(3D/L) June was a pleasant month. In our neck of the woods the weather was warm, we mostly stopped wearing masks, and the Red Sox finished the month in first place. The S&P gained a tidy 2.33% in June, bringing it to a satisfying up 15.25% for the first half the year.
Market sentiment appears to be a mixture of summer doldrums and foreboding. To be fair, foreboding is almost always in the mix, but this time fears of the future are more specific than the usual background hum of angst brought on by new all-time highs. The phrase “late-stage capitalism” seems to be appearing rather a lot. It is usually used somewhat ironically, but there is a definite feeling that we have crossed over into some kind of decadent period at the end of the economic cycle.
On the last Monday in June Bloomberg published a story “Record Stock Sales From Money-Losing Firms Ring the Alarm Bells” about secondary equity offerings from unprofitable companies. It seems that the ratio of issues from money losers to issues from money makers is now as high as it ever has been. To be clear, money losing issuers regularly outnumber profitable ones, but the ratio is now higher than it has been since at least 1982 when the data begins. Moreover, since the size of the profitable company issues tends to be larger, it is rare for the dollar value of unprofitable secondaries to be larger than the dollar value of profitable secondaries. But it is the case now. The only other times post-1982 this has happened were 2000 and 2008.
That unprofitable companies find issuing stock to be attractive is hardly surprising. It is the logical obverse of the attraction that buying back shares has for healthy ones. What is remarkable is the ready market that these unprofitable companies are finding for their shares. The “meme” stocks such as Game Stop and AMC are extreme and high-profile examples, but according to Bloomberg no fewer than 750 different money losing firms have made secondary offerings in the past 12 months.
If the widespread purchase of newly minted shares from unprofitable companies does not inspire a the-end-is-near reaction, consider the case of edX. According to an email recently sent to MIT alumni, edX was a non-profit jointly launched in 2012 by MIT and Harvard “to offer the world an open-source online learning platform for university-level courses.” In this it was, apparently, modestly successful but fell behind other platforms amidst a boom in online learning last year. Not to worry, one of the more successful players in the field, publicly traded 2U, Inc., has agreed to purchase the non-profit for $800 million. As part of the deal, 2U is obligated to continue to offer edX’s services for free.
Credulously buying new shares in a company that does not currently make money, but has aspirations to do so in the future, is one thing. Shelling out the better part of a billion dollars for a firm that is unprofitable by design, and promising to keep it that way, is quite another thing. Surely this is some kind of sign of the times?
More concretely, June saw a modest amount of concern in the markets over hints from the Fed that maybe rates would have to be raised earlier than expected, maybe as soon as late next year. It is easy to exaggerate the level of concern. There was much discussion in the media, and a flutter of activity in the bond market, but stocks and 10-year Treasuries went up for the month. The potential raising of rates was conditional on higher than expected inflation, which the Fed has pronounced unlikely.
To us, worrying about the higher rates that might follow the appearance of stronger inflation is like worrying about the water damage the fire department might cause if your house catches on fire. If inflation becomes significant enough to scare the Fed off its course, higher rates will not be our biggest problem.
Is the end near? We do not know. There are reasons for concern, but when has that not been true? This may be the late stage of something, but we do not believe the economy follows a natural progression from one state to another. This would all be a lot easier if it did. In the meantime, let us hope the weather holds and that the Red Sox keep winning.
The Market Sentiment Framework
We use our Market Sentiment Framework to adapt the mechanics and weightings of our full quantitative models to changing market conditions.
The Sentiment Framework gauges the current state of market psychology on two dimensions. Efficiency measures the crowdedness of the market, the volume of participants seeking investment opportunities. Lower levels of efficiency imply more market mispricing. Optimism measures the willingness of investors to take on risk in exchange for distant and uncertain rewards. Higher levels of optimism imply a better outlook for risky asset classes.
June saw the Optimism level increase and the Efficiency level decrease, both modestly.
Optimism began the month at 0.39 and ended the month at 0.51. Although still relatively low in absolute terms, Optimism is above its pre-COVID level and near its post-COVID high of 0.70 seen in mid-April.
Efficiency fell slightly, starting the month at 0.66 and ending at 0.32. Efficiency continues to be comparatively low as compared to historical averages, which suggests a market that is still under stress.
Both measures are higher than where they were in early 2020. The current positioning of the Sentiment Framework implies a market that is functioning less than ideally, with marginally optimistic but fearful investors. This would imply a positive but challenging outlook for the market as a whole, but possibly an opening for value strategies to find opportunities.
