We are only 2 weeks in to 2021 and we have already witnessed a full year’s worth of events. While I am sure those events will be analyzed in history classes for decades to come, I will focus here on markets.
Turning to investments, I think the subject of the day needs to be what is happening in Bitcoin, Tesla, and the ARK ETFs. To say that these have had a bit of a rally is putting it mildly. Let’s think for a moment. If I put money into ARK I am buying TESLA. In fact, I am buying a lot of Tesla! ARK funds have received billions over the last 12 months and in turn bought large amounts of Tesla. So of course, Tesla keeps going higher. The more money these funds attract, the more Tesla they must buy. Those old enough to have enjoyed the dotcom era will remember the Janus 20 fund that made its name during the first tech bubble. They attracted large sums of money, like ARK is today, through performance during that bull market and invested those funds in 20 high conviction stocks. Unfortunately, we all remember when the tide turned so did Janus’s and investors’ fortunes. I am not saying this is the top, this can continue for a lot longer. As Chuck Prince alluded to before the GFC, you want to be on the dance floor as long as the music is playing, just make sure you aren’t the last to leave when it stops. With Bitcoin, I think it will be interesting to see how it behaves in a market pullback. If it holds its own, I will become more of a believer, if it stays correlated to Tesla, well….
On Thursday Jim Simons of Renaissance stepped down. He had a truly remarkable run and it is just amazing what he and Renaissance have accomplished. I think it is interesting he is stepping down during one of the worse quant performances in a very long time. There are questions about whether all the quant models are just plain breaking down, that they need to be rewritten. I view myself as a bit of a quant and I think models are fantastic things. At the end of the day, they are models. Financial markets are not a particle in space like we studied in physics class. Math might provide the solution most of the time, but math does not solve for emotions and liquidity. Math also does not solve for an event like March, and a response to that event like we saw in April. Nobody can model that kind of jump in unemployment or the fact that oil went negative! Portfolios need to adapt and improvise in situations like what happened last March. That adaptation comes from a human with experience, battle scars, and a deep understanding of markets. The second problem with big quants is… they are simply too big.
That leads me to ask some more questions. Is a lot of what’s going on driven by new funds gaining assets in a way we haven’t seen since dotcom? Are quants being forced to liquidate? How is that impacting markets right now? Well, Tesla we see, so the first question is an easy ‘yes’. The second answer is a likely ‘yes’ as well. Morgan Stanley’s short basket is up 12.6% as of Friday morning! Look at Gamestop (GME) and Bed Bath and Beyond (BBBY) as two examples. This is one example of where quants live. It is impacting markets right now in a way we haven’t seen before. As people add positions (ARK) or reduce positions (quants) the cost of doing business, access to liquidity, is high. This cost could be distorting markets and the performance of funds, both on the way up and on the way down. Think of it as liquidity/momentum driven performance. Outsized outperformance on the way in and outsized underperformance on the way out.
What are options telling me? VIX remains above 20 not because of downside protection buying, but because of call buying. NOBODY wants to be short calls in any of these names and as a result, momentum wins the race. Put/call ratio is the lowest it has been since 1999! In other words, all open interest vs put open interest is very one way towards the calls. Again, is this a market top? A lot of evidence in flows and derivative positioning is saying that very thing. We haven’t even talked about SPACs or ‘how VCs dump garbage they can’t sell by bundling it’! Financial engineering is alive and well, in the same manner we saw portfolios of residential mortgages! The problem with being a bear is fundamentals. ISM numbers keep improving. The government is literally pulling an Oprah with “you get $2000, you get $2000”. The government, in my opinion, has also socialized the listed bond market. They have come in and bailed this group out repeatedly, best union in the world, those credit traders! Not to mention when lock down ends, people are going to go nuts like the 1920s! There are not enough tickets at Disney World to keep up with that pent-up demand.
Overall, I am cautiously optimistic. I do think markets and market structure have changed. I think how we invested in the past doesn’t necessarily predict future performance. I think people should be thinking about diversification differently. It could be that the torque wrench your father-in-law bought you isn’t going to help you fix your Tesla.
Partner, Portfolio Manager
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