Tag Archives: Stocks

You cannot time the market

When you look at the stock market, it’s very human to want to “time” it, that you can buy a stock at it’s lowest point, sell it at its peak, and make oodles of cash. When Apple first IPO’d, it was selling for about 14 cents (when stock splits are taken into account) and it reached an all time high at closing of 180.96$ just within the last year. If you’d bought 1000$ of Apple stock at IPO, and sold them in January, you’d be a millionaire. Even if you weren’t born in 1992, if you’d bought 1000$ of Apple stock in January of 2019, you could have caught it at a price of 37$, giving you a nearly 500% return if you’d sold it in January 2022. This isn’t even taking into account the dividends paid by Apple, which would have increased your return even more especially if you’d reinvested them back into Apple!

But timing the market is impossible, or at least that’s what mainstream economists usually think. It goes back to what I’ve said about The Efficient Market Hypothesis, the stock market is believed to approximate a random walk, therefore it is impossible to know exactly when the bottom is, for the market or for any stock. Therefore the hypothesis says it’s impossible to buy at the bottom and sell at the top except by dumb luck. Even if the hypothesis is wrong (Warren Buffett doesn’t believe it), it is still likely to be functionally impossible to time the market because no one can bring together all the knowledge of the entire economy to accurately declare “yes, this is the bottom”

As a silly example, I follow a lot of stock twits on various social media forums, and the consensus in mid-October was that inflation was still roaring and we had a long way to fall. Since then the S&P 500 has gone up around 15%. Will it pull back down? Maybe, but maybe not. Either way, sitting on the sidelines and losing the opportunity to make a 15% free return a month in a half was probably a dumb move. If people could really, reliably time the market, then investing in mid-October to get a free return through late November would have definitely been the play. And if we’re due for a pullback then you could sell now and keep your winnings. Yet I heard not a peep of this kind of advice through mid-October, so I don’t think any of those stock twits could time the market.

Even more silly of an example is looking back at the recent market crash of 2008. The market bottomed completely in march 2009 and rose from there, but it didn’t stop takemongers from claiming that we were due for an even worse crash any day now.

I know my examples are just anecdotes, but basically I haven’t seen any single person who could reliably time the market over any timecourse whatsoever. Timing the market isn’t value investing it isn’t finding good companies at good prices, it would be going all-cash at the top and going all-in at the bottom, and doing this multiple times a year in order to maximize your returns on each up- and down-swing. You occasionally see hedge funds or take-mongers say they’ve gone all cash, but they then usually miss the bottom of the market by a lot and quietly re-enter it after the big gains have already happened, without ever admitting they were wrong.

In these cases, the old adage is probably the most correct: time in the market beats timing the market.

Stock buybacks are very similar to dividends

There’s an old saying in the Tech industry: “Tech companies only give dividends when they have nothing better to do with their money.” It’s been used as an explanation for why so many Tech companies don’t have dividends, and why that’s a good thing: they’re spending their money in better ways which should bring more value to the investors. Yet this is honestly nothing more than a lie: Tech companies don’t give dividends because they found a more tax-efficient way to give money to investors: buybacks.

Amazon is the poster child for buybacks instead of dividends. It has long defended its no dividends policy by saying it spends all its money on capital expansion (ie growing the business). And to be honest it has posted impressive growth numbers for years. But while it has never given a dividend, it has almost always used a buyback.

A buyback of stock, like a dividend, is merely a way for the company to hand value back to its investors. The company floods the market with asks for its stock which raises the stock price, and those investors who wish to cash out can now do so at the higher price. It’s no secret that buybacks increase a stock’s price, pretty much everyone who isn’t economically illiterate understands this, what is less understood is why Amazon uses them instead of dividends.

Dividends are an unavoidable capital gain for investors, unless the stock is held in a preferential account (an IRA or 401k) the investor will have to pay tax on the dividends. A stock buyback though, only creates realized gains for the investors who do want to cash out, and they were going to take a realized gain anyway. For everyone who wants to hold the stock, a buyback raises their stock price without them having the realize the profit, the investors become measurably richer but don’t get taxed. Stock buybacks were illegal until 1982, which is a damn good reason for why most “boomer” companies (Coke, Ford, Boeing) never got into them. Tech companies like Amazon and Google were incorporated in the 90s though, and once they IPO’d management quickly became aware of the tax benefits to buybacks over dividends. For these tax reasons, Tech companies perform buybacks instead of dividends, while giving lip service to the idea that they’re actually fully committed to capital expansion and not shareholder value.

Make no mistake, Amazon, Tesla, and other growth companies are just as committed to shareholder value as Intel and Ford if for no other reason than to enrich Bezos, Musk and the other major investors. They do so with buybacks instead of dividends because it’s more efficient tax-wise, but they are still committed to handing money back to their shareholders. If congress presses ahead with raising taxes on buybacks, we may see a change, or if Amazon and Tesla’s growth begin to slow their shareholders may start to demand a true dividend in addition to buybacks. Either way the shareholders will always be compensated, that’s just how companies work.

Can retail investors make money in real estate?

Maybe not

This is going to be a kind of short post that may prove me to be a dumbass, but I’ve been thinking about real estate and I wanted to talk about it.

For background, I had a friend at work who had to quit her job and move back to her hometown because she could no longer afford rent in the city. She had a steady job at a big research university but it just didn’t pay her rent and so she moved away. I was saddened by both her loss (since she could no longer do the job she loved) and the loss to science, how many other bright minds have been pushed away by low pay and the cost of living crisis?

But it also got me thinking. I’ve talked before about how dividends are supposed to help cure inflation. The housing crisis is caused by a lack of housing supply, and this should mean that housing investors are making bank (much like oil investors). While we think of housing investors as just the individuals who own their own home, the landlords who own most of America’s rental stock are often incorporated and can be invested in. A common investment vehicle for investing in these companies are REITs (real estate investment trusts), which are often publicly traded just like stocks and ETFs. So if landlords are making bank, then REITs should be making bank, so people investing in REITs should also make bank, right? Maaaaaaaybe not.

I did a quick scan of popular REITs and for whatever reason almost all of them seem like strong underperformers. A REIT invests in the real estate market much like an ETF invests in the stock market, and you can grade how well a REIT or ETF is doing by a few metrics, such as alpha, beta, and Sharpe ratio. Note that all REITs and ETFs will be graded relative to a chosen index, $VOO is an ETF that seeks to track the performance of the S&P 500 so it is graded relative to that index. REITs track the performance of the housing market and so will be graded according to a housing market index. Anyway let’s start with alpha, this tells us how much better or worse the fund is doing than it’s chosen index. If $VOO goes up more than the S&P 500, then it has a positive alpha, if it goes down more than the S&P 500 then it has a negative alpha. Beta is a measurement of volatility, $VOO may track the S&P over time, but if it swings wildly up and down (moreso than the S&P) then it will have a higher beta. The Sharpe ratio then is a measurement of reward relative to risk. A higher Sharpe ratio means the ETF or REIT has over-performed on a risk-reward basis, and a lower Sharpe ratio means it has underperformed.

What does this all mean for REITs? They all seem to underperform. The most popular REITs I could find online all had negative alpha (meaning they underperformed their index) and surprisingly low Sharpe ratios of below 0.2 (meaning they weren’t stellar on a risk-reward basis either). Compare that with the most popular ETFs out there, $VOO (mentioned above) has about 0 alpha and a Sharpe ratio of 0.5, meaning it tracks its index almost exactly and is at least OK on a risk/reward basis. $QQQ (another popular ETF, this one tracking the NASDAQ) has a positive alpha (overperforms its index) and a Sharpe ratio of 0.6. Add to this that the stock market has higher expected returns than real estate (meaning you’d expect $VOO and $QQQ to do better than REITs anyway) and it doesn’t look like REITs are a good investment. Past performance does not determine future performance and all that, but the real estate market would have to moon while the stock market tanked for me to expect these REITs to overperform the most popular ETFs.

So it seems that despite skyrocketing housing costs, it’s hard for a retail investor to make money on real estate. I’m not sure who exactly is making money on real estate, if the landlords are making money then it isn’t coming back to the investors, and if the builders/maintainers are making money then it isn’t coming back to their investors either. It seems at this point that the housing market is hurting us all in ways we can’t even make money off of.

Are passive ETFs creating market inefficiencies?

Yesterday I wrote about how the YOLO memesters might be creating market inefficiencies, today I thought I’d look at the other side of the coin with the more mature, more upscale passive ETFs.

For those who don’t know, a passive ETF is just a pile of money that you can buy into like a stock. When you hold a stock of $VTI for example, you own a tiny percentage of that big pile of money. The money in turn isn’t just a bunch of cash, it’s invested into the stock market according to the ETF’s prospectus, from which the ETF is not allowed to deviate from by law. $VTI’s prospectus says for example that it will seek to track the performance of the whole US stock market by investing in a representative sample of companies in that market. In this way, $VTI isn’t making a decision on the worth or value of any individual stock, it is merely buying every stock and assuming the market will do the hard work. Since the value of the total US stock market grows at an average rate of between 5% and 10% every year (with some down years like 2022), this means that $VTI is expected to grow at that pace as well and an investor in $VTI can make 5% to 10% returns without any of the stress or hassle of picking their own stocks. The only things $VTI asks for in return is a tiny amount of money in the form of it’s expense ratio, just 3¢ for every 100$ of investor’s money is taken for expenses, which seems to be a reasonable deal for everyone involved.

$VTI and other ETFs like it are easy, low-risk investment vehicles, so it’s no wonder they have exploded in popularity. Not only that, but studies have demonstrated that passively managed ETFs almost always outperform their actively managed peers. But is this “$VTI and chill” mindset of investors creating market inefficiencies of its own? Remember that passive ETFs invest in the whole market, regardless of if an underlying stock is any good or not. Not all ETFs are as broad as $VTI of course, some seek to track a certain market segment or a certain type of stock, but all passive ETFs share a commitment to obeying their prospectus and investing in valid companies without precondition. This means that they cannot participate in price discovery which is seen by some as the primary purpose of markets, including stock markets. If company A is growing, profitable, and well run, then it should be rewarded with having a higher value than it’s competitor, company B which is shrinking, unprofitable, and poorly run. We would expect that the stock market would perform price discovery on these two companies, investors would buy stock in the A and sell the stock in company B, raising and lowering their stock prices in turn. This then rewards company A for its success, and lets it use its high stock price as a tool to further expand the company, hopefully rewarding investors in the process and creating a virtuous cycle of success breeding success.

But passive ETFs don’t participate in price discovery, they don’t sell bad companies and buy good ones. Passive ETFs buy a representative sample of companies according to their prospectus, and they keep their expense ratios as low as possible in part by not doing the kind of deep dive on their investments that you would expect from an active investor. If company A and B are both worth 5% of the total stock in a passive ETF’s market, then it will hold 5% of its total value in both A and B. And if every investor in the market was a passive ETF, then there would be no way for the price of A and B to move relative to each other, because there would be no sell pressure on one relative to the other. Indeed some have claimed that the rise of passive ETFs is making the market less efficient, and tipping the scales towards large companies that will get bought up by the most popular ETFs simply because they are large and thus make up such a large portion of the market. If this is the case, then the erudite bogleheads are doing as much damage as the memesters.

Are stocks-as-memes creating market inefficiencies?

Stocks have long been the investment vehicle of choice for people with small amounts of excess cash.  Bonds are confusing, bank interest doesn’t pay much, and property requires high amounts of cash that most people don’t have.  But stocks are easy to understand, potentially give jackpots, and require such a small amount of upfront investment that almost anyone can afford them.  In ages past stocks were still usually bought through a specialized broker, and while the shoe shine boys in New York giving out stock tips may have been seen as a signal of a price crash, most people not living in major cities didn’t have access to a broker who could help them buy.  The brokers were therefore a barrier to entry that prohibited a lot of people from owning stocks who otherwise might have.  These days buying a stock can be as easy as installing the app, so quite literally anyone can own one at the push of a button.  This has democratized the market, but may have led to some unexpected consequences.

It seems that these days, stocks have become more than an investment opportunity.  Some stocks can be a badge of honor, a feeling of belonging, or a source of self-actualization.  You may invest in nuclear power because you want to help fight climate change, you may invest in Manchester United because you love the club, you may invest in GameStop because you believe you’re destroying the short sellers and want to be part of something greater.  None of these feelings have anything to do with the stock’s financial value.  They aren’t a dividend, they aren’t growth, they are a feeling you have when you own the stock and those feelings are often irrational.  In some ways these feelings call into question our understanding of stocks and investors generally.  

Now let’s be clear, there has always been emotions in the stock market.  Some people have always bought a company simply because they “liked” it with no better reason why, and “panics” can be just that: mindless rushes to cash out based on fear without thought.  But when a stock’s price is almost entirely based on feeling rather than actual value, to some extend it forces us to re-evaluate the market as a whole.  Last year, GameStop’s stock rose exponentially for no good reason whatsoever, and while some have considered it nothing more than a bubble, the price remains irrationally elevated even today.  There is no way a stock with no growth, no earnings, and no path to profit should be trading so high, and yet it is. If you took a company that was identical to GameStop in every way, but called it something different, it would  have but a small fraction of GameStop’s market cap.  That’s because GameStop isn’t just a company, GameStop truly is a meme. It seems insane, but there truly is a group of people for whom ownership of GME stock is bringing them no financial value whatsoever, but who continue to hold it out of emotional value.  You wouldn’t think such a group would be big enough to move the market, but last year showed them to be plenty large, and I believe there are still enough of them hanging around, holding the stock, and even buying more to ensure continued upward pressure on the stock’s price. 

If a market is anything, it is a mechanism of price discovery. The stock market should be a mechanism to discover the correct price of companies, and our research assumes that this in turn allows profitable and growing companies to prosper while unprofitable and shrinking companies fail. We know market actors can be irrational, but the average of all market actors, the “wisdom of the crowds” so to speak should have some logical underpinning if the market is to find the correct price of these companies. Stocks becoming a form of self-expression more than an investment vehicle could introduce inefficiencies to this market, and I’ll still trying to come to grips with what the consequences could be. We might imagine a future in which board members will seek out a CEO based not on the value they can add to the company but by whether or not they, like Ryan Cohen, have a ready-made base of support among the memesters. But I don’t have the economic or statistical background to understand how much this would change things, maybe CEO’s have always been picked for dumb reasons. What do you think?

Biotech update: Vertex Pharmaceuticals and CTX001

I’ve said before that I don’t feel like I can reasonably invest in any biotech company since they all feel like a gamble, but for the gamblers out there I took a look at the science behind Vertex Pharmaceuticals (VRTX).

Vertex has a drug called CTX001 which has been in the news as it seeks FDA approval to treat sickle cell anemia and beta thalassemia.  Sickle cell anemia happens when the hemoglobin in your blood has a mutation that makes it fold into the wrong shape, this makes red blood cells become sickle shaped instead of their usual donut shape, and these sickle-shaped red blood cells get caught in the tiny capillaries of your body.  This causes damage and a lack of energy as blood isn’t able to efficiently transfer nutrients and waste into and out of your cells.  Sickle cell anemia reduces one’s life expectancy to around 40-60 years.  Beta thalassemia is another hemoglobin disease this time caused by reduced production of hemoglobin itself.  Less hemoglobin means less nutrients and waste can be transferred by the blood, meaning the body can’t work as efficiently.  Beta thalassemia in its major form has a life expectancy of around 20-30 years.  

Despite the fact that both diseases are caused by mutations in hemoglobin, the mutations are very different from each other and so it surprised me that both were being treated by a single CRISPR drug.  How CRISPR works is that a protein uses a piece of DNA to very specifically target itself towards an area on a gene of interest.  The protein can then cut into that gene of interest and if another piece of DNA is on the protein, then that other piece of DNA can be incorporated into the gene by the cell’s DNA repair machinery.  This process is somewhat random in nature, it’s hard to ensure that your other piece of DNA gets incorporated and even harder to ensure that it is incorporated in just the right orientation, just the right position, and just the right way so as not to cause problems down the line.  Since sickle cell and beta thalassemia are caused by mutations in very different places within the hemoglobin gene, a CRISPR drug that is targeted towards the sickle cell mutation site should not be able to also hit the beta thalassemia mutation site.

But the trick is that CTX001 isn’t targeting hemoglobin, it’s targeting fetal hemoglobin.  When a baby is in the womb, it needs to take oxygen from its mother’s blood stream to survive.  If a baby’s hemoglobin were the same as its mother’s, this process would be inefficient because both the baby’s and mother’s hemoglobin would bind to the oxygen equally well and there would not be enough oxygen flowing from the mother’s blood into the baby’s.  It would be like a tug of war where both sides are of equal strength.  However, fetal hemoglobin binds to oxygen more strongly than adult hemoglobin, and this ensures that a baby can take the oxygen it needs from its mother’s blood stream.  Fetal hemoglobin usually stops being produced around the time the baby is born, and after the body switches over to purely adult hemoglobin by around 6-months after birth.  What CTX001 does is it tries to switch on the production of fetal hemoglobin in people suffering from sickle cell anemia and beta thalassemia.  If they can produce fetal hemoglobin instead then it can compensate for the fact that their normal hemoglobin isn’t working properly, and should reduce their symptoms and prolong their lives.

How CTX001 does this is by altering the promotion of the fetal hemoglobin gene.  The promoter regions of genes are the segments of a gene that help the gene get transcribed into new mRNA.  That mRNA will then get translated into a new protein.  The promoter of fetal hemoglobin does not usually allow the gene to get transcribed into adulthood, so no fetal hemoglobin gets made.  But altering the promotion of the gene would allow it to be transcribed, and thus translated, and so fetal hemoglobin would be produced in the body.  Now here’s where it gets a bit tricky: they aren’t actually altering the promoter region of fetal hemoglobin, but rather the promoter region of another gene called BCL11A.  I wanted to explain how promoters work, but there’s more to explain now because biology is complicated so bear with me:

The reason the promoter region of fetal hemoglobin doesn’t normally allow transcription (and thus production of the gene) is because of a repressor called BCL11A.  BCL11A is a protein that sits on the promoter of fetal hemoglobin and refuses to budge, this prevents any other protein from accessing the fetal hemoglobin gene and thus prevents fetal hemoglobin from being transcribed.  Now BCL11A is produced by its own gene, and CTX001 alters the promoter region of BCL11A in such a way that no BCL11A can be produced.  Without BCL11A, there is nothing to repress the promotion of fetal hemoglobin.  Without the repression of fetal hemoglobin, its promoter region is accessible and it can be transcribed.  With the transcription of fetal hemoglobin, the fetal hemoglobin protein will be produced in the body.  And with the production of fetal hemoglobin, the diseases caused by malformed adult hemoglobin (sickle cell anemia and beta thalassemia) should be reduced.

But it’s still not over!  How the hell would CTX001 find every red blood cell in the body and do its thing?  It doesn’t have to!  Hematopoietic stem cells are the stem cells which produce red blood cells (and it’s red blood cells which will carry the hemoglobin or fetal hemoglobin in the blood).  Hematopoietic stem cells can be extracted from the patient’s blood and then altered with CTX001 so that they will produce fetal hemoglobin.  The cells which are successfully altered can then be transferred back into the patient.  Before the altered cells are given back to the patient, the patient is given busulfan to kill off stem cells.  This is necessary to kill off some of the stem cells which are producing the malformed hemoglobin so that the new stem cells producing fetal hemoglobin can reproduce and become the majority.  The patient is then monitored for improvements in their sickle cell anemia or beta thalassemia condition.

So this process is long, involved and complicated.  Just to list all the things that could go wrong: when altering the promoter the DNA could accidentally be mutated towards being cancerous, killing of so many stem cells using busulfan could have harsh side effects, the infused hematopoietic stem cells might not reproduce and become the majority, and even then the DNA of the promoter might not be altered enough so that fetal hemoglobin becomes the majority of the hemoglobin in the body.  But I’m sure every step is heavily monitored by Vertex during the treatment process.  So is Vertex Pharmaceuticals a buy?  I have no idea, if you believe the Efficient Market Hypothesis then all their upside is already priced in, but they’re in phase 3 of clinical trials and if you’re a gambling man I see nothing wrong with their scientific thesis.  So idk, go ahead?

Biotech seems far more speculative than other tech

There’s a mantra that gets repeated by everyone around me: biotech is the next big thing.  I’m willing to believe that on average the biotech industry will probably grow faster than the market, maybe even faster than the tech industry over the next 20 or 30 years.  What I’m less enthused by is the prospect of trying to pick and invest in the winners of that market and not get stuck holding the losers.  I feel like biotech in general will have a much larger standard deviation on its returns, a small number of companies will make out like bandits and a very very large number of companies will make nothing.  This is generally true in most markets, but in biotech you have the added barrier of the government to think about.

When a tech company brings a new product to market, they will design it, test it, then try to sell it to consumers.  But when a biotech company brings a new product to market, they often have an added hurdle of the government.  They need to design a product, test it, ask the government for permission to sell it, and then sell it to consumers.  These consumers are usually healthcare patients because the product is usually a drug or medical device.  The government in this case is protecting us from bad products in healthcare, but in turn this puts up a barrier to entry that ensures that only a few products get through and get all the money in the market.  There’s a large market for crappy but cheap smartphones that retail for far less than an iPhone or an Android, there isn’t any market for crap drugs that only “sort of” cure your disease. 

50 years ago biotech’s second biggest area was agribusiness, but today all the biggest movers and shakers are all related to medical in some way.  Everyone is working in an industry where money only comes in if you can improve the health of a patient.  Even the non-medical companies, the “shovel salesmen” in the biotech gold rush, the products they sell will only get bought by companies which are themselves trying to make a drug or a device that will prolong the life of a patient.  So I feel like any biotech giant I wanted to invest in, be it Pfizer or Merck or Johnson and Johnson, investing in any one of them is like playing a crap shoot with the FDA.  If Pfizer’s next biggest drugs don’t get approval, Pfizer’s stock will go way down.  And if the FDA approves a “better Tylenol” for mass market, then Johnson and Johnson could drop.  So biotech feels like I’m investing in the future of the FDA more than I am the future of the market.

And then there’s Thermo Fisher, the biggest shovel salesman of the biotech gold rush.  They make the products used in labs all over the world,I know even my lab uses a lot of Thermo Fisher brand products.  Even here the future seems less certain than it is for say Amazon or Google because all the labs which buy Thermo Fisher products are still at the whims of the FDA.  Everyone buys polypropylene tubes from Thermo Fisher, but what if the FDA decides polypropylene leaves behind microplastics which harm patients and mandates that polypropylene never be used in medical devices or drug manufacturing?  Then Thermo and every company like them would be scrambling for a substitute, and there’s no way of predicting that Thermo would come out of that mess the victor.  So shovel salesmen make for safer but by no means safe bets.

And finally there’s the small players in biotech, the startups and mid-sized companies which hope to build the products of the future.  They are the most speculative companies of then all because they’re often pre-revenue companies which are hoping that whatever drug or device they own the IP for can get through the FDA’s hurdles and reach the mass market.  These hurdles are very high and there’s no money in only getting past the first few just to fall at the last one.  So when you invest in a company like that you’re investing in a business of hope and hype, and since even the greatest experts in biotechnology can’t predict which drug or device will work for patients there’s little chance of someone like me making all the right predictions.

So I guess biotech might be the future, but the future is too murky to invest in.  I’d keep my money in biotech ETFs and hope for the best.

Technology is supposed to be deflationary

Elon Musk and Cathie Wood are complaining about deflation again.  For the most part they’re just sad that the Fed’s actions have cut off the flow of cheap money, reducing the price of stocks and thus reducing their total wealth.  But they both have a tiny kernel of truth within their whining, technology is deflationary by nature and our monetary policy should be prepared to deal with it.  But what does that even mean for technology to be deflationary?

I’d like to go back to a post I did on dividends for an example here.  Let’s look at the Oil Shock of the 70s for a good example of an inflationary period.  The rise in the price of oil led to inflation as companies and people who still needed it bid up the price in order to compete for what little oil was left to go around.  This in turn pushed inflation into other sectors, as the lack of oil meant there was a lack of goods that relied on oil, thus the price of those was bid up as well.  If we take the example of a company which uses oil to make certain goods, how do they deal with the oil shock?  

Most directly, they can continue to buy oil at a high price and raise the price of their goods to compensate.  As long as every other company in their sector is also forced to raise prices, the company will survive by pushing inflation onto their customers, but if the other companies making their good are not affected by the price of oil, then this strategy won’t work as the company will just bleed market share into bankruptcy.

Alternatively, they can look to find ways to reduce the amount of oil they use per unit product.  In this way they can try to keep their prices low while their competitors’ prices are forced to rise, thereby gaining market share.

In a very real way, reducing the amount of oil used to create products would require some sort of innovation in technology, the creation of things like electric cars and nuclear power plants so that less of some stuff (oil) is being demanded and more goods are being supplied. This decrease in demand and increase in supply will cause deflation as prices drop due to these factors.  Remember that this is why some neoliberals pushed back against price controls and rationing during the oil crisis, those things depress the market forces which would otherwise cause people to invest in innovation and trigger deflation.

So today we don’t have an oil crisis, but in Europe we have a gas crisis, and European countries have also declared their intentions to accelerate the gas crisis by subsidizing demand instead of reigning in supply.  The problem here is that the government will pay the cost of this gas inflation and so there’s no reason for market-actors like companies to change their behavior or invest in alternative technologies.  Perhaps the governments themselves will try to force investment in alternative technologies, but I’m skeptical they’ll do as well as the market would.

So what does all this mean? Well if you believe that we’re on the cusp of a technological revolution, then it’s true that the Fed could accidentally flip us into deflation without even trying. On the other hand one of the biggest drivers of inflation this year, energy, is being subsidized by the government with price caps or tax reductions so companies and individuals aren’t being forced to invest in new technology in order to limit their use. Technology is supposed to be deflationary, but that’s no guarantee.

The Short Cramer ETF and the paradox of the stock picking

Tuttle Capital made waves last week by bringing out an ETF called SJIM that would let you short the stock picks of TV personality Jim Cramer.  Cramer, the longtime host of “Mad Money” on CNBC, has a prolific history of making bad calls from “Bear Sterns is Fine” to “sell Netflix in 2012” and even “Buy Netflix in 2022.” So it’s entirely unsurprising that “just do the opposite of Cramer” would gain traction as a valid investment strategy.  What’s interesting is that this strategy runs counter to the semi-strong version of the Efficient Market Hypothesis (EMF) in a way that some might not expect.  I’ve at times seen people attack Cramer based on the EMF, pointing out that even the best stock pickers rarely perform better than random chance and that therefore Cramer is by definition a waste of time.  Yet many of those same people wouldn’t realize that if Cramer himself is a waste of time, then shorting him is a waste of money.

It comes down to what I sometimes call “the paradox of stock picking”: if you believe it’s impossible to predict the winners in the market, you must also agree it’s impossible to predict the losers.  Many people agree that you can’t know with certainty which company in the stock market will do well in the future, past performance is no guarantee of future success and all that.  What is the best electric vehicle company to invest in today?  Tesla is synonymous with EVs, but then Microsoft was synonymous with tech in 2001, and if you put all your money into Microsoft in 2001 you would have missed out on the massive gains made by Apple, Google, and others.  It’s hard to be certain that Telsa will continue to be the EV leader or even that it’s current growth trajectory is sustainable, and in either of those cases there could be some other company that would make a much better EV investment.  So then let’s flip this question on it’s head: what is the worst EV company to invest in?  Rivian is trading at around 600 times revenue for example (revenue 55 million, market cap 33 billion), can you guarantee that it is a bad investment?  What about Nikola?  They faked an electric truck by rolling one down a hill, are beset by scandal, and are still trading at about 80 times revenue, are they a bad investment?  The EMF states that you cannot beat the market with fundamental analysis, so the investment opportunity of scandal-plagued Nikola and profit-less Rivian are already priced in by the market just as the growth opportunities of Tesla are already priced in.  If you thought you could with 100% certainty pick which EV company was the worst investment, or even just a below average investment, then you could make an EFT made up of every EV company except the definitely-bad one. Then your EFT would beat the EV market as a whole because it would include all the market winners while eliminating one of the market losers.  This would run directly counter to the EMF which says you cannot beat the market.

So getting back to Cramer, is shorting him via an ETF a waste of money?  If you believe the semi-strong or strong versions of the EMF then Cramer’s chance of success as a stock picker is perfectly random, no more no less.  In order for shorting him to be a good investment, then you must believe: 

  • The market is not efficient and it is possible to pick winners and losers
  • Cramer’s analysis is not just so bad that his chances of success are random, but rather he is so bad that chances of success are worse than random.  
  • Cramer’s chances of success are so much worse than random that the gains from shorting him outweigh the expense ratio of the ETF

It’s important to note here that shorting Jim Cramer puts you on the hook for his successful calls as well as his failures.  Failed predictions often generate more buzz than successes since the schadenfreude of seeing some idiot on the TV be proven wrong is a powerful emotional tool for getting people talking.  But if SJIM had come about 15 years ago and you had held it, then you shorted Jim Cramer on his “Bear Sterns is Fine” call but also shorted him on “Buy Apple” in 2010.  Adjusting for stock splits Apple’s price has gone from around 5$ to around 150$ in that time period, is that the kind of short position you want to take?  Only time will tell if SJIM is a good investment I guess.

The stock market is not the economy, so what is it?

With the stock market down almost 25% year-to-date, it’s always necessary to remind people that the stock market is not the economy. The market can go way up in a “bad” economy (as we saw during the COVID lockdowns) and likewise can go way down in a “good” economy. But if the market is not the economy, then what is it?

Well in some ways that is a question with multiple answers. As stated in a previous post, for companies the stock market is a source of money, what professionals call “liquidity.” The ability to get more money when you need it just by selling stock, or to purchase assets with stock or borrow against stock, these are all ways that a company can treat stock like it is money and use it to grow their business. So when the stock market is down companies could have a harder time raising the money they need in order to grow and expand their business. In this way it can be argued that the stock market does affect the wider economy significantly by determining how easy it is for companies to grow and expand their business off the money from stock investors. If this source of money/liquidity is hard to come by (because of a bust stock market) then growth will suffer.

From an outside perspective however, the stock market can be seen as the expected near future of all the companies in the market. In a different post I explained that one mechanism that gives a stock value is the expectation of all future dividends (accounting for inflation and uncertainty). Dividends require profits in order to be sustainable, so if in the near future one expects most companies to turn unprofitable, then one would expect many companies to be forced to cut their dividend, and thus one would value stocks less and other investments (like bonds) more. Thus many people have argued that the stock market is a leading indicator for the economy as a whole, if the market is down then that probably says something about the near future of the companies in the market ie that they would be expected to be entering rough straights. In the same way the stock market can be the first thing to rebound out of a recession as investors look to the near future and expect profits and dividends to make a comeback.

So no, the stock market is not the economy. But this the stock market may tell us about the future of the economy, either directly causing that future (companies grow more slowly because it’s harder to raise money) or being an effect of that future (economic storm clouds cause the stock market to tank before the real economy). Either way, we should be prepared for whatever future it holds for us.