just moved less than the market in both directions. That is risk control.

Risk is a funny thing. Many people will look at the fact that the market has rallied and that everything has thus far been peaceful as proof that these events were certain. That is not true; there was a probability that things could have been much different. Understanding the different probabilities is what investment risk control is all about.

One of the biggest differences between the lay investor and the professional is that lay investors tend to think in all-or-nothing terms. Should I be invested? Should I buy XYZ stock? To lay investors, these are yes-and-no questions. Professionals think in terms of degrees: How invested should I be? How much of this stock should I own? What percentage of my portfolio should it be? These are the questions professionals ask, and they are seldom yes-or-no answers.

Had the lay investor gone to all cash in advance of the election he would have been happy last week and crying this week. The professional doesn’t go to all cash; she trims back her exposure to ride out the possible storms, but almost never shuts down. The problem with that all-or-nothing attitude is knowing when to reverse course. That becomes the guessing game of trying to time the market.

Prudent investors do not try to time the market; they make decisions from the bottom-up. They think in terms of absolute returns, not worrying about missing out on some magic, and that allows them to be risk-averse. Risk control is what allows investors to keep moving forward towards their goals.

We still don’t know who the President will be for the next four years. However, we do know that the checks and balances of our system are still in place. The sun came up on Wednesday, the earth is still spinning, and that is all good news for Wall Street. We avoided the storm, but were prepared if we hadn’t. We will prepare the same way for the next potential storm, and the next. Risk control: that is really the job. As they say in football, “defense wins championships.”

Warm regards,

Chuck Osborne, CFA
Managing Director

~The Art and Science of Risk Control