Tech Crash Strategy

This is not investing advice. Seek a financial professional before making important financial decisions. Nothing we say or write is a recommendation to buy/sell/or trade any security.


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Our portfolio took a big hit the past two weeks. In this article we discuss our recent track record of predictions, what went right vs wrong, and how we shifted positions to account for the rapid repricing in nearly all the securities we holdin our Strategy 2021.


Our Strategy for 2021 builds on the outlook we described at the end of 2020. If you haven't watched it then you may find it helpful because we also walk through the past year. We experienced many ups and down, but came out up more than 400% ... a return that we don't expect to ever achieve again. You will note that we change our minds quickly when the facts change, but stick with core convictions...especially when they are contrarian. Our biggest takeaway from 2020 is that change creates opportunity and we feel the same way about the tech crash.

Why Tech Crashed


The narrative today is that the rise in rates caused a rationale re-pricing of risky assets ... an argument we believe to be nonsensical as we explained in this article on Why Tech Crashed. main reason is that risky assets have high risk premiums so changes in benchmark rates don't really have a material impact when discounting future cash flows...even when those cash flows are very far out into the future.


We also showed that there is no historical relationship between interest rates and S&P 500 dividend yields, or outperformance of the S&P 500 relative to NASDAQ. The Dot Com Bubble occured while Treasury Bonds yielded 6% compared to a bottom of 1% for the S&P 500. After the Dot Com Bubble burst the 10 year treasury yield fell to 4% by 2004 ... the only period in which "value" outperformed stocks since 1996.


Tech crashed because it was overdue for a correction...which is why we sold most of it on Jan 28, 2021 and went overweight Crypto, Silver, and foreign stocks. The rapid rise in rates started the sell off which then popped the Call Option Bubble. That's why Tesla fell 30% in 10 days ... it had higher outstanding call options than any other stock by a factor of 2 and that's after adjusting for its high market cap. ARKK sold off 30% as well because of extreme call option exposure that evaporated; which in turn forced broker dealers to sell their stocks to delta hedge their reduced call option exposure.


Key point = Our favorite tech names for 2021 sold off 30-60% in two weeks because of forced selling driven by over leveraged exposure. That's the biggest opportunity in the market today.



Prediction Track Record


So far nearly all of our predictions for 2021 have been right. For the record we list our public predictions below and linked them to our blog and Twitter. Where we don't seem to do as well is short term (daily) market timing; which we acknowledge is more for fun, and not something that we put a lot of capital behind. Algorithms are going to win at the high frequency games because of our the Algo Efficient Market Hypothesis. What we have been successful at is buying undervalued assets, selling them before they crash, and buying them back when most everyone is terrified...like we did last week.


Correct Public Predictions...

  1. Genomics and 3D Printing would outperform (Oct 7, 2020)

  2. Gold would keep falling and underperform Silver (Oct 28, 2020)

  3. Reopening Trade would start after the election (November 1, 2020)

  4. Bitcoin would rise from $14,000 by around 10x over the next 1.5 years (Nov 4, 2020)

  5. Treasury 10 year would break 1% and hit 1.5% by Jul 2021 (December 7, 2020)

  6. Bonds are in a bubble and rising rates are biggest threat to S&P 500 (Dec 7, 2020)

  7. Electric Vehicles are in a Bubble that would crash when Tesla falls (December 13, 2020)

  8. Tech Stocks are not in a bubble yet, but probably will over next 1-3 years (Dec 16, 2020)

  9. Stocks (especially ARKK) would underperform Crypto next few months (Jan 28, 2021)

  10. Tesla will fall 30% and not fully recover over the next year (Feb 12, 2021)


Incorrect Public Predictions...

  1. Shorting pandemic stocks like Zoom, TDOC, and Peloton (Nov 10, 2020)

  2. COVID19 may have already won (Jan 11, 2021)

  3. Silver would break $30 within days and outperform stocks (Jan 31, 2021)

  4. Calling bottom on tech selloff (Feb 23, 2021)

  5. Buy Grayscale Ethereum because of 1% discount to NAV (Feb 26, 2021)


Outlook for 2021


Perhaps the most important prediction we made was being generally long risk assets and leveraged long the broad stock market just before the election and riding it out until the S&P 500 dividend yield fell below 1.5% ... which happened about a month ago. While the rise in rates is not going to be a headwind for tech stocks we do think it's going to put some pressure on the S&P 500 because these companies have much lower risk premiums making their discount rates more sensitive to Treasury Yields.

https://twitter.com/IntuitEcon/status/1328803303958999042?s=20


The S&P 500 seems fairly valued. Out of all the broad market indexes it's our least favorite for several reasons. First, by construction it holds the 500 most highly valued by market cap profitable companies in the USA. The USA is a declining power and 25% of all the dollars in existence have been printed in the past year. The term "Value" has become a proxy for lack of innovation and the S&P 500 is full of companies investors believe to be "safe". We hate stocks that most investors think are "safe" because the lack of fear elevates prices to levels that make them unsafe. Low risk premiums also make the S&P 500 more sensitive to rising rates which is why we see it trading in a $3,700 to $4,000 range through 2021 as treasury yields rise to at least 2% by year end.

Treasury yields are likely to pause for a few months before continuing higher. The main reason is that breakeven inflation is nearly a full 1% higher than Treasury 10 year yields which is unusual. But foreign central banks like the ECB, Australia and Japan are aggressively keeping rates lower making US yields look more attractive. That's why the dollar stopped falling despite the oversupply.

Inflation expectations will probably keep rising some because of the commodity supercycle. There are three reasons for this...electrification of energy ...capital cycle...and monetary debasement. Electrification hits in two ways but putting upward pressure on metals and reducing investment in fossil fuels. But inflation is unlikely to get out of control unless Democrats keep doing MMT after the pandemic subsides (which could happen).

Foreign stocks are likely to outperform the S&P 500 over the next decade for five reasons...

  1. Trump undermined credibility in the strength of the USA Democracy

  2. Democrats are undermining the credibility of USA Capitalism

  3. Big Tech is what led to S&P 500 outperformance but the services provided by companies like Facebook, Apple, Square and Google are helping emerging markets overcome the geographic barriers that have held them in a perpetual state of "emerging" for decades.

  4. Foreign currencies are likely to rise and stock risk premiums fall because of 1-3.

  5. Foreign markets benefit more from rising rate and the commodity supercycle than the USA because they are heavy financials and mining companies.

We generally agree with Ray Dalio's thesis on the Changing World Order. China is the rising power and America is a declining power. The evidence is everywhere...but many Americans are too wrapped up in their own political tribalism to see it in themselves. China largely controlled the pandemic along with most of Asia. Meanwhile...America's president told everyone to not wear masks and consider injecting bleach.

Democrats were only a bit less damaging. Police shot and killed 226 black people last year. In response 20 Million America's took to the streets in protest. This probably contributed ten times as many deaths to the more than 500,000 COVID19 deaths as of this writing. Debt to GDP is now over 100% with deficits rising faster than any point since WWII. America is the only industrialized country with a declining life expectancy. We have many problems...but the worst problem of all is political tribalism that blinds politicians from sensible solutions.

Our best guess is that American tribalism continues to send the USA into a steady downward spiral. Things need to get so bad that America's politicians and voters have no other choice but to come together and start acting like adults. At least...that's the conclusion of our Fourth Turning article. We thought maybe President Trump inciting an insurrection and attacking the nation's capital would do the trick. The attack left one police officer dead and included clear intent to execute the Vice President (both white men by the way). But Republicans never turned against Trump and Democrats turned it into a race issue so just guessing here that it's going to have to be worse than that.


Until then...relative CAPE ratios across the world seem likely to change. Foreign countries have very high risk premiums because of anchoring bias to a 75 year track record of stability in the USA. That simply doesn't make sense anymore.

https://www.starcapital.de/en/research/stock-market-valuation/


The dollar will continue to fall as well despite the relative rise in recent weeks. Why? Same reason as above. The dollar just like America's relative perception of "safety" is baked into the 65% allocation in central bank reserves. America is 4% of the world's population and just 23% of global GDP. Yet America has 50% of the world's stock market capitalization and 65% of the world's reserve currency?

Dollar abundance is the single most important macroeconomic reality of 2021. Thanks to money printing and wealth transfers American's had their first recession ever with a rise in savings rates. Household wealth grew by 300% during 2020 with most of this still sitting in deposit accounts and money market funds.

Money market accounts alone are still up $1 Trillion ... more than doubling from pre-pandemic levels. Meanwhile stocks are only just finally catching up to corporate bonds in terms of net flows since January 2018. Perhaps it was a bit too much to fast...but with this much money on the sidelines it's more likely than not that investors will keep doing what has worked for 12 years now...buy the dip.

All that money is the biggest reason why you keep seeing risk asset prices go up. You see your account balances going up (until two weeks ago) but another way of interpreting this is that the value of dollars is going down.


You put all this together and you have the perfect recipe for a 2nd Tech Bubble...

  1. Many years of stock prices going up and led by "tech"

  2. Strong fundamental truths that can easily turn into euphoric narratives

  3. Broad based economic growth and strong household balance sheets

Add to that ... trillions in printed money that made its way into the hands of retail investors. Retail went from 10% to 25% of market volumes during 2020. These new younger investors don't believe in buying and holdings the S&P 500 ... they believe in stories, narratives, and follow momentum.


For the party to end you need two things:

  1. Valuations that can't be justified by any reasonable future scenario

  2. A shock that turns sentiment

We don't have either of those conditions yet.


Tech Valuations


Ray Dalio is probably better at timing bubbles than we are...except that we read all his stuff and other brilliant minds so that helps. He basically said a month ago that it looked like emerging technologies like the kind ARK Invest holds could be in a bubble. Stocks generally...not really close.

We agreed ...that's why we sold most of it and prepared for a correction...which we believe just happened. If we are in a true bubble then buying back in is going to be painful. But a quick comparison to the Dot Com Bubble gives us some comfort.


Comparison to DotCom Bubble is misleading by most measures: Price-to-book, Price-to-sales, 5y performance, profitability, earnings yield relative to bonds, and very real value behind #genomics, #3Dprinting, #blockchain vs narrow internet euphoria.


Then there is the size of the correction in our favorite names. Most already lost most or all 2020 gains...in 10 days! That's forced liquidation because of leverage ... a.k.a. the Call Option Bubble ... not capitulation. Also...unlike in 2000 these tech stocks are generally profitable and growing rapidly. They have been around for a decade or more...they didn't IPO yesterday and double in price because Chamath tweeted about them.

Most of these companies are in the Genomics and 3D Printing space. Both have experienced a rapid rise in price over the past year. That's why really sharp value hunters like Jesse Livermore seem to be so confident that tech is in a bubble.

But Jesse's been saying the same thing about Tesla and Bitcoin for a long time. Eventually he will be right. Maybe. But all the fear of Tech right now gives us comfort. Just like it did when we bought Tesla in May 2019.


Conclusion


So ... what does all this mean?


It basically means that the outlook for our tech stocks has changed...but the price just got way cheaper.


We are staying the course with our Strategy 2021...with a few adjustments:

  1. Closed our shorts on bonds and gold.

  2. Increased our weight on Brazil because of the recent selloff.

  3. Equal weight across Ark Funds post Tesla selloff.

  4. Long TIP ... long duration TIPS ... because of the selloff

  5. Increased our weight on Nickel ... because of the selloff


Buy the dip if you dare.


Sincerely,

Bernard




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