Here are the top market developments we have been watching in March.
1. Same As It Ever Was. Unsustainably high financial leverage was to blame for the implosion of Archegos Capital Management’s $50+ billion equity portfolio.
“Same as It Ever Was” is a lyric from the 1981 song “Once in a Lifetime” by Talking Heads. The lyric rang in my head when I discovered the Archegos equity portfolio was more than 5x levered. Too much financial leverage seems to be at the root almost every market panic or crisis. And the same items appear.
First, visible leverage in the markets recently spiked as evidenced by margin balances for FINRA and NYSE firms.
Source: FINRA
Second, the visible leverage statistics from FINRA hinted at the real culprit, namely “invisible” leverage. Archegos built up stakes in various stocks via over-the-counter (OTC) derivatives, specifically Certificates For Difference (CFD). Its portfolio experienced the price fluctuations of the underlying stock holdings but was not the actual owner of record of the stocks. And the usual suspects, namely investment banks acting as prime brokers, provided the leverage and were the counterparties to the derivatives.
Third, the use of OTC derivatives meant that the prime brokers had no insight other prime brokers were also providing financial leverage. As of this writing, it is not clear whether the same holdings were rehypothecated, i.e., used as collateral more than once to borrow and increase leverage. Regardless, the use of OTC derivatives once again created systematic risk. Fortunately the risk only materialized as a forced a liquidation of the portfolio without creating a market contagion.
Fourth, the action of some stocks indicated something technical and not fundamental or behavioral (speculation) was moving the stocks. Check out the price action of ViacomCBS. Its stock price increased 169% from year end 2020, before suddenly plummeting. No one could pinpoint what was going on with the stock, except in hindsight.
Source: Koyfin. This chart shows the year-to-date performance of ViacomCBS Inc. (VIAC).
Finally, Goldman Sachs makes an appearance, as explained in the brief clip below by Bethany McLean, who co-authored ‘Enron: The Smartest Guys in the Room” and “All the Devils are Here: The Hidden History of the Financial Crisis”.
https://twitter.com/SquawkCNBC/status/1376857157770096645?s=20
2. The yield curve has continued its bearish steepening path. Is it a cause for concern?
No, is our short answer. See more here.
Source: treasury.gov, Two Centuries Investments
Source: Koyfin. This chart shows the year-to-date performance of four semiconductor stocks, Applied Materials, Inc, (AMAT), Lam Research Corp. (LRCX), Texas Instruments, Inc. (TXN), and Nvidia Corp. (NVDA)
Only a small portion of the Biden Administration’s proposed fiscal spending program is devoted to productive uses, such as infrastructure spending. It is unlikely real economic growth rises sustainably to justify long term interest rates rising much further.
3. Value stocks have recently outperformed growth stocks by the most since 2001. Is a value stock renaissance in the offing?
Source: Koyfin. This chart shows the year-to-date performance of the iShares Russell 1000 Value ETF (IWD) and the iShares Russell 1000 Growth ETF (IWF).
Since February 12 of this year, U.S. value stocks have outperformed U.S. growth stocks by over 10%, led by the energy and financial sectors. We believe the trend of value outperformance will continue as the U.S. economy normalizes and a large fiscal stimulus is rolled out. However, a value stock renaissance will likely require stronger economic growth to be sustained behind a few quarters. For more of our quant perspective on systematic value investing, see here.
4. Geopolitical tensions continue to rise. As investors, we will be concerned if the tensions lead to global trade frictions and supply chain issues. However, extended supply shortages often create attractive investment opportunities, best exemplified by the recent performance of semiconductor stocks.
The Covid-19 pandemic and the associated economic “lockdowns” increased the demand for electronics. Semiconductor demand was already strong due to various secular trends, particularly increased connectivity. All semiconductor stocks benefitted as shown in the chart below.
Source: Koyfin. This chart shows the trailing one-year performance of a representative group of semiconductor stocks, namely Applied Materials, Inc. (AMAT), Nvidia Corp. (NVDA), and Texas Instruments, Inc. (TXN).
In the first quarter of 2021, the global semiconductor shortage worsened as the global economy normalized. In addition, China expanded its push to build its own semiconductor industry as geopolitical tensions with the U.S. have not abated. Existing semiconductor foundry capacity has not been sufficient to keep up with the acceleration in demand. As a result, economic activity has been hampered, most visible in the auto industry as many automakers have been forced to reduce production of vehicles. It is a powerful reminder of the importance of supply, despite all the focus on demand in the form of fiscal and monetary stimulus. As shown below, the big winners in such situations are the “arms dealers”, in this case the semiconductor equipment manufacturers, like AMAT and LRCX, especially since they operate in an oligopolistic industry.
Source: Koyfin. This chart shows the year-to-date performance of four semiconductor stocks, namely Applied Materials, Inc. (AMAT), Lam Research Corp (LRCX), Nvidia Corp. (NVDA), and Texas Instruments, Inc. (TXN).