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.
Blackbird Capital 