MOMENTUM GIVETH; MOMENTUM TAKETH AWAY
Escalator Up; Elevator Down
January 24, 2022
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BEAT THE BANK
Growing up there was a radio segment called Beat the Bank. I’m not sure if it still exists today but the premise is as follows. Contestants would call in and try to win money by opening vaults. Each successive vault had more money than the previous one. But every time a vault is opened, the contestant runs the risk of triggering the alarm, giving back all gains.
For instance, opening the first vault might net you $100. The second would take your winnings to $300. The third $600. But if the alarm bell goes off when the contestant opens vault #4, they walk away with nothing. They had the option of crystalizing gains at any point but lost everything trying to squeeze out more than they should. This feels a lot like the stock market today.
NFLX – PARETO ON THE GEAR
Everybody is probably familiar with the famous Pareto principle, also known as the 80/20 rule. Financial markets experience this principle on steroids. The adage “up like an escalator, down like an elevator” exists for good reason.
Last Friday Netflix reported earnings that took the stock down 25% (after already falling 28% from its peak). Investors can now buy shares below pre-Covid levels. The stock went up 80% in roughly 430 trading days, only to give back all of those gains – and then some – in the follow 45 trading days.
The distribution of gains, in this case, follows a 90/10 principle. Investors were making money 90% of the trip all the way up, overstayed their welcome by 10% and have round-tripped the entire journey. Even worse, shareholders and money managers were likely averaging up along the way as price action confirmed their thesis (or so they thought) and/or as they received fund inflows from performance chasers.
Chasing things feels great while the tide rises but, if you overstay your welcome by even just a little bit, the door slams shut, and the house takes your money. No refunds.
ARKK – EPITOME OF PERFORMANCE CHASING
Sometimes drawdowns are more prolonged. For instance, ARK Innovation ETF (ARKK) is a perfect example of a bubble grinding lower and deflating for longer. In fact, as of today, the flagship ARKK ETF is only up ~8.5% in total since February 2020. Investors piled in at the top, and the ETF has lost money for clients overall as net inflows coincided with the stock price peak. Worth noting, this 60% decline took almost a year and would have been bigger and happened more quickly if it wasn’t for TSLA.
Peloton Interactive (PTON) is another stock trading below pre-Covid levels. The stock was up almost 400% from February 2020 before giving it all back. The ~85% drawdown happened in step functions and many PTON bulls likely approached each “correction” with a buy-on-dip mentality.
As we scroll through our watch list, this price action is more common than you might think. Specifically, a lot of SMID cap stocks on our watch list experienced blow off tops last year and have fallen incredibly quickly since then. Many are down 50%+ and have round-tripped back to where they were pre-Covid. The broad indexes are finally beginning to bleed, albeit slightly, but there is carnage underneath the surface.
Momentum giveth, momentum taketh away.