Too Fangtastic for Their Own Good
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Too FANGtastic for their own good If You Only Look At One Chart… Time is short, so here is one chart to get you thinking in a new direction. Peak Indexation – Time to Go Active? Source: BofAML – h/t Jawad Mian • Falling correlations between stocks means that the individual characteristics of a security are now a more important source of returns – think alpha rather than beta. • This is a call to arms for active investors – a ‘stock pickers’ market. Time to dust off your copy of The Intelligent Investor. Right Here, Right Now The best trading ideas of the week from RVP Contributors Sell FANGs Says Jesse Felder The FANG stocks are under threat – could now be the time to shift to a long-term bearish outlook? Jesse Felder thinks so: Threats to the digital advertising market are emerging from ineffective campaigns that fail to deliver tangible results. Big-spending consumer staples groups like Proctor & Gamble are pulling the plug. Furthermore, the deployment of unethical marketing tactics by Facebook and Google will shift public sentiment against two of the world’s most popular brands. Netflix faces new competition from Disney, and Amazon is just everywhere. Is this the pinnacle of FANG-mania and the start of a broader secular decline? Adam’s Portfolio Picks I have picked only the most compelling and highest conviction trade ideas of our RVP Contributors and will track them in a portfolio for you to follow. No new Portfolio Picks this week. Note: This is not investment advice. You understand that no content published as part of the services constitutes a recommendation or a statement that any particular investment, security, portfolio of securities, transaction, or investment strategy is suitable for any specific person The Big Call Legendary hedge fund manager Stanley Druckenmiller said when you see something in the market that really, really excites you, “Bet the ranch on it.” These are the Big Calls, the investment themes that can make or break you. Think differently from the crowd and have a different time horizon, and you have an edge. RVP, with its crack team of financial minds, identifies the Big Calls and guides you through the investment opportunities when they present themselves. The Bond Bears What will it take? I set out my secular bull case on bonds in The Hack 16 June. I see bonds staying lower for longer because the central banks have trapped us in a low-rate, low-growth environment where over-indebted governments have no fiscal firepower to stimulate the real economy. The 30-year secular bull bond market that started in the 1980s has shown little meaningful sign of reversing. Yet top money managers like Ray Dalio and Jeffrey Gundlach have been vocal in calling time on the trend toward lower and lower yields. If nothing else, a medium-term tactical rout looks possible given the weight of long-term positioning in bonds. It’s crucial to explore the potential for a bearish move in bonds. Stray Reflections sets the stage One vocal bond bear is Jawad Mian of Stray Reflections. He thinks the bull market is over, having succumbed to extreme positioning, with investors adopting a ‘There Is no alternative’ mentality towards the bond trade – a complete volte-face from the 1981 peak in negative sentiment where bonds were seen as ‘certificates of confiscation’. The delta on bonds to interest rates hugely favours a taking a bearish stance now, says Jawad: The long-run return prospects for Treasurys, and by extension most government bonds, remains unappealing as evidence continues to pile up that we are close to a major turning point in yields. A 100bp increase in yields would deliver a 9% loss in 10-year bond prices… in 30-year bonds, the same increase would lead to a 21% loss. But what could drive yields higher? Rates are low, policy is accommodative, inflation is under control… Gundlach’s view: the copper–gold ratio Jeffrey Gundlach is the founder of Doubleline Capital and a legendary bond investor with $50bn under management – he is not afraid to make bold calls. One of the things that I follow to give a really good short-term cyclical indication of the yield of the 10-year Treasury is the ratio of copper to gold. When the copper-gold ratio is rising, it’s incredibly suggestive that something is going on that might be a little inflationary. It suggests to me yields are going to break out to the upside.… The leg up in yields will be a catalyst of volatility in the market. The copper-to-gold ratio has been rising, and the recent breakout in copper noted by Greg Weldon this month may herald a groundswell of economic growth – something the bond market is not betting on: Source: FactSet Ray Dalio’s view Ray Dalio is one of the world’s most famous hedge fund investors, known for his outspoken calls and the somewhat bizarre culture of his $150bn hedge fund, Bridgewater Associates. Back in November Dalio called a bottom on bond yields: We think that there’s a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation. When reversals of major moves happen, there are many market participants who have skewed their positions to be stung and shaken out of them by the move, making the move self-reinforcing until they are shaken out. That inflation Gundlach sees in the copper–gold ratio might just be the thing that shakes out the structural positioning that Dalio alludes to. That structure is all part of the ‘risk parity’ trade. Risk parity: rise together, fall together The risk parity trade works by allocating portfolios across stocks and bonds to improve risk-adjusted performance. It has been increasingly popular since the GFC, because it performed well when global bonds rallied and stock volatility was high. But deeper historical back testing shows it was a poor strategy in the 1990s and earlier, when equity returns and bond returns were more highly correlated: Source: Artemis Capital Management The risk is that both stocks and bonds fall together – such that leverage in the risk parity trade is forced to unwind in a catastrophic manner. What the chart above shows is that investors are betting on a recent and relatively unusual phenomenon of a high anticorrelation between stocks and bonds – the historical norm is a moderate-to-high positive correlation. But what could possibly cause a breakdown in the trend and a selloff in bonds and stocks? Chris Cole of Artemis Capital Management identifies the volatility of inflation as the key driver. Inflation has remained surprisingly benign since the crisis, carefully managed and guided by the central banks. It is not hard to imagine a regime whereby central banks lose credibility or are not capable of moderating swings in inflation in a way consistent with the past three decades. Any period of sustained correlation failure will result in rising volatility and selling pressures across bonds and stocks in a self-reflexive cycle. Now recall Gundlach’s copper–gold ratio. The risks of inflation are real. Central banks hold the key The next six months are crucially important for asset markets. As I said in The Hack July 6th, the central banks are cautiously hinting at tightening and shifting in their chairs to set up the first baby steps toward withdrawing nine years of extraordinary liquidity. This week, the Jackson Hole gathering may shed a bit of light on a roadmap for the future – the movers and shakers have one last tiny sliver of a chance to regain some credibility. So I’ve changed my view? No. What the bond bear arguments show you is just the other side of the same coin: The longer CBs remain loose, the more they invite inflationary outcomes and the more dangerous the risk parity trade becomes. I still think they have enough sense to at least try to climb out of the rabbit hole. I remain a long-term bond bull: The mathematics of debt, deflation, and demographics in the West means growth rates won’t get us out from under these debt loads. I see central banks trying on some tightening for size in an attempt to rein in the market – and when it blows up they will have carte blanche to ease again, sending yields crashing. Are You On This Yet? In such a fast paced world staying on top of relevant market news and developments is tough. RVP scours the globe for the most interesting stories and distills them, keeping you ahead of the crowd. How to Avoid Being a Patsy Buy the Story, sell the news Inevitably, very few investors are able to get in on the ground floor of the ‘next ‘big thing’. Very few people will be close enough to the genius who creates the next billion-dollar business to see the stratospheric gains that will accrue to the founders and entrepreneurs. Amazon, for example, was founded in Jeff Bezos’s garage in 1994 as an online bookstore. But unless you were Jeff’s friend or neighbour, it’s hard to see how you could have got in on it at the start. Even if you had been involved with the startup, it’s likely you would have been bought out at an early stage because of proto-Amazon’s lack of success. We’ve all heard of Steve Jobs, and many have heard of Steve Wozniak, but few have heard of Ronald Gerald Wayne, who sold his share of Apple to the two Steves for $2,300 in 1976.