Meme stocks, interest rates and drama

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Meme stocks show the value of active management

By Cara Esser, CFA
Director of Portfolio Management and Research

The euphoria in the stock market following the so-called Vaccine Monday (November 9, 2020) left very few stocks and sectors untouched. Stocks soared and interest rates spiked as investors began to imagine a post-COVID world. Most broad-market stock indexes made tremendous gains in the months that followed, and small-cap value stocks led the way. During the last two months of 2020, the Russell 2000 Value index gained nearly 30%. The index continued to rise and is up an additional 22% for the year to date, though dropped 3% during the third quarter.

The Russell 2000 Value returns over the last several quarters have largely been led by two stocks, GameStop (GME), up 832% for the year to date, and AMC Entertainment (AMC), up 1,695%. According to research done by Sycamore Capital, a manager of active small and mid-cap value stock portfolios, both stocks accounted for approximately 7% of the index’s returns for the year to date through June 30. And, incredibly, those two stocks accounted for more than a quarter of the returns during the second quarter alone.

This is because most indexes are calculated based on market cap—higher market cap stocks account for larger portions of the index. As AMC and GME captured the hearts of “meme” traders, their market caps skyrocketed as their prices soared. For context, as of August 31, AMC accounted for about 1.5% of the Russell 2000 Value index, a whole percentage point higher than the next largest stock. GameStop was pushed out of the small-cap value index and into the mid-cap value index at the end of June due to its ever growing market cap. These impressive gains have been a boon to index returns and passive strategies that follow them, but the story for active managers is a different one.

Small (and sometimes) mighty 

In the small-cap arena, there are many unprofitable companies—around 50% of the stocks in the Russell 2000 Index do not have positive earnings. Another subset of companies populating the index are once-industry leaders whose fortunes have changed and futures remain murky, this includes AMC and GME. Most active small-cap managers either avoid such stocks or own very few and in very small allocations given their undesirable current earnings streams, future prospects, or both. While AMC and GME share prices were skyrocketing, many active managers watched from the sidelines as performance lagged indexes and many passive peers. The average active small-cap value fund trailed the Russell 2000 Value index by more than 300 basis points for the trailing one year through June 30.

But fortunes can change quickly and last quarter active managers gained ground as AMC dropped over 30% (GME also lost ground last quarter, down 18%, but it was removed from the index at the end of June).  The average actively managed small-cap value fund outperformed the index by 100 basis points last quarter. AMC’s share price drop isn’t the only reason for the outperformance, but it is part of the rotation that took place last quarter, to high quality from low quality stocks. The table below compares returns for AMC, GME, Russell 2000 Value index, and the average active small value manager.

  Total Return (%)
  3Q2021 YTD 1 Yr 3 Yr
GameStop (18.06) 831.37 1,620.29 125.99
AMC Entertainment (32.85) 1,695.28 708.07 24.00
Russell 2000 Value (2.98) 22.92 63.92 8.58
Average Active Small Value Manager (1.90) 23.95 61.84 8.39

Source: Morningstar as of 9.30.21. Past performance is not indicative of furture results

The average active small-cap value manager is slowly gaining ground, but the huge returns during the fourth quarter of 2020 are still holding back trailing one-year returns. As the market has reached all-time highs and with uncertainty in the market also high, active managers maintain a potential advantage over index fund and passive peers given their ability to avoid low-quality names and emphasize those with better financial positions, strong management teams, and strong future prospects.

Signal or noise?

Other than the excitement around certain “meme” stocks, the market has had no shortage of noise this year. Most recently, the Federal Reserve has begun talks of tapering (purchasing fewer and fewer Treasury bonds over time until they stop purchasing all together) which is a precursor to raising the Federal Funds rate off of zero. The market has taken this news in stride so far and the Federal Reserve has been a careful communicator of the changing policies. 

Congress provided another potential concern for the stock market last quarter with a possible government shutdown due to the failure to raise the debt ceiling. After a few weeks of posturing and several days of losses in the stock market, the debt ceiling has likely been resolved, at least temporarily.

Meme stocks, interest rates, and drama in Washington can roil the market and become short-term distractions, especially for retirement savers. Remember that saving for retirement is a long-term goal, even for those in retirement who may have upwards of 30 years in retirement. If news stories like these cause an uneasy feeling about your current retirement allocation, it’s a good time to revisit your risk tolerance. It’s also a good time to consider the level of diversification in your portfolio. The growth-fueled rally of the last decade may have left some portfolios heavily tilted towards large-cap growth stocks which can alter the risk/reward profile of your portfolio in a manner that is unsuitable for your risk tolerance. A regular check-in on your allocations will ensure your portfolio maintains an appropriate tilt to both size (small versus large) and factor (value versus growth) tilts.

Market Metrics

During the third quarter, markets put up mixed results—the S&P 500 Index closed the quarter nearly flat (up 0.58%), bringing the year-to-date return to 16%. The Aggregate Bond index was flat this quarter, leaving year-to-date returns at -1.6%. International stocks continued to lag the US stock market. The MSCI ACWI ex US lost 0.45% for the quarter, putting it up just 8% for the year. The MSCI Emerging Markets index lagged further behind as it lost 8% during the quarter largely due to the issues in China. The index is now down more than 1% for the year.

  Total Return (%)
  3Q2021 YTD 1 Yr 3 Yr 5 Yr 10 Yr
S&P 500 0.58 15.92 30.00 15.99 16.90 16.63
MSCI EAFE (0.45) 8.35 25.73 7.62 8.81 8.10
MSCI Emerging Markets (8.09) (1.25) 18.20 8.58 9.23 6.09
BBgBarc Aggregate Bond 0.05 (0.55) (0.90) 5.36 2.94 3.01

Source: Morningstar as of 9.30.21. Past performance is not indicative of furture results

 

Source: Morningstar

Important Information:
The Bloomberg Barclay’s Aggregate Bond Index is a broad based, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States.
The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The MSCI ACWI ex US Index is comprised of non-U.S. stocks from developed markets and emerging markets.
The Russell 1000 Index is a broadly diversified index made up of top companies by market capitalization in the United States.
The S&P 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.
The Russell 1000 Growth Index is a broadly diversified index predominantly made up of growth stocks of large U.S. companies.
The Russell 1000 Value Index is a broadly diversified index predominantly made up of value stocks of large U.S. companies.
The Russell 2000 Index is a composite of small cap companies located in the United States.
The Russell 2000 Growth Index is a composite of small cap companies located in the United States that also exhibit a growth probability.
The Russell 2000 Value Growth Index is a composite of small cap companies located in the United States that also exhibit a value probability.
The Russell Mid Cap Growth Index measures the performance of the mid- cap growth segment of the US equity universe.
The Russell Mid Cap Value Index measures the performance of the midcap value segment of the US equity universe.
The indices are unmanaged and does not incur management fees, transaction costs or other expenses associated with investable products. It is not possible to directly invest in an index.

GameStop and AMC Entertainment were included for illustrative purposes only and are not a recommendation to buy or sell.
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