Uncategorized – Blackbird Capital

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.

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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

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ESG – Nebulous Dream or Durable Theme?

First, you’ve seen multiple governments across the globe committing to net zero emissions by 2050-60 such as China, Korea and Japan and other governments will likely follow including the US under Biden leadership. This means that there will be trillions of dollars that will be spent on enabling the transition to clean energy and to achieve this commitment. China for example is looking to phase out coal which is currently still the largest power source. This monumental government push towards net zero will drive adoption of clean energy technology / infrastructure including renewables / EV and adoption will in turn drive scale which in turn will bring down unit cost. Take offshore wind, which due to these commitments see an increase from 30GW to 950Gw by 2050 (up 30x). Similarly for EV, which could grow from 7m EV cars as of 2019 to 245m EV cars by 2050 (>30x), which explains the run ups for EV related thematic stocks.

Second, in addition to government / policy support, you are seeing shifts in people’s perception or concerns around ESG issues, particularly in regards to climate related issues. A new generation of consumers or Gen Z are caring a lot more about environmental impact and other social issues (e.g. labour practices) when buying goods. That is why you’ve seen the rise of Impossible and Beyond Meats as well as shoes / clothes made from sustainable material. Corporates are incentivized to change their product lines and introduce new businesses to adapt to this changing consumer behaviour. Furthermore, corporates are increasing their commitments / disclosure on ESG issues which is why you are seeing rise of corporates taking energy sources direct from renewable developers or developing renewables themselves (e.g. Apple and Amazon).

Third, investors are looking beyond returns and have become a lot more focused ESG issues, particularly post Covid, ranging from exclusion to ESG focused investing which has resulted in significant capital flow into the ESG sectors including clean energy etc (take clean energy ETF, ICLN, for example).The final piece of this ESG puzzle is the improving technology and cost curves . Take solar and wind for example, on cost per MGW basis for solar and onshore wind is already cheaper than producing power for coal powered plants and this cost is expected to decline (offshore wind will soon become cheaper). On the technology front, wind turbines are getting bigger and more cost efficient in terms of construction which allows companies to generate larger amount of power at more effective cost.

Another example and a hot topic is Hydrogen. Hydrogen has been around for the last decade or more but suffered from a lack of adoption. It is also typically produced from natural gas which is carbon intensive (i.e. grey hydrogen). However, as renewable source of energy proliferates Hydrogen production will shift to “green” hydrogen and as cost becomes cheaper, adoption is expected to accelerate. In particular for long haul and large transportation, Hydrogen is likely to be more viable solution vis-a-vi electric vehicles given current view of economics and can typically achieve longer distance.

With these factors in mind, I am of the view that outlook and fundamentals for ESG thematics (e.g. EV or renewables) are very strong. Yes, high valuation in a lot of cases does pose a challenge and likely to see some level of correction but given multi decade themes and growth and explosive capital flow, I am happy to ride the ESG wave.

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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.

🤞

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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.

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The classic “timing vs. time in” debate

timing Quite frequently I get asked how I think about potentially investing at the top of the market with an inevitable market crash (ala GFC) around the corner. The one thing I agree with is that a market crash is inevitable, but that’s about it. I didn’t bother calculating historically how many all-time highs the market achieved as the point would be moot given we know how the market has evolved and grown in the long-term.

It’s true that if you did invest at the peak of the market, it’s possible you’ll suffer poor returns for a significant period of time. For example, if you invested $1000 in the market index in 1929, you would not have broken-even until 1955. Timing the market is difficult, and I believe it can be quite costly. So how do you mitigate such a scenario? The benefit of asset allocation and stock diversification is well preached, but often forgotten is the element of time diversification. There is no better example of time diversification than with a pure, disciplined dollar cost averaging strategy – that is, you continuously invest a fixed sum each month into the market, whether it goes up or down.

So to bring the point home, let’s assume our investment journey began in January 2007 – a full 18 months before the GFC went into full force. To put some context around January 2007:

S&P500 was up a healthy 13.6% in 2006 and trading at 15x forward P/E
GDP came in at 2.7% growth for the full year of 2006
US unemployment rate was 4.60% as a 1 Jan 2007

Here’s the chart of what a dollar cost averaging strategy on a range of stocks (from high growth to defensive staples) would yield over the next 5 years (can you spot the GFC?). As a comparison point, I’ve overlayed cash invested at 2%p.a. interest compounding monthly.

DCA chart.JPG

The key takeaways are:

If you have the luxury of investing with a long-term horizon, use it
If you can’t predict the next crash then you should time-diversify with a consistent, disciplined approach
Buying quality companies with sound future prospects is more important than picking the bottom

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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)” →