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What mattered #3: Ws and Ls
This week was a mixed bag with some winners and losers.
Welcome to What mattered. It was a shortened week for the markets with a long Easter weekend. Yay. Still, we got plenty of action and of course some W’s and L’s. Lets get right into it.
Another week another HF blow up:
You almost feel there’s something weird going on with the ‘smart money’ in the markets. After the Melvin Capital blow-up in the $GME saga, one would think it was a one-off event, an outlier, just an institution with inadequate risk controls. This week saw another fund take the big L – Archegos Capital Management, founded by former HF manager Bill Hwang.
Archegos apparently had taken massively leveraged positions in Chinese tech names, ViacomCBS and others, with leverage (via equity swaps) on some of them being as high as 8:1 and 20:1 (!!!). Margin calls by one of the many prime brokers he used (Credit Suisse, Nomura, GS, Morgan Stanley etc.) sent the dominoes tumbling and led to unwinding of huge blocks of shares by the banks (due to insufficient capital to cover the losses). Nomura and CS incurred heavy losses too (~$2-$4bn). The markets were on the edge with fears of contagion –fire sales in shares by the banks leading to unwinding of more leveraged positions and so on.
Archegos isn’t (or wasn’t) a typical hedge fund. It was run as a ‘Family office’, a different structure to manage private wealth. With lesser regulatory oversight, this allows you to take on more risk via excessive leverage, something that in a vanilla HF structure you wouldn’t be able to do. The FT did a great profile on Archegos and the family office structure this week – here
Time after time we’ve witnessed these banks take the hits due to excessive risk taking and laughable risk controls. For Credit Suisse, that’s Strike 3 in the span of a few weeks after the Greensill debacle. Now Nomura and CS stand to see their entire FY 2020 profits being wiped out. One step forward, two steps back.
And on leverage… some say it’s the fastest way to financial ruin. The new array of trading apps (Robinhood et all) have made it incredibly easy to trade levered products. They even give you upfront capital for it! “Do not risk something you have for something you don’t need.”
Now time for some W’s
Last week saw the clearing of the Suez Canal passageway being blocked by Ever Given. The giant 1300 feet long container ship got horizontally wedged in the canal for six days leading to a massive disruption in global supply chains, which, had already been under serious strain since last year. The passage is one of the key trade routes through which $9bn worth of goods pass through each DAY.
Although it’s a big win for global trade, the effect of the delays casued is still reverberating through the markets. Congestion at ports due to ships not being where they should have been, disruptions due to container shortage to name a few.
“It’s never been stressed this badly before, and it’s going to take a really long time, and they’re just beginning the process of sorting it out ... you’ve essentially created this traffic jam that doesn’t allow you just to reset and restart — you have to restack and reset the system and that’s something that’s going to take a lot of choreography,”
Stephen Flynn, founder, Global Resilience Institute
Supply chain bottlenecks not only create unwanted delays, the create cascading effects in the form of rising raw material costs due to lack of supplies. Supply chains have turned into that rubber-band being pulled apart from either side by supply-demand tension.
An unintended consequence could be higher input costs turning into higher inflation. Inflation talk has picked up steam lately and has made its way into the market via the 10 year breakevens in the U.S, a proxy for inflation expectations. The Fed is confident about the economy having enough slack to keep wage inflation but labour costs might have already started to move in some job sectors.
The S&P 500 crossed the 4,000 mark for the first-time last week on a positive jobs report and better economic data. The NASDAQ index has also made sort of a comeback in the last couple of weeks as big tech earnings season draws closer. It has been SOME ride since March, 2020 when the index touched 2300 levels.
The European Stoxx 600 index has inched closer to its ATHs of 433 as well with the Euro tech stocks leading the way. Jamie Dimon in his annual shareholders letter sounded optimistic on the U.S economy and hailed the monetary and fiscal measures’ ability to create a ‘Goldilocks’ moment for the U.S economy. The path for European economy, however, remains uncertain.
I will be back with some interesting earnings reports and much more next week!
As always, What mattered signs off with the Fund of the week. This time around we have an interesting pick. The ETFMG Prime Cyber Security ETF, the first ETF to exclusively invest in companies providing cyber security services.
The AUM has ballooned to more than $2bn and looks in a strong position to keep wind in its sails. Interestingly, it follows an equal-weighted scheme to provide a small-cap tilt to the fund.
Cyber threats have almost become omni-present as our physical world turns into a digital one. Recent attacks on Microsoft, SolarWinds and government institutions around the world should come as a wake-up call for more attention to and innovation and investment in the space. A nice pure-play exposure to large and small-cap cyber security companies.
The Atomic Investor