Time to Sell Those Meme Stocks?

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Hello, this is Jackson Cantrell. Welcome to a special edition of the Barron's Streetwise Podcast where we answer the questions that you, our listeners, have been kind enough to record and send in. Coming up, we'll weigh whether or not you should base your investments on analysts' buy and sell recommendations. Plus, we'll talk about what to make of Tesla's $920 billion market value. Quick note, this is an encore episode. It originally aired back in February, and listeners should keep in mind that a lot of the figures have changed. For example, back then, markets were pricing in just 5 1/4 percentage point Federal Reserve rate hikes for 2022. We've already had the equivalent of 9. Still, I'd say this episode is one of our best, especially when it comes to practical investing tips. And all of those are just as relevant today. And one last thing, if you haven't had the chance, please send us in your questions. Tape them on your phone, use the voice memo app, and send them to jack.houw@barons.com. We'll be back with a regular episode next week.

Listening in is our audio producer Jackson. Hi Jackson.

Hi Jack.

What is the over-under on the number of questions I'm going to get to? I know we've done listener specials in the past and I think I'm averaging about 3 questions. I can be a bit of a rambler, but I'm feeling a little pep in my step this week and I think I can do 4. What do you say?

Based on how long it took you to ask that question, I'm going with 3.

But if you hear me going off on a tangent, you just play some gentle music in the background, a little signal, maybe some wind chimes. Let me know it's time to move on. Go ahead and let me hear it now so that I know what to listen for. Me? No. Was that a recording or was that you just now?

That was me.

It is distinctive. Now, there won't be any big CEO guests on this episode, but we will be hearing from one next week. And later in this episode, we'll have a quick visit from someone that many of you have been asking about. Jackson, let's get to our first listener question.

Right. We've got David from San Antonio.

San Antonio, Texas, birthplace of the puffy taco. It's not soft shell, not a hard shell taco. You take corn batter that's a little bit on the wetter side. You press it into a tortilla, drop it into a deep fryer until it's Right, David.

Hey, Jack. It's no secret that the market cap for electric vehicle companies has boomed in recent years. Part of the increase seems due to the total addressable market increasing from autonomous vehicles in the EV space. However, it does look to me like the market cap of combustion engine and EV companies combined has grown more than the total addressable market for all vehicles.

Thank you, David. Your question is, has the combined stock market value of carmakers gotten too big for the car business? And at its core, I think it's a question about Tesla. Investors are so excited about Tesla's potential that they've driven its stock market value up to nearly a trillion dollars. That means it's worth 3 times as much as Toyota, even though Toyota produces close to 10 times as many cars. In fact, Tesla is worth more than Toyota and the next 6 largest car makers combined. And the legacy carmakers have mostly gained value over the past 5 years. It's just that Tesla has gone up in price a lot faster. There are some other electric vehicle startups, Rivian and Lucid, which only just started producing vehicles and are each worth more than Hyundai. My guess is that yes, there is too much stock market value in the car industry. The stock market is saying not only that there's plenty of room for all these players in the years ahead, but also that the car-making business is going to achieve a much higher level of combined profitability to support its much higher combined stock market value. That could happen eventually. As cars become more software-driven, they could generate higher ongoing revenue, much like how I buy a phone from Apple every few years and then keep paying monthly fees for things like extra storage, music, and Apple's cut of some third-party subscriptions., but that could take a decade or longer. Meanwhile, there are 85 new electric vehicles coming to market over the next several years in the U.S. alone, many of them from legacy carmakers. It's unclear to me how both the automotive incumbents and insurgents are going to come out winners over the next several years, which is what the group's combined stock market value seems to be implying now. Jackson, who's our next listener?

We have John from Tucson, Arizona. John sent an email asking about Kodiak Sciences, ticker KOD. Last year he bought some shares after some positive news around their clinical trials and has since seen his investment drop. He compared that trajectory with a biotech-specific exchange-traded fund and noticed they were following a similar path. So John's wondering why is it that his favorite stock is moving in lockstep with the ETF? He asks, quote, is the market really smart or is it insane or stupid or what?

Thank you, John. The company you mentioned is a clinical stage biotech, which means it doesn't sell anything yet, so it has little by way of revenue, to say nothing of earnings. Companies like that have a treasure hunt investment profile. Many go nowhere and a few strike it rich. The exchange-traded fund you mentioned is similar. Most of its top holdings produce losses. I don't have any opinions on the particular stock you mentioned, but I can tell you why the whole sector has been doing poorly. Two reasons. First, a lot of hot money flooded into biotech just over a year ago. You can see that by looking at the fund flows for the ETF you mentioned. If you look at a long-term chart of the ETF, you can see that biotech has gradually become more valuable over time, with some bubbles and busts along the way. A year ago, there was a biotech bubble, and since then it's been letting out. The second reason is that, as I touched on earlier, investors now expect the Federal Reserve to aggressively raise interest rates to combat inflation. Higher interest rates can make all sorts of investments look less attractive by comparison, but one of the most vulnerable groups is growth stocks that have little by way of profits today. Once investors can earn a decent return on their cash, the thinking goes, they'll have less patience to wait many years for speculative companies to find their way to profitability. So lots of speculative stocks have been selling off including biotechs. Speaking of which, Jackson, do you have that question from the gentleman who says that he lost a lot of money, wants to know how to clean up what he calls his messy portfolio?

Yeah, his name's Karthik and it was an email, so I can paraphrase it for you here. So he started investing into stocks and options seriously in December of 2019. And he writes, here's my portfolio for options and stocks. And he gives you some screenshots there. And he says, please review and kindly guide me on how you'd recover from such a messy portfolio.

Thank you, Karthik. Listeners can't see your list of stocks and options contracts, but I think messy is a fair word. All of them are sitting at losses ranging from 21% to 97%. I see a SPAC, an electric vehicle startup, a meme stock, some long-shot options. This one seems simple to me, although you might not like it. I recommend you sell everything you own and put the money in a low-cost stock index fund. And I'm assuming you have other money in bonds or cash for diversification. If not, talk to a financial planner about a mix that's right for your age and circumstances. The problem with the stocks you own is that they're all kind of the same—highly speculative companies that aren't expected to turn profits anytime soon. I'm guessing you heard about all of these stocks from the same source or sources, maybe a newsletter or a chat room. Something tells me that multiple rocket ship emojis were involved. The backdrop for these types of stocks has not been kind this year. Investors are running away from speculative stocks and towards safer ones with plenty of profits and other signs of prosperity. Try not to develop a "wait until it comes back" mentality. Sometimes investors put off selling decliners for too long to avoid facing the discomfort of losses. If there are one or two stocks on the list you just can't bring yourself to part with, fine. Put the bulk of your money in an index fund and keep a little on the side for speculation. I notice that your deepest losses are in the options contracts. Option speculation is especially difficult. Not only do you have to be right in the underlying stocks, you also have to be right quickly before the time value of your contracts erodes. Many investors do just fine over the long term with zero use of options. I'm one of them. Karthik, interest rates in the U.S. have been near zero for more than a decade, and that's not normal. It's caused all sorts of bubbly activity in investment assets, especially speculative ones, and that's caused some newer participants to believe that the best approach is to try to pick and ride the next hot name. A better approach is to put money in quality companies that can become more valuable and distribute cash to shareholders over decades, and index funds are a cheap and simple way for even novices to do just that. Now, Jackson, you have to be impressed with how quickly I'm running through these questions.

I'm actually worried you're pushing yourself too hard and could get hurt.

It's a good point. I don't want to hit the wall. I've heard people talk about the wall. It doesn't sound—

Maybe chug a sports drink and stretch your hamstrings.

Okay, I like what you're saying. I'm not going to do it. I'm going to have a coffee and no stretching, but We'll be right back.

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.

Welcome back, Jackson. Who do we have? Oh, sorry.

I was chugging my sports drink here. We have Lawrence from New York City.

New York City. You ever see the commercial where they go, this stuff's made in New York City? You know what I mean?

Lawrence's question is about the US Federal Reserve or Fed raising interest rates. Markets seem to anticipate around 5 interest rate hikes this year of about a quarter of a percent each. If that happens, government bonds would pay investors higher yields than they do now. But Lawrence questions if that 1.25% or so hike would really be enough to fight inflation.

In theory, with inflation at 7% and investing at 3.5%, you're losing 3.5% of your money. So my question is, how can this stop inflation? It seems to me that rates will have to be over 7% in order to actually slow inflation, stimulate savings, and stop spending. Am I missing something? Love the podcast. Thank you. Thanks, Lawrence. We just got a fresh reading on inflation this past week, and now it's 7.5%. And your question is, will the Federal Reserve have to raise interest rates to more than 7% to stop inflation? I hope not. I don't know of many investors who are predicting a rise to that level, but it is starting to look to me like the Fed will have to take more aggressive action than investors might be expecting. Inflation is not only too hot, it's also broad, affecting things everyone needs like food and electricity. Credit Suisse recently pointed out that the consensus expectation is still for inflation to fall below 3% by the end of the year. That seems optimistic. Some people say low Treasury yields are telling us that inflation will fall. As you say, Lawrence, the 10-year Treasury yield has recently hovered around 2%. The problem is that as recently as this past week, the Federal Reserve was still buying Treasuries to suppress their yields. It's difficult to know what bonds are saying when they're not free to speak their minds. Also, the bond market might not be that smart. Deutsche Bank recently looked at the historical link between 10-year Treasury yields and subsequent inflation. It didn't find one. So Lawrence, while there's nothing to suggest the Fed will have to raise rates above 7% to get inflation under control, if inflation doesn't come down a bit on its own soon, The Fed could have to raise rates more than economists or investors are predicting. Jackson, we had a listener who didn't sound like a big fan of analysts.

Yeah, that's Zoe, and you have her note.

She writes, love your podcast, and she subscribes to Barron's magazine. She has a saying and she wants to know if it's too harsh. It's about financial analysts. She says, I describe it as the art of 20/20 hindsight with zero foresight. Great to hear from you, Zoe. And yes, it's a little too harsh. I talk with analysts all the time, and I think they're valuable sources of information, but you have to know how to use them. The two things every investor wants an analyst to tell them are, should I buy this stock and where is it going over the next year? And research suggests that on the whole, analysts are not great at predicting either of those things. And I suspect that's because, if you think about it, the short-term direction of a particular stock is up to us. It's like we're asking analysts, how excitable will I be over the coming year? Will I get carried away and bid this stock up too high, or will I be gloomy and let the stock fall? Long-term stock performance is tied to fundamental measures of value, but in the short term, stocks trade on sentiment, and sentiment is a difficult thing to pin down. Now, there's been decades of academic research on which clues from analysts hold predictive power, and if I were to sum it up, I'd say that recent opinion changes are more telling than the standing average of opinions. In other words, whether analysts on average say to buy a stock doesn't mean much. But recent upgrades, for example, from hold to buy, are more interesting. And the same goes for rising earnings estimates. The other generalization I'd make is that analyst opinions that move away from the herd rather than toward the herd are particularly noteworthy. Analysts take career risk when they disagree sharply with their peers, so they'd better have good reason for doing so., and often they do. These are statistical indicators. Investors can run stock screens for things like rising earnings estimates and recently issued positive recommendations, and if you're using higher-end screening software, you can look for cases where these individual changes are moving away from rather than toward the consensus. But I think one of the most valuable things analysts provide can't be reduced to statistical analysis. I like to read their research reports for all the background information they provide on particular industries. So, Zoe, you're right to be suspicious of analysts' price targets and buy recommendations, but I wouldn't ignore their research altogether. Jackson, we can squeeze in one more super quick one, right?

Yeah, let's do it. Here's Doug with a question on what to do during big down days for the stock market. One of my investing struggles is how often and what to think about my portfolio during volatility. What are some Jedi mind tricks you've used or heard used over the years to help investors not get spooked during volatile markets? Sticking your head in the sand and not looking doesn't work when our apps and computers serve up our portfolio every day. What does social science or investor psychology tell us to do?

Thanks, Doug. I'm not sure that investor psychology holds any answers here. One thing it's clear about is that investors tend to feel the pain of losses more acutely than they feel the joy of gains. That doesn't make us better as investors. It makes us prone to panic. One thing that helps is if you hold shares of companies you'd be happy to hang on to even if prices plunged. Decades ago, investors used to recommend counting the number of shares you own rather than the value of those shares. Dividends were a bigger deal then, and investors would make the point that even when stock prices fall, strong companies can keep the same dividend payments coming. After a decade of rip-roaring price gains, investors have come to rely much more on gains than dividends for their total returns, but maybe dividends will come back in favor again. All I can tell you is that if you like what you own, try not to check the prices so much. It helps if you're distracted by something else, maybe something even more worrying. I got married during the global financial crisis when US stocks at one point lost half their value. I knew I'd have to dance in public during the wedding, and Doug, just between you and me, I am not a dancer. My best move for many years was avoiding situations that involved public dancing. With my wedding approaching, I decided to meet my fear head-on with cash, which I paid to a Manhattan dance instructor. And then I went for weeks with my then-fiancée until I learned to dance to that song, 'Cuando, Cuando, Cuando,' without causing grievous injury to her or excessive humiliation to myself. I was so preoccupied with dancing at the time that I wasn't paying much attention to the beating I was taking in the stock market. And as we now know, things bounce back quickly. Sometimes I still hum that song on big down days for the market. So I don't know, Doug, maybe when the next crash hits, you can find something that worries you even more than losing money and pay someone to teach it to you. Bull riding. Beekeeping. Help me out here, Jackson. Have you heard of squirrel suiting? I'm thinking of a squirrel in a tuxedo with a big furry tail.

Is it different from that? No, basically it's where you strap on plastic wings and then jump off a cliff.

On behalf of Doug, thank you, Jackson. Thank you, David, John, Karthik, Lawrence, Zoe, and Doug for sending in your questions. And everyone, please keep the questions coming. Just tape on your phone, Use the voice memo app and send it to jack.hough@barons.com. Thank you for listening. Jackson Cantrell is our squirrel-suited producer. Subscribe to the podcast on your favorite app. If you listen on Apple, write us a review. And you can follow me on Twitter if that's the kind of thing you're into. It's @jackhowe, H-O-U-G-H. See you next week.

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.