[Editor’s note: The following excerpts are from a much longer piece by Kevin Muir, formerly head of equity derivatives at RBC Dominion and better known for his exploits as “The Macro Tourist.” The full piece, which outlines Kevin’s trade ideas, is available exclusively to his subscribers. Those interested can check out the new MacroTourist here.]
More than three years ago, I wrote a piece titled A SERIES OF ROLLING MINI-BUBBLES.
Looking it over today, the details make me smile. Back then, hedge fund managers and other fast money folk were sure Trump’s policies would cause small-cap stocks to skyrocket. From the piece:
…the market was convinced Trump was about to usher in a new wave of free market nirvana. Hedge fund managers piled into small-cap equity long positions, confident the pro-growth policies would fuel a massive outperformance for the Russell 2000 index.
When someone suggested small-caps were overbought and prone to disappoint, they were labeled a Luddite who didn’t understand the true extent of Trump’s transformative policies. It was a one way freight train that seemed to have no end.
Yet it did end. Not in a big bang, but in a quiet abandonment of the trade. Hedge fund managers might move in herds, but they don’t sit in losing trades indefinitely.
It’s easy to forget, but there was a time in late 2016 when investors were foaming at the mouth to buy small-caps.
I remember this period well because it seemed like every portfolio manager was bullish on small-cap stocks, and absolutely sure nothing would derail the rally.
As I urged caution to those joining the frantic small-cap rally, I summed up the real reason for the price action:
With so many shrewd managers chasing limited alpha, combined with the near instantaneous spreading of information, markets almost immediately fully price good ideas. A common cycle plays out like this: There is a new piece of information that requires the market to reprice. The smartest, quickest managers put on the position. Markets quickly move to the new level, and at this point, slower, less nimble managers start chasing, causing the price to develop a reflexive quality. With the smartest managers touting their position, and the price action affirming their view, more and more money flows into the idea, until eventually its price reaches a level that cannot be fundamentally justified, and the inevitable disappointment settles in.
And then I gave my conclusion on how to trade it:
I have seen this scenario play out time and time again. The trades hedge funds are most enthusiastic about are the very ones you should avoid.
Instead of focusing on what the hedge funds are buying or selling today, think about what is cheap and might be the object of their obsession tomorrow. Trust me, as sure as an empty cocktail glass in Lindsay Lohan’s hand is followed by a full one, there will be another mini-bubble in next “great” hedge fund idea.
This is what I meant when I wrote that the market was nothing more than a SERIES OF ROLLING MINI-BUBBLES.
They ain’t so “mini” anymore
I’ve been thinking about this analysis a lot over the past week. It’s been repeating in a loop in my head. I’ve stared in awe as the crypto and EV sectors, which have gone full Tugg Speedman.
I’ve been surprised at the violence of their upward trajectory.
But really, I shouldn’t be. And that’s the point of this piece.
I’ve been preaching how governments’ fiscal stimulus, along with central banks’ stack of blue tickets, will fill any hole COVID-19 might create. However, to think they’ll be able to fine-tune this stimulus to perfectly balance the economy and markets is naÃ¯ve. Of course they’ll overshoot.
Yeah, sure, lots of pundits are worried about the American government’s inability to agree to another fiscal package. But, the global economy is more than just America. The rest of the world can also share some of the burden.
And let’s face it, determining the correct level of fiscal and monetary stimulus is almost impossible. Who’s to say we actually need more fiscal? Maybe we already have way more than enough. Now, you might say, “Of course we need to come to the aid of those members of our society who are suffering during this pandemic.” I won’t argue with that assessment. But that’s a political decision. It might be the right thing to do from a normative perspective, but that’s not necessarily the same thing as tuning for the macro-equilibrium.
This inability to target the needy members of our society is why governments are taking a “sun screening your red-headed toddler in Aruba” approach to stimulus – you can almost never do too much because if you miss one area, the consequences are disastrous.
I’ll leave the finer details about which programs should be extended / cancelled / increased to people smarter than me, but let’s agree that the entire world is stimulating as much as possible. And if they aren’t – if for example, the fiscal impulse falls short – then monetary policy will do more. But rest assured, few officials are holding back waiting for the “truly bad time” to finally shoot their last bullet.
And let’s not forget that even before COVID, governments were having trouble stimulating without causing asset bubbles. When Jerome Powell took over the Fed in 2018, he realized this problem and tried to tame the mini-financial asset bubble that had enveloped America.
What did Powell get for his trouble? Well, President Trump telling him he couldn’t putt for one thing.
Powell was also chided by Wall Street legends. Recall the scathing Op-Ed penned by Stan Druckenmiller and Kevin Warsh, who was briefly in the running for Fed Chair.
I contend the reason we have asset bubbles is that we have relied way too much on monetary policy to do the heavy lifting of economic stimulus, but that’s a story for another day. Whatever the cause, the minute we try to help the economy, it’s accompanied by a SERIES OF ROLLING MINI-BUBBLES.
Given the incredible amount of stimulus applied to global economies in the wake of the COVID crisis, why are any of us even the slightest bit surprised when every story du jour turns into a bubble?
Take Bitcoin. Could it be a game-changing technology that revolutionizes the world? Sure. What do I know? Remember, a good trader never says never. But really, who cares? The reality is that cryptocurrencies are one of the narratives that investors have chosen to chase. It doesn’t even matter if the technology eventually proves useful or not. As long as enough investors think it might, that’s all that’s needed.
Or how about electric vehicles? Are they a good idea? Most certainly, yes. Will fortunes be made as the world transitions? Again, yes. Is the market doing a good job pricing the companies competing in this space? Not a bloody chance. It’s a full-on mania.
Now, you might say “Isn’t this always the case?” Sure, but never to this degree. When money is priced at zero (and lower) throughout the world, and governments aggressively push money into the economy with their fiscal stimulus programs, it’s extremely easy for these bubbles to develop. It’s like leaving the house to your 17-year-old teenager with a full liquor cabinet and telling them you will be back on Sunday night. If you expect anything less than a party, you aren’t paying attention.
There is a massive pool of savings that needs to go somewhere. When some investment guru creates a convincing narrative explaining why Bitcoin is the “technology of the future,” it’s an easier sell in this environment. Or when a stock promoter tells the story of the next great automobile company – no wait, they’re “technology” companies, not car companies – investors are quicker to open their wallets.
I wrote my piece about A SERIES OF ROLLING MINI-BUBBLES three years ago. Well, it needs to be changed. We need to get rid of the word “MINI.”
Today, stimulus is much larger, and the bubbles are likely to be commensurately more spectacular.
Some market pundits will realize this new reality, yet still fight it. They’ll say things like “This will end badly” while trying to short these bubbles.
I’m here to remind you (and myself) that this is way too hard. Let’s take Tesla. Do I think this recent move is ridiculous? Yup. You betcha. Yet I’ve been wasting energy on this name as many of the other stocks I’ve long advocated are running hard. I’ve spent mental (and monetary) capital on this EV bubble while my value trade is exploding higher. I would have been better off doubling my positions in the trades that were working, and giving up on Tesla.
Now, don’t misconstrue my remarks. I’m a trader and when these bubble names turn, it’ll be an epic opportunity to short on the way down. And it won’t be solely Tesla. It’ll be the crypto frauds and the sketchy EV names. They’ll probably be even better sales than Tesla.
But I’m writing today with one main message. We will have more bubbles. They’ll roll through with different themes catching investors’ fancy. Right now, it’s crypto and EV. Tomorrow it might be renewable energy and copper. Or maybe small-caps will once again be the “must own” asset.
All I know for sure is that today the crypto and EV folks think they can do no wrong, but there will come a time when these bubbles become so fully priced, they’ll pop under their own weight. At that point, the massive pool of capital will move on to the next “life changing” investment theme.
Make no mistake: Crypto and EV are bubbles. No doubt in my mind. Late investors to these stories will get hurt. Badly. Many pundits will look back and wonder what they were thinking. But then, just as sure as night follows day, these crypto and EV bulls will forget their breathless buy recommendations and move right on to the next bubble.
This cycle has been playing out with increasing frequency over the past decade. The COVID governmental response has injected steroids into this phenomenon. In the coming months and years, we can expect more bubbles, and for their intensity to increase. It’s just not possible for the government to stimulate without creating bubbles. And don’t think this reality will cause the government to step back and withdraw stimulus. Not a bloody chance. They’ll accept asset bubbles as a worthwhile tradeoff for what needs to be done.
So, the new post-COVID world has become one of A SERIES OF ROLLING BUBBLES.