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I read the April Review from Fleming & Curti, PLC with interest and thought it would be a good excuse to lighten my writing duties this month. Jacquelyne Mingle covers potential changes in tax laws, elder law and estate planning issues, celebrity estates, and aging in dogs. She provides links to sources for more details on selected topics. Enjoy!
https://elder-law.com/april-review/
Robert G. Kahl
CFA, CPA, MBA
In the title of his latest commentary, Ray Dalio, Founder of Bridgewater Associates, asks “Why in the World Would You Own Dollar Debt?” He argues that the current dynamic is “typical of the late stage of the long-term debt cycle.”
The world is a) substantially overweighted in bonds (and other financial assets, especially US bonds) at the same time that b) governments (especially the US) are producing enormous amounts more debt and bonds and other debt assets. This is particularly true for US bonds. US bond holdings are over a third of global bond holdings held by central banks, sovereign wealth funds, and international investors with the next largest country/currency bond being euro bonds at only roughly 60% of US bond holdings. Their overweighted position in US bonds is largely because of the “exorbitant privilege” the US has had being the world’s leading reserve currency, which has allowed the US to overborrow for decades. The cycle of becoming a reserve currency, overborrowing, and being overindebted threatening the reserve currency status is classic.
Some international investors are shifting a portion of their fixed income allocation from US$ bonds to Chinese bonds, which now account for about 6% of global portfolios. Given the low interest rates in many countries, investors have also been willing to invest more in common stocks and precious metals. However, bonds still have a place in portfolios for now, given valuation levels in the stock market that have already priced in a strong recovery.
The recent disclosure of some large bank losses due to business with Bill Hwang’s Archegos Capital raises some questions about derivatives and capital markets. A record level of margin debt has contributed to higher prices in the stock market, but derivatives have added another source of leverage for speculators.
Bloomberg estimates that derivative contracts with Archegos caused the forced liquidation of more than $20 billion in holdings. Much of the leverage used by Archegos was provided by Nomura Holdings Inc. and Credit Suisse Group AG via equity swaps and a type of derivative contract called contracts for difference. Archegos may never actually have owned most of the underlying securities, preferring to bet on the highly levered derivatives contracts instead. Among the stocks impacted by the forced liquidations was ViacomCBS which has dropped nearly 60% since March 22. The prime brokerage losses have not been fully disclosed yet, but Credit Suisse has reported a loss of $4.7 billion so far due to their business relationship with Archegos. Total losses for all banks are likely to exceed $10 billion.
Some of the large banks also have exposure in the precious metals markets with large short positions in silver, platinum, and gold. Futures contracts for these three metals have a higher level of contractual open interest relative to global production than other commodities. The short positions are highly concentrated among among eight large bank trading groups. For example, the eight largest traders are net short silver an amount that would require 180 days of global mine production. They are also net short platinum by 117 days and gold by 86 days of global mine production.
Investment demand for bullion and coins has picked up considerably from prior years. Sprott Asset Management compared the total demand for coins and bars at three government mints: the US Mint, Perth (Australia) Mint, and Royal Canadian Mint. For 2020, sales of gold coins and bars at the three mints was 157% higher than 2019, while the sale of silver coins and bars was 54% higher. Gold and silver bullion ETFs have increased their inventories of bars. Buyers of COMEX contracts are also requiring delivery of physical metal at higher levels than they did in past years. Given government and central bank policies around the world, investment demand for precious metals is likely to continue or rise from current levels. Higher prices should follow.
If you have any questions or comments, please contact me.
Robert G. Kahl
CFA, CPA, MBA
It has become too easy for Congress to borrow trillions of dollars per year. Why should Congress reduce spending or raise taxes when the Federal Reserve will accommodate a higher level of borrowing? READ MORE
The SECURE Act provides tax credits to offset some of the costs of establishing a new retirement plan, effective January 1, 2020. The maximum credit allowable is $5,000 per year for each of the first three years of the plan. This applies to a SEP, SIMPLE IRA, or a qualified plan (such as a 401(k) plan).
You are eligible as an employer to claim the retirement plan startup cost credit if:
The credit is 50% of your eligible startup costs, up to the greater of
In addition, there is a tax credit available of $500 per year for a 3-year period for employers that include an auto-enrollment feature. This credit also applies to plans that are in existence that do not currently have an auto-enrollment feature and convert to auto-enrollment.
If you would like information about the investment management services that Sabino Investment Management, LLC offers for 401(k) and 403(b) plans, click here: https://sabinoim.com/401k-and-403b-plans/
We also offer a free benchmarking comparison and efficiency analysis for existing plans with assets greater than $500,000. Our contact information: https://sabinoim.com/contact-us/
There has been much in the news about the Reddit crowd beating the hedge funds at their own game. GameStop Corp (GME), the retailer of video games and consumer electronics received the most attention. For the most recent twelve months that were reported ending in October 2020, the company had revenue of $5.16 billion and a net loss of $274.8 million. Revenue for the October quarter had declined by 30.2% from the prior year’s comparable quarter and the company had $446 million of cash and short-term investments. The declining fundamentals attracted short sellers. GME has a 52-week low price of $2.57 per share and a 52-week high of $483.00, achieved during its spectacular run-up last week. As recently as January 12, GME closed at $19.95 per share.
GME has 69.7 million shares outstanding. The float, which excludes restricted stock that cannot be sold to the public, is 49.3 million shares. In mid-January, there were 71.2 million shares of GME that had been sold short, or 144.3% of the float. Technically, shares which are sold short must be borrowed from a brokerage firm that holds the shares in the margin account of customers. Short sales generate additional business for brokerage firms. The cost of borrowing shares of GME stock exceeded 20%. When a brokerage firm lends shares that it does not hold in a customer margin account, it is called a “naked short” and the brokerage firm is taking a financial risk.
Call options contributed to the price action in GME stock. Some speculators buy options instead of the stock to get more leverage. Options dealers who sell the call options usually purchase the stock to hedge their exposure on the call options. So, the options dealers become another source of demand for the stock.
The large GME short position attracted some attention and the Reddit/WallStreetBets crowd, with over 8 million members, pushed the idea of buying GME stock and its call options en masse to force additional buying by the shorts to cover their losses. It worked! According to some traders, as older shorts incurred large mark-to-market losses and were forced to buy shares to meet margin calls during the last week of January, new shorts who were able to find shares to borrow established new short positions. The shorts were then aided by several brokerage firms who forbid the purchase of GME shares by retail investors late last week. The hedge funds and other short sellers were able to cover their short positions (buy shares) without competition from the Reddit crowd, many of whom were unable to buy shares but were allowed to sell shares. By Monday, February 1, the GME short interest had declined to 39% of the float.
Other heavily shorted stocks benefitted from the market action. AMC Entertainment (AMC), BlackBerry (BB), and Nokia (NOK) all had similar but less exaggerated price action. AMC and American Airlines (AAL) used the price spike to sell additional shares to the public to raise some cash for their businesses.
Some media commentators, professional investors, and politicians have called for a Congressional investigation and additional regulatory intervention. Jack Inglis, CEO of the Alternative Investment Management Association (AIMA), said, “What is dangerous, amid this trading frenzy, is that retail investors have been chasing prices so far above any sane valuation and that many well end up nursing losses.” True, but many are skeptical that an organization that includes many hedge fund managers is concerned about small investors.
Hedge funds that shorted Gamestop and other companies with poor fundamentals have large losses for the month of January. ZeroHedge.com estimates that one hedge fund, Melvin Capital, lost over $7 billion or 53% of its capital in the month of January. The Wall Street Journal reported that another smaller hedge fund, Maplelane Capital, started the year with $3.5 billion and had a loss of 45% by the end of January.
Regarding potential changes in the regulatory environment to rein in the Reddit crowd, Ryan McMaken, senior editor at the Mises Institute wrote this:
This “exemption from free market discipline” is what Wall Street is all about these days. The financial sector has become accustomed to enjoying bailouts, easy money, and the resulting financialization which puts ever greater amounts of the US economy into the hands of Wall Street money managers. The sector is now built on corporate welfare, not “free markets.” No matter what happens, Wall Street expects the deck to be stacked in its favor.
One question that has not been addressed in all the media coverage of the GME saga is the function of short sales in the financial markets. It generates more commissions and fees for brokerage firms, and the hedge funds claim that it is a strategy that justifies their generous fees. But short sales shift capital from a productive economy that produces goods and services to a speculative economy that does not provide capital to produce anything but has a lot of activity to support a zero-sum game where market participants place bets against each other. Is it any wonder that the US now has large trade deficits every month? For the last reported month of November 2020, the US trade deficit was $68.1 billion. Maybe our financial markets should put a greater emphasis on providing capital to companies that can provide goods and services at a profit.
If you have any questions or comments, please contact me.
Robert G. Kahl
CFA, CPA, MBA