Profitability of Stocks in the Russell 2000 Index

The below chart is a look at the percent of unprofitable companies in the Russell 2000, looking back from 1998 through the second quarter of 2023. This particular chart was in JPMorgan’s Guide to the Markets. On its own, it generates a number of questions. The primary question I asked myself is, Has the upward trend in unprofitable companies in the Russell 2000 impacted the return over the same time period?

When this was posted by JPMorgan and when I reviewed it, the markets had yet to pop from the positive news from Jerome Powell and the Fed of interest rates holding firm. Granted, the door is still open for more hikes, but the language and odd for now suggest a pause. Since that news, small cap stocks are up over 6%. But again, based on the timing of the post post Q3 and with how Q4 was starting, it seemed the implication of unprofitable companies was to suggest a possible reason for small cap underperformance in 2023. Perhaps the increase in unprofitable companies has led to an uptick in volatility and downside pressure during any time of uncertainty. That was my first thought, so perhaps I’m biased when thinking others made the same connection.

When looking at the historical returns of the Russell 2000 index (below), it seems far from the truth. In the same time period, (1998 to now) the Russell 2000 index has return a cumulative 309%. Annually, that math’s to roughly 12.25% each year. To be fair, that’s to be expected with the stock market - over time, stock prices appreciate and the riskier ones tend to appreciate a little more.

 

One thought to wrap this up - perhaps as the unprofitability trends up and the risk associate with small caps (one would assume) follows, the expected annual return may follow.

The Impact of Rates on Aggregate Bond

Interest rates and bond prices have an inverse relationship. When rates go up, bond prices go down, with the opposite being true as well. So as the Fed has hiked interest rates with breakneck speed to try and counter inflation, bond prices have fallen. 

The chart above is a look at the US Aggregate bond index as of September with forward charting estimates based on potential rate changes. Based on current duration and yield: 

• If rates increase 1.0%, we can expect the yield to return 5.4% (current) while experiencing a negative price return of -6.2%. 
• The middle hypothetical shows a 5.4% 1-year return, all earned from the yield. 
• Should rates fall by 1.0%, investors would expect to earn the yield return of 5.4% along with the positive price return of 6.2% for a total 1-year return of 11.6%.

 

Bitcoin: Blockchain, Mining, Energy

It’s no secret that Bitcoin and cryptocurrencies, in general, have gained significant popularity and notoriety over the last 12 months. Most notably because the return has been an astronomical 430% over the time period, but also due to companies such as Tesla, MicroStrategy, and Square investing a collective $3.9 billion earlier this year. For anyone invested in Bitcoin or following the asset, this last year has not been without its ups and downs.

What is Bitcoin?

Bitcoin is a decentralized digital currency. All transactions made with bitcoin are noted on a public ledger and verified by a network of computers. Many people and companies are working to verify transactions instead of just one entity, making it decentralized. The public ledger of bitcoin transactions is stored in the blockchain.

 

Irrational Exuberance

There’s no question markets have been volatile this year. If we peel back the top layer, there are many different events we can blame it on: inflation, treasury yields, the Fed and interest rates, Covid vaccines, unemployment, even the colder than normal February. But, what if we didn’t peel back the top layer? Instead, we focus on a potential over-arching theme as a way to over-simplify what’s been happening in the stock market.

In a December 1996 nationally televised speech, then Chair of the Federal Reserve Board Alan Greenspan referred to the behavior of stock market investors as “irrational exuberance”. Since then, this term – irrational exuberance – has been used to in conjunction with speculative and instable markets.

In his bestselling book aptly titled Irrational Exuberance, author/economist/Nobel prize winner Robert Shiller defined it as,

“the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increase spurs investor enthusiasm, which spreads by psychological contagion from person to person, and, in the process, amplifies stories that might justify the price increase and brings in a larger and larger class of investors, who, despite doubts about the real value of the investments, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.”

One of the longer sentences you’ll see, but by breaking it down and providing some examples we can better understand what it means. And, how it might explain markets today.

 

Power of the Retail Investor

In recent weeks, and more notably recent days, shares of GameStop [GME] and AMC Entertainment Holdings [AMC] have been gobbled up hordes of retail investors. So much so that prices have gone up 320%, and 161% just since Monday, respectively. In “GameStop Mania Reveals Power Shift on Wall Street—and the Pros Are Reeling”, a recent article published in the Wall Street Journal, journalists Gunjan Banerji, Juliet Chung, and Caitlin McCabe explain how this has been happening and the culprit behind these mammoth price movements.

What started as a general conversation about the potential value of GameStop on popular platforms like Reddit, Facebook, Twitter and Discord has turned into an all-out war “between professionals losing billions and the individual investors jeering at them on social media.” So much so that regulators within the SEC are beginning to look into the potential of market manipulation.

 

Market Predictions

“The only function of economic forecasting is to make astrology look respectable.”  – John Kenneth Galbraith, Economist

 

THE 2021 MARKET PREDICTIONS ARE IN, AND THEY’RE PROBABLY WRONG.

 

Every year, the top investment banks, research institutions, and market analysts make their predictions on where the S&P 500 (stock market) will close the year. They have mountains of research at their disposal, a slew of economic indicators, and they still get it wrong most of the time.

Take 2008 when the markets fell 38% as an example:

• “Stocks will reach new record highs at some point during the upcoming year.” – Robert C. Doll, Vice Chairman and Chief Investment Officer of Global Equities at BlackRock (January 2009)
• “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of these [credit default swap] transactions.” – Joseph Cassano, AIG financial products head (August 2007)
• “The Federal Reserve and Congress have delivered a ton of economic stimulus, and that stimulus is set to juice up an economy that has been weak, but not terrible. If everything goes according to plan, the economy will grow faster in the second half of the year, and a recession will have been avoided.” – Kevin Hassett, American Enterprise Institute (June 2008)