Though the challenging year of 2020 finally ended, the first month of the New Year was no big improvement. As expected, coronavirus case numbers continued to rise, and the long-awaited vaccine rollout was fraught with problems. Meanwhile, new strains of the Covid-19 virus emerged and—even as a new presidential administration took office—the nation remained as politically divided as ever. How did the financial markets react to all this? Well, mostly with the same kind of cautious optimism we’ve seen since November, but there were some new signs of vulnerability.
The Dow Jones Industrial Average started February near where it started January: at just over 30,200. In the days between, it hit several new record highs, and just before the month ended, it briefly sank below 30,000 again for the first time since mid-December. What caused the dip? Well, as I’m sure you know, it was a wave of investor panic and confusion over the stunning GameStop rally fueled by day traders on apps like Robinhood and Reddit.* The surge of buying in this fairly modest retail stock pushed the price sky-high and caused what’s known as a “short squeeze”, which forced sellers who had bet against the stock to quickly unwind their trades. Those sellers were mainly big hedge funds, and they ended up losing billions.
In addition to the Dow’s big drop, the S&P 500 and Nasdaq both fell by nearly 2% amid the frenzy, and the market overall had its worst week since October.** Within a few days, it had regained most of those losses as the GameStop rally fizzled.*** Many hailed all this as a David and Goliath tale showing how “everyday Americans” could beat Wall Street at its own game. Unfortunately, it’s not that simple, since it wasn’t just big brokerage firms and corporate kingpins who took the hit; it was other “everyday Americans” whose pensions are tied to those hedge funds, and whose 401(k)s shrink when the market drops.****
Much has already been written about this remarkable turn of events, and the Securities and Exchange Commission is taking a hard look at it. Was it a fluke, or a hint that the market may be vulnerable to a major correction triggered by everyday investors playing games (no pun intended)? Some analysts have said the incident illustrates all too clearly how a certain kind of stock market investing is really just another form of legal gambling.
I agree there is a strong element of “gaming” involved in investing in growth stocks. Although you might feel the risk is worthwhile when you’re in your 30s or 40s, once you’re older you tend to realize that suffering a big loss at the “gaming table” would have harsher consequences. That’s because you no longer have the luxury of time to recoup the savings you’ll need to generate retirement income. That’s one of the main reasons I began specializing in income-based strategies, which are less vulnerable to the kind of volatility triggered by the GameStop incident. Even the common stock strategies used in an income portfolio can mitigate risk by being value-based rather than growth-based, which means oriented toward dividends rather than capital gains.
Another good example of the difference between investing for income versus growth was well-illustrated by another market development in January that got much less attention than the GameStop rally. Between January 4th and the 11th, the yield on the 10-Year Treasury rate spiked from 0.93 to 1.15%, then leveled off.***** That’s significant because when interest rates go up it creates a bit of a headwind for the bonds and bond-like instruments that typically form the foundation of an income-based portfolio. If you have such a portfolio and were reviewing your statements every day during the week when the 10-Year took that jump, you may have seen the value of your bonds and bond-like instruments drop by 1 or 1.5% due to the headwind. However, if you had kept reviewing them daily for the rest of the month, you would have seen those values rebound to a large extent as interest rates leveled off.
The even better news is that none of that really matters because your income was unaffected. That means if you didn’t look at your statements at all during January, you probably wouldn’t even have noticed how the interest rate jump affected your investments. Now, is another interest rate jump possible this year? Could the 10-Year Treasury yield get to 2%? Well, anything is possible, but I think that scenario is unlikely.
The initial rate spike in January was probably triggered by New Year’s optimism around the prospect of more coronavirus relief, along with the Fed’s commitment to quantitative easing and keeping short-term rates near zero. That could trigger some healthy inflation and keep the recovery moving forward. Although with Covid-19 cases still rising and unemployment a growing concern again, there is still a lot of uncertainty out there, and many potential triggers for another stock market correction.****** Those are just the obvious triggers; never mind the potential of another surprise like the GameStop saga!
As always, the main point right now is to make sure your current allocation is still aligned with your goals, your situation and your risk tolerance—all of which are subject to change, especially during a period of unprecedented change and uncertainty, like now!
*“GameStop? Reddit? Explaining What’s Happening in the Stock Market,” NBC, Jan. 27, 2021
**“Dow Drops More Than 600 Points… Amid GameStop Trading Frenzy,” Jan. 28, 2021
***“GameStop Rout Deepens to Erase $26 Billion from Peak,” Bloomberg, Feb. 2, 2021
****“Why GameStop Frenzy May Hurt Retirees Along with Hedge Funds,” CNBC, Feb. 1, 2021
*****YCharts.com *****“US Workers File 847,000 New Jobless Claims as Pandemic Rages On,” AP, Jan. 28, 2021