Risk assets that do not price risk
It is becoming more and more apparent that “stocks” have little concern for the underlying economy, fundamentals of the companies they represent or even something as potentially economically disruptive as a global pandemic.
There has never been a time in history where central banks (globally) have acted in such unison to promote asset price inflation – inadvertently or not. In the span of the last 12 months the US Federal Reserve has printed more money that in any other 12 month period in history. Traditionally such an extreme measure would be found at the depths of a recession or perhaps even a depression.
There was a time where governments let markets more or less fend for themselves and focused on balancing the budgets and other pressing societal challenges. That time is not 2020. In fact this interventionist era extends back to Alan Greenspan’s tenure as Fed Chair in the wake of the 2000 tech collapse when the origins of the first housing bubble began with a near zero percent interest rates at that time. This time we have near zero (or negative) interest rates with an additional 20 trillion dollars of asset purchases (a first in history) to ensure assets really bubble before crashing. We have seen this bubble developing for years and began to act on it nearly 2 years ago now. A majority of valuation metrics today are in the 99th percentile (or higher) relative to historical mania peaks. A few metrics do not register at quite those extremes but the vast majority supersede previous extensions.
Today’s stock market seems to be void of risk for long only investors. No amount of ones capital is too much to invest in stocks because they always go up (it seems). Ironically, our fund positioning has developed out of the view that equity investors are exposed to enormous downside when equity prices finally give way to materially lower levels. Instead, we suffer from the egregious bubble getting even more extreme in the short term.
The fund continues to be challenged in an environment where price discovery has essentially vanished and all that remains are vestigial tethers to the underlying businesses. Our positioning has been proven “wrong” in the short term as stocks rarely decline for any reason. Having a diversified short position of nearly any composition has been an impossible challenge since late 2018.
On the long side of the portfolio we have been invested where there are pockets of value, and often deep value despite the broader environment. There are energy/commodity companies that now trade at 1.5X cashflow meaning, roughly, that if you owned the company outright you would have your full investment back in 1.5 years and you would double your initial investment every 1.5 years thereafter. Of course it means little if prices continue to fall and no one has an interest in owning these companies. This is more or less the situation especially as ESG factors force the hand of funds that once invested in these spaces. These are the undesirables. What investors seek are companies with revenue growth with little to no regard for profitability or even the prospect of profitability. We call these companies “story stocks”. Stocks disconnected from their underlying business but with a great story that investors can share with one another.
It has been our intent that the fund is structured such that we can withstand mis-pricings, even large mis-pricings, without having to capitulate on our positions. Of course, a deviation above our cost hurts our profit/loss (or our portfolio values) until that mis-pricing is corrected by more rational market participants (in time). We witnessed marijuana stocks rise exponentially before they crashed back to earth and never recovered. We managed our way though that bubble with profits in the end but this bubble is “fed fueled” and there are literally no limits to their tampering.
With that said, there remains a huge opportunity when this mania comes to an end.