A Look to the October Stock Markets
The USA Debt Ceiling – “The never ending story”
As expected, the politicians in Washington waited until just before the stroke of midnight to prevent a
government shutdown. As with countless issues, they agreed to kick the can down the road and have
President Biden sign a bill that funds the government until December 3 rd . Passing a funding plan puts a
Band-Aid on the first crisis, now the focus turns to the looming threat of default unless Congress raises
or suspends the debt ceiling. If this is all too familiar to you, there’s a reason. Congress has raised or
suspended the ceiling 78 times since 1960. The most eventful climax came in 2011, when the debt
ceiling wasn’t raised until the last minute which really spooked markets. Given today’s political standoff,
we should expect there to be some increased level of market volatility, but not to the same extent as
2011. The most likely reason, the markets, just like the American people have become accustom to
Washington bickering and infighting. In the end, the market believes a deal will be had and the
politicians will go back to earning their lackluster approval ratings.
Evergrande – “Another Lehman Brothers Event? Don’t hold your breath”
Funny the difference a week makes. A once nondescript Chinese company that the general public had
never heard of suddenly was grabbing all the headlines. The initial uncertainty, caused a knee jerk
reaction and provided traders an excuse to sell a market that has run up nicely this year. Most of the
volatility in markets was not actually caused by Evergrande, but yet again, the big upward moves in the
10-year US Treasury (as already seen earlier this year), especially hitting growth and tech stocks. The
panic even caused my brother in Canada, who never follows the markets to call and warn me that the
sky was falling. After quickly reassuring him that the world wasn’t going to end, he was able to get back
to his day to day life. I understand where he and millions of other people are coming from. We’re all still
scarred from the financial crisis of 2008. But what we’re really saying when we refer to another “Lehman
event” is our fear of market contagion (the spread of an economic crisis from one market or region to
another). Although Evergrande debt is in excess of $300 billion, the majority of that is held domestically
in China, which limits the negative effects from spreading outside the country in a worst case scenario.
Don’t forget the vast number of state owned/directed companies at the Chinese governments disposal.
A recapitalization/reorganization of Evergrande is really the most likely scenario. Just this August, China
recapitalized Huarong Asset Management Co, ensuring it made good on its $242 billion of liabilities. All
this after a five month “will they” or “won’t they” saga that caused the most extreme swings ever for an
investment grade Chinese bond issuer. Investors that bought those distressed Huarong bonds ended up
enjoying one of the most profitable trades this year. Don’t get me wrong, Chinese bad debt is definitely
an issue, especially within their real estate sector and if not addressed will hinder China’s growth and, in
turn, lead to lower overall global GDP. But this is a far cry from the Global Financial Crisis of 2008. More
likely than not, it’s potentially a great opportunity to buy into China’s market leading large cap tech
names that have pulled back because of the perceived uncertainty surrounding the Evergrande
situation. For long term investors, China’s economy is too big to ignore even though it comes with
heartburn for now.
Beaten down SPAC’s – Bargain hunters. The thrill of the find!
Oh how the pendulum swings! The once hottest part of the market has now become stone cold. The
euphoria surrounding SPAC’s and the subsequent stampede of companies trying to go public as quickly
as possible through these blank-check structures is long gone. SPACs stand for special purpose
acquisition companies, which raise capital in an IPO that are typically priced at a nominal $10 per share.
Once funded, they use the cash to target a private company (typically within two years) to merge with,
instantaneously taking it public. Whenever there’s this level of hype and easy money flowing, the
bankers will circle and find a way to cash in. What followed, is a total of 125 SPACs mergers in 2021 with
a whopping 58% of those currently trading below the initial $10 level. The bloodbath in SPACs has dried
up the deals and funding sources, tumbling from over $28 billion per month in Q1 to a minuscule $1.6
billion since April.
The end result, SPAC has become a dirty word in finance. It has tainted both future SPACs and those
companies that were once SPACs and now trade under their own public shares. The public has a right to
be pissed, as many retail investors got caught up in the hype and lost their shirts.
Now that the destruction has taken place it’s time to pounce. Similar to rummaging through a sale rack
at your favorite department store, the bulk of what you’ll find belongs there. But for those with the
patience and a keen eye for a great deal, you’ll be able to find a hidden gem or two. The same is true for
SPACs. The majority of deals should have never seen the light of day. But I’m confident a few will
blossom into super successful public companies and now’s the time to go bargain hunting. One of my
favorites (which I own and have continued to accumulate) is SOFI Technologies Inc, one of the leading
Fintech players in the United States. It was down roughly 50% from its 52 week highs in September.
Don’t forget great companies will shine through whatever the structure; just make sure to do your
Bond King Bill Gross “Bonds are Trash” – No kidding Sherlock
Its official, the king himself went out on a limb (yawn) and stated to the world that, “bonds are now new
contenders for the investment garbage can”. Thank you for the great insight your highness, but honestly
this maybe the most obvious observation on the planet. I guess since the Fed recently announced the
tapering of its $120 billion in monthly bond purchases later this year, Bill felt the coast was now clear to
make his call that the 10-year Treasury would rise from 1.3% to 2% (which is pretty much the market
consensus). The unfortunate part for investors is Bill didn’t help by suggesting any alternatives to trashy
bonds. Personally, I’ve been pretty vocal myself over the past year, but at least I suggested benefiting
from alternatives and structured notes (for those with the right risk tolerance). Those with more
traditional asset allocation type portfolios, I strongly propose thinking outside the box. In my opinion,
investors are even better off holding cash than investment grade bonds in this potentially upcoming
rising rate environment. It’s been a strong forty yearlong run for bonds, but don’t be surprised to see
negative returns in the asset class that’s been a work horse for so many decades.
Video game developers – “These tricks aren’t just for kids”
It’s been a rough few months for my beloved video game companies. China yet again causing issues or in
my opinion more opportunities. All video game stocks took a big hit after China recently announced it
would restrict minors to playing video games to just three hours a week. The Chinese government
believes that video games are highly addictive which I don’t doubt, but a ban is ridiculous. The
communist party can do what they like, because video games aren’t going anywhere. Video game
revenue has surged over recent years, climbing to approximately $160 Billion in 2020. Even though the
COVID pandemic has helped the industry it’s not just a stay at home story, so don’t be selling these
gems just because the economy is opening back up. The truth is the industry is unstoppable and that’s a
statement coming from a guy that doesn’t even play video games! Here are just a few recent positives
for the industry;
Apple V. Epic Games which proved to be a huge victory for all gaming companies. The Apple mafia can
no longer be allowed to prohibit developers from providing links or other communications that direct
users away from the Apple in-app purchasing. This in short means, developers will no longer be forced
to pay as much in commissions to Tim “Capone” Cook and in turn will generate a lot more cash.
The E-sports movement continues to heat up. E-sports is the term used for professional gaming leagues.
That’s right, gamers are getting paid large sum of money to play video games for a living. The industry is
projected to grow 400% in the next few years reaching $4.28 billion by 2027. In terms of viewership the
2019 “League of Legends” World Championship finals drew more viewers than the super bowl…not bad
for a “fringe” sport.
Netflix has made a push into video game streaming as well. Pushing even further, Netflix announced in
September that it bought video game creator Night School Studio. Having all the big boys; Netflix,
Amazon, Microsoft and Google in the gaming space just increases the value of game developers as they
fight to become leaders in the space. Remember, just like traditional media, content is king!