Retail investors take the reins
Welcome back to Investment Matters.
The market began 2021 where it left off the previous year.
The rise in the ASX since early November 2020 has been remarkable – with the market up approximately 3% for the calendar year to Wednesday (before a 2% pullback on Thursday).
This most recent rally over January saw what has been a hallmark of ‘market tops’ of the past– a rapid acceleration in participation by retail investors (i.e. nonprofessional investors).
This has been capped by the curious tale of a group of retail investors banding together last week to effectively “hijack” the share prices of several unloved companies. The most visible of these has been the rapid rise of GameStop, a US retailer whose share price has soared on the back of retail trade.
To us, this activity speaks to pockets of rising exuberance and speculation in the market. This recent activity provides the most extreme example that, in some areas of the market, prices have become untethered from fundamentals.
First Samuel’s clients have benefited from some of these pockets of exuberance. Accordingly, we have trimmed several positions that have outrun our price targets, with client portfolios now holding more meaningful levels of cash (approximately 13%).
We look back at a strange month of market activity, one where retail took the reins.
These were the words used by investor Michael Burry (of The Big Short fame) to describe the breathtaking rally seen in shares of GameStop, a US-based video game retailer. The company has become America’s most traded stock, with an army of retail investors propelled its share price from $19 to $347.51 over the last month – a 1,800% increase.
The company now boasts a market capitalization of $24.5 billion, despite losing $470 million last year and having revenue over only $6.5 billion (with its top-line declining by almost 30% over the past two years).
Source: IRESS, First Samuel
The battle between retail investors and institutional investors
On one side we have a merry mob of retail investors who banded together to push the share price of the out-of-favour retailer to absurd levels.
On the other side were several sophisticated hedge funds who had “short sold” the stock – that is, bet that its price would go down.
These hedge funds have subsequently been left red-faced, having to quickly “cover” their positions by buying shares in the stock back, creating a not so virtuous circle sending the share price even higher. One hedge fund has supposedly required a $2.8 billion bailout as it sustained heavy losses.
How did this happen? The perfect storm
This violent movement in GameStop’s share price is a stunning reminder of the disconnect that can arise between company fundamentals and price.
It also highlights the rise of the retail investor due to the unique circumstances across households around the world arising out of COVID-19.
An accumulation of savings, homebound and disenfranchised individuals, zero brokerage trading and rapid recovery in markets have birthed a new breed of investor dubbed “Robin Hood investors” – named after the zero-brokerage platform that many of these investors use to trade.
The rise of the retail investor has also been evident in Australia with SelfWealth, a low-cost trading platform, seeing the number of active traders on its platform more than triple over the past year.
Active traders on SelfWealth’s platform have more than tripled over the last year
Current state of play
All this action came to a head last night as Robinhood and several other low fee platforms halted the buying of GameStop and several other stocks that have soared. All in the name of preserving “market integrity” of course.
This activity was not confined to the US, with what appeared to be several institutions in Australia scrambling to close their “short” positions.
This sent some of the markets most heavily shorted stocks - such as Treasury Wine Estates, Invocare and Tassal, which all ended trading on Thursday - higher, despite the market falling by 2%.
Perhaps the clearest indication that retail mania had spilled over to our market was the 30% rise of GME Resources of the week – a company fortunate enough to share the same stock ticker as GameStop (GME.ASX vs GME.NYS) and capitalize on a combination of confusion and speculation.
Cause for caution
The story of GameStop is simply the latest in a list of anecdotes that have demonstrated exuberant behaviour in markets.
This includes retail investors piling into a bankrupt Hertz last year, the price of Bitcoin doubling in December 2020, a recent surge in battery-related resource stocks, and an explosion in several microcap stocks.
Some stocks in our clients’ portfolios have benefited from this latest spurt in the market and pockets of exuberance. We have been active over the past month and have trimmed several successful positions that have run well in advance of what we assess as their long-term value.
Clients’ Australian Equity Portfolios are now bolstered by higher levels of cash (approximately 14%) although we continue to look for opportunities in the current market.
Aside from the spectacle of witnessing stocks rocket to nosebleed levels and the battle as retail Davids take on Wall Street Goliaths, this latest anecdote reinforces three key messages to us:
1. The power of the flow of money
Share prices can move with complete disregard for fundamentals, particularly if there is a large enough weight of money and liquidity driving them.
This week’s events fly in the face of the notion of an efficient market – one where stocks are always priced accurately, and all knowable information is already in the price.
The GameStop phenomenon demonstrates that, at times, market forces and irrational behaviour can cause prices of stocks to decouple from their value by a wide margin - which provides opportunities for investors.
2. The accumulation of savings by households over the past year can have a powerful effect on the economy and markets
We have long spoken about the accumulation of household savings over the past year, which we have seen translate to stunning retail and auto sales numbers.
This latest display of the “dry powder” households have on hand demonstrates the latent potential for inflation given a successful global vaccination program and the re-opening of economies.
3. The signs of exuberance in the market
This latest anecdote highlights to us the importance of maintaining a disciplined valuation-based approach, particularly at times when pockets of the market become irrational.
We will see some of this exuberance come face-to-face with reality next week as we begin the all-important reporting season for the first half of the financial year, which will reveal how Australian companies have fared during the post-COVID recovery.
We look forward to providing you with further updates in the coming weeks.