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