Another mid-month of quarter-end book squaring monetary bottleneck is approaching. Undoubtedly, there is a seasonality behind financial disorders, from little distresses to colossal panics, which tend to crop up at the end of each quarter. Although being usually the March and September quarters that present the most trouble, the looming June bottleneck, which historically has not been a problem, considering that we are living in extraordinary times, a second meltdown could take place next month due to emerging liquidity constraints. For whatever reason, with the turn of the seasons, the financial markets often experience some turmoil, especially in the beginning of Spring and Autumn, particularly the latter, for even in our modern society, economic activity is still tied to the seasons. Nevertheless, the explanation for the existence of quarter-end landmines is quite simple: it is the time to square the books. In periods of uncertainty and distrust, like the current one, market participants run into trouble when getting the funding for their operations. While during the middle of the trimester the markets seem to function without any worry, the problems become ostensible when the participants settle their accounts and financial statements. Accordingly, looking at the graph below, in spite of subsided earnings expectations, the stock market is pricing in a quick economic recovery on account of the massive fiscal and monetary response. Obviously, there is no V-shaped recovery in the cards. Investors are just buying the Fed's and the financial media's trickery by believing the Fed is flooding the financial system with the precious US dollars - check out the Eurodollar system: the untamable beast series to know more. In addition, the UST market is pointing to an ongoing lethargic economic activity for at least another decade. On the left graph, the Treasury yields are indicating incredibly weak economic growth over the next ten years, reflecting very poor opportunities in an unwelcoming environment. Likewise, the 5-year forward inflation expectation rate (on the right chart in green) is signaling the restoration of the pre-COVID paradigm will not even start five years from now. Furthermore, there is one interesting indicator that may be a telltale sign for an imminent event of financial panic and meltdown. For retail investors across the US, signing up to zero-cost online trading platforms like Robinhood, Etrade and Schwab has been a popular means of curbing the boredom of being locked down. Their recent pursuit of some of the hottest momentum stocks has created a self-fulfilling prophecy whereby the biggest momentum stocks keep rising, drawing in even more retail investors who mostly chase what goes up, resulting in even higher prices for the most visible momentum names and megacap growth stocks, such as the FAAMGs (Facebook, Apple, Amazon, Microsoft and Google). To be sure, there was some initial confusion where retail investors found all this capital they are now allocating to risk assets, but as this report lays to rest, in which credit card data from analytics company Yodlee show, after putting some of the money of the "stimulus checks" into savings and withdrawing cash, the third most popular activity for most income segments was "securities trades" - i.e. buying stocks - especially among the pure middle class, those making between $35k and $75k. Remarkably, retail investors chase many of the same names that make up the Hedge Fund VIP list (profiled here). However, "without a downside hedging pair-trade", which has hurt so many hedge funds owing to, as the name implies, their need to hedge and the inability to being all in a handful of long positions, they have detracted substantially from broad L/S equity hedge fund gains this year, which are down 9% YTD and performing far worse on a risk-adjusted basis. Therefore, retail investors have successfully outperformed the so-called smart money. As Goldman confirms in its latest hedge fund performance tracker, the continued surge in retail investor trading activity has helped boost the growth stocks most popular with hedge funds, adding that "data collected by our equity analysts from brokers show daily average trades more than doubling in early 2020 relative to the typical pace in recent years". This echoes the data from Robinhood, which showed nearly a tripling in user activity this year, with the number of distinct user-positions in S&P 500 stocks rising from 4 million at the start of 2020 to 5 million at the market peak in February, 7 million at the S&P 500 trough in March, and 12 million today. This sharp increase in retail trading has helped a basket of popular retail stocks (which for those who have access can track it using Goldman's Marquee platform under the GSXURFAV ticker) outperform the S&P 500 by 13 percentage points YTD . As Goldman notes, "because so many retail favorite stocks are also popular with hedge funds, the retail trading surge has also benefited the performance of hedge fund portfolios. Eleven of the 50 stocks in our Hedge Fund VIP basket also rank among the 50 most popular retail trading stocks, including the top three stocks in the VIP list (AMZN, MSFT, and FB)".
Needless to say, this is a bizarre outcome: after all, what is the point of all the in-depth analysis conducted by hedge funds if 20-year-old retail investors armed with just an online trading platform and listening to CNBC can outperform them? Moreover, this is not the first time retail managed to outperform hedge funds in recent months. In fact, in mid-February - just a few days before the S&P 500 hit an all time high - retail investors managed to pull out this stunt. Unsurprisingly, this divergence was very short-lived. To conclude, fasting forward three months to today when the same unthinkable divergence is back, many have been wondering if the same selloff observed in March is about to strike again. For the financial analysts and "experts", with the Fed going all in to to keep markets afloat, this time it will be different. Hopefully, the Fed and the opinion-makers have managed to deceive not only those "experts" who just stand on the sidelines, but the actual market participants who have to deal with the real financial constraints. Otherwise, this fake liquidity-induced rally, which is based on the illusion of the Fed's mastery, is about to crumble. Guess on which scenario I am betting on. The Q2 climax is around the corner and, thus, the time to square the books is arriving. Despite liquidity allegedly being handled by the central bankers, with all the fancy programmes and facilities set up by the Fed putting the March meltdown in the rearview mirror, the bond market and other indicators, which would be redundant to refer to - such as crude oil, gold, etc. -, are hinting at tight liquidity conditions vis-à-vis a dreadful economic outlook for years to come. As a result, another tremendous episode of fire-sale liquidations is bound to happen.
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AuthorDaniel Gomes Luís Archives
March 2024
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