April 12, 2021
We’ve now entered the “hold my beer” phase of the investment cycle…
In case you’re not familiar, the full expression is, “Hold my beer and watch this.” You say it when you’re about to take a dare that you shouldn’t take.
The implication that inebriation plays a role is appropriate… given the sort of hasty, risky acts and bad outcomes it represents. And if you’ve spent any amount of time on social media in recent years, you’ve likely seen tons of disastrous “hold my beer” moments.
When it comes to the investment cycle, the “hold my beer” moment is when financial actors great and small – convinced that easy wealth is imminent – most brazenly push the risk envelope. It’s also when they start taking themselves out of the financial gene pool by getting caught lying, blowing up their portfolios, and other tragedies.
These folks all share a deeply shallow understanding of risk… and a stunning ignorance of thousands of years of ancient wisdom.
I will get to the shallow understanding of risk on a case-by-case basis. As for ancient wisdom, let’s use the “Delphic entrance maxims” inscribed on the forecourt of the temple of Delphi in Greece…
- Know Yourself
- Nothing in Excess
- Surety Brings Ruin
Know yourself… including how you’re likely to behave with money in dire straits.
Nothing in excess… especially the use of debt and other dangerous and unnecessary financial strategies.
Surety brings ruin… because you can’t know the future – and betting with real money that you can tends to work out poorly.
That brings me to the No. 1 example this week of violating the maxims with a large dose of “hold my beer” hubris…
It involves Bill Hwang and Archegos Capital Management. Kim Iskyan covered Hwang and his Wall Street failures in depth on Friday.
In short, Hwang previously worked for hedge-fund mogul Julian Robertson’s Tiger Management. But in 2012, he was essentially run out of town… He pled guilty to insider trading and was fined $44 million after the U.S. Securities and Exchange Commission (SEC) alleged that he “committed insider trading by short selling three Chinese bank stocks based on confidential information [he] received in private placement offerings.”
However, Hwang didn’t stay out of the game for long… Within a year, he was back in business, managing family money in a firm that he named Archegos (the Greek word for “chief” or “leader”).
An intriguing part of this story is how little was known of such a large fortune in the first place…
Described by one analyst as an “aggressive moneymaking genius,” Hwang grew Archegos’ assets from $200 million at its 2012 launch to almost $10 billion in just nine years. He kept a low profile in part by using “total return swaps”…
A total return swap is a pretty simple arrangement between a bank and a client.
The client makes a stream of payments to the bank, usually based on an interest rate. And the bank agrees to send the client a stream of payments based on the total returns generated by an asset. In this case, the assets were large positions in several stocks – including ViacomCBS (VIAC), Discovery (DISCA, DISCB), and Baidu (BIDU), among others.
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Total return swaps allow a large investor like Hwang to remain anonymous because the swaps don’t trade on a public exchange and the bank maintains ownership of the asset… So because of that, the client doesn’t have to report a large position to the SEC.
However, there’s also a dangerous side to total return swaps…
It’s a big reason why legendary investor Warren Buffett labeled derivatives like these as “financial weapons of mass destruction” in his 2002 letter to Berkshire Hathaway (BRK-B) shareholders.
You see, they’re a way for investors to get plenty of leverage – which can wind up being more than the investors can handle. That’s because, as Buffett pointed out almost 20 years ago, the bank requires pitifully small collateral for total return swaps.
Through swaps and other leverage, Archegos may have levered as much as 5 to 1, with positions totaling as much as $50 billion… despite the firm’s assets of only $10 billion.
A Billion-Dollar Fire Sale
Everything started to unravel recently for Archegos when the banks issued a margin call…
That’s a demand to put up more collateral for the positions… But Archegos couldn’t do it.
The banks reportedly agreed to hold an orderly liquidation in a call on March 25. But by the next morning, Bloomberg reported that “it was everyone for themselves”… with banks selling Archegos’ positions in a “mad dash.”
The Economist estimates that the “fire sale” that day involved “at least $20 [billion] worth of equities.” The Wall Street Journal put the total sales near $30 billion. J.P. Morgan Securities analysts estimated the losses at the banks in the range of $5 billion to $10 billion.
The latest action in some of Archegos’ biggest holdings – including ViacomCBS, Discovery, and Baidu – has been brutal. Just look at the following chart…
The lessons here are simple, and the questions seem endless…
The obvious lesson is… don’t use leverage.
Would a real “moneymaking genius” – again, as Hwang has been described – expose himself to such a spectacular blowup if he were of sound mind? Buffett once wrote…
Rational people don’t risk what they have and need for what they don’t have and don’t need.
If you had $10 billion, I bet you’d never even consider borrowing another penny as long as you lived.
And what about all these banks? Why would they expose themselves to billions of dollars in losses? Did they forget all the well-publicized times this didn’t work out over the past few decades?
Hwang violated all three Delphic entrance maxims… He didn’t know himself, and he indulged in excessive leverage. But he really went out of his way to show his contempt for the third maxim…
‘Hold My Beer’ Hubris
Hwang appears to have been trying to feed a massive, voracious ego…
I don’t know for sure… But the “genius” label, Wall Street pedigree, violation of SEC rules, and massive leverage feels like the sort of cocktail you mix up to feed a massive ego.
His behavior is overflowing with “hold my beer” hubris…
Anybody with that kind of background who thinks he’ll get away with that much leverage automatically falls into that category. Like the Greek myth of Icarus, Hwang made wings of wax and flew straight at the sun.
I wonder if Hwang will have anything left after the banks get done liquidating him… And potentially even more alarming, I wonder how long it will be until some young banker with no memory of this episode lends him the money he’ll need to blow up again.
I don’t think this Archegos episode is necessarily the start of a contagion. It’s more about speculative excesses in the equity market than excesses in the credit markets. And it might not even be the latest, best example of sheer, unbridled, in-your-face hubris…
You see, European Central Bank (ECB) President Christine Lagarde might be asking Hwang, “hold my beer”…
Lagarde is giving Hwang a run for his money (which is now the banks’ money, of course).
Lagarde walked straight up to the third Delphic entrance maxim… and smashed it with a hammer. From a Bloomberg TV interview on March 31…
Bloomberg: [Markets] seem to be continuing [to test] central banks…
Lagarde: They can test us as much as they want. We have a mandate. We have an aim. We’re going to be riveted to that, and we’re going to do what is required to deliver on that… And we have exceptional tools to use at the moment, and a battery of those, and we will use them as – and when – needed in order to… deliver on our mandate and deliver on our pledge to the economy.
They can test us as much as they want.
If that doesn’t translate to “hold my beer” in Bankspeak, nothing does.
Has Lagarde never read the Bible? As Proverbs 16:18 says, “Pride goeth before destruction, and a haughty spirit before a fall.”
For the buttoned-up lot of central bankers, “They can test us as much as they want,” is as haughty as it gets. I suspect Lagarde’s fall will be no less spectacular than Hwang’s. She may as well have said, “If you short stocks anywhere in the Western Hemisphere, I’ll make you feel like a levered family office way over its skis in total return swaps.”
Lagarde’s unflagging confidence is not merely in the ECB’s ability to protect asset prices… but also to not create enormous systemic risks that blow up even worse than Hwang (meaning the 2008 financial crisis on steroids).
Now, anyone familiar with the work of Austin-based Hoisington Investment Management knows there’s a teensy-weensy, little problem with the idea of a central bank financing government spending to generate economic growth…
In Hoisington’s 2020 Fourth Quarter Review and Outlook, the firm cited research showing that highly indebted countries – those with central government debt greater than 60% of GDP – generate negative growth when they engage in noninvestment fiscal spending. (You know, like handing out stimulus checks and most of the huge spending that governments undertook to fight the effects of their COVID-19 lockdowns in 2020… and most of the newest $2 trillion-plus spending package proposed by the current administration.)
Hoisington said increasing the amount of debt becomes “a persistent drag on economic activity that restrains growth despite the best efforts of monetary and fiscal policy.”
And in a recent interview with financial TV outlet Real Vision, Hoisington’s Lacy Hunt pointed out that, early in his career – back in the 1960s and 1970s – $1 of government spending might have generated as much as $4 or $5 of GDP within a few years. But today, according to Hunt, that multiplier is negative… It’s about -0.2, resulting in -$1.20 roughly three years after $1 of new fiscal spending.
The belief that the ECB, the Federal Reserve, or any other central bank in a highly indebted economy will generate real economic growth by financing higher debt-fueled fiscal spending is exactly what you’d expect…
It’s a fantasy based on a past that bears no relation to today’s economic reality.
ARK Is Bringing Its Beer to the Party, Too…
ARK, an investment firm, and its suddenly iconic founder Cathie Wood launched its latest innovation-focused technology exchange-traded fund (“ETF”) earlier this week – the ARK Space Exploration and Innovation Fund (ARKX).
At about 8.5% of the ETF’s assets, Trimble (TRMB) is ARKX’s largest holding. That seems to make sense… Trimble is a software company that gets about a fifth of its revenue from geospatial technologies.
But ARKX’s second-largest holding is where things start to get a bit more controversial…
You see, it is ARK’s own 3D Printing Fund (PRNT), at about 6%. Nothing says “hold my beer” and shatters the third Delphic entrance maxim like betting on yourself within yourself… especially when the bet-within-a-bet has nothing to do with the alleged theme of the new portfolio!
Meanwhile, Virgin Galactic (SPCE) – a company whose business is taking people into outer space – is only the 20th-largest holding… It makes up less than 2% of the fund’s assets.
Perhaps the most mysterious of all ARKX holdings is Deere (DE). It comes in at No. 13, making up a little more than 3%.
Yes, we’re talking about the company that makes farming vehicles, lawnmowers, and other heavy machinery. Who knows… maybe ARK Investment Management’s portfolio managers saw Matt Damon struggling to grow potatoes on Mars in the 2015 film The Martian and figured they would get ahead of the trend. Otherwise, I’m not sure I have an answer here.
I couldn’t help but chuckle as Cale Flage, a financial adviser in Florida, poked fun at Deere’s inclusion in ARKX on Twitter. He shared the following “evolution of space flight”…
While it’s the most mysterious, Deere isn’t the only un-spacey stock in ARK’s new ETF…
The fund also includes the following companies…
- JD.com (JD) – No. 5, 4.9%
- Amazon (AMZN) – No. 14, 3%
- Alibaba (BABA) – No. 23, 1.6%
- Netflix (NFLX) – No. 26, 1.3%
I searched for “space exploration” on Amazon and got more than 10,000 hits… mostly books or Prime Video titles. I would do the same on JD.com or Alibaba – two of China’s largest e-commerce companies – but I don’t want to accidentally type some freedom-y sounding words and wind up being kidnapped by Chinese secret agents.
Meanwhile, you can watch a lot of Star Trek on Netflix, and there’s probably a documentary about Elon Musk’s space company or something on there… So I guess that makes sense.
And of course, I’m certain that Wood didn’t throw these companies in there simply because they’re huge, liquid, extremely popular names that have generated some of the biggest returns among all global equity markets in the past several years.
No, she would never do that.
I’ve praised Wood for her achievements before. As I noted in the February 26 Digest…
Look, you can’t take anything away from the performance of Wood’s ETFs over the past year. They’ve helped a bunch of investors make a lot of money. And I can see why some folks… would reason that Wood is a brilliant fund manager.
Wood has been ahead of several major tech trends since founding ARK back in 2014. And all of her funds were up triple digits last year. So I get it…
She can be considered a genius who has built a great business. She’s firing on all cylinders, with a stellar year of returns behind her… And with her recent track record, she could probably attract investor assets with a coal and buggy whip ETF if she wanted to try.
But calling ARKX a “space exploration and innovation” ETF takes an incredible amount of hubris…
It seems cynical – or at least disingenuous – to me.
It’s a thinly veiled attempt to attach a sexy-sounding tech investment theme to a basket of stocks only marginally related to space exploration.
My local Walmart (WMT) has a pharmacy… Does that make it a biotech stock? Costco Wholesale (COST) sells produce and pays a dividend… Is it a farm REIT?
Wood is apparently so far ahead of space exploration as an investment trend that it hasn’t actually started yet…
The public doesn’t seem to care that it’s buying more shares of Amazon and Deere than Virgin Galactic in the new ETF. Nearly $300 million of ARKX traded hands on Tuesday, its first trading day… That made it the eighth-largest ETF debut in stock market history.
Only time will tell how successful ARKX is…
Until then, you might love the 38 stocks in it. But my point is that you are investing very little in space exploration compared with the many other industries in the ARKX portfolio by buying shares.
The three examples of Hwang, Lagarde, and Wood show that even the most sophisticated people in finance are susceptible to the hubris that’s all too typical of a speculative frenzy.
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Contributor, American Consequences
With Editorial Staff
April 12, 2021