Presentations about developments in technology, life sciences, digital assets, and other transformational businesses, as well as market, economic, and geopolitical developments
Prepare for more frequent and extreme volatility. New and powerful influences, ranging from social media and financial technology to algorithmic trading and esoteric valuation models, will increasingly upset market stability and bring unprecedented rewards and unpredictable disaster.
Predictable market conditions will be upset by sudden unpredictable movements.
Financial markets can be predicted reliably only when the world does not change.
Even during periods of stability, judgment based on expectations and assumptions as much as hard facts and economic analysis, form the basis for buying and selling decisions. Market crashes and financial crises are a continuing and breathtaking reminder that markets are irrational and uncertain. Taken to an extreme, the combustible combination disrupts global markets and societies.
Everything you don’t understand about money combined with everything you don’t understand about computers.
Bitcoin and other digital currencies are going mainstream, and along with that, increased volatility. Last week, cryptocurrencies jumped in value as Coinbase, a cryptocurrency exchange, became a publicly traded company worth approximately $100 billion. In other words, trading in digital currencies, with all the expected volatility and unpredictable nature such securities bring, is here to stay.
Clear and coherent markets, free from political agenda, bad compromises, and ineffective regulation is almost nonexistent. The consequences are usually pyrotechnic. It is not as if the world hadn’t provided ample warnings about the risks associated with irresponsible finance. History has centuries worth of such examples, but even looking at recent events over the last 25 years is illuminating.
In spite of Alan Greenspan acknowledging the “irrational exuberance” of the markets in 1996, stock market valuations continued to rise. The warning signs of unstable economies were believed to be localized and the broader markets decoupled from this turbulence. This was naïve thinking then and outright irresponsible now.
The idea that markets are uncertain, and consistent prediction is essentially impossible, is not new. John Maynard Keynes published a book on probability and uncertainty in 1921, with this concept of uncertain and irrational markets forming the basis of his general theory of financial markets. So, years before the stock market crash of 1929, and almost every 10 to 15 years afterward, the cycle of financial crashes and panics was predicted by a well-publicized thinker, and then, as is typical, ignored. The lesson is simple, and Keynes laid it out 100 years ago: markets seem rational but only during periods of stability. Markets are uncertain. Predictive models work most of the time, and that is their fundamental flaw. They will fail. Investment models that account for uncertainty and failure succeed in the long term.
The pandemic, Fed interest rate policy and bond purchases, restrictive banking regulations, and banks’ swelling cash balances will have a lingering impact on liquidity and produce some mind-bending policies to deal with this uncharted territory.
As the pandemic emerged in March 2020, strange things happened:
o Bond markets seized up and investors panicked.
o Bond yields spiked causing severe price declines.
o Credit default swap prices (debt protection derivatives) rose 100x in less than a month.
o The dollar rose and liquidity dropped for U.S. Treasuries, usually the world’s most liquid security.
o There was substantially lower demand at U.S. Treasury auctions.
The Federal Reserve responded with an almost never-ending pile of cash, buying vast quantities of bonds with newly created cash. It has continued its purchases, at a pace of at least $120 billion a month.
But this has not resulted in “happy days are here again.” This mountain of dollars is limiting liquidity and constraining markets. That’s right, read that again if you must – too much cash can constrain the economy.
S&P 500 stock market values are experiencing the same volatility as the first half of 2020, the start of the Covid-19 pandemic (based on the 50 largest value movements as a percentage of the index’s total market value). These dramatic movements show that market volatility leads to big price movements in stocks, both up and down. There are a couple of factors combining to enhance this turbulence: The popularity of the momentum trade (buying stocks that are rising quickly and dump the relative losers quickly). Decreasing liquidity (fewer buyers and sellers for the other side of trades). Both factors magnify the market’s moves in either direction.
The Archegos implosion teaches the same lessons that apparently need to be taught over and over again.
1. High leverage eventually brings margin calls.
2. Margin calls equal disaster.
3. Margin calls come when too much leverage is attached to securities linked to market volatility.
4. All securities are linked to market volatility.
There is no such thing as uncorrelated assets anymore. Investment strategies founded on the belief that the securities held are somehow immune from previously “uncorrelated” volatility are anachronistic. Combine these investments with substantial leverage intended to enhance returns, and this strategy ends in disaster.
If it’s zero eventually, great quarterly performance is meaningless.
Fundamental drivers for pricing valuations in public markets have changed. Now, there is a new interaction among factors unseen just recently. Advanced technologies such as artificial intelligence have had a profound impact on the tools available and analysis presented to even the most amateurish investor. Social media, such as Reddit, Twitter, and other platforms, have allowed access to information and influence from media “stars” driving demand in an almost herd-like mentality driving up prices, and causing extreme volatility. Finally, technology has enabled a trading floor to be in everyone’s pocket. That same trading floor allows access to any information on anything from anywhere, and communication with anyone or, via social media, receive communication and information (regardless of how dubious) from anyone about any security or investment strategy.
These factors will cause unprecedented market volatility, along with extreme price movements for well-known (or perhaps more accurately, well-publicized) companies and their securities. While the supply of securities remains somewhat constant, demand for those securities is increasing (sometimes exponentially) because many more investors are now chasing those same securities.
The price of anything cannot escape supply and demand dynamics. Recent IPO activity is an attempt to meet growing demand (and raise capital at attractive prices). The new supply from IPO’s, secondary stock issuances, and most recently and monumentally, SPAC offerings, still do not provide enough supply to quench a growing and overwhelming demand. The valuations, especially those given to the SPAC’s, are entering stratospheric levels that could hardly be justified under normal market conditions. Successful investors are the ones who understand adding return without corresponding risk is the most critical component of successful investing, especially given the new equation for valuation:
Economics + Advanced Technologies + Social Media = Price
These three components are now inexorably linked and constitute an influential role in determining valuation from now on.
The More Things Change…
The pandemic has challenged many preconceived notions about the economy, markets, and public policy – and has impacted the way we live. But the inescapable truth remains unchanged:
There is no magic answer. No solution other than superior skill enables an investor to earn a high return safely and dependably. That is even more true in today’s low-interest rate, low return Tower of Babel world.
When Everything is Going Great, It Probably Isn’t.
Things can only get better from here… said the turkey the day before Thanksgiving. It’s challenging to know when it’s too late because things go badly gradually, then suddenly.
It might be time to start worrying about tech-stock valuations. Usually, all it takes is a few overly ebullient stock analysts to set off an alarm. When unreasonableness takes over (remember all those analysts’ reports from March 2000? The NASDAQ could only go up and all those internet funds were going to double again in 2001?). In March 2000, the bellwether for this nonsense was Henry Blodget’s recommendation of Amazon with a target price of $400.00 by March 2001 (at the time Amazon was trading for about $60.00 a share). Instead of being $400.00 in March 2001, Amazon’s price was $5.97 per share.
Long Term Value Means Long Term
Of course, Amazon has created an amazing business model and is fundamentally rewriting technology services and customer logistics. Trading at almost 100 times earnings the market believes there is much more growth and profitability to come. Really? Regardless of your perspective about that, Amazon is an example of investments that are either “don’t bother it’s ridiculous” or “never sell it’s ridiculous.”
The market may stay permanently irrational about companies like Amazon, or Amazon may catch up to the market’s irrationality. What should an investor do? The answer is simple – don’t play. By that I mean you either buy the stock and ride the tiger (which means you can never get off – or sell) or stay out of the jungle completely – don’t ever buy. Half measures rarely have good outcomes.
Amazon is exemplary. This tiger has rallied substantially since those woeful days in March 2001 to close above $3,200 per share in February 2021. So, even if you listened to the absurdity belched out in March 2000, and on paper, had substantial losses from your Amazon investment for several years, if you held on, you are brilliant and rich (more like lucky; but it’s smarter to be lucky than lucky to be smart). Don’t listen to the analysts and don’t get off.
Is It Really Different This Time? Well, sort of – and that makes all the difference. Interest rates are at zero, and worldwide markets assume that will change little for some time to come. Global coordinated monetary and fiscal policy are spiraling interest rates to this flattened level with little prospect of upward movement. The combination of monetary, fiscal, and interest-rate policy coordinated in this manner is unprecedented and is being pushed to its limits. A subliminal fear may be permeating the markets, generating extreme movements, causing both substantial profits and losses from massive capital flows magnifying price movements within compressed time frames. How do we explain this, and more importantly, how do we predict and profit from it? Bitcoin Explains Everything – Read That Twice If You Need To
The world economy is an infinitely complicated web of interconnections. We each experience a series of direct economic interrelationships: the stores we buy from, the employer that pays us our salary, the bank that gives us a home loan, etc. But once we are two or three levels degrees separated, it’s impossible to really know with any confidence how the connections are working. That, in turn, shows what is unnerving about the economic calamity potentially accompanying the coronavirus.
In the years ahead we will learn what happens when that web is torn apart when millions of those links are destroyed all at once. It opens the possibility of a global economy quite different from the one that has prevailed in recent decades. Or, as John Kenneth Galbraith has said, “we have two classes of forecasters: those who don’t know and those who don’t know they don’t know. “The bottom line is establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear imprudent in the eyes of conventional wisdom. We are entering a new world and must think differently.
