Special Market Commentary

February 02, 2021
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All,

I just wanted to give you a quick update as it relates to the unusual market volatility last week.

If you aren’t aware, some company shares have experienced tremendous volatility this week (Gamestop, AMC Theaters, to name a few).  This growth was based on a concentrated effort through a message board (Reddit) to target hedge funds who held significant short positions in several companies, including Gamestop and AMC.

Why is this making news?  The hedge funds have the ability to short these company shares.  This means they can sell a company today and buy it back in the future at (hopefully) a lower price.  Typically, hedge funds short companies that do not have a strong balance sheet or projected revenue flow.  The investors that organized on Reddit decided they wanted to force the hedge funds into significant losses by driving up the price of the companies that were held short within the funds.  Therefore, the funds were forced to close out their positions early due to the rapid rise in the shares.  Many of the investors used the retail app Robinhood, where you can open an account from your phone and trade shares.

There are two opinions on this.  First, some are concerned about the integrity of open markets.  If an organized message board of investors can significantly impact select company shares, why try to invest based on projected revenue and cash flow?  Does this mean the market is just a roll of the dice with no logical reason to investment growth?

The other side argues that hedge fund managers, due to their tremendous wealth, have had significant influence over the market for years. They believe they have been protected by politicians to continue this type of activity which can harm some retail investors.  There are those that also believe short selling should not even be allowed because you can receive proceeds from the sale of an asset that is not owned. It is speculated that billions of dollars are made annually by large hedge funds applying downward pressures on companies they deem are no longer worthy of long-term investment.

This week, we saw many retail broker dealers, including Robinhood, Schwab, and Fidelity, suspend retail trading in several of the extremely volatile companies.  Investors who trade through these firms are now upset that they have been restricted from a supposedly open, free market in order to protect the billions of dollars in hedge funds.  What a week in the market.

My opinion:  I never have believed that short selling was a good idea.  I have never recommended a client invest in a hedge fund.  I believe most returns on hedge funds do not justify their fees or the risk.  I believe many are an illusion sold to clients who believe they are getting an opportunity more “unique” than what is available to the “average” retail investor.

I also do not believe that active trading by retail investors equates to long-term investment success.  I have worked for several retail brokerage firms.ot once have I witnessed a client trading their portfolio to financial security based on their time horizon or financial goals.  

The portfolios I recommend for clients stick to mostly large cap companies on the S&P 500 or Large Cap Dividend Growth companies.  Companies that the hedge funds short may have a lower probability of being included in the ETF’s I recommend because of their lower projected cash flow and revenue streams.  A good example would be Gamestop being removed from the S&P 500 in 2016.

I will continue to stay in tune with everything happening in the market. I will also monitor your holdings to ensure the ETFs, although more passive (meaning they do not have a portfolio manager buying and selling stocks), are holding companies consistent with their stated criteria to be listed in the ETF ( in many cases, in order to be included in a particular index or ETF, companies must consistently exhibit positive revenue, cash flow and dividends over several months).  

I am available to discuss all your questions or concerns.  Please know that your trust means a great deal to me, and I value the responsibility I have been given to oversee your financial lives today and well into the future.