Everyone is talking about what is happening to Gamestop. Even my kids are into it, probably because the Gamestop short squeeze originated and is being perpetuated on social media, substantially by the gamer element. What lesson can be learned by the Gamestock situation as well as those of AMC and others caught in a short squeeze? My take is that this reinforces that it is dangerous for investors to short a stock. There are safer ways to play the short game if you think you have an eye for a stock that is more likely to fall than to rise.

Shorting

What does it mean to short a stock? In order to short a stock, you must have an agreement with your brokerage firm that you are able to short stocks. This typically means that you also need to agree to lend or “hypothecate” any stock that you own. Why is that? Because shorting a stock entails borrowing that same stock from someone else who agrees to lend it. They don’t lend it to you directly; they lend it to your brokerage firm. If you want to short a stock, you borrow the stock from your brokerage firm, who has borrowed it from one of their other clients. Then you take the borrowed stock and sell it in the marketplace, for which you receive cash, just as in any other sales transaction. When you short a stock, you are betting that you will be able to buy it back at a lower price so that you can give the stock back to your brokerage firm, thus closing the borrowing transaction, and you pocket the difference. What could go wrong?

Squeeze

A lot can go wrong if the stock goes up instead of down after you have shorted it. First of all, you lose money if the stock goes up because you have to buy back your short position at a price higher than your sales price, and you have to come out of pocket to make up the difference. It’s a bad feeling when you have to pay restitution for your prior mistakes. Secondly, you may have trouble buying the stock that you have to give back, especially at a market price, and especially if the stock is that of a small company and/or is thinly traded. This is what happened with Gamestop, and this is when a short squeeze happens. When a stock is thinly traded and when those that are short are in urgent need of purchasing the stock to close a short position, the owners of the stock are now in the catbird’s seat. Stock owners in this situation will hold out for the highest price they can possibly get before selling it. It’s basic supply and demand: demand is off the charts and supply is constrained, and so prices skyrocket.

Margin

Why might holders of short positions be forced to cover their positions if a squeeze happens? This is third bad thing that can go wrong if you are short and the stock goes up. Your brokerage firm has margin requirements that need to be met and maintained. If you are short a stock that goes up, especially way up, unless you have beaucoup unused cash in your account such that you pass a maintenance margin requirement, you have to cover your short position, or else you will be liquidated, or even worse. Being short and in the midst of a short squeeze is a scary proposition. Your downside risk if you are short a stock is infinite.

Puts

A less-risky way to play the short game is to buy a put option, which gives you the right to sell a stock at a set price, which is called the strike price. If you are right about the stock, the put will increase in value and so you can sell the put at a profit. If you are wrong, you can hold on to the put as long as you can until it expires worthless, whereupon you have lost only the money you spent to buy the put, and no more. One downside of a put instead of a straight short is that buying a put is a debit transaction, meaning you have to come out of pocket today to pay for the put, whereas a short transaction is a credit to you (but a debit later when you cover the short). A second downside of a put is that there is a time element to a put: a put has an expiration date. What if you are right about the stock’s poor future prospects but your timing is off? A put might expire worthless before you are proved to be correct. Still think you are right when your put expires? Buy another put that expires at a later date, but that will cost you more.

IMO

Maybe you are a stock curmudgeon, who think most companies suck or are at least overvalued. If you aren’t that type, I’m sure you have met someone who can’t see the good in a company. Many cheapskates fall into this category. That may be a good quality to have when it comes to saving and not spending one’s income, but it doesn’t work as well in the investment world. Stocks have positive values, not negative, and they tend to go up over time as a whole, not down. If you find a situation that you think is a surefire short, a company you are sure is on the road to bankruptcy, the problem is the regulations are stacked against you shorting a stock with the mechanics of borrowing and then selling stock you don’t own, and with the margin requirements therein. You may be cheering that rebellious young traders are getting the best of supposedly smart hedge funders in the Gamestop situation, but don’t get yourself in that situation. Buy puts instead of selling short if you are really sure of your downcast view of a stock.

“Cancel Culture” is currently topical in politics. The Parler app was shut down (perhaps temporarily) because Apple and its hosting service couldn’t live with Parler’s status as a more conservative alternative to Twitter and/or Facebook. Several Republican senators and representatives are facing massive backlash for elector objections that have been commonplace through our country’s history. Nobody wants to do business in the future with former President Trump. While the political “cancels” get the press, such cancels happen all of the time in the investment world, usually without an announcement by the cancelor as to why they are choosing to cancel a company.

Sell…or Don’t Buy

Cancel culture happens in the investment world when an investor decides to sell or not buy stock in a company based on principle rather than on earnings fundamentals. This happens all of the time. For instance: currently, there is an ongoing drive to force pension funds to divest themselves of stocks of oil and tobacco companies. This drive is based on its advocates’ desire to defund oil as being bad for the environment and tobacco as bad for people’s health. The drive is not based on business fundamentals, though the advocates hope also to drive oil and tobacco companies out of business, thereby making their position both principle-and fundamental-based. Another example: some investors don’t buy Wal-Mart or Amazon stock and some people don’t shop at either retailer because of what they believe these companies have done that has led to the downfall of many small retail businesses. How are these investment decisions part of “Cancel” culture? Because, by selling or not buying their stock, investors are collectively choosing not to allocate capital to these companies, and if companies have a harder time raising capital, it will be harder for them to do business, even if future sales prospects look good. Take this concept to its logical conclusion and these targeted companies could go out of business because they are unable to raise capital. That is the ultimate goal of these divest movements.

Buy This But Not That

Wall Street Cancel Culture works on the flip side, as well, meaning that companies with “woke” business models get bid up by far more than they should based on the fundamentals of their businesses. Tesla is the latest example. Tesla has become a 10-bagger during the past 2-3 years and is now possesses the 6th largest market cap in the country because investors believe that Tesla is saving the planet by producing electric cars. Nothing against Tesla, but there is no way Tesla will be able to produce cars and earn enough money to justify its current $800 billion market cap, and Elon Musk would probably agree. Ford and General Motors have seen this and their renewed efforts toward electric vehicles (Mustang Mach-E for Ford, and electric delivery vans for GM) have caused both of their stocks to run up thus far in 2021, despite that neither company will likely see any positive cash flow for their electric vehicle initiatives for the foreseeable future. Investors are “canceling” the traditional internal combustion engine and are instead allocating capital toward electric alternatives, and it is having an effect on how companies do business. Whether electric vehicles actually succeed in their goal to save the planet remains to be seen.

ESG Investing

ESG stands for environmental, social, and governance, and those who promote or even run funds that invest in companies that promote “woke” ESG policies seek to change the world for the better in their opinion. Such investors are investing based on their beliefs and principles and not necessarily based on making money for their investors, although they hope to do that as well. Like it or not, ESG investing is a form of cancel culture because the way they allocate capital is based on how they believe the world should work and not necessarily on how the world actually does work. ESG investors would just as soon companies that aren’t up to their snuff go away. They are trying to cancel these “bad” companies and industries by not allocating capital in their direction.

IMO

You may not agree with cancel culture in the political realm but if you invest in one company over another for purely principled reasons and not because of business fundamentals, you are engaging in your own version of cancel culture in your own little way. The end result of cancel culture is not good: people and companies that don’t fit with the prevailing conventional wisdom get shut down or otherwise be put out of business. That is really bad for anyone who might have a divergent opinion on anything. My advice: Always look to business fundamentals with respect to investing, and of course stay diversified within your portfolio and with different asset classes. It is dangerous to play the game of the ESG investor at any level because the result is bad if taken to the nth degree.

The stock market likes President Biden so far. Both the S&P 500 and the Nasdaq 100 indexes are up about 14% since he was elected. We can speculate on why, but one factor has to be that investors are looking forward to a lower level of the volatility in the meaning of the term than was present during President Trump’s term.

Unity

President Biden’s inaugural speech stressed the theme of unity, for the most part, which would be a good thing. If he means it, he can promote unity by not making any changes to the tax code punitive and/or retroactive. While it is likely that individual and corporate tax rates will have to go up to pay for the explosion in spending we had in 2020 and that we will likely expand on in 2021, because we still have major issues related to Covid, it would be best to take a gradual approach to tax increases. Don’t make tax increases retroactive so that at least we can make plans for them. The stock market will appreciate that. As to the punitive part, it doesn’t make sense to vilify wealthy taxpayers while at the same time to ask more of them. If President Biden can at least show some appreciation to the top 10%, that would help toward the Unity goal. A spoonful of sugar helps the medicine go down. Previous Presidents who sought to raise taxes didn’t necessarily follow Mary Poppins’ advice.

Bipartisanship

I don’t really know what President Biden means exactly by Unity, but surely part of it involves bipartisan legislation. With the insiders now firmly back in control in DC and with Republicans likely looking for ways to move forward in a good light, there are likely many ways for the R’s and the D’s to work together. One area is immigration reform and another is infrastructure spending, which is perhaps the 2020’s version of FDR’s WPA. The hope for infrastructure spending is cited as one of the reasons the stock market has run up to the extent that it has since Biden’s election. Infrastructure is a hanging curve over the plate, so let’s see if the Biden administration can hit it.

IMO

President Biden says he wants Unity, but others in his party seem to want blood instead. Biden stands a better chance of achieving Unity if he can keep a check on the bloodthirsty motives of others. I believe the stock market is more likely to reward President Biden if Unity, whatever it means, wins out. I wish him luck!

The Put/Call Ratio is currently low: 0.66 according to the chart below. That is as low as we have seen in the last 18 months (per the chart), and is in fact as low as it is been in the last 10 years. As it is a contrarian indicator, the Put/Call Ratio at the low 0.66 level is not a good sign for the near future. It means the stock market is currently over-bought.

Meaning

Puts are options to sell stocks at a specific “strike” price and Calls are options to buy stocks at a specific “strike” price. Investors who buy Calls look for the underlying stock to go up, and Put buyers look for the stock to go down. Calls are optimistic plays, and Puts are pessimistic plays. When more Calls are purchased in aggregate than are Puts, the Put/Call ratio will be below 1, and vice versa. The ratio is normally slightly below 1 – the chart shows that its 200-day moving average is 0.96 – because stocks tend to go up more than down. Notice also in the chart that the Put/Call Ratio was about 1.8 back in March 2020, which is when we had our bear market correction as a result of the initial Coronavirus economic shutdown.

Contrarian

However, when the Put/Call Ratio moves more than 1 standard deviation from the mean, where it is now, it will likely mean revert back. That means the ratio will go up from its current 0.66, which means more puts will be bought than they are now, which means the stock market is likely headed lower in the near future until the ratio is more normalized.

IMO

It is a good idea to keep an eye on the Put/Call Ratio when you are trying to figure out if and when the market might reverse itself. Right now, it doesn’t look promising because the ratio is extremely low. Let’s see if it eases back to a more normalized number, or if the change is more drastic. Likely more drastic, if the past is any guide. Watch it!

After having read several economists’ reports regarding what they expect Federal tax policy will look like for 2021, I believe the most likely case is that any change in tax rates that Congress passes and President Biden signs will go into effect as of 1/1/22 and not retroactive to 1/1/21. Though there is a strong urge to purge anything and everything that the Trump administration did including tax cuts, I believe the remaining issues related to the economic troubles we face as a result of Covid will outweigh the urge to purge. Raising taxes during slow economic times is contrary to Keynesian orthodoxy and it makes no sense to raise taxes while at the same time writing checks directly to the citizenry. I believe you can count on current tax rates for individuals, corporations, and estates to remain as they currently are for 2021.

Better For Planning

If I am correct, then it would be really good for financial planners and/or anyone else who does their financial and tax planning for themselves. Uncertainty about tax laws and rates is bad because it makes planning difficult, even for a few months out. Conversely, if you know that rates are going to change as of next year and not retroactive to this year, you can make plans this year to address those changes. This goes for individuals, businesses, and estates. For instance, what if Congress doesn’t take up the tax debate until late in Q1 or even after that and doesn’t get it passed for a bit longer? If the law were to be retroactive back several months, then that would really be moving the goal posts well after the game has started. We need to be able to count on laws that are on the books at the start of the year remaining on the books for the entire year. Otherwise you have to change your entire attack in the middle of the game, and that is a recipe for disaster. Surely the new Congress and President recognize this, right?

Individual Tax Rates

For most of us, the rates that are most pertinent are Individual Tax Rates. The following are 2021 tax rates, taken from the IRS.gov website:

The tax items for tax year 2021 of greatest interest to most taxpayers include the following dollar amounts:

• The standard deduction for married couples filing jointly for tax year 2021 rises to $25,100, up $300 from the prior year. For single taxpayers and married individuals filing separately, the standard deduction rises to $12,550 for 2021, up $150, and for heads of households, the standard deduction will be $18,800 for tax year 2021, up $150.
   
• The personal exemption for tax year 2021 remains at 0, as it was for 2020; this elimination of the personal exemption was a provision in the Tax Cuts and Jobs Act. 
   
• Marginal Rates: For tax year 2021, the top tax rate remains 37% for individual single taxpayers with incomes greater than $523,600 ($628,300 for married couples filing jointly). The other rates are:
   
  • 35%, for incomes over $209,425 ($418,850 for married couples filing jointly);
  • 32% for incomes over $164,925 ($329,850 for married couples filing jointly);
  • 24% for incomes over $86,375 ($172,750 for married couples filing jointly);
  • 22% for incomes over $40,525 ($81,050 for married couples filing jointly);
  • 12% for incomes over $9,950 ($19,900 for married couples filing jointly).
  • The lowest rate is 10% for incomes of single individuals with incomes of $9,950 or less ($19,900 for married couples filing jointly).

If in fact these rates remain the law through 2021, think about how you might use this standard deduction and these tax brackets to minimize your tax burden this year. Alternatively, perhaps use this information to pay taxes this year at a lower rate so that you don’t pay even higher taxes next year if and when the law changes. Hopefully soon you will have the proposed new tax laws and brackets to help you with that planning.

IMO

With the Democrats in power in DC and with astronomical budget deficits due to efforts to prop up the economy as a result of Covid, I think it is a pretty safe bet that taxes will be going up. However, I believe part of the recovery plan will be to keep them at their current lower rates this year, then raise them in 2022 when hopefully Covid will not be as much of a problem. Let’s see if I and the others who agree with me are correct.

Granted, it was an unusual year, but Growth investing outpaced Value investing in 2020 according to the metrics and definitions of both categories. The Center for Research of Security Prices (CRSP) publishes several stock indexes, two of which are the US Large Cap Growth Index and the US Large Cap Value Index. Whereas the Value Index was barely breakeven for 2020, the Growth Index returned about 33%. A big win for Growth Investing – or is it?

According To The Metrics and Definitions

Notice that I used the qualifying phrase “according to the metrics and definitions of both categories.” A Value Stock is considered as such and is included in a Value index if it meets one or more of certain “value” metrics such as low P/E ratio, low Price to Book or Price to Sales ratio, or low Price to Cash Flow ratio. A stock can be considered to be a value stock without being a good value. Conversely, a stock can be a good value (at least for some investors) even if doesn’t meet any of the value metrics. My point is that Value is in the eye of the beholder. You can invest in growth stocks and still consider yourself to be a “Value Investor” even if your investments don’t fit with the definition of value stocks. If you buy a stock with the belief that you are buying it at a price that is lower than what its value will be in the future, then you are a “Value Investor”. Consider this: One of Warren Buffett’s largest and best performing holdings is Apple. How can the most renowned value investor in the US own a big chunk of Apple, which is not a “value” company by any metric? Because Buffett believes in Apple’s ability to generate and grow its cash flow in the future, and that that cash flow discounted back to the present represents a positive net present value to Apple’s current stock price by his calculation. Buffett believes Apple’s current price represents good value to him and his shareholders even though Apple’s current ratios do not qualify it for any Value index.

IMO

If you are a committed value investor and your performance in 2020 has lagged, don’t give up being a value investor. Instead, enlarge the definition of what it means to be a value investor. Think about buying good companies at prices that make sense rather than finding unloved gems in the scrap heap. Good companies are rarely found at scrap heap prices. That said, they can often be found at prices that can be deemed to represent good investments if the future turns out the way you believe it will. This is not throwing in the towel on value investing. It is pivoting somewhat to allow you to keep in tune with market conditions while remaining faithful to Buffett’s and Benjamin Graham’s concepts of value investing.

Also: 2020 was one thing, but let’s see how 2021 plays out with respect to this supposed Value vs. Growth competition. My sense is that there won’t be nearly the difference in returns between the two categories.

Most New Year’s resolutions are pretty dull. Lose weight, exercise more, eat less, yadda yadda. Same with financial resolutions. Google it and see what comes up: create a budget, save more, spend less, work harder. Good advice all, but dull. With my 2021 Resolutions, I will try to be a little more interesting. Let’s see if I succeed.

Pay Cash

One of the selling points of Bitcoin is that you can use it to pay for stuff anonymously, leaving no digital footprint. Guess what else accomplishes the same objective? Good old cash! Don’t want anyone to know what you bought or how much you spent on it? Pay cash. Don’t like it when you get your credit card bill at the end of the month? Pay cash, and the stuff you bought won’t show up on your bill. I feel like I pay twice when I use the credit card – once when I buy the item, and again when I pay the credit card bill. Instead, just use cash and pay once. Go to the ATM once a week, withdraw as much cash as you need for the week, and when you have spent it all, that’s it until you go back to the ATM the next week. If you want to save for something big, stick a $20 in an envelope and put it in a drawer in your home. Do the same thing for 5 weeks and you have $100 you can use to treat yourself or your family. Buy your gasoline at an ARCO or another gas station that has a discount price for paying cash. It is becoming harder and harder to pay cash, especially with Amazon and electronic shopping, but that may make it more appealing. When you pay cash, you feel a little bit like you are getting away with something, and that is a good feeling that could prompt a wry smile.

Drink Cheap Liquor

My friend gave me a vodka drink with Sam’s Club store brand vodka, and it was really good. Same thing with Kirkwood-brand vodka from Costco, which rumor has it is actually Grey Goose in a different bottle. Two Buck Chuck from Trader Joes is pretty bad (imo), but some jug and box wines are actually pretty good. Try out some store brand liquor or wine and see what you think. Same thing with soda pop or seltzer water – try the much cheaper store brands. I’ve never been big on off-brand beer, but if you shop the specials at the store, you can shave several bucks off of the cost and enjoy the adventure if you aren’t too picky. All of you collectors of expensive wine have a nice hobby but not one that is good from a financial standpoint. You may tell yourself that it is, but it’s not if you are consuming a lot of high-end wine.

Figure Out A Way To Save On Phone, Internet, and Cable

Everyone has different options for phone, internet, and cable based mostly on where they live. Choose the option that best suits you and how you use these services. Make sure you get value for what you spend. For instance, many people have ditched their land line and have opted instead for an internet-based phone or just a cell phone. That doesn’t work well for our family because, for whatever reason, cell service in our house is spotty, and I am not a fan of the call quality of internet phones. So I still have a traditional land line with AT&T, but I called and downgraded the service and our bill is now only about 60% of what it was before. Those of you who are heavy internet users probably need a good, fast internet service, so you might use that as the starting point for what you pay for. Is your internet service reliable enough to stream you TV through it without degrading your ability to use the net? Then you might dump your cable TV service and go with a streaming TV service. All of the cable TV/internet providers have bundle services, and some of those bundles now include cell phone services. If you now have a stand-alone cell service, maybe you can save buy bundling up. Before you do, though, ask your neighbors if they have a different cell phone network provider than you do, and, if so, how well it works at home. Your objective should be to have quality service at a good price and not double-pay for some services. Take advantage of bundles if it makes sense with minimal sacrifice. This should be an annual exercise for you as the quality of some services change and technologies advance. For instance, as 5G service advances over the next few years, you may be able to ditch your expensive cable internet service entirely, which could realign a number of your spending priorities.

Deprioritize Politics

The TV pundits say we are a divided nation, but I think we are pretty united in our unhappiness with the current state of politics in the US. Unhappy perhaps for different reasons, but unhappy nonetheless. If watching the news on TV makes you unhappy, then don’t watch it. If your whole mood or attitude is based upon the political party in charge or what is happening in Washington DC or your state capitol, then you are setting yourself up for a life of anxiety and disappointment.

Prioritize Yoga

I don’t do yoga, but I like it, and I might take it up once the pandemic is over. Yoga is good for you physically and spiritually and hopefully puts you in a good state of mind. Unlike politics and watching the news. If not yoga, then some other physical activity such as just taking a walk or meditating or staring into space. Do some activity that puts you in a good state of mind and don’t let negative thoughts or activities ruin your life.

Buy Stocks Instead of Bonds

I say this because bond yields are so low, especially for US Treasury bonds and bank CDs. Stocks always outperform in the long run, and you can stay safe if you diversify your stock portfolio substantially. Instead of allocating to bonds, put like 1-2 years of your annual spending in a money market account in your bank, and invest the remainder in total market funds or ETFs.

Happy New Year and stick with your resolutions!