The market went down about 620 points in January or about 2%. 2% is not a big deal. The market will likely recover from that quickly. Given that the group WallStreetBets caused a short squeeze of Gamestop and various other securities, the topic of this newsletter will be on defining what a short squeeze is.

There are two basic ways you can theoretically profit from a stock. You can go long (you profit when the stock goes up) and you can go short (you profit when the stock goes down). Going long is easier to understand. You bought a stock at given price, you sell it later at another price, and hopefully you sold it at a higher price than how you bought it. For example, if you buy a baseball card at 5 dollars, and later sold it at 10 dollars you engage in and profited from a long transaction. You made 5 dollars of profit. A short transaction would be you borrowed a stock and then sold that borrowed stock to another person. You later buy that stock in the market and give it back to whoever you borrowed it from. Someone who engages in short transaction is called a short seller. Continuing the baseball example, let’s say you borrow that card from a friend and then you sell that card for 10 dollars. The price of the card drops to 5 dollars, and you buy the card back from the store for 5 dollars. After you return the baseball card to your friend, you made 5 dollars of profit. Of course, if the price of the baseball card soars to 100 dollars, you are still required to buy that card back so you can return your friend’s property, in that case you lose 90 dollars.

With stocks, you are not borrowing from a friend, you are borrowing from the brokerage company. They want to be sure you can pay it back. If the price of the stock soars really high, the brokerage company is going to be worried that you don’t have enough money to buy the stock back. Therefore, they will initiate a margin call. When that happens either you deposit more money into the account or you have to buy the stock back immediately in the market and return it to the brokerage company. The sequence of a short squeeze would be, a margin call causes a bunch of short sellers to buy the stock. The buying causes the price to go up. The increasing price causes more margin calls to occur. As a result, more short sellers buy the stock, which causes the price to go up further, and so forth. The stock thereby goes up in a self-perpetuating loop. Gamestop was a heavily shorted stock, so when a bunch of people from the WallStreetBets forum bought the stock, that loop was initiated.

If you have any questions about this topic or any other, please call at any time. We sincerely hope you got value from this newsletter. We appreciate your business and trust.

Thank-You,

Daniel and Eli

As we’re writing these to help our readers, we would be very appreciative of any input in regards to what we should write next. If you want us to write about a particular topic, please contact me. Please contact me if you would like to submit a post to our blog.

If anything that we mentioned above interests you, please consider downloading our free e-book. The book contains our thoughts on investment management and some information that we think everyone should know. You can also download it below.

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The stock market in November was fantastic. The Dow went up over 3100 points or 11.7%. Despite the pandemic and the chaos in the world, the market is actually up for the year (1055 points or 3.7%), which illustrates clearly the importance of staying calm and ignoring the talking heads on TV that constantly foretell doom. The topic of this newsletter will be Market Capitalization.

Market Capitalization (Also known as Market Cap) is simply what a company is worth on the stock market. It is the price per share multiplied by the number of shares outstanding. Market Cap is used as a way of categorizing companies because historically stock returns for large cap (over $10 billion), mid cap (between $2 billion and $10 billion), and small cap (below $2 billion) have all been different. As a rough rule of thumb, the larger the company, the lower the annualized returns have been historically. While there are time periods that are exceptions, over time a small cap index will most likely have a higher return than a large cap index.

The reason for these return characteristics is risk. In finance there is a relationship between risk and return. Riskier assets tend to have higher returns. As risky assets have a higher risk of default or bankruptcy than a non-risky asset, investors demand a higher return in order to assume that risk. For a risky stock that stock will only be purchased by investors if the price of that stock is bid down until it is cheap relative to its value. Most large cap companies have likely been around for many years, and have stable cash flows, profits, and expenses. Therefore, the chance of some catastrophic corporate event happening is low. Investors don’t need that much of a risk premium to assume the risk of investing because there isn’t much risk. Small cap companies of the other hand might not have a long lasting or reliable track record on cash flow, operating history, etc. The chance of a catastrophic corporate event is pretty high. Investors therefore need a high risk premium for them to assume that risk because they want to be compensated for taking on that high risk.

If you have any questions about this topic or any other, please call at any time. We sincerely hope you got value from this newsletter. We appreciate your business and trust.

Thank-You,

Daniel and Eli

As we’re writing these to help our readers, we would be very appreciative of any input in regards to what we should write next. If you want us to write about a particular topic, please contact me. Please contact me if you would like to submit a post to our blog.

If anything that we mentioned above interests you, please consider downloading our free e-book. The book contains our thoughts on investment management and some information that we think everyone should know. You can also download it below.

E-Book Download

Questions for the comments

Did the newsletter make sense? Do you agree or disagree with what we said?

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The market recovered by over 1,100 points in May. While the Dow is still 4,000 points off the peak, we have gained back about 7,000 points from the low in March. Almost all of you made money this month and that recovery leads us to the topic of this newsletter.

The topic of this newsletter will be contrarianism. In short, it refers to the idea that the crowd that makes up stock market investors are often irrational. They are foolish when the news is dramatic and then overreact to news which drives stock prices too low or too high. Eventually, the stock prices will snap back to a normal level. The normal level is very subjective but can be approximated via valuation metrics, GDP growth, inflation, etc. Pop quiz, if the market plunges 50%, is that a time to buy to sell? We assert that it is a time to buy.

If you’re invested in a well-diversified domestic collection of stocks, then you are in essence invested in the US economy. Unless you think that COVID is going to permanently lower the US economy, eventually the US economy and the stock market will recover to its previous peak and exceed it. If you are concerned that COVID will permanently lower the economy, you shouldn’t be, we have recovered from many disasters in the past and this situation shouldn’t be any different. As we said in a previous newsletter, some industries will die, some industries will adapt, and some new industries will be created in the new world we are entering. Overall, we will be fine.

When the market started to plunge in February, our contrarianism made us think that eventually stock prices would snap back to normal. Of course, we did not know how long it would take to snap back. As long-term investors, we are willing to wait for our profits. Instead of seeing the plunge as a reason to panic, we saw it as an opportunity to grab a bargain. We rebalanced client portfolios during the plunge. We bought more mutual funds and stocks. Also, for their own portfolios, both Daniel and Eli invested heavily during this time. In the long run, we assert that the plunge is temporary, and the recovery supports our assertion. It is also very nice that this recovery is happening so quickly.

If you have any questions for us, please call at any time. We sincerely hope you got value from this newsletter. We appreciate your business and trust.

Thank-You,

Daniel and Eli

As we’re writing these to help our readers, we would be very appreciative of any input in regards to what we should write next. If you want us to write about a particular topic, please contact me. Please contact me if you would like to submit a post to our blog.

If anything that we mentioned above interests you, please consider downloading my free e-book. The book contains our thoughts on investment management and some information that we think everyone should know. You can also download it below.

E-Book Download

Questions for the comments

Did the newsletter make sense? Do you agree or disagree with what we said?

Learn About Our Business