by Bryan Perry
August 10, 2021
Income investors who depend on yield for pension distributions and general living expenses are finding it more difficult than ever to find assets with dependable, low-beta features that pay decent dividends. With the latest CPI data showing annual inflation running at 5.4%, one needs to make 15% just to net 9.6% in inflation-adjusted return on equity. Tell that to your broker and see what kind of response you get.
Well, for some of us that grew up in the days of Michael Milken and his firm, Drexel Burnham Lambert (I’m dating myself), we recall that pitching 9% to 15% yields to prospective clients was an everyday practice. When I was working as a broker at Bear Stearns, KKR put out an RJR Nabisco convertible bond with a 13.5% coupon. At the time, RJR was a private holding of KKR, soon to go public. The story was made into a 1989 book, “Barbarians at the Gate,” which became a 1993 movie starring James Garner.
Selling this kind of paper was like shooting fish in a barrel, but so was selling the Solomon Brothers’ Nikkei Puts when the Nikkei was trading at almost 40,000 and the Japanese were buying up Times Square and Pebble Beach. By the way, both trades worked out fabulously and I organized a party on a 110-foot yacht for the entire trading floor on San Francisco Bay. Yes, those were the days – 1989!
Alan “Ace” Greenberg was CEO of Bear Stearns at the time. He was arguably the best bridge player in the world. He held no quarter with people that had “woke feelings” about things that got in the way of business. He was famous for telling an audience of 110 pin-stripers on our trading floor that “stocks are like toilet paper – use them and throw them away.” Sounds simple enough!
At the time, Larry Kudlow was the senior in-house economist at Bear Sterns, and he would show up from time to time when the market closed at 1:00 pm PST to pontificate on his view of the investing landscape. He would light up a Dunhill with his Cartier lighter — despite a strict “no smoking” sign on the building.
Yeah, right. The guy was great to listen to – and he still is today.
When Ace stepped down, Jimmie Cain took the helm at Bear, and to everyone’s surprise, he got way too involved with the heathen devil weed, marijuana. He lost his focus, let his MBS minions puff up his ego with the promise of ginormous profits, and so Bear Stearns came crashing down with the entire 2008 mortgage crisis. Thankfully, I was long gone from the company before that trap door situation unfolded.
That story also made it into the movies. Oddly enough, two of my favorite movies are “The Big Short” and “Margin Call,” describing those years. To say I’m lucky, blessed, or both is an understatement. After leaving Bear, I was employed at Lehman Brothers for a time before that house also burned up.
From 1999 through 2007 was a wild time in the securities business as risk was thrown to the curb for yield and profit, with no regard for what happens if or when the rug gets pulled out from under us.
Oh, how history has a way of repeating itself, and in this day and age, it seems the time for a repeat of foolish investing behavior happens in a more abbreviated fashion. Take for instance the rise of Cathy Wood and the Ark Funds. From a marketing standpoint, it’s a phenomenal story, having seen total assets under management (AUM) rise to over $50 billion in the span of just over five years. Investors that bought early (say, 2017 to early 2020), like those that got in the mortgage-backed securities (MBS) programs in 2000-2001, are making out pretty huge. For those that bought in during late 2020 and after, however, they haven’t made a dime and the S&P has rallied from 3,600 to 4,400 since last December.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Here’s the reason why I say history may rear up and repeat itself. The flagship ARK Innovation ETF (ARKK) is trading at dot-com valuations. Anytime a stock or fund has a P/E ratio of negative 65x, that should be a cause for concern, especially when the top 10 holdings account for 51.8% of total assets. There is no room for escape from the inevitable massive multiple contraction if the market corrects more than the garden variety 3% to 5% pullback we’ve witnessed during the past 16 months.
Granted, if the stock market continues its path higher without a major correction, then shares of ARKK might well hold the 200-day MA and push up through the resistance line noted in the chart above. But here I have to throw the caution flag. The ARK Innovation Fund has bought over 3.6 million shares of Robinhood Markets (HOOD) as of last Friday. This is a meme stock. The company may never make money and that may become a liability for fiduciaries. With almost 98 million shares set to hit the market from shareholders in the first tranche of venture money hitting the exits, and the stock trading in a 40-point range in the past week, one has to wonder if this is investing or gambling, dot-com style.
I would tend to think the latter is more accurate. The whole meme movement – the Reddit, Wall Street Bets, Diamond Hands movement – smacks too much of 1999, and for the sake of the 20 million account holders at Robinhood, I hope it doesn’t end badly, but I’m afraid it could.
I have my own ideas about what, how, and when the market will correct. It usually comes when the great majority of investors don’t see it coming. Investing in stocks with rising sales and no earnings is fraught with risk, and that’s what’s in fashion for a great portion of the investing public. If the market endures a 10% to 20% correction, I predict shares of ARKK will drop to $65, implying a near-50% decline.
I hope I’m wrong, but having been through a few periods where P/E ratios get redefined as “metrics” and other useful phrases to rationalize sky-high valuations, I think judgment day is a matter of when, not if.
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