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Value Versus YOLO

01 October 2020   |  

The pandemic has accelerated secular trends—such as the shifts to e-commerce and digital payments, social media’s dominance of advertising spend and the rise of gaming. It’s also intensifying normal cyclical fluctuations, pulling forward home improvement projects and pressuring retailers—particularly those reliant on shopping mall locations—to declare bankruptcy. None of this is terribly surprising. More likely to catch market participants’ eyes, the combination of COVID-19 and social media is amplifying the oldest cyclical phenomenon known to mankind: greed!

With everyone sheltering in place and practically zero outside entertainment options, the combination of this summer’s fiscal stimulus, a highly accommodative Fed chair (affectionately known on Reddit as JPow) and no-commission retail trading has created a rich environment for speculation. Online brokerages like Charles Schwab, E*TRADE and Interactive Brokers had been taking market share for some time, but like other secular trends, the pandemic has accelerated the transition.

Behemoth Schwab’s account growth has surged to the high-teens, up from mid-to-high-single digits, putting to bed fears that the law of large numbers would hold it back. Interactive Brokers, which is smaller and has a great derivatives platform, saw ~40% account growth year over year and about a doubling in trading activity. In addition to legacy platforms, Silicon Valley has been busy democratizing investing. Fintech app builder Robinhood—Main Street’s hero to Wall Street’s Sherriff of Nottingham—is rapidly expanding access to stock and options trading. And alongside this explosion in new market participants,  options activity is similarly on the rise. Goldman Sachs noted in July the average daily value of options traded had exceeded that of shares for the first time. Further, at the time of writing, July single stock options volumes ran roughly 114% of share volumes. Goldman flagged extreme options trading levels for stocks like Amazon, Tesla and Apple. Similarly, Morgan Stanley highlighted a huge divergence in small lot, single stock call buying versus put buying. The Financial Times reported a surge in options of 10 contracts or less and a massive jump in activity in the 0- to 10-day maturity bucket.

There are other signs the retail side may be moving markets. Taking a spin through some social network Reddit message boards, I was introduced to the concept of “YOLO trades—yes, that YOLO; Gen Z’s “carpe diem”—that are essentially make-or-break, all-in bets to get rich quick, occasionally presented in meme form. Financial networks that used to host exclusive interviews with Warren Buffet have shifted to giving airtime to day traders who have started betting on (largely correctly, so far!) and moving markets.

So why do bottom-up, fundamental focused value investors like us care about all this? Well, high retail engagement strikes us as cyclical. Should the market wobble and catch enough short-term leveraged trades offside, we just may find the cyclical peak.

But it isn’t just retail investors. The so-called professionals have also gone all in. SoftBank bought call options on $30bn notional exposure in US technology shares this summer in what a Financial Times source described as “just a levered punt on the market. The whole strategy is just momentum buying.” Shareholders believed the balance sheet cash was pegged for deleveraging and share repurchases—but hey, maybe when you invest with Masa, YOLO! Other algos are combing Reddit boards for ideas after picking through Robinhood earlier in the year.

As a new generation rediscovers day trading, this time powered by phones instead of PCs, there is a whole new layer of speculation available: the special purpose acquisition company (SPAC). Often referred to as “blank-check companies,” SPACs are listed stocks with no underlying business. Not an immature business or a nascent business … no business. You invest first, then they go out and find a business to acquire. Some $22bn of SPACs were issued through July, with the bulk coming over the summer. With their fast-paced growth, investors can choose any flavor of SPAC they like—run by anyone from former House Speaker Paul Ryan to hedge fund titan Bill Ackman to Moneyball-featured MLB GM Billy Beane. These SPACs have two years to find the YOLO target of their dreams before returning capital to holders. Of course, returning capital might not be a bad thing—not all SPACs will work. COVID-19 took a toll on Global Blue Group Holding (GB) for example, a SPAC merger that was announced in February and closed in August after a great deal of renegotiation. Others such as Nikola (NKLA) have surged and then plunged as the SPAC  vehicle tends to subvert typical due diligence and appeals to a less-committed type of shareholder. The SEC is starting to take notice. Perhaps once we get a SPAC that invests its cash in copycat SoftBank options trades, we’ll know we’re near peak-madness.

We are frequently asked about value versus growth dynamics. But we would submit the better comparison is actually value versus YOLO. We are absolute return-focused value investors looking for out-of-favor securities with strong cash flows and balance sheets. Our process leads us to controversial areas of the market for new ideas and to popular areas of the market for harvesting. In recent years and during periods of controversy, we have purchased stocks which at the time were cheaper than the market, despite massive net-cash balance sheets and cash flows. They also had strong growth prospects and dominated their respective markets. August’s YOLO-option-driven frenzy, in contrast, represents a period in which we would typically not look for such opportunities. Conversely, there have been ample less-loved areas and stocks which have been more attractive during this same period—i.e., companies with that take the opposite of a YOLO approach and consequently have bountiful capital and expertise to grow share. Financials is an area we think has become more attractive. It might seem strange to fight JPow and buy financials stocks, but we believe prices are attractive in companies that are less interest-rate sensitive and have strong balance sheets.

To be sure, value stocks’ earnings expectations have been knocked down and haven’t yet risen from the mat. The good news is valuations have ample room for gradual recovery as time passes and the global economy recovers—or even more suddenly in the event of an effective vaccination or an unexpectedly positive path out of COVID-19.

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