CWS Market Review – June 29, 2021

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The S&P 500 closed a little bit higher today marking its 33rd new high of the year. That’s about one in every four trading days this year. Since its low 15 months ago, the stock market has nearly doubled. Charlie Bilello, one of my favorite market stats guys, notes that going back to the beginning of 2013, the index has now made 309 new all-time highs.

I used to call this the Honey Badger market for its ability not to care. Now I may call it the Rita Coolidge market. Nothing but all-time highs.

How much further can it run? Eh, that’s hard to say but there’s no obvious reason we’re due for a plunge. Tomorrow is the final trading day of Q2 and the first half of 2021. So far, it’s been a great year for stock investors. What’s interesting is that a strong first half of the year has often been a good omen for a strong second half of the year. You might think it would revert to the mean, but that’s not necessarily the case.

Ryan Detrick of LPL Financial points out that when the S&P 500 gains more than 12.5% in the first half of the year, the median gain for the second half is close to 10%. That’s nearly doubled the other years. In other words, strong gains often lead to more strong gains. Rallies build on themselves. Of course, that will eventually lead to a breaking point.

The Bull Market for Crap

While I doubt we’re at a breaking point just yet, there’s been a disturbing trend of a lot of terrible companies turning to the public market to raise tons of cash. I suppose that’s how markets are designed to work, but it’s a little unsettling that’s so many unsound companies can effortlessly rake in so much from investors.

Bloomberg notes that since March, almost 100 money-losing companies have raised money via secondary offerings. That’s twice the number of profitable companies.

According to Sundial Research, over the past 12 months, 750 unprofitable companies have turned to the secondary market. That’s the widest margin between money-making and money-losing firms in nearly 40 years.

There may be a few factors driving this phenomenon. For one, the higher-quality companies may already be flush with cash thanks to a strong market, a recovering economy and low interest rates. As the pandemic broke, many companies were quick to raise cash so they had enough protection to ride out the storm. Now that rates are still low, it’s probably not worth it to pay off those credit lines. That could be leading to a wave of buyouts.

Also, the booming market for lower-quality stocks adds extra incentive for these companies to raise money. That’s just natural supply and demand. I can’t blame low-quality companies for taking advantage of a good market for them. Several of the meme stocks already have raised money.

This isn’t just happening in the stock market. Junk bonds are now yielding just over 4%. That’s an all-time low. In fact, the spread between junk debt and investment-grade is the narrowest it’s been in over a decade. Crap is in, and the crappier the better.

Here’s a long term chart of junk bonds. Sorry, I mean “high yield” bonds.

Of course, it’s important that low-quality sectors have their day in the sun. That’s how marginal areas can thrive. However, our concern is when it overshoots any reasonable expectations. Some low-quality companies will improve even though the odds are against them.

This raises some interesting questions about investment analysis. So much of valuation analysis works on a disconnect between price and value. But what’s interesting is how price can impact value.

Let me explain what I mean. Is AMC a good company? Not at all. But that didn’t stop them from raising a ton of cash thanks to an inflated stock price. Heck, if folks are going to throw money your way, why not take it? All that new cash is a big help to AMC’s business. As a result, the business is truly more valuable. AMC’s finances are better. A change in price caused a real increase in value. In fact, thanks to the new cash, AMC got a credit-rating upgrade.

Investor George Soros wrote about this process in his book, The Alchemy of Finance. Soros calls the interplay between price and value the General Theory of Reflexivity. (I tried to read the book a few times and didn’t get far.)

I suspect that the run for low-quality may be nearing an end. At the Financial Times, Michael Mackenzie writes:

Other strategists are looking at the merits of shifting towards “quality” companies that are well managed with strong balance sheets and steadily increasing dividends. After the stirring rebound of lower quality companies that populate the value stock universe, these are looking more attractive on a relative basis.

BlackRock’s benchmark of high-quality companies is currently trading at its largest discount to the Russell 1000 index in more than two decades. That reflects how investors have sought recovery stories in companies that were hit hard by lockdowns in the leisure, travel and retail industries.

“We are still very value tilted, but we are starting to dial that back and look at the quality trade,” says Tony DeSpirito, chief investment officer of US fundamental active equity at BlackRock. While he expects that value and cyclical shares have not fully exhausted their run, the clock is ticking.

Once the economy shifts into a mid-cycle phase, history shows that quality shares start outperforming.

I wouldn’t be surprise to see a turn to quality sometime soon.

Facebook Becomes a Trillionaire

Yesterday, shares of Facebook (FB) rallied after a judge dismissed two anti-trust complaints. The stock gained more than 4% and FB’s market cap broke the $1 trillion barrier.

Facebook becomes the fifth member of the “four comma” club. The others are Apple, Amazon, Google and Microsoft. What’s most interesting about Facebook is that it made the journey in the fastest time. The company was founded, famously, in Mark Zuckerberg’s dorm room 17 years ago.

I’m reminded of the scene in The Social Network when Sean Parker says, “one million dollars isn’t cool. You know what’s cool? A billion dollars.” Now Facebook is at one thousand times that.

I found an interesting tidbit at Bloomberg. There are currently 58 Wall Street analysts who follow Facebook. Among those, 49 have it rated as a buy. I can’t imagine what the 49th buy opinion has to say that hasn’t been covered by any of the other 48. What’s the point of analysis if everyone agrees with each other? Just three analysts rate Facebook a sell.

Speaking of the ultra-wealth, Morgan Housel tweets that Steve Ballmer’s net wealth is about $100 billion. That’s especially impressive because he wasn’t a founder of Microsoft. He was employee #30. Also, Ballmer hasn’t sold as much stock as Bill Gates has. I’m pretty sure that Gates would be the richest person in the world if he had held onto all his shares.

But I find Ballmer’s enormous wealth fascinating because so much of it came after he left Microsoft. Here’s a chart of MSFT since Ballmer left:

Wow! Shares of MSFT didn’t perform terribly well when Ballmer was CEO. He came in for a lot of criticism and some prominent folks on Wall Street urged him to step down. It’s a tough job, so I’m not going to pile on.

Since Satya Nadella took over as CEO seven years ago, the stock has been a big winner. No one has benefitted as much as Steve Ballmer. That’s an impressive achievement to profit off of getting replaced. He’s now one of the wealthiest people who has ever lived. In any event, Ballmer’s Clippers are trailing the Suns 3-2.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

Posted by on June 29th, 2021 at 8:04 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.