You name it – Robinhood, Reddit, GameStop, AMC, BlackBerry, et cetera – they were all there. January ended with a lot of buzz around these names. It was described as a battle between retail investors and the “suits”. Retail was sticking it to the man. Retail investors were taking down billionaires – hedge fund managers. It started with some forum posts on Reddit where individual investors were trying to rally around GameStop stock. The messages said GameStop was heavily shorted by a top-shelf hedge fund and the retail investors wanted to squeeze that fund out of the position. From there the price went into the stratosphere as investors piled on and not only created a short squeeze, but also created a gamma squeeze by buying out-of-the-money call options that cause more stock buying by triggering the options dealer hedging mechanism. Yet more buyers piled in. They went after other stocks too – AMC, BlackBerry, etc.
In the financial universe, it is now considered common knowledge that many recipients of federal stimulus checks have deposited their money into retail brokerage accounts as a free-money flier on the stock market. Many had a successful 2020 since it was an up-trending market. The favorite retail broker for the above trading and speculative stimulus deposits was Robinhood, a Johnny-come-lately that offers commission-less trading. Robinhood has notoriously lax restrictions compared to peers like E*Trade, Schwab, and Ameritrade. In one example last year, some Robinhood investors discovered a loophole that gave them infinite leverage – a very combustible proposition for even the most experienced investor.
If inflicting harm on major hedge funds was the mission of these retail investors, it was a success. At least one hedge fund has closed in the aftermath and several others have reported major losses since the start of the year. One hedge fund – the initial target, Melvin Capital – received a rescue package of $2.75 billion in loans (from Citadel and Point72) to help it survive the turmoil and it still was down 53% in the month.
There is a secret here though. Robinhood (and others like it) can offer commission-free trading because they sell order flow. When investors buy and sell securities on their platform, their order has been sold by the platform to executing brokers – the likes of Citadel Securities and other market makers. Using their larger book, technology, partners, and, perhaps, questionable means market makers earn profit by capturing value between bid and ask prices. They are the middleman between buyers and sellers. In general, if trading volume goes up, they make more money – lots of it.
By mid-week retail brokers – mainly Robinhood and Interactive Brokers – began limiting activity in the hot stocks. Soon the brokers were forcing investors out of their positions. This was upsetting to many retail investors who thought they were unjustly having their positions taken from them. They viewed this as an act of billionaires (hedge funds) calling in favors. The reality of the situation could probably just be found in their retail margin account agreement (if you have not read one, to put it simply, brokers reserve a lot of leeway with your account. Example). Maybe this was the first experience with margin and margin calls for these retail investors. But the cold hard reality, it turns out, was much worse than silly retail investor margin calls. Robinhood, with its lax controls managed to sink itself into a major liquidity hole. Even though Robinhood’s CEO did his patriotic duty of lying about liquidity on mainstream network interviews, the company’s needs were dire. At about the same time or shortly thereafter, Robinhood drew its credit line, raised more equity, and is now contemplating raising debt.
Alas, the whole situation was rich with irony. Maybe hedge funds received scars to be sure, but retail got margin called just like the hedge funds, and retail may very well have imperiled the very venue that enabled their democratized investing. Robinhood required a big rescue package and might be insolvent when all is said and done, and the “billionaires” likely just got richer from the market frenzy – higher volumes are a boon for high frequency traders, market makers, and predatory investor hedge fund-types.
Contrary to current sentiment, it does not appear that government or billionaire intervention was at play here, just simple market mechanics. Big losses accrued throughout the system. On the other side of it big gains accrued. Net-net, we think retail investors were dollar losers and this was likely a big, expensive learning experience for them. It will be telling to see where the next round of stimulus checks goes.
In investing, it pays to be early. Otherwise, it pays to be a good middleman. That is the quickest take on the GameStop saga.
Elon’s payday is coming again. This time to the tune of $7 billion. Talk about grift. Tesla produced shy of 500k cars in 2020, which was Elon’s target for the company. The company produced another quarter of profit, thanks again to regulatory credit sales. Amazingly, Tesla is worth more than all other car manufacturers in the world as measured by market capitalization, but only produces a fraction of one of the other major car manufacturers.
Is this the start of chronic pandemic pains in the life insurance industry? The year 2020 was a major mortality year for any carrier selling death benefit coverage. Now the industry has at least two other problems looming: 1) more deaths will likely follow, either directly or indirectly from virus infection, and 2) what to do with the pre-existing condition – whether asymptomatic or symptomatic the long-term health effects can dramatically change the results of life insurance and so the industry is making changes. Premiums are on the rise, underwriting is screening for COVID-19, and applications now come with waiting periods. Low fixed income yields, high mortality experience, and other problematic products like long-term care and long-term disability present an enduring challenge for the industry. We will be watching for opportunities.
The virus has been burning red-hot around the world. Such places previously thought to have herd immunity are experiencing new waves – Sweden, Brazil. Countries among the most diligent in rolling out vaccines are shutting down as new variants flare – Israel and China. There are at least three new variants of concern. They are nicknamed after the region of initial prevalence: UK (B.1.1.7), Brazilian (B.1.1.248, or P.1), and South African (B.1.351). All three have been identified within the US. Each has reached community spread level in the US – those infected have no known travel or acquaintances who have traveled. This could be the setup for a repeat of March 2020. All three variants are more transmissible but the question remains about whether they are more lethal and whether they evade vaccines. It is a race against the clock to deliver vaccines before vulnerable become ill and more variants emerge, putting further strain on vaccine efficacy. This comes at a time when everyone is exhausted of precautions and shutdowns. Be careful out there.
Activist investor Third Point announced a new position in Intel and has begun dialogue with management. Under pressure Intel’s CEO, Bob Swan, has resigned and he was replaced by Pat Gelsinger, former CEO of VMWare. Intel’s stock promptly rallied on the news but has since retreated a bit. The new CEO is expected to restore focus by selling fabrication plants and ancillary businesses. He will also accelerate the push to outsourced manufacturing. This comes at an important juncture for the country. Much of the highest quality chip manufacturing is done in Taiwan. If you have not been paying attention to geopolitical news, China is increasingly taking provocative moves against Taiwan, which runs decidedly against US interests. It is a major global tension potentially coming to a boil. Neither Trump nor Biden matter – China wants to tuck Taiwan back under communist party control much like it has done with Hong Kong. This would pose serious national security risk for the US.
The cryptocurrency Bitcoin continued to amaze. During January, Bitcoin – and many others – reached new all-time highs. It has peaked for now, it seems. We stumbled upon an anonymously authored piece by a former Bitcoin market participant that puts forth reason and supporting evidence for why Bitcoin is a bubble about to burst. To our surprise it is not Bitcoin directly, rather another cryptocurrency called Tether that is the lynchpin to the whole thing. If you are up for an amusing read on the matter, the anonymously authored piece can be found here. We find it compelling and continue to believe Bitcoin is a speculative frenzy that should be avoided by anyone not prepared to write-off the position.
It has been a turbulent start to the year. Beginning with Boeing announcing a $2.5 billion settlement to resolve criminal case relating to two 737 MAX plane crashes 2 years ago. Boeing reported earnings that missed expectations. More 737 orders have been cancelled from the order book and the company was hit with more delays in delivering its 787s. Despite leverage massively out of sync with similarly rated credit, Boeing remains investment grade.