Monthly Outlook: February 2021
One year ago, the world was just becoming aware of the coronavirus, and we had no idea what the next year would entail. COVID came as a total surprise and a catalyst for a 30% stock market decline in March 2020. No one would have predicted that one year later, many parts of the economy would still be in restricted or “lock-down” mode, 10 million people would still be unemployed, that we’d be just beginning to roll out a vaccine, or that 450,000+ people in the U.S. had died. Further, no one would have predicted that given this economic and human disaster, the stock market would be up 11%. It doesn’t really make sense and that’s the point. As we look ahead to 2021, we really can’t know what we don’t know. And even if you did know, you couldn’t be sure what the markets would do about it. So how does one invest intelligently in this environment?
The truth is, investing today is no different than it was last year or last decade. You have to acknowledge what you do know, make smart bets, and always have a plan to avoid the big loss. You wouldn’t drive a car without brakes, and you wouldn’t rock climb without a rope, would you? Similarly, we wouldn’t invest for growth without a sell discipline, specifically trailing sell stops. These act as our “line in the sand” for where we become sellers and postpone investing for growth to avoid the big loss. It’s systematic and disciplined. Our sell stops in late February 2020, for example, allowed us to miss most of the big loss from the initial COVID surprise in March 2020.
Today, the stock market is one of the most over-valued, over-extended, and over-exuberant markets in 100-year history. That’s what we know; it’s just a fact. What we don’t know is whether the recovering economy will grow into these valuations or whether a surprise catalyst will come along to force a correction. And even if we do get a correction, will it be a small and temporary correction of 5% to 8% or the beginning of something more meaningful like down 30% or more? The beauty of our sell-stops is that they will get us out of the market without knowing the size of the correction. Down is down and we want to avoid it. As long as the markets continue to grind higher, the sell stops just sit out there like an insurance policy and are unused. They don’t cost anything so why not? And when they do get triggered, it’s not necessarily a “sky is falling” opinion but rather an acknowledgement that the recent uptrend is on pause.
Most stock markets have been in a post-election rally that literally started on November 4th, 2020, the day of the election results. It’s been a good three-month rally. That uptrend continued into 2021 and for the first three weeks of this year, markets were up about 3%, YTD. But then, in the fourth week of January, markets reversed and dropped 4%, for a 1% loss, YTD. The important development is that a few markets triggered our sell stop orders on the last day of January including US Large Value, US Dividend, and Europe. We don’t see any obvious surprise catalyst for the trend change, but sometimes they don’t become apparent until later. As we start February, we’re watching carefully to see if other markets join this slight downtrend, or whether our sell signals weren’t much needed this time. There’s no sense guessing, really, but we’re truly at a crossroads today.
What’s the Deal with GameStop and Short Squeezes?
We have to address the News DuJour that is making headlines and stirring up a frenzy in a narrow part of the stock market. Through social media and internet sites like Reddit.com and RobinHood.com, investors have banded together to exploit a niche area of the market called short selling, which has been around for decades. Specifically, they’ve been able to identify beaten down stocks that have large short positions against them. Then, they band together (Reddit has over 4 million individual subscribers) to buy the beaten down stock and force a short squeeze that drives the stock price dramatically higher for quick gains. For now, the media celebrates how the Main St. investor is getting revenge on the big (& evil) Wall St. investor who shorted the stocks. Maybe. We’ve seen this movie before in 1999-2000 and it didn’t end up well for the little guy. It’s certainly a sign of the times, and evidence of today’s exuberance and gambling mentality. I applaud anyone who makes a lot of money this way, but it’s not investing and not something we will ever do for our clients. We’ll stick to investing in global markets using low-cost index funds and using trailing stop orders.