What’s with all the “ ”?
2020 Tax Information
Just a reminder on the timetable for 2020 income tax information to be mailed. All 1099-R forms for retirement plan (including IRA accounts) distributions were mailed on January 31st. Notifications for all IRA account owners subject to the Required Minimum Distributions (RMD) in 2020 were also mailed on January 31st. We track the RMD’s for you and the actual distribution is required to be taken from the IRA account by December 31, 2021.
All other tax reporting for non-retirement accounts will be mailed by February 15, 2020. This includes forms 1099-B, 1099-DIV, 1099-INT, 1099-MISC, etc.
All these forms are also accessible on the Liberty website under the “About Your Account” tab once they become available. As always, don’t hesitate to call us if you have any questions. If you would like us to send your CPA/tax preparer the digital files for you, just let us know.
Washington’s Birthday/President’s Day-Market Holiday
Monday, February 15th the US financial markets will be closed for Washington’s birthday, and our office will close as well. This is also a banking holiday, so keep in mind any withdrawals requested from E*Trade Advisor Services accounts will be delayed one day as well.
Please call or email us to schedule your 2020 year-end and first quarter, 2021 review if you have not already done so. The events over the past year have been anything but normal and a full review of your personal goals, investment risk, performance, etc. would be beneficial. Now is a great time to look ahead to 2021 for your personal planning as well. Schedule your personal review, either online or in-person, today!
“ ” “BRRR”
With the recent headlines and intense media attention regarding GameStop, “shorting” stocks, etc., we felt it fitting to give you some explanation of what has been happening in the financial markets. First and foremost, we do not “short” with F.I.G. client assets, nor do we have intention to do so anytime soon. Although some of our mutual fund holdings may employ leverage, we do not lever any client funds in any way from your direct investments. Client assets are currently custodied with E*Trade Advisor Services, a subsidiary of Morgan Stanley. To our knowledge, there has been no impact from the present events on either firm. The brokerage facing the most difficulties is Robinhood, which we do not use or have exposure to in any way.
While conversation has picked up dramatically from what seems to be a case of “presentism,” we do want to remind clients that short squeezes happen. While the magnitude that occurred with GameStop is unique, the process itself has occurred multiple times before in the past. And as we’ll explain further, these dramatic events occur when there’s more of a ”plumbing” issue rather than a mispricing. The last time a comparable event occurred of such magnitude was in 2008 with Volkwagen’s stock, which momentarily made Volkswagen the largest company in the world in terms of market cap. Does anyone remember even hearing about that one? That short squeeze was not granted headlines of a “cultural movement” or multiple rocket ship emojis going “to the moon” or even most cleverly “BRRRR”, which is to mimic the sound of a money counting machine.
The Anatomy of a Short Squeeze
The process of “shorting” a stock is relatively simple. You are essentially borrowing the value of the stock and promising to repay the lender in shares of the company you are shorting. For example, if stock ABC is trading at $100 per share, you can short one share, receive $100, and invest those proceeds however you wish. When you wish to repay the loan, you simply deliver a share of ABC to “close out” the trade, thereby needing to buy one share at that moment. Simple enough, right? Well, there’s a process called “margin calls” that is in-between opening and closing the trade to help protect both sides as well as the intermediary or broker.
Since shorting is utilizing leverage, essentially think “loan”, there needs to be protections to assure that the debt can be repaid. As in our example, the investor shorting or borrowing the $100 ABC stock would most likely believe it is worth less than $100. However, if the stock starts rising in price, the investor could be exposed to theoretically limitless losses and no investor has infinite capital. If the stock doubles to $200, the investor would be at a $100 loss. At $300 per share, a $200 loss would be on paper for the investor, over twice what they had received for the loan. Margin calls can eventually occur in order to force the investor to essentially pay down some of the loan, assuring the amount can be covered. The investor may deposit more capital or be forced to sell off other positions to accomplish this.
If a stock is heavily shorted and begins to dramatically rise quickly, it can bring a rush of buying for short sellers either wanting to or being forced to close out of their short position. This event is considered a “short squeeze,” where those investors who were short are having to buy the stock at any price to close their loan, thereby causing a further rise in price. Outside of those closing out of the loans, typically other investors are piling into the stock to create this event.
An investor that goes by the name, “Roaring Kitty,” (we’re including these details as we believe it lends to why so much media attention has surround this event) posted a “stock tip” on Reddit (an online forum and you may see “Wall Street Bets” or WSB, which is a sub-forum within Reddit), claiming GameStop to be undervalued. Although, we believe Dr. Michael Burry, most known for being played by Christian Bale in the Big Short, saw the possibility of a massive short squeeze occurring in GameStop, which he discussed back in 2019. He deserves most of the credit for what actually unfolded. Regardless, “Roaring Kitty” is taking most of the headlines by trading in the basement of his mom’s house and undoubtedly lending to the entertainment of the story.
Deeper into the story though is an outright hate and distaste for one specific firm, Melvin Capital. We believe it could point to more of an “inside job” or somehow knowing this fund specifically had such a large short portion against GameStop. On October 27th, the Reddit forums saw a post of a “prophetic” video calling for the demise of Melvin Capital from the epic short squeeze to come in the stock. It would seem someone had to have information with this data, as funds only have to post their publicly held long holdings in a quarterly filing known as a 13F. The irony in this: it seems confusing for such a fund to be hated so much and for why? This fund is a value-based investment company that utilizes a common strategy known as a Long/Short investment.
A Long/Short fund does exactly that, it will borrow against a stock in order to invest in another stock. While you are exposed to leverage by doing this, we believe it to be rather prudent in the event that something chaotic such as a pandemic occurs (who would expect that, right?) in the markets, your “short” positions should theoretically be profitable, while the “long” positions should fall with the market. Thereby, investors would potentially be breaking even during times of massive equity draw downs. Additionally, a long/short strategy may not even believe the company to be worth less, just potentially another similar company may trade at such a substantial discount to the other. So, “shorting” the stock trading at a premium and buying the stock trading at a discount may serve the investor well while protecting them from other risks that would theoretically impact both stocks. And in theory, the stock trading at a premium would fall further in an adverse event, again protecting investors from loss.
But Melvin Capital’s focus using their short positions that hypothetically should be worth less over time are used to finance their long positions while being protected from systemic events like a market crash. This is nothing unique. Many funds do this exact same thing. And for some reason, this fund was specifically targeted and has become a hatred scape goat for these Reddit investors, which seems fueled by the initial video posted specifically calling out Melvin Capital. We would see the other firm involved, Citron Research, to be a much better “villain” candidate, as they openly participate in naked shorts, meaning the firm is not doing so as risk mitigation but rather an investment itself: investing solely on the shorted stock’s demise. Citron’s founder is also very vocal at how bad the businesses are. From this event, Citron has now announced that it will no longer be releasing its short reports, which it had done for the last 20 years. But ironically, Citron originally started to do this to try to expose frauds and/or failing businesses to help investors see another perspective, outside of that of the “Wall Street” promoters that were simply releasing positive reports at the time.
GameStop was a unique case study, as the stock was shorted beyond the available float. But what does this mean and why does it matter? Let’s use our ABC stock example again to better explain. When the short seller needs to pay back the loan, they must buy shares in order to do so. However, what if there are no shares available to buy? The investor that shorted the stock would be stuck in the position, exposed to potential infinite losses as the stock continued to rise. GameStop was an example of this. More shares were shorted than could possibly be bought. So, when short sellers were being forced to buy back stock due to margin calls, it was not always possible. Investors, such as the Reddit crew, were also buying at any price to exacerbate this price jump. We must clarify though, we believe many more were involved than simply a group of traders on a forum orchestrating this. The amount of capital that was flowing through this trade last week was to the tune of 10’s of billions of dollars per day. Both Melvin Capital and Citron Research have now been able to close out of their short position, even though the story remains that somehow buying GameStop stock is sticking it to “the man” or that “Wall Street” is somehow collapsing. To that point, Robinhood, an online broker catering predominantly to a younger investor, actually could have collapsed.
Robinhood caught tremendous heat for limiting or banning purchase orders on specific stocks such as GameStop. However, this was not Robinhood’s fault. They are also under regulations that force them to post capital requirements in order to protect consumers on their platform and making it more difficult for the firm to collapse. If Robinhood continued with no changes, it could have brought the entire broker down, causing a much larger issue. Investors were angered at Robinhood for restricting trades in certain stocks, but we believe they do not understand the regulatory burdens placed on Robinhood to maintain adequate capital, which has caused the company to raise an unprecedented amount of funds. We believe these requirements are a good thing for systemwide stability, especially in extreme moments as these. The system worked.
Ultimately, we see the largest contributor to this price surge as the ability for the markets to short beyond the shares available to purchase. This clearly causes an issue and may be a focus of regulators in the future. However, we do not advocate for a change. It will take time and cause quite a few issues if required, and we do not see any substantial benefit gained from regulations placed to avoid these unique instances. We personally see this situation being a warning to short sellers focused on securities that are already excessively shorted. It will make these funds tread much more softly, especially after it was reported that Melvin Capital had lost over 50% in the month of January alone. This fact alone will cause market forces to shift for some time without the need for regulation.
We do hope this does bring more attention to less talked about issue on payments for order flow. When Robinhood first came about, most brokers still charged commissions. Because of this competition, commissions have now mostly gone away, however Robinhood as well as other brokers are now paid to sell your order data to other parties, such as Citadel. Citadel then is able to generate just a fraction of a penny per share. In general, this could still be a decent deal for a small investor. However, we still need to examine the larger picture that these firms are creating a cost on investors that isn’t visible, which could have dramatic impacts during periods of high volatility. We believe it’s pretty amazing to see this practice escape the limelight and instead the media focusing on collateral damaged companies like Melvin Capital. Some media headlines circulated conspiracy theory that Citadel shut down Robinhood to stop the stock trading. Quite the contrary. These events are insanely profitable for companies like Citadel who would love to see them occur more often. Because of this, we believe order flow payments is an area that should be further scrutinized. It is something we’re aware of for client accounts and would love to explain how we mitigate it. However, it’s much too long of a discussion for this update. In a nutshell, we push orders through the IEX exchange, when possible.
Client Portfolios – Long Value Investing
For us as value investors, all of these events are short term in nature and not “trades” we would ever participate in. Additionally, it is really a hindsight event that might have never come, which would have been the only reason to invest in it in the first place. As we wrote about Bitcoin a few weeks back, we have no idea what a “fair value” for Bitcoin is, and we do not believe it to be more than a price speculative line of code. However, with GameStop, we can actually look at what we believe it may be worth. GameStop is a stock; therefore, you are buying a share of that company. We look at GameStop’s business and do believe it’s dying. Almost half of their revenues come from game sales, which could completely evaporate in time as Microsoft, Sony and even Apple own their own game stores that have entirely shifted to a digital monopoly. The other bulk is in hardware sales, which will be increasingly difficult to differentiate yourself from the likes of Best Buy, Amazon or even Wal-Mart. That leaves less than 10% of their revenues, which are in collectibles. It seems the only area in which they may grow, but it seems difficult to beat eBay, who has already dominated this niche online. If GameStop bolsters their e-Commerce business, all the investment made in this we see as just delaying the inevitable. They had a value proposition to trade in your old games. However, that advantage is quickly disappearing, if not already gone. Therefore, it was a business we would have never wanted to own.
We wish the company the best. But when you see a struggling company that was trading at nearly a $30 billion total value with half the revenues it had five years ago when it was valued at 1/10th the amount, you quickly see the market inefficiencies and investors paying zero attention to the price being paid. This was simply an exploitation of an over-shorted company, which lead to a short squeeze in a magnitude not seen since 2008 with Volkswagen. We do worry for those not understanding this and trying to jump on a band wagon that will eventually run out of gas. But, as we can only do, we highly advise clients to avoid and not participate in the “trade” and simply watch the events for entertainment. We love to see so much interest drummed up around invest, however we hope it teaches investors that valuations eventually matter. We continue to be astounded by market events that witness investors not paying attention to what value is being paid. UPDATE: The price of GameStop was just $17.25 on January 4th, hit a high of over $400 last week, and closed at $90.00 per share in today’s trading. This has occurred during a period of less than one month. The “bubble” may have burst already.
If you were to go buy a private business, we assume you’d look at the financials and attempt to make a reasonable offer. Within the public markets, we continue to see examples of businesses that trade at values that may never make sense or at least take decades of superb execution to justify. At F.I.G., we utilize value-based investment principles focusing on what we believe to be undervalued securities to purchase for client accounts. We are not gamblers or price speculators. We are investors, and we will continue being so into the foreseeable future. We believe it is the best strategy for the long-term during most environments that will assist in preserving clients’ wealth over the decades ahead. Our clients rely on us to achieving their financial goals and plans. Value investing is not a strategy to mint new multi-millionaires overnight, but rather helping clients stick to their financial plan and achieve goals outlined far into the future. We are saddened by investors’ constantly expecting to “get rich” overnight, when investing is truly a lifelong planning process. We do optimistically hope this event brings more interest in younger crowds towards long-term investing and maybe create a few value investors from it.
As always, please don’t hesitate to call if you have any questions or we can be of further service in any way. We appreciate the privilege to be of service and look forward to working with you in the years to come.
Your TEAM at F.I.G Financial Advisory Services, Inc.
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