Bad for Business? Wild Media Sector Swings Point to Overheated Equities Market

There’s no better moment to take the pulse of the investment landscape than during the annual shareholders meeting of Berkshire Hathaway, the $700 billion holding company headed by legendary investor Warren Buffett.

The highlight of the event known as “Woodstock for capitalists” is three-plus hours of open Q&A with Buffett, Berkshire vice chairman Charlie Munger and other top managers at the firm. At this year’s event, held May 1 in virtual form, Buffett and Munger didn’t mince words when asked for their views on the stock market volatility that enveloped ViacomCBS, Discovery and AMC Entertainment earlier this year. Shares in the three companies soared by triple digits and then fell almost as quickly in a roller-coaster ride that deeply unsettled longtime market watchers.

“It’s not just stupid — it’s shameful,” Munger said.

Buffett lamented the “casino” mentality around equities that has been fueled by the rise of retail stock trading apps like Robin Hood, which aim to make it easier for everyday people to buy and sell stocks. This became acute in March and April as tens of millions of Americans received stimulus checks of as much as $1,400.

The bull market for stocks that emerged over the past year — defying the gravity of the pandemic’s impact on global markets — has also been driven in part by the kind of investor maneuvering that is anathema to the value-investing gospel that Buffett, 90, has preached for decades: Find solid companies that you have faith in and hold the stock for long-term gains, not short-term wins from betting on shares to rise or fall within a short time frame.

“The gambling impulse is very strong in people worldwide, and occasionally it gets an enormous shove,” Buffett said. ”It creates its own reality for a while, and nobody tells you when the clock is going to strike 12 and it all turns to pumpkins and mice.”

The “gamification” of stock market investing has sounded alarms at the Securities and Exchange Commission, which is investigating the circumstances around the March fluctuations. The reasons for the volatility vary, but they come down to new vehicles for investors that, in some cases, allow them to buy significant shares with other people’s money, until losses pile up. The highs and lows of the past year have many wondering what will happen when the bull market conditions inevitably turn bearish.

Mario Gabelli, chairman and CEO of Gamco Investors and a longtime investor in ViacomCBS and Discovery, says he’s not fazed by volatility — that’s the price of admission to working on Wall Street. But the lack of disclosure for some types of investments and the  so-called app effect made for a perfect storm.

“I’m concerned about not having an electronic fence around some of the new participants in this volatility,” Gabelli says. “I’m concerned about entities that encourage people to buy securities and not pay commission.”

For inexperienced investors, there’s a disconnect at present because the buoyancy of stocks is a sign of a strong economy. Corporate earnings as reported so far this year have generally been healthy even amid the lingering pain felt on Main Street because of pandemic shutdowns. That can leave the impression that stock prices are only going to go up, when in fact the speed of communication these days has made companies more vulnerable to manipulation.

“The markets are supposed to work efficiently. The price of the stock reflects the value of the company,” says Charles Elson, professor of finance at the University of Delaware and a corporate governance expert. “Anything that distorts that theory is problematic for the whole market.”

Berkshire Hathaway’s Munger also shared his disdain for the rush of private investment dollars flowing into special purpose acquisition companies, which offer an alternate route for taking smaller companies public. SPACs are not a new invention, but they have become more popular in the past two years as the traditional IPO market has cooled off.

Now, with equities in strong bull territory, there are worries that the SPAC boom will lead to a host of flimsy companies going public. Moreover, the number of private investment firms that are crafting complicated derivative transactions around stocks also puts unnatural strain on a system that hinges on public trust in a regulated market that is moved by business fundamentals.

“You push that to excess, it causes horrible problems for civilization,” Munger asserted.

In the case of AMC Entertainment, the stock movement around a company that was seen as nearly bankrupt was galvanized by social media-driven campaigns targeting specific companies. When it became clear that AMC’s stock was being targeted by short sellers, a coordinated effort to buy up AMC shares emerged on Reddit and other platforms to deny the shorts their profits. Idealism, anger and stimulus money combined for a wild ride that began in late January when shares inexplicably began to rise despite dire headlines for AMC Entertainment.

After hitting a high of $19.90 on Jan. 27, shares plunged the next day to $8.63. They’ve been hovering in the $9-$10 range ever since. Even the good news in March of movie theaters reopening in New York and Los Angeles didn’t move AMC shares as much as the coordinated “stop the shorts” buying effort in late January.

The activity around core media industry stocks is notable too because the sector hasn’t been a Wall Street darling of late. For the past seven years or so, media stocks have been depressed because of the fundamental headwinds from shifts in consumer entertainment choices and the streaming market, says Cowen equity analyst Doug Creutz.

But he points to the returning strength of the advertising market, as well as old media’s investment in new streaming products, as positive signs.

“For most of these companies, the initial returns as they launch these products have been pretty good from a subscriber standpoint,” he says. “On the other hand, they’re spending a crazy amount of money. And it’s sort of TBD whether all these costs are going to lead, down the road, to a stable, profitable product. In the meantime, the cable bundle is still under pressure and people are still losing linear subs. The more that direct-to-consumer succeeds in capturing subscribers, it just means more pressure on linear.”

But certain (normally uninteresting) media stocks have seen sharp rises and steep falls of late. Discovery’s Class B shares, which are thinly traded and largely owned by Liberty Media mogul John Malone, shot up around 80% in late March. A month before that, Discovery even issued a press release assuring investors that its price volatility ”is not the result of insider transactions or transactions by Advance/Newhouse Programming Partnership or its affiliates.”

The explanation for why Discovery shares were on the march is the same as that for why ViacomCBS shares saw a steady uptick starting in early February. The New York-based investment fund Archegos Capital Management, headed by Bill Hwang, had been aggressively buying up shares in both companies in complicated transactions done largely with money borrowed from banks including Credit Suisse, UBS and Goldman Sachs. The banks offered Archegos credit to buy shares that they would own, although Archegos would harvest any profits.

Archegos’ buying spree helped bid up the price of ViacomCBS and Discovery shares, unbeknownst to the companies or other investors. ViacomCBS sought to capitalize on the frothy market by announcing plans on March 22 to sell $2.7  billion in stock, at $85 a share, to help fund its investment in the Paramount Plus streamer. That, not surprisingly, led ViacomCBS’ stock price to dip. Two days later, shares that had been at $100 were down to $70 and falling fast. The modest downturn after the announcement that more shares were to be issued created big problems for Archegos because it owed the banks for shares bought at higher prices. It’s estimated that Archegos losses hit $20 billion across at least eight companies.

The experience was a wild 72 hours for company insiders. In the end, ViacomCBS and Discovery shares settled down to prices that were justified by business fundamentals.

“I got to know a lot more about swaps and some exotic [investment] instruments than I ever wanted to know,” Discovery CEO David Zaslav told CNBC last month. “But that’s a lot of noise. We’re back at work, and the stock is going to be where it deserves to be.”

Creutz and others credit ViacomCBS with making an opportunistic move to support the larger agenda of investing in direct-to-consumer growth properties.

“They didn’t force anybody to buy their stock,” Creutz says. “With a lot of this volatility, it sort of happens, and its investors are either making money or losing money, but in at least one case, a company was able to take advantage of the volatility and raise capital at very attractive rates.”

Despite how frothy the broader market would appear, it’s important to note that the S&P 500 has not only rebounded from the massive hit it took a year ago when the pandemic struck, but hasn’t slid into correction territory, says Economic Cycle Research Institute co-founder Lakshman Achuthan, who specializes in analyzing business cycles. And the current upswing has prompted hedge funds to borrow more money.

“You’ve got a fundamental recovery goosed by stimulus, either monetary or fiscal, and part of the way that it gets goosed is these different funds will leverage their bets,” he says. ”So Archegos, these guys were super leveraged. And they were leveraged to the upside in big amounts.”

Gabelli and other seasoned investors also express frustration that disclosure rules can be skirted by some forms of stock trading. Traditionally, equity purchases and sales have to be disclosed if a single entity amasses more than 5% of a company’s outstanding shares. Archegos was believed to be well over that with ViacomCBS and Discovery, but because of the nature of the transactions, it was not disclosed. That level of activity by a little-known firm usually would have set off alarm bells, for ViacomCBS leaders and other investors.

“Clearly anyone that owns a certain percentage of a company should have to disclose that no matter what derivatives they own,” Gabelli says.

The ability of one investor to exercise that much influence over the fate of large and well-established companies is mystifying to Wall Streeters.

“We know that there was a hedge fund that was playing Russian roulette with derivatives and leverage and was a big driver moving these stocks,” says Creutz. ”Now, I think in a normal market, probably one single hedge fund or a small group of investors wouldn’t be able to do that. I think we’ve seen in many areas of the market, this isn’t a normal market.”

What’s more, in these volatile conditions, the market has been flooded this past year with SPACs — aka blank-check companies with no business operations that raise capital through an IPO in order to acquire an existing private company and take it public. Such entities do not undergo as much regulatory scrutiny as traditional public issues, contributing to the atmosphere of an opaque market in which strings are pulled and cards are played in the shadows.

“There’s just a lot of money sloshing around there, and you don’t know what’s going on,” says Achuthan. ”To the extent we have free-market capitalism — which is a separate debate — the money is going to try to find a way to make a profit, by hook or by crook. There’s all kinds of systemic imperfections that a capitalist approach is going to try to take advantage [of]. You’re pouring lots of fuel on the fire.”

What Achuthan is watching out for now are signals of a pending downturn.

“Trees don’t grow to the sky,” he says. And when the market comes off its peak and growth eases, “there’s going to be a big disconnect between the reality of growth starting to slow and the stories behind the market running up. And that’s when the risk or the likelihood is of more downside volatility in the broad market than we’ve seen in the past year.”

Veteran investors are girding for a busy year. Buffett, speaking at the shareholders meeting, said the market for acquisitions has been upended by the burst of SPAC activity. But there’s also some bargain hunting to be done.

“It really makes us money when people are doing stupid things,” Buffett said.

Adds Gabelli, “There’s lessons to be learned here. Volatility itself isn’t an issue for me. It just makes me work harder.”