And the Correction Continues!

image: Wikimedia commons (link).

Over the last few months, we have seen a continuation of significant volatility in our portfolios, in both directions, up and down.  In our recent Investment Climate quarterly commentary, we described it as wild.  Well, in the first couple weeks of May the correction in growth companies' stock prices has returned to the downside, again mostly based on the "rotation" by traders (speculators, and sometimes outright gamblers) out of "growth" stocks and into "cyclical" stocks.  

In what we view as an oxymoronic type of "conventional wisdom," the idea is that higher inflation will cause an "outperformance" of cyclical companies which might fare better, albeit on a short-term basis, due to an over-heating economy driven by plentiful money being supplied by the US Federal Reserve.  

While more cyclical industries may well demonstrate higher earnings growth for a short period in an overheating economy (think for example of a company which produces commodities)  -- as opposed to businesses which grow over longer periods lasting through many economic cycles --  the very cyclical nature of those companies means that their fortunes will be short-lived.  Ultimately, the investor is forced to become a trader, picking the bottoms and tops of economic cycles: a very difficult task to say the least.

Taking this a step further, inflation will eventually lead to a steep and aggressive tightening of the money supply by the Fed.  This ultimately results in slower economic growth, thereby forcing the cyclical trade in the opposite direction.  

And let's go one step further than that.  We are hearing the geniuses that run the U.S. Government politicians saying they want to increase tax rates significantly.  Combine the effects of massive tax increases with higher interest rates and you are looking at a serious hit to economic growth. Good luck with trading that!

Regardless, as we have said before regarding corrections in the values of our companies, the reasons for cyclical market swings are almost irrelevant to us.  They are bound to occur, especially after periods of strong performance.  Yes, the values of our companies can get ahead of themselves.  And, as we counseled previously: when values become stretched, it is wise to raise cash if there are needs for that cash in the shorter-term outlook (1-3 years).  

However, these corrections are definitely opportunities to buy with long-term investment capital.  We have no idea if we are at the end of the current corrective phase or not.  What we do know is that the vast majority of our portfolio just came off of very positive earnings reports and, in general, those businesses are doing what we ask of them.  

We believe the values of our companies will reflect those positive prospects over time, as they always have in the past.  Time to start stepping up the buying!


Disclosures: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Taylor Frigon Capital Management LLC (“Taylor Frigon”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Taylor Frigon. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Taylor Frigon is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Taylor Frigon’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are a Taylor Frigon client, please remember to contact Taylor Frigon, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.

Continue Reading

Investment Climate April 2021: The Challenge Ahead


Market activity in the first quarter of 2021 can be best described as “wild. Volatility, now a staple of the modern market, has taken on a whole new meaning and we would use the phrase “wild volatility” in order to describe what we have been witnessing on a day-to-day, hour-to-hour, and even second-to-second basis! While we have experienced outsized performance in recent years, quarters and months, we have been warning that a correction was due.  About mid-quarter, we began to see the correction take form. The excuse was a “rotation” from growth-type stocks to cyclical or “value” stocks, but the reason is irrelevant; it was simply time to “ring the bell” for a correction.  

That said, we have come off a period of very strong stock price performance for our portfolio companies, largely because of very strong business activity in those companies. Despite the aforementioned correction in recent weeks, strong performance overall resulted in outperformance for our growth portfolios versus most major stock market averages again in the first quarter of 2021. 


Recall that our strategy stays fully invested through market and economic cycles.  We don't try to predict the market or economy; we try to predict businesses and let the stock prices take care of themselves.  We believe that if we predict the businesses properly, prices will follow over time. 


Nonetheless, we are very early in the lifecycles for many of the businesses we currently own. We have spent the last few years exiting some very successful companies that had grown to be quite large and had matured enough to where they no longer were meeting our criteria for future growth. As such, we have spent those years positioning the portfolio in many younger, high-potential companies that we believe have exceptional growth still in front of them. We believe these innovative companies are the best defense against what is shaping up to be a less-than-favorable economic environment.   


While the economy is currently rebounding from the “self-induced” recession created by governments around the world forcing draconian “lockdowns” on citizens and businesses in their crusade against the COVID-19 virus, we believe that the attempts to offset the COVID-19 fiasco by those same governments the world over will ultimately result in a slowing of economic growth. Private industry capital will be “crowded out” by massive government spending, and the likely tax increases that will be government’s response to “pay” for its own largesse will result in much lower production from businesses. Generally, those two factors together have historically resulted in inflation. In years past, what appeared to be “inflating” by the world’s central banks turned out to be meeting an insatiable desire on the part of the world for cash, exacerbated by the ‘08-’09 financial crisis.  Technological innovations, and the ensuing productivity enhancements that resulted, served to limit price increases as productivity boomed.   


It will be harder for that to be the case in the face of higher tax rates.  However, it is precisely in times like those, which we appear to be entering, that real innovators succeed and even thrive -- thus, the importance of maintaining focus on finding and owning the best up-and-coming companies in the world.  That is our charge, and we are ready for the challenge! 




Disclosures: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Taylor Frigon Capital Management LLC (“Taylor Frigon”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Taylor Frigon. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Taylor Frigon is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Taylor Frigon’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are a Taylor Frigon client, please remember to contact Taylor Frigon, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.

Continue Reading

Have you heard of this company? Nano-X (NNOX)

 



Nano-X Imaging is an innovative company based in Jerusalem which is developing a revolutionary "cold cathode" X-ray technology with the intention of making X-ray diagnosis less expensive and more available for the world's population -- two-thirds of whom still have limited or no access to medical imaging (and which is often characterized by long wait times for both the imaging and for the analysis of the results, even for those who do have access).

The company's name is pronounced like "Nannox" and the stock is listed on Nasdaq, trading under the ticker symbol NNOX.*

The traditional X-ray uses electrical energy to heat a cathode filament (often to temperatures in excess of 2000 degrees Celsius) and cause it to release electrons towards a "target" anode (often a metal disc composed of tungsten or molybdenum) which then produces X-ray radiation. This "analog" method of generating X-rays requires the machine to be large and bulky because the process involves tremendous heat and therefore requires a motor to turn the anode to keep it from melting, as well as filling the device with a liquid coolant around the X-ray generation core in order to absorb the heat. 

All of this makes X-ray machines expensive, which reduces their availability -- and yet X-rays remain the single most important type of medical imaging for diagnosing a huge variety of health issues.

Nano-X Imaging is pioneering the digital production of X-rays using field emission technology developed by engineers at Sony, in which the cathode does not produce electrons because it is heated but rather because it interacts with an electric field (hence it is called a "field emitter"). This process can be done at room temperature and is thus also referred to as "cold cathode" technology -- and it enables numerous transformational advantages over the hot cathode process described above, one of the most important of these advantages being the fact that the cathode can be turned into thousands of tiny electric "gates" on a silicon microchip, enabling very precise and efficient emission of electrons in a much smaller tube than would be possible using the conventional analog X-ray generation technology.

By digitizing the X-ray tube, Nano-X can produce a much smaller, less expensive, and more energy-efficient X-ray device, and one that can produce high-quality results while exposing the patient to less radiation than would be necessary for an analog X-ray machine to produce the same images. The digital X-ray tube can generate quality imagery with less X-ray exposure because, unlike an analog machine which must be always on or off and which has limitations regarding how fast you can turn it on or off, the digital array can turn each individual emitter on or off according to complex algorithms in order to be equally effective while exposing the patient to much less radiation. 

Also, because the traditional machines are so large, they have to physically "circle around" the patient in order to take a full scan (such as when you are getting a dental X-ray, and the technician circles the X-ray projector around your jaw: this also exposes the patient to more X-ray radiation than will be necessary with machines using the new digital cold-cathode technology).

The Nano-X device pictured above has a motorized arc which will contain six individual X-ray tubes and which can track backwards and forwards over the patient, and which will also be able to tilt in order to change the angle of the X-ray. The patient will lie on the bed underneath the arc, with the bed itself functioning as the receiving element for the X-rays and generating the digital images. Such a design would be impossible with conventional analog X-ray machines. Nano-X is calling their machine, for self-evident reasons, the Nano-X ARC.

The production of X-rays using cold-cathode digital technology on silicon is so revolutionary that many who heard about it at first did not even believe it was possible -- including some medical professionals, a few of whom were interviewed by a short-seller firm calling themselves "Muddy Waters," who published an inflammatory "hit piece" on Nano-X in September of 2020, alleging that the company and its technology are completely fraudulent. But there is no reason that X-rays cannot be produced through field emission technology embedded in silicon: in fact, the process is very much parallel to the way that a digital LED (light-emitting diode) produces visible light using electrical energy in a semiconductor material, as opposed to the conventional analog light bulb which produces light by heating a metal filament until it glows.

The US Food and Drug Administration has now given 510(k) medical device pre-market approval to the Nano-X digital cold-cathode X-ray tube (see this press release from the company, published this past Friday, April 2). In order to obtain 510(k) approval, the medical device in question must demonstrate both safety and efficacy -- meaning that it must be as effective as the existing approved devices. This approval from the FDA, in addition to a live demonstration which Nano-X broadcast in early December of last year, should prove beyond doubt that their X-ray technology is not fraudulent, and that the allegations to that effect published by the short-seller calling themselves "Muddy Waters" are baseless.

Of course, just because the FDA has now stated that the Nano-X digital X-ray tubes are safe and effective does not mean that they will be a successful business. There are many hurdles which the company must successfully navigate in order to bring their device to market, including gaining approval for their intended "multi-source" design (the ARC with six tubes embedded in the arc above the patient, shown above), as well as all the manufacturing and distribution and software design and sales and customer service and maintenance of equipment that will be required to go to market.

However, the company already has contracts for thousands of devices with distributors wanting to place the Nano-X ARC in countries around the world, pending the necessary regulatory approval and the ability of the company to produce those devices -- as well as important partnerships including a partnership with manufacturing giant Foxconn to actually assemble the Nano-X ARC itself.

Additionally, Nano-X has stated that it intends to pursue a business model that is almost as revolutionary as the cold-cathode technology itself, in which Nano-X will place the device in healthcare facilities basically for free, instead charging on a "per-scan" basis and stipulating a minimum of seven scans per day at around $14 per scan. This model has the potential to radically increase the availability of medical imaging by X-ray around the world, to the point that Nano-X hopes that every person could one day be able to get a diagnostic X-ray once per year in order to provide detection of health issues that can be much more effectively treated if caught early enough.

We have been investors in Nano-X since the very first public trades of the stock, on August 20 of 2020. While there are still many execution issues which must take place before this technology can be widely deployed and begin helping people around the world, we believe that this digital X-ray innovation has the potential to be transformational.

Now that the FDA has approved the Nano-X device, we doubt that short-seller "Muddy Waters" will issue an apology to the company for calling the company a "piece of garbage," but if whoever wrote that short-selling hit piece was actually honestly mistaken (perhaps because they relied on medical professionals who themselves just could not believe that digital field emission of X-rays was possible, and who did not conduct the due diligence to research the possibility for themselves), then they should apologize.

We think they should also apologize to the memory of the great American blues musician McKinley Morganfield, known professionally as Muddy Waters (1913 - 1983), and change the name of their short-research writing company to something else.


* At the time of publication, the principals of Taylor Frigon Capital owned shares issued by NNOX.

Disclosures: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Taylor Frigon Capital Management LLC (“Taylor Frigon”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Taylor Frigon. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Taylor Frigon is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Taylor Frigon’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are a Taylor Frigon client, please remember to contact Taylor Frigon, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.

Continue Reading

The Correction Is Here!

We have been warning our clients for months that a correction in our portfolios was inevitable.  It is here!


In those warnings, we suggested it would be normal, although likely short, sharp and shocking (Pink Floyd fans will appreciate that sentence!).  Ten to fifteen percent corrections are normal and healthy to shake out the weak hands in our companies.

  

Given the fantastic rise in our growth portfolios since the COVID-induced downturn last year at this time, an even deeper correction would not be at all surprising.  As we have counseled for our entire professional money management careers, it is crucial that investors stay calm, centered and still in these types of markets. 

 

More so than ever, stock prices, in any short-term period of time, are impacted by almost anything but fundamental business activity.  Over time, those business fundamentals will ultimately drive values of companies.  However, those who react to the crazy volatility that can occur in these short bursts -- as we are witnessing now -- do so at their own peril.  If the proper planning has been done, an investor should have ample cash on hand to handle whatever near term needs he or she may have.  


Certainly, in the last few months we have been advising those who rely on cash flow from their portfolio on a regular basis to take advantage of recent positive performance and add two to three years worth of cash needs to their cash accounts.  This was not a timing call; simply practicing prudence.  However, the vast majority of investors, who do not have near term cash needs, are best served riding the ups and downs out.  


This entire situation highlights the importance of the distinction we draw between true investing and what we call "short-termism." It is why we say "We predict businesses, not markets."  The short-term gyrations of individual stocks and in fact entire markets almost never has anything to do with actual business fundamentals (sometimes they do, but more often not). Trying to predict these short-term moves -- or worse, trying to base one's investment strategy on predicting and timing such moves -- has always been impossible, and in the modern landscape of high-frequency trading, massive algorithmic trading schemes, and now the social-media induced get-rich-quick flavors-of-the-minute being touted on Reddit and traded on RobinHood, we would argue that short-term strategies have become more hazardous than ever.


Don't take that comment about RobinHood the wrong way: in fact, we very much applaud the concept of retail investors participating in the market and always have. But what RobinHood has done with its emphasis on the so-called "free" trading (which may not have traditional commissions but which are anything but free) and with its gamification of the entire process (and its encouragement of short-term tactics such as options trading) has pushed an entire rising generation of retail investors into even more short-termism, which ultimately becomes indistinguishable from gambling. 


Meanwhile, we continue to look for solid businesses, and spending virtually all of our time analyzing and  predicting the business prospects of individual companies, rather than markets, central banks, hedge fund shorts, bond yield gurus, and the plethora of ETF gimmickry which has invaded the investment world like a toxic bloom of algae.


To our investors and indeed to all our readers, we say of this current meltdown (however long it runs): "This too shall pass." Remain focused on the long-term prospects of good businesses, businesses which can be reasonably expected to see even more demand for their products and services in five years than they are seeing today. 


We would add in closing that the most-recent round of earnings has only solidified our confidence in the outstanding prospects of the businesses we own on behalf of our clients, and highlighted the importance of focusing on the business, rather than running around in circles trying to predict the next move of the market.


At the time of publication, the principals at Taylor Frigon Capital did not own securities issued by Gamestop (GME), TD Ameritrade (owned by Charles Schwab Corporation, SCHW), or Robinhood (private).

Disclosures: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Taylor Frigon Capital Management LLC (“Taylor Frigon”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Taylor Frigon. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Taylor Frigon is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Taylor Frigon’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are a Taylor Frigon client, please remember to contact Taylor Frigon, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.

Continue Reading

Robinhood and the short-sellers: Same old story, a few new names

Citadel realizes how smooth brained Melvin Capital really is from r/wallstreetbets

It has been a wild week with attention-grabbing headlines involving the eye-popping moves in the stock of heavily-shorted names, especially GameStop Corporation (GME).*


No less startling have been the decisions by discount brokers such as TD Ameritrade and Robinhood to freeze new buys in stocks that have been going up "too much" (such as GME), or even to close out positions without having been instructed to sell.


The media -- and the politicians -- are all focusing on the most predictable and obvious aspects of this story, painting the price action in GME (and the pain that it is causing to short-sellers, who are primarily hedge funds) as some kind of "revolt of the little guy" against the big Wall Street hedge funds, and the shutting down of the ability to buy more shares (by firms such as TD Ameritrade and Robinhood Markets, Inc.)* as collusion by brokers to help ease the losses of their friends (and major clients), the hedge funds.   We certainly acknowledge that this is taking place and believe that brokers should not be colluding with anyone -- least of all hedge funds -- by stopping retail buyers or even closing out their positions "for their own protection."


But we would also argue that there is a lot more to this story and that there are a lot more lessons to be learned from the astonishing recent events -- and that while it may seem like a "new situation," it is really part of a very old story, and one that the media and politicians have been overlooking for decades.


While most people generally understand that the insane volatility in names such as GameStop have to do with a "short squeeze" in which speculators who bet against GameStop by selling shares of GME short (primarily these short-sellers are hedge funds) are hammered by waves of buying (much of it driven by participants in the Reddit board known as "Wall Street Bets"), and while the media and politicians have cast this market action as "the little guy vs the big hedge funds," the real elephant in the room is the practice of "naked short selling," a fact which gets very little if any attention in the media and even less from the politicians.


Naked short selling is illegal -- and yet it still continues to go on quite blatantly, and has for years, despite the efforts of some investors to call attention to this illegal activity.


Short selling, as most readers already know, involves selling a stock first and then buying it back later (the "buying back later" part is known as "covering"). But how can you sell it first and buy it later -- in other words, how can you sell something you don't own? (It should be pretty obvious that if you sell it first and buy it later, you didn't own it when you sold it).


The answer to that question is that you have to borrow the stock before you sell it, and then you return the stock later, when you buy some more shares at (what you hope will be) the lower price. 


Note that this fact of having to borrow the stock in order to short it already means that short-selling as a practice is inherently a short-term activity, because when you borrow anything you typically have to pay interest on the loan, which means that short-sellers do not tend to hold their positions for years and years, as long investors will sometimes do (at Taylor Frigon Capital, we sometimes hold our investments not just for years but for decades -- short sellers can never do that, due to the mechanics of the arrangement just described).


The practice of "naked" short selling, however (which is, as mentioned above but which we repeat for emphasis, illegal) means placing a short order without even borrowing the stock. When the time comes to "cover" and close out the position, the short seller gives an "IOU" instead of returning the stock. This practice, of giving an IOU instead of settling the trade with the stock itself, is known as "failure to deliver" and it is a term that is meant to cover delays in settlement due to various clerical or technical delays that might take place in an otherwise-functional market. Practitioners of naked short-selling, however, are taking advantage of this ability to give an IOU instead of settling the trade with actual stock in order to make even more money on their trades, because by deliberately shorting naked they can drive the stock price down even further using what are, essentially, counterfeit or non-existant shares.


The problem of naked short selling was highlighted in a 2007 special report which aired on Bloomberg TV entitled "Phantom Shares" and which you can still find on YouTube. This expose on naked shorting is well worth watching, especially this week which has exposed the fact that this problem has obviously not been dealt with, almost fourteen years after that program was first broadcast. Here are the links to part one, part two, and part three of that special report from 2007. 

There appears to be very little media focus thus far on implications of the fact that when the buyers from Wall Street Bets and elsewhere began piling into shares of GameStop (GME), the company's net short position was equivalent to 140% of the outstanding shares issued by the company!


Readers might ask themselves how it is possible for there to be a net short position of 140%, if short selling by its very nature requires the shorts to borrow the stock first before selling it. One would certainly expect that enterprising journalists in the media who are talking about the events of this week, and that concerned politicians who are also diving in with their opinions, would ask themselves the same question. How could anyone sell short more than the total number of shares outstanding?


Clearly, there is some naked shorting going on -- in fact, there's a whole lot of naked shorting going on.


If politicians and the media really want to address the problems that have been exposed by the crazy volatility in a few stocks over the past week, they should start with the problem of naked short selling, which is already illegal but which is obviously still extremely prevalent. They should ask how it is still taking place and who is enabling it to happen, and why the regulators seem unable (or unwilling) to put a stop to it. 


That would make a lot more sense than asking whether we need to put restrictions on bulletin boards such as Wall Street Bets, which are not illegal and are not at the heart of this problem. 


From there, instead of asking questions about whether Reddit boards should be restricted in some way, or whether investors should be prevented ("for their own protection," of course) from buying high-flying stocks, we might ask why we even allow any short selling to begin with, whether naked or not!


We know the standard defenses of the institution of shorting, which generally center around the two excuses that short sellers supposedly "add discipline" to the market and that short sellers supposedly "add liquidity," and in the past we ourselves have agreed with those arguments. But upon further reflection, both of those lines of argument appear extremely dubious. 


The argument that short sellers somehow add liquidity to the market has been exposed this week as being false. We saw stocks which were heavily shorted experiencing extreme volatility to such a degree that shorts could not cover and that new market entrants wanting to take a long position were shut down from doing so by brokerage firms such as Robinhood and TD Ameritrade (and a host of others who followed their lead). And in fact, extreme volatility and illiquidity always tend to go hand in hand, for reasons that should be fairly obvious when one takes the time to think about it.


As for the oft-repeated conventional wisdom that argues that short sellers discipline the management of a company, we say: the shareholders themselves can discipline the management by selling shares: those shareholders don't need to loan their shares to someone else to sell those shares for them! 


We've already seen that for good and cogent reasons, short sellers are by definition short-term in their focus, as opposed to actual long shareholders who may own shares in a company for years or even for decades. What a ridiculous proposition it is to argue that the short-term, short-selling hedge fund speculators are more insightful and more capable of "disciplining" a management team than the actual owners of the stock, owners who in some cases have been involved in that company for many years and who have an interest in the company's success, rather than in its failure.


The more we think about this subject, the more we come to the conclusion that short selling is a mechanism for financial speculation and that is all that it is, and that it does not offer any redeeming qualities to offset its detrimental effects. 


If people want to be short-term in their market activities, that's up to them -- but let them actually buy and sell the shares themselves, just as they would have to do with virtually any other asset. We don't think "house flipping" is necessarily a good idea, but if you want to purchase a house and then try to sell it again in a short period of time ("flipping" it), you generally have to actually buy the house before you sell it. Why should people be allowed to sell stock that they don't own (thus driving down its price in the process), unlike most other assets that people buy and sell?


The same can also be said of options contracts, which are also at the heart of this week's stock market events. Options contracts on stocks (puts and calls and the myriad combinations of puts and calls) are another financial instrument which have no redeeming purpose other than sheer financial speculation, and which are themselves basically a form of gambling. 


To elaborate on the house-flipping analogy, if Jane wants to buy a house one week and sell it a few weeks later, that doesn't strike us as a very good idea, but there doesn't seem to be a need to restrict people from doing it if they want to. However, that doesn't mean that we should let John and Jim start setting up side bets on whether Jane is going to be able to sell that house two weeks later for more money (in which case John will get a payout) or for less money than the original purchase price (in which case Jim will get a payout instead of John). 


This kind of "off-track betting" is exactly what options contracts represent, and there are sound reasons why off-track betting is illegal in many states. We would argue that options contracts can and should be done away with altogether and society as a whole (and the functioning of markets in particular) would not be any worse off for it -- in fact they would be much better off.


The capital markets perform a vital function in enabling access to capital by corporations which create real industry, real medical advances, real technological breakthroughs, real goods and services of all kinds. Short-selling and options trading represent betting and speculation at the expense of industry and business, and often to the detriment of those very industries and businesses. 


Politicians and journalists who have been looking at the events of the past week should in fact be investigating this very angle on the story, if they are actually interested in the public good. It is the mechanisms of out-of-control financial speculation, namely short-selling and options writing (to say nothing of naked short selling) which are the real story here, not the novelty of "Wall Street Bets" and the question of what "those pesky Millennials" and Gen Z kids are up to with their memes and their retail brokerage accounts.


This distinction is so important for investors to understand. There is a world of difference between short-term betting or speculation and the concept of connecting your investment capital with real companies that have promising business opportunities. 


Some pundits are using the events of the past week to try to tell you that "it's all a giant casino (and a rigged casino, at that)" -- and we agree with them to this extent: if you "play" the markets in a short-term, speculative manner, then that is a very accurate description of what you will experience.


But, as professional investors who have been involved in business analysis and portfolio management for many decades (long-only portfolio management, we might add), we take a different lesson from the events of this past week. We believe that this story is actually nothing new at all -- only the names have changed a bit. 


We have always argued that short-term speculation is dangerous and destructive of wealth, and that the only safe path involves staying diversified in a portfolio of real companies held for a period of years rather than weeks, days, minutes (or seconds!), and focusing on those companies from a business perspective, day-in and day-out, to continuously assess their long-term prospects.


The increase in betting and speculation by hedge funds, the rise in high-frequency trading and algorithmic trading strategies, and the use of new media outlets such as Twitter or Reddit only makes it more hazardous to try to pursue a short-term strategy, in our view (it's always been nearly impossible to have long-term success by following a short-term strategy, but now it's even more impossible).


We doubt you will hear too many pundits, or too many politicians, making these points. We also doubt that short selling and options contracts will ever be seriously restricted or even stopped altogether.  But in the meantime, we advise investors to clearly understand the very serious distinction between gambling, speculation, and investment -- and by understanding that distinction, they will realize which category we've seen demonstrated by the events of this week, and which category they should be focused on with their own capital investments.


* At the time of publication, the principals at Taylor Frigon Capital did not own securities issued by Gamestop (GME), TD Ameritrade (owned by Charles Schwab Corporation, SCHW), or Robinhood (private).

Disclosures: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Taylor Frigon Capital Management LLC (“Taylor Frigon”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Taylor Frigon. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Taylor Frigon is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Taylor Frigon’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are a Taylor Frigon client, please remember to contact Taylor Frigon, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.

Continue Reading