Fund Performance Commentary

Fund Performance Commentary // October 2019

By October 31, 2019 March 3rd, 2020 No Comments

Price discovery has been cancelled

During October risk assets were driven higher catalyzed predominantly by jawboning from policy makers and politicians. Despite the lack of meaningful news the Russell 2000 and Nasdaq climbed nearly 9% from their lows early in the month.
The most significant support for equities was the announcement of “not-QE” or what can best be described as QE4 in late September. Policy makers went to great lengths to assure market participants this is not additional QE (quantitative easing). However, it is difficult to see how the Fed injecting upwards of $60 billion a month into financial markets is not a form of further debt monetization. Unless these funds are going to be withdrawn at a later date then they are just printing money. Recall that the initial wave of QE was temporary and an “emergency measure”. Today these interventions are just business as usual, all part of keeping equity markets afloat.

The Federal Reserve’s latest interventions are a response to the recent repo market turbulence. This is the type of disturbance one would expect during a period with visible strain on the financial system. At present, at least on the surface, markets are experiencing a period of sustained complacency.

The strained repo market is noteworthy because a frozen or impaired repo market has real economic consequences. A firm that relies upon the repo market for short term funding needs can find itself insolvent overnight if/when these issues arise. Funding issues of this sort were prevalent during the financial crisis of 2008. As such, to require the assistance of the Fed in today’s market should raise concerns. Further, experts in repo market mechanics are particularly concerned about December due to expected balance sheet constraints among liquidity providers.

Concurrently a number of bubbles have begun to unwind despite the broad market continuing to march higher.
Total negative yielding debt globally peaked at over $17 trillion and as of this month is now below $12 trillion. Market distorting negative yielding assets remain a factor but are at least trending in the right direction. Many prominent market participants have acknowledged that negative yielding assets are difficult to reconcile. Such a phenomenon is largely experimental in nature and has unknown consequences. The presence of such assets are a distorting market force. When you are comparing an equity with a negative yielding bond it makes it difficult to assign a fair value to the equity in light of the distorted bond price.
The second unwind occurring is a dramatic shift away from lower quality risk assets, particularly those that have recently come to market via IPO. Many of these companies have similar price charts. Their highest prices tend to be around the time of IPO with their prices falling up to 50% in the case of an Uber, Slack, etc. Additionally, we have seen many IPOs withdrawn prior to launch due to waning risk appetite.
Lastly, Marijuana stocks, a popular area of speculation among Canadian investors has unwound dramatically with most down at least 60% from their highs but many down 80% or more from their peak last year. We had been short these companies but in light of the broader “risk-on” environment decided to take our profits much earlier. Of course, we took losses on paper first while these stocks went through their highs. Had we had the fortitude to remain convicted we would have done much better.
Our portfolio is primarily suffering from our short positions running ever higher on little to no news in most cases, much like the euphoria mentioned above. A few companies have surprised the market on “earnings” though in most cases our shorts are cash flow negative businesses; businesses that are not self-sustaining. We are short the equity of companies that are being afforded absurd valuations in conjunction with business models that tend to lose money quarter after quarter. We are in an environment where traditional metrics are of little value when analyzing companies.
We have moved towards hedging the portfolio in light of the endless appetite for low quality stocks among market participants. With that said, the underlying data continues to support our positioning. We are seeing notable upticks in delinquencies and even a series of bank failures in China. However, if equities choose to ignore the trend in economic data and now two quarters of earnings contraction then we will have to increase our hedge to protect the portfolio.


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