Font size
Bearish equity strategists are calling the GameStop saga a sign of a market bubble.
Marangifoto / Dreamstime
It was a crazy time. Stocks left for dead exploded. Short sellers were beaten. And everyone wondered if too much “liquidity” is blowing up bubbles.
It was 2003.
The GameStop saga, as a market event, seemed to be coming to an end last week.
GameStop‘s
stock (ticker: GME) fell 80% to $ 63.77, and while that was still more than three times as high as at the end of 2020, its ability to engage had seriously diminished.
Yes, politicians are still calling for research and town planning regulations. Reddit merchants continue to rally around the beleaguered video game retailer. And talk of “manipulated markets” and the “democratization of trade” and the “little man’s uprising” continues to resonate through the electronic halls of Wall Street and beyond. Even bearish equity strategists have come into play, calling GameStop’s rip a sign of a market bubble that is sure to pop every day.
If only it didn’t sound so familiar. Here’s how the Trader column described the situation in May 2003, when the dot-com bust had finally come to an end: “There are emerging hints of the kind of speculative excitement and latent selling pressure that can undermine strong markets. Risky sectors outperform the broader market. Small-cap stocks have been roaring for the larger … Low-priced stocks, many of which have become this way for very good reasons, have been bouncing for months now. “We could have pasted that into almost any Trader column in recent weeks.
The comparisons don’t end there. Recent headlines highlighting losses at Melvin Capital and other short-selling hedge funds also echo that of 2003. Only one of 17 short funds ended that year with a positive return, with Rocker Partners, a prominent short-selling fund, year with 36%. The fund’s David Rocker said it made him feel like “Alice at the Mad Hatter’s Ball.” That quote could now come from any short seller.
What the shorts forget is that when a recession is over, crappy businesses, especially those that don’t seem to have a future, rally. In 2003, the list included Lucent, the former Bell Labs; Yahoo! and
Research in motion,
known today as
BlackBerry
(BB). Nowadays they are names like GameStop,
AMC Entertainment Holdings
(AMC), and, well, BlackBerry. That actually makes sense: when the US goes into recession, the weakest companies ask for bankruptcy protection, while the rest get themselves some time. ‘We are on stage [in the business cycle] when you expect lower quality companies to do better, ”says Barry Knapp, managing partner at Ironsides Macro Economics.
In the 12 months since its low in October 2002, the S&P 500 Quality – Lowest Quintile Index rose 38%, doubling its
S&P 500’s
19% increase. Low-quality stocks also outperformed after the recession in 2009, with their index up 69% from the S&P 500’s 47% rise over the 12 months beginning in March of that year. (According to S&P, high-quality companies have, among other things, a high return on equity and less financial leverage. Low-quality companies do not.)
We haven’t seen that kind of performance since the March 2020 low – low quality is up 40% and lags behind the S&P 500’s 44% rise – but it could just be early in the process. After all, the bear market only lasted 19 days. The low quality rally, if it occurs, must have legs. It certainly did after the bear market bottomed in 2002 and 2009, when the outperformance of those stocks continued for a second year. That could mean that opportunities still exist in some areas of the low quality stock market.
But once the bounces are over, longer-term games can be hard to find. Some companies are disappearing, others continue to dominate their industries, struggling even more to survive, while their stocks have gone nowhere for a decade or more.
That was the case with utility
AES
(AES). It was hit hard, like many utility companies, after the Enron collapse, trading for less than a dollar in October 2002. A brief drop took it to $ 8.35 – an astonishing 781% increase – then to $ 25.52 in June 2007. Since then, it has never closed higher than those highs of 2007.
Until now. AES, which has a major renewable energy company, finally broke out of that reach when Democrats took control of the Senate in January. That, coupled with a subsequent relapse, caused Evercore ISI technical analyst Rich Ross to call it a “ high conviction lung ” and offer a “ table-pounding 14-year base breakout. ”
But it’s not just the technical factors that make AES, which is now trading at $ 26.86, look attractive. The win was hit by the Covid lockdown, but not as big a hit as expected. And it should get a boost from President Joe Biden’s climate plans and the drive to cut emissions. The company has also – finally – overcome all of its problems from nearly 20 years ago by obtaining an investment-grade rating from S&P in November.
After more than a decade in the wilderness, AES may be ready to run again.
Read the rest of The Trader:The stock market is bouncing back for all the right reasons, but the yield curve can be problematic
Write to Ben Levisohn at [email protected]