Bubble Double-Click

Markets have bounced back nicely after the jitters caused by the Yolo x Reddit trading gang. The plumbing of US capital markets – an intricate network of exchanges, brokers, custodians, market makers  and clearing houses – passed the little stress-test fairly well, despite all the sensationalist cries of foul-play. Robinhood practically had to be back-stopped by its investors and house banks. Lastly, GameStop has since then imploded, leaving the Yolo-gang to re-group – you win or learn in life, but you never give up 👊.

While the impact was concentrated on a small market corner, ripple effects could be felt across the broader market and led to a short-lived sell-off. Since then the NASDAQ is up 7%+ and 10%+ for the year, supported by a rock-solid earnings season thus far. That still leaves us with highly stretched valuations now against the backdrop of continuous strong momentum.

As expected the wall of fear is only getting higher and we are being bombarded with reports on the imminent bursting of the bubble. But should we care at all – why not rather stick to a set-and-forget investment strategy? The short answer is that this is probably a good strategy for a well diversified portfolio and preferable if one lacks the willingness and time to actively manage risk. Nevertheless, let’s double-click on some of the relevant risk-reward considerations that one could factor in for positioning purposes.

To start with, stretched or even ‘Bubble-Esque’ valuations should not be given too much weight for 1 to 3 month positioning considerations. Valuation tools are somewhat comparable to a broken clock that only shows the right time 2x a day. Real bubbles almost mechanically have to burst since there are just too many investors crowded on one side of the trade. However, even if we entered bubble-territory we could as well experience a blow-off top, accelerating us into a mega-bubble,  and valuation tools are not going to tell us how far and long away we are from the top. The 2000 dot-com crash is usually considered the mother of all bubbles in the last 25 years but let us remember that there is always a step up in life.

So what else is important for investments in tech / growth companies? Mutual funds are now sitting on multi-year low cash-reserves, decreasing their ability in relative terms to buy corrections. IPO activity is back in the ballpark level of 1999 and we have seen an abundance of SPAC-driven IPOs. And of course, we have also witnessed the emergence of the Yolo-traders, which have driven up the % of US retail volumes from roughly 10% to 20%, enabled by margin loans and options. This is also reflected by call option volumes at the highest levels in a decade. 

A more qualitative question is how to think about the new force of Yolo-traders and their impact on equilibrium prices. Based on what’s observable in the last 12 months, the Yolo gang does not fall into the typical retail investor bracket of noise traders. They seem to be more comparable to institutional trend-following investors maybe with a sprinkle of fundamental research inspiration, judging based on Reddit discussions and Youtube videos. In extreme cases, such as recently with GameStop they also embrace highly sophisticated trading strategies such as short / gamma squeezes. The power of swarm intelligence that we just witnessed in that context was quite an eye opener.

But this still begs the question, how they are going to react when facing more drawn out corrections or grinding sidewards movements. Will they display 💎🤲 (diamond hands) or run for the hills? Lastly, it also remains to be seen how sustainable this influx of Yolo-traders is, especially when social activities normalise on the back of Covid-19 vaccinations efforts. 

In summary, the ebbs and flows of Yolo-trader dynamics strike us as potentially most important, when thinking about positioning in tech / growth companies in the coming months. We remain cautiously optimistic but prefer seats close to the emergency exit.

Are we finally in BUBBLE territory?

As ever so often this is the million dollar question. We are certainly observing excesses in various corners of the market. Such as most recently, the Reddit x Robinhood gang (#yolo), who are blowing Hedge Funds out of the water by means of short/ gamma squeeze torpedos. Those coordinated manoeuvres appear to focus on a small number of counters but have pushed up option trading volumes to multi-year highs. 


We hence do not see wide-spread excesses a la 1999 yet but more contained bubbles that are bound to burst and hurt some investors in the process – a number of Hedge Funds on the short side of the #yolo-traders are indeed licking their wounds already.


Could this lead to a market-wide meltdown?


At least, the frequently referenced ‘systemic’ risk of margin loans on the back of option contracts does not strike us as an obvious trigger. Since #yolo-traders are long call options, losses are limited to those premiums times the margin loan leverage. This setup is certainly preferable to riskier levered short positions, which do not seem to be accessible at size through the retail broking platforms. 


But what about those sky-high valuations?


The end of Jan’21 valuation snapshot does indeed look stretched. Growth-adjusted revenue multiples of tech / high-growth stocks have increased by another up to ~50% in the last 3 to 4 months. But there is also significantly more certainty available today (e.g. US presidency, size range of fiscal stimulus). So far this seems to have offset some of the reflation upward pressure on treasury yields. Let’s hence hope that we can continue walking the tightrope at those stretched valuations. #famouslastwords

2021 Foresight

This is going to be an interesting year with a wide range of scenarios, some of which are bound to much more discrete outcomes than markets tend to like such as the adoption and efficacy of Covid-19 vaccines. As we start the year many investors are primed for more monetary and fiscal bazookas and loading up on the reflation / inflation trade that should benefit cyclical sectors, small-caps, gold & precious metals, commodities and emerging markets. Price action and early inflation indicators are already spurring excitement and if maintained might lead to a further rotation away from secular, tech-enabled themes. 


So what does this mean for growth stocks and the set-and-forget inclined investor?


In short, this might well become a challenging year for secular compounders, having run up substantially in terms of prices. Even on a growth-adjusted basis revenue and earnings multiple have reached high levels. Fundamentally, this is not necessarily unjustified. Valuations of long-duration growth stocks are very convex and sensitive to changes in growth and discount rate expectations. 

However, that means that the tailwinds of historically low rates have to continue blowing. Hawking inflation indicators and the FED’s every movement could hence become the growth investor’s headache in 2021. An additional curve-ball will be the new Average Inflation Targeting Framework, which in the absence of historical heuristics is going to be a source of volatility. 

Let’s acknowledge that a mean-reversion of rates poses material downside risks to price-levels of growth stocks, unless assertively offset by an extra shot of growth. But this would also materially affect highly levered sectors, small-caps, etc.


Can we counter the ‘one-trick pony’ argument?


To start with we aren’t quite convinced that the mean-reversion argument for rates (to 2-3%) makes sense as a central scenario against the backdrop of counter-inflationary undercurrents. The ever increasing adoption of technology is pushing out marginal costs and supply curves. We all consume more digital and physical goods and services (e.g. streaming, delivery, ride-hailing) that have not been drivers of inflation. Accelerating technology enablement of work (from home), health, education and housing could add runway to this secular trend. Moreover, demographic dynamics in particular the ageing of populations in DMs will further add to those counter-inflationary pressures. 


This could set-up the conditions in 2021 for a goldilocks tightrope walk right down the middle between spiralling inflation and the next crisis. And growth stocks do particularly well in those phases of cautious optimism. 


🤞

Hindsight is 2020.


2020 was tremendously challenging for investors independent of style, geographical remit and experience. We were very lucky and slightly skillful, having positioned our portfolio across secular, tech-enabled themes and having entered the year with an adequate cash-buffer to draw from. And we are relieved that the worst appears to be behind us.


Any interesting lessons learned?


The Covid-19 crisis led to personal tragedies and wide spread fear that led to the most extreme volatility spikes and sell-offs. However, central banks in many countries and in particular in the US as well as governments stepped in faster and more forcefully with unparalleled monetary as well as fiscal stimulus. Bolstered by 100bps+ lower rates across tenures markets swiftly looked beyond the short-term pain and started discounting long-term possibilities. A new bull markets was subsequently born on the abundance of pessimism and against the backdrop of sharp contraction of economic activity across the globe. 


Could this be a new normal?


Some structural changes might indeed have occured. The capabilities of central banks and willingness of governments to intervene was breathtaking. Our guess is that the FED would have even started buying equities if required. There are of course concerns about the long-term consequences of incredibly expanded central bank reserves, but this should not take away from an ‘All-Star’ performance that we witnessed.


There also seems to be a new kid in town, referred to as the Robinhood trading gang who trolled and outperformed the ‘smart money’ with ease. We wonder how meaningful the Robinhooders really are when it comes to their actual impact on marginal demand and supply. But if we assume that they do indeed move markets we should certainly spend more time understanding their expected preferences and risk appetite going forward. 


So what about 2021? We shall turn to some outlooks in short order.

M&M update (Jan 2018)

1200px-Plain-M&Ms-Pile

To us M&M’s are a real pain in the butt – and we are referring to macro & market questions not the chocolate snacks leading to adorable love handles. We get asked M&M questions all the time but have never come across a coherent framework that would really allow anybody to make reliable predictions. Here are a couple of conclusions that we are quite certain of when it comes to M&M forecasts. First, they have as much predictive power as a coin toss. Second, they do not make a material difference to long-term, secular investment themes that we are focused on. Finally, most investors, i.e. Mr Market, still pay attention.

The latter fact should not even come as surprise when we remind ourselves that Mr Market is not an imaginary higher being but humans (mostly institutional investors) like you and me, who have to answer to their bosses. And many bosses like to ask questions that come up on the short-term horizon… impact of Brexit… timing of QE tapering and rate increases… Trump… NAFTA and the wall… China hard-landing. We don’t agree that time is well spent trying to quantify the short-term impact of those events, but we can relate to the dilemma faced by all the market lemmings out there.

Hence a honest disclaimer: By disregarding our M&M updates, you will not miss out on any useful insights for being a high-conviction, long-term investor. But we’ll nevertheless put in some work to provide you with our thoughts on an ongoing basis. Continue reading “M&M update (Jan 2018)”

The REAL disruptor: Blockchain, not Bitcoin.

Blockchain

One of the hottest topics these days are cryptocurrencies (“cryptos”), such as Bitcoin. The noise created by cryptos is unfortunately currently stealing the thunder of its underlying technology, the so called blockchain.

Cryptos are one of many applications that can run on Blockchain technology. Put simplistically Bitcoin is to Blockchain what Email used to be to the Internet. Which means cryptos are one of many viable and useful applications on the Blockchain but not necessarily the most impactful nor commercially meaningful one, although the jury is still out on this.

Moreover, we believe that Cryptos are potentially close to peaking in terms of the “hype-cycle”. However, we are only at the beginning of grasping the wide-ranging potential of the underlying blockchain technology.

While this notion of “Cryptos: not so sure” vs. “Blockchain: disruptive” has already become somewhat of a consensus view amongst many academics, tech-entrepreneurs and venture capitalists, we’d like to share a couple of simple insights into the discussion.

Continue reading “The REAL disruptor: Blockchain, not Bitcoin.”

The Debate on Bitcoin and Cryptocurrencies

Bitcoin bubbleBitcoin, Ethereum and other cryptocurrencies have seen an astronomical ascent in the last years, culminating in an extraordinary rise in 2017. As to the reasons behind this unprecedented rise, they actually seem far less nebulous than the identity of Bitcoin founder Satoshi Nakamoto: good old ANIMAL SPIRITS. However, the sustainability of the rise remains one of the most hotly debated topics of the year.

All this has many people asking us to opine on the whole cryptocurrency landscape and determine whether or not we are just in a bubble here – and this is something that we here at Blackbird Capital have debated vigorously as this isn’t an easy topic to come to a landing on. So to put simply, let’s start by breaking down the arguments for and against bitcoin…

Continue reading “The Debate on Bitcoin and Cryptocurrencies”