The markets continued to climb during the first quarter with the S&P 500 Index gaining 5.8% and sitting at all-time highs, although many growth and stay-at-home stocks that were big winners during the pandemic did not participate in the rise.  The increased pace of the vaccine rollout and reduced Covid cases, hospitalization and deaths led investors to bid up stocks of companies they believe will benefit from the reopening of the economy.  Airlines, cruise ship operators, banks, retailers and hospitality companies were among the big winners.  Also, fossil fuel companies rallied as oil prices rose while green energy companies gave back some of the huge gains they had in 2020.

The biggest market headlines during the quarter were generated by a handful of small capitalization companies that garnered the attention of retail investors.  Most notable among these was GameStop (“GME”), a struggling brick and mortar, video game retailer that during 2020 was thought to be a failing business and whose stock traded under three dollars per share as recently as April 2020.  GME was the subject of numerous posts in Reddit’s Wall Street Bets (WSB), which called upon an army of inexperienced (and some experienced) investors to buy the stock in part to damage some large hedge funds that had shorted the company’s stock.  Shorting a stock is essentially selling a stock with the hopes that it will decline in price and can be purchased later for less than it was sold prior.  While profitable when a stock declines, shorting a stock risks potentially unlimited losses should the stock price increase, and increase it did!  During this “mania”, the stock reached as high as $482 in January 2021.  Imagine selling a stock for $10 dollars and having to buy it back at $400?  That was reality (although nobody outside those hedge funds knows the exact numbers) and caused some hedge funds to suffer huge losses to the delight of the Reddit posts’ authors.  The problem is that some of the inexperienced, Reddit-post reading investors continued to buy at $300, $400 and more only to watch as the price of GME declined to below $40 within weeks and then rebounding to close the quarter at about $190 per share.  I found it fun and interesting to watch from the sidelines, but it is pure speculation, an attempt to game the greater fool theory and not what I consider investing.  Therefore, Maidstone did not participate in these stocks with clients’ funds.

GME and other Reddit WSB stocks, digital currencies and cannabis companies are what I believe to be examples of speculative areas of the markets that cause me great concern.  As I mentioned in last quarter’s letter, speculative momentum can continue longer than many market participants, myself included, think rational.  As I also wrote, momentum cuts both ways and when the tide turns, you will not want to be standing in the way.  Examples of pandemic winners that had huge gains and became household names in 2020 were home fitness company Peloton, remote meeting company Zoom Video and cloud data platform Snowflake.  All are great companies with great products, but their valuations were based on investor demand (momentum) and not fundamentals.  At quarter’s end, they were all down 35-50% from their high prices touched earlier in the quarter or in the fourth quarter of 2020.

While there clearly are speculative excesses, there were also several fiscal and monetary policies and proposals that positively impact my view of certain segments within the markets.  The Federal Reserve continues to communicate their belief that inflation will remain at acceptable levels and therefore intend to keep rates low (and stimulative) for the foreseeable future.  The Biden administration got their $1.9 trillion stimulus package passed and much of the money is now in the pockets and bank and investment accounts of American citizens.  We are now awaiting the outcome of the proposed $2.3 trillion infrastructure plan, which includes a huge amount of investments and tax credits to accelerate the move to cleaner energy and universal broadband access among other items.  The Biden Administration plans to fund it through an increase in corporate tax rates from 21% to 28% (which Trump had lowered from 35% to 21% in 2017), closing tax loopholes and increased tax rates on families earning over $400,000.

I’m experiencing a cognitive tug-of-war when analyzing the speculative excesses and increasing deficit against the accommodative monetary and stimulative fiscal policies, While the prospect of ever-increasing deficits is troubling, the historically low interest rates keep the debt-servicing costs at reasonable levels and many parts of the economy will benefit from the infrastructure investment.  Additionally, many companies whose businesses were crushed by the pandemic have learned how to operate with less and as revenues return to more normalized levels, I would expect their operating margins and profitability to increase, justifying higher stock prices.

Corporate bonds fell during the quarter as inflation fears due to the large stimulus plan distributions and the proposed infrastructure plan moves closer to reality.  As stated in last quarter’s commentary, I had more cash in my clients’ fixed income allocations than normal and I continue to hold cash, but given the decline in bond prices, it has proved wise thus far.  That cash will be deployed into bonds and fixed-income ETFs when prices better reflect the risk of increasing interest rates and credit risks.

I hope you and your loved ones are safe and looking forward to a return to a more open society.  I, for one, have received both doses of the vaccine and feel more confident about getting back to engaging with friends and family although I will continue to observe many of the recommended safeguards.   I’m grateful to the pharmaceutical companies and all the healthcare and other workers who have been and continue to work non-stop to develop and distribute the vaccines.

If you have any questions about this commentary, the markets or anything else related to your financial life, my line is always open.

Best regards,

Steve