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PostRic Mauricio on the GameStop Bubble, Other Market Shenanigans (John Eipper, USA, 02/09/21 3:21 am)
Ric Mauricio writes:
The most asked question lately? Will the Game Stop? The answer is NO! There will always be those who will attempt to get an "edge" in markets. Whether it's the Hunt Brothers trying to corner the silver market, Long Term Capital Management (the hedge fund that almost destroyed the American stock market by investing in very illiquid Russian bonds), the dot-com bubble, the real estate bubble, the tulip mania, the South Sea bubble, and now, the Robinhood/Reddit/short squeeze, there will always be those who will play the game. And there will be winners and losers, mostly losers. As the saying goes, Bulls make money, Bears make money, but Pigs get slaughtered.
There are many who fear we are in a financial bubble, aided and abetted by the wanton creation of fiat currencies. But would you rather hold? Depreciating fiat currency (or its masked avatar: bonds or CDs) or an asset that holds or creates value? One analyst stated that cryptocurrency does not provide earnings that you can spend at the supermarket. Can you even spend such currency at the supermarket, or gas station? It, like GameStop, is a ball rolling on a roulette table.
So how does one invest in value-creating assets? First of all, those assets are businesses (yes, companies; yes, stocks) and real estate. And yes, that business can be a gold mining (or silver or lithium or copper) company (stock), but not actual gold coin or bullion. Keep in mind, though, that not all businesses are good businesses and not all real estate is a good investment. But how does one choose these investments? Ah, by following the guys on TV. LOL, no, no, don't do that. Oh, by following the pundits on the Internet. You can even pay thousands of dollars on newsletters. Ugh! No.
Yes, Jim Simons is the smartest investor ever. He is worth $23.5 billion. Unfortunately, one cannot invest in the Medallion Fund, the fund managed by Jim Simons' company, Renaissance Technologies, aka RenTech, unless you work for RenTech. To work for RenTech, one normally has to have an advanced degree, yup, a PhD, preferably in mathematics, computer science, or finance. His Medallion Fund over 20 years averaged 39.1% per year. To place that in perspective, over 20 years, a $100,000 investment earning that rate of return becomes $73.5 million. The S&P 500, over the same time period, $100,000 became $649,000. Amazon became $38 million. Apple became $20 million. And the self-proclaimed investment "genius," ex-President Donald Trump's $100,000 became $326,000. In reality, because Trump's net worth was estimated to be $200 million in 1979, inherited from his dad, it did grow to $2.5 billion. He is #1213 on the Forbes billionaire's list and fell way off the Forbes 400 list. By the way, Professor Somette, who does not run an investment fund is worth between $1 to $5 million, so this is relatively non-comparable.
By the way, there is a way that you can invest in RenTech-run funds. But the big news today is that investors are pulling their money out in a big way (we're talking billions). Why? Well, the Medallion Fund made 78% in 2020. But the RenTech run Renaissance Institutional Equities Fund (REIF) fell 19% and the Renaissance Institutional Diversified Alpha (RIDA) fell 32%. Compare that to the S&P 500's +18% and the Nasdaq 100's +49% and now you know why investors are pulling out. By why such a disparity? Well, the Medallion Fund does rapid fire trading in many asset classes, such as US equities, Foreign equities, commodities, etc. Since it is not publicly offered, it is not restricted by any SEC rules. REIF and RIDA are publicly offered, so they are restricted by SEC rules, thus they invest only in equities and they have a long-term outlook. But wait, if so, how did they underperform the equities market so badly? Oops, the algorithms that are used in the Medallion fund don't work in the real world of taxes and SEC regulation. In fact, 99.9% of you would go absolutely crazy trying to mimic the Medallion fund trades.
But how does Jim Simons do it in the Medallion fund? Pattern recognition. Run by computers. No human biases involved. But don't try this at home. People used to laugh at me when I pulled up the numbers on companies, then looked at the chart patterns to discern whether or not to buy or sell a stock. When I was a stockbroker, they told me to just follow the analysts' recommendations. I often ran into trouble by questioning the track record of the analysts, which oftentimes, they couldn't or wouldn't provide me with. A wholesaler, one who pitches a certain investment, once told us to move our retired clients from muni bonds to an oil and gas partnership. I pointed out to him that whereas the absolute return was a higher amount, the after tax (after all, the muni bonds were tax free, most often federally and state-wise) return was not enough to compensate for the risk one was taking in an illiquid investment that had no guarantees (municipals have guarantees). Snake oil salespeople. Ugh!
And yes, scientific analysis and pattern recognition does take into account, more so than one may think, the psychology of the market. Jim Simons' mathematics truly boggles the mind. So the question, "how does one invest if one doesn't have access to the Jim Simons computer?" Now keep in mind that 95% of hedge fund managers underperform the S&P 500. In the last 20 years, the S&P 500 has averaged a 9.8% return. In fact, true to the Pareto principle, 80% of the S&P 500 companies underperform the index. Ah, that leaves 100 companies that do outperform the S&P 500. Is there one investment that mimics those 100 companies? Yes, the Nasdaq 100. But the Nasdaq 100 is more tech heavy you say, and thus more volatile. Here's where the asset allocators come in. The standard asset allocation to dampen volatility is 60% equities and 40% fixed-income or bonds. So let's say that our equities are allocated to the Nasdaq 100 and since I am of the opinion that bonds are a depreciating asset, let's substitute REITs, as represented by a REIT ETF, in the last 20 years, the average return would have been 12.2%. $100,000 would then have grown to almost $1 million.
Talking about bonds, Tor Guimaraes asked the question: what is the optimum interest rate? Well, Tor, the optimum interest rate is a moving target. The borrower (the company or government issuing the bond), of course, wants to pay the least amount of interest rate, while the lender (the buyer of the bond) wants to earn the highest interest rate. There's a point where both lender and borrower agree. But for a lender (you, the bond buyer), the optimum interest rate is one that compensates you for a depreciating currency. Now here's where it gets tricky. How do you determine the depreciation rate of your bond denominated in a particular currency? When I refer to it as a depreciation rate, I am really talking about inflation, which is the deterioration of purchasing power. Often this is brought about by a government creating (notice that I no longer say "printing" since most fiat currency is created digitally, ah yes, like cryptocurrencies) more and more currency. All governments do this, it's just a matter of the velocity of the creation. Some governments create faster than others. To further complicate matters, governments manipulate the inflation rate. One can purchase a longer term bond to earn a higher interest rate, but the risk they are undertaking is that inflation and higher interest rates will kick in down the road and thus their bond is now underperforming the "optimum" interest rate. Every government does this, the Swiss less so, Zimbabwe more so. Every empire, from the dynasties of China, to the ancient empires of Persia and Rome, to the current empires of Europe, the US and China, they all do it. It's called fiat currency. Wait, does fiat mean "fix it again Tony?" Yeah, I used to have a Fiat, which I totaled down a hillside when I was 20. I learned how easy it was to die. What? The TV talking heads are talking about reflation? Uh, kinda slow, guys.
In my career in investments, there has been one lesson that never seems to fail, a lesson taught by Sir John Templeton. "The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell."
One thing I also learned is that when the pundits on TV say "buy," it is not time to buy and when they say "sell," it's time to buy.
Another rule: "don't follow the lemmings off the cliff."
JE comments: Ric, I never heard about your "lemming stunt" down the hill in that Fiat. Fell in a Deep Trench? That would be a FIADT. Either way, please share! One of my recurring nightmares involves driving along the California Coastal Highway, and crashing down to the beach with the sea lions. Or are they walruses? Either way, it's a scary dream. Here in Michigan we prefer our roads nice and flat.
A question about the GameStop bubble. I understand the principle of the "short squeeze," but didn't the market manipulators have to put up real money to make it happen? Many were lucky enough to sell at the peak, but some of these manipulators certainly got caught holding the bag at $490. You can pick up GameStop shares two weeks later at the fire-sale price of $60. I'm a humanist and not a finance guy, but the price still seems too high.
When Can You Retire? How Much Money Do You Need?
(Enrique Torner, USA
02/09/21 10:25 AM)
I would like to ask our dear financial expert Ric Mauricio:
How do you know when you can retire? Do you have any special calculator or "system" to help us make this important decision? I would really appreciate your input, and I bet other WAISers as well, given their wisdom and experience.
JE comments: Enrique, you and I are on the same page. I never tell my students I'm old, just that I have wisdom and experience.
So how big of a nest egg do you need to retire comfortably? Or at least modestly? Ric Mauricio would probably tell us not to retire ever, unless one stays very active, both physically and mentally.
So the answer is, as with interest rates, it depends. The basic financial rule says you can skim off 5% of your savings per year, so a million bucks in your 401K would translate to $50K per annum. This is enough for a comfortable middle-class retired life in most parts of the US (such as Minnesota and Michigan). Two things: you can't draw from your 401K until age 59 and 1/2, and also there's the nasty rub of health insurance: Medicare doesn't kick in until 65, and private insurance for the almost-65 demographic is obscenely expensive.
I'm spewing financial platitudes in the above paragraph, so I'll stop before you hear me saying: "past performance does not guarantee future yields." Rather, let's use Enrique Torner's question to discuss comparative retirement finances among the far-ranging WAISitudes. The big distinction is between the pension-focused nations and those that rely primarily on personal savings.
And Ric, I hope you'll add your 2 cents.
When Can You Retire? Ric Mauricio's Benchmarks
(John Eipper, USA
02/11/21 4:03 AM)
Ric Mauricio writes:
Xīn Nián Kuài Lè! 新年快乐! (Happy New Year!) The Year of the Ox. Start celebrating on February 12th.
I love the Chinese New Year. It's celebrated over a two-week period. Two weeks of dim sum. Yum.
Let me first respond to John E's query as to my Fiat accident. I was on my way to the College of San Mateo (north of Stanford on the Peninsula for those unfamiliar with the area) and took a shortcut on Crystal Springs Road, which winds under Highway 280. It was right below the underpass that I lost control of my Fiat 850 on the first rain of the season. Yes, the mixture of the new rain and auto fluids mixed to create a very slippery icy-like surface. I recall steering towards the skid attempting to regain control. Alas, the force was too strong and I hit the asphalt lip on the side of the road and it flipped me over down into the ravine.
When I first hit, my head hit the steering wheel, knocking me out for a few seconds. As I regained consciousness, I was upside down landing on the side of the ravine. I remember it being in slow motion. I watched as the passenger side (which was hitting the hillside of the ravine first) was crushing down. Thank goodness I did not have a passenger. Then my windshield shattered and the entire windshield structure exploded outwards. And the cowling and dashboard was being crushed downwards. Then it stopped. I was upside down and I released my shoulder harness/seatbelt, but could not pull out my feet which were on the gas and clutch pedals. The boots I was wearing were being held in place by the car. I was able to slip my feet out, crawled out of the car, and crawled up to the road. Fortunately, a friend of mine was passing by, stopped and asked me what happened. I told him to get me to the nearest hospital because my head hurt.
Injuries: Concussion and contusion of the brain and broken jaw. Condition: Very serious. Jaws were wired shut. But no surgery on my head was necessary, just observation and pain pills as my brain swelling was coming off the inside of my skull. I would hold out as long as possible on the pain pills, practicing my yoga to alleviate the pain. I told the doctor that I needed to get well, because I had a job lined up at the ski resort. That night I also had a business math test, so when I returned to school, it was time for the second midterm. I told the professor what had happened and asked if I could take both the first midterm and the second midterm that night. Yeah, I studied when I was in the hospital. I not only finished both midterms before others finished the one midterm, but got 100% on both of them. I guess you can say, the blow to the head knocked some "cents" into me. By the way, I do not recommend a rear-engine automobile (where the engine is behind the rear axle). A mid engine (where the engine is before or on top off the rear axle; think Ferrari or Porsche), is much more stable.
Now to Enrique's inquiry on retirement. As a CFP Emeritus, I am often asked this question (although not enough people ask). Most people think about retirement zero to 5 years before they retire. They'll come to me and say, "I have no savings, I retire in 5 years, now show me how good you are." This is why I started teaching my kids, and now my grandkids, to start early. Time is on your side.
Now to the calculations: First, estimate how much it would cost to retire comfortably. To do this, total your housing, food, medical expenses, auto expenses, utilities, and comfort items (entertainment, eating out, vacations) for the year. Now multiply that amount by 4% to account for inflation (historically it's been officially 2% although some calculate it to be 8%; as with most statistics, the truth is often in the middle) for each year from the present to your intended retirement age. Take that amount and divide by 8% (a target rate of return on investments; doable) and you will have the amount that you need to retire comfortably. What about Social Security benefits? I don't take those benefits into account. It provides a bonus amount that I can spend any way I want. Unfortunately, too many people count on government benefits to retire on. And shockingly, but not surprisingly, it falls far short of providing a comfortable living.
Need an example? Let's say your living expenses today are $48,000 per year. OK, wait, my living expenses here in the SF Bay Area are way more than that. There is a way around that. You can purchase a home and in 30 years, have it paid off, so no mortgage payment, just property taxes and maintenance. Or you can target an area you would like to retire to that is less expensive (like outside of the Bay Area, Nevada, Arizona (my best man bought a house there for $163,000), Texas, Florida, Mississippi, or yes, Michigan or even Costa Rica or Portugal) and estimate the cost from there. But let's start with our living expenses of $48,000. Let's say we have 10 years to retirement. At a 4% inflation rate, you will need $71,000 in 10 years. Now to produce $71,000, you will need to earn 4% before taxes (there are ways to avoid taxes at this level; one is to move to a no-tax state; a married couple with an AGI of less than $80,800, currently do not pay capital gains tax). You will need $1,775,000 to produce this income. Oh, but don't forget about future inflation. So double that amount with another 4% earnings and reinvest that 4% to protect against inflation. Ah, your $1,775,000 would need to produce an 8% return. That's below the S&P 500 historical average, so very doable. But let's say you can earn 12% per year on your investments (again, very doable). At this point you would only need $1.18M. Again, the lower your expenses, the less you will require in investments when you retire.
Here's another calculation: Let's say you are planning to retire today. Your comfortable living expenses are $48,000. You earn 12% on your investments. You really only need $800,000. That 6% will generate your essential income. 6% will be reinvested for future inflation.
Here's another scenario: You retire today at age 67 (full retirement age); your Social Security benefit and perhaps other pensions is $24,000 per year. Your comfortable living expenses are $48,000. You earn 12% on your investments. You need $400,000.
So you see, it is a function of your comfortable living expenses (my definition of comfortable living expenses is that you are enjoying life without skimping) and your investment's rate of return.
One more thought on retirement (my 2 cents worth): Retirement is a state of mind. Think of it. There are 52 weeks in a year. Let's say you vacation (travel?) 3 weeks out of the year. Funny how my European cohorts seem to always be "on holiday." That leaves you 49 weeks to do what? I actually experienced this in my first "retirement." One hour a week to mow the grass. One hour a week to clean the house. Fifty hours a week of sleep. Twenty-one hours a week of daily to-do's (meals, bathroom, shower, etc.). Two hours a week to wash and wax the cars. One hour for church. Five hours a week working out. Three hours a week on investments. That left me about 85 hours a week for? I used to play my Atari games or visit my local library, but really, how many hours can you do that? Aha. I learned early in life that what brought me the greatest joy was helping other people. So now my "retirement" was helping people with their automotive/tool needs at Sears. One thing I found was that "helping" other people resulted in a greater net income to me. I had exceeded my quota by 3 times every year and became the highest paid sales rep at Sears nationally (until they capped it; time to move on).
Then Sears bought Dean Witter. And I loved investing. So what better way to help people than to educate them on investing? I became a stockbroker. One of my clients really enjoyed having me as his broker, because he learned a lot about investing, vs. other brokers, whose main intent was to sell you something and earn their commission. My mindset was that this was not working; this was helping other people. Currently, as a Personal Trainer, a retired Enrolled Agent, and a CFP Emeritus, I am enjoying helping people become physically and financially fit. Ah, the joy. This is retirement.
So if you are a teacher and you enjoy teaching, you are, de facto, happily retired.
JE comments: Ric, we are grateful. From showing us the horrors of "oversteer" (rear-engined cars like to swap ends, back out front) to putting our retirement needs in perspective, you reassure us with your level-headed wisdom. Regarding retirement, you've put your finger on the essential requirement: have something to retire to, and not retire from.
- When Do Italians Retire? (Eugenio Battaglia, Italy 02/11/21 8:13 AM)
John E asked about retirement finances in different countries. Italy is a pension fund-focused nation and you retire as soon you legally can--meaning, when you are sick and tired of your place of work.
In my last place of employment, the principals were trying to screw their employees, the employees were trying to screw the principals, and both were trying to screw the State. This Bastion Contrario was mad at all three.
It was quite a difference from my earlier job with Amoco.
JE comments: Here's Wikipedia on comparative retirement ages. There aren't great differences from one country to the next, except that Asian nations (Japan, S Korea, China) tend to have the lowest: around 60, even though life expectancy is among the highest. It's also surprising that many nations still distinguish between men's and women's retirement ages, with women (who live longer) getting to retire sooner.
- The GameStep Bubble and Its Victims; from Michael Frank (John Eipper, USA 02/10/21 4:01 AM)
Michael Frank responds to Ric Mauricio (February 9th):
The market manipulators in the GameStop incident did indeed need to put up real money, and even at the retail level, there is substantial leverage available through options trading and the use of margin. But what made this particular exploit so powerful wasn't leverage or capital, but the simple volume of participation. Thousands of small players conspired to have great market impact. To what end?
The popular press would have us think that this was a great blow for everyman vs. the "hedge funds" and "shorts." In fact, this conclusion is a non sequitur. As the price peaked, reports suggest that short interest was still more than 100% of float. That means that in the 80% price collapse that followed, short sellers cleaned house. Those retail investors who jumped into the trade ended the week with less than nothing, because leverage amplifies losses as well as gains. The crisis here isn't that the big guys won, but that the small guys were misled and lost badly.
Congress seems primed to investigate a list of irrelevances: first, they seem to consider it "anti-investor" that some brokerage firms shut down trading on the momentum stocks. But if investors had been allowed to buy into that last blow out top, it would have only increased their losses. I'll come back to the trading stop in a moment.
The second thing that Congress wants to investigate is the influence of hedge funds. This is perverse, since the hedge funds were the target of this manipulation, and some of them may have actually been harmed. Blaming the victim is not fair play. Sympathy for the wealthy isn't necessary, but being blinded by envy is not the road to good regulation. Finally, there is rumbling about the harm done by short selling. But it seems to me that given the amount of harm done to the gullible retail investors by touting this action, more shorting rather than less might have been a valuable countervailing force to the touts.
So what should the concerns be? First of all, we need to recognize that thousands of retail investors paid a price. Sure, some made it out early and are celebrating their riches. But the collapse was too rapid for everyone to make it out alive. I don't look at the markets as a casino, but many do, and misreporting these events reinforces that view. What I think needs to be investigated are the early participants: Wallstreetbeats may be an organic experience, but I suspect someone was shrewd enough to realize that it could be stampeded, and made a good profit by doing it. Or maybe it was spontaneous madness, but either way, it needs to be deconstructed and examined.
What really needs to be investigated are the brokers. Not because they closed trading, that was the only rational move they had. A brokerage firm with a capital insufficiency is lucky to survive. That is not what's important about how the brokers operated here.
Some background. The Fintech "revolution" is largely nonsense: there's really nothing new here from a technology point of view. What is different is the way in which fintech firms monetize their customers. Traditional retail brokerage has been slowly squeezed out of the commission business. This began with the deregulation of commission rates in 1975, and with several key events, brought us to a point where commissions were approaching zero even without the Fintechs. Retail brokers enhance their returns by several means: sale of order flow, margin lending and stock loan. This has been an increasingly decreasing business for years, which is why brokerage firms have added wealth management, mutual funds, insurance, banking products, and fiduciary services to their product mix. Many also have thriving institutional and investment banking arms. These services have become the dominant revenue producers in the industry, while traditional agency stock brokerage was dying.
So along come the Fintechs, and they are classic agency brokers, with the twist that they fully embrace the no-commission environment. But somehow, with only payment for order flow, margin and stock lending, they have found enormous value. The way they do it should be obvious: if you only make pennies on a transaction, you need a whole lot of transaction volume to make it pay. The stock mania of the last few weeks is their meat. I'm not saying that the Fintechs were on the boards cracking the whip, but they surely profited mightily from the mania.
The danger of these firms is that they really are turning the street into a casino. They need people addicted to trading, who will sit on their aps and click buy and sell all day. It's hard to see this as a problem, because on the surface, it looks like the same old same old. But it really isn't. never before has day trading been the dominant force in the retail market, despite public misconceptions and assumptions. This is really, really different and very dangerous. And that's what the regulators need to focus on.
What was astonishing here wasn't that brokers stopped trading (they really had no choice). What's amazing is that a firm with a five billion-dollar capital insufficiency was able to borrow the money from somewhere and soldier on. Five billion would have gone a long way to saving Bear Stearns or Lehman not long ago. In this case, we have some inscrutable entity which has stepped up to save a firm that was every bit as fragile. Where did this money come from, and what possible opportunity could there be that would make such an investment justifiable?
Apparently, there is a lot of money that says that turning Wall Street into a casino is going to be an immensely profitable opportunity. And that's what we should be worrying about.
JE comments: Michael Frank is the retired Chief Information Officer of the Bank of New York's institutional brokerage arm. WAISers will remember Mike's post from last August:
A very informative explanation above, Mike. My takeaway from the GameStop insanity: while the stunt may be viewed as the revenge of the Little Guy, the more likely cause is manipulation of the LGs by the same old, or perhaps slightly newer, Major Players. Every market frenzy/bubble has a few winners and many losers. And as long as this is the case, we'll continue to have frenzies and bubbles.
May 1st, 1975 was a watershed date for US investors: this was when commissions, previously very high, were allowed to be set by market competition. Discount brokerages like Charles Schwab soon entered the game, and the rest is history. Presently, stock commissions are zero or nearly so.
- Short Squeeze...or Perfect Storm? Price-Takers vs Price-Makers (A. J. Cave, USA 02/11/21 3:23 AM)
Since I am a member of subreddit's WallStreetBets (r/wallstreetbets) or WSB, along with close to 9 million others, who mostly joined after the game of GameStop started, I should unpack this right from the eye of the storm.
I have two reasons for this exercise: 1) This is just the beginning not the end; and 2) Because the "retail investors" like me, typically summarily dismissed as flies on the wall (street), have finally and fundamentally changed the nature of investing in the global financial markets.
This has been accelerated and amplified by the changing global demographics--more tech-savvy millennials than the mostly technophobic aging and dying baby-boomers--and more time to engage since the pandemic has restricted, redirected and rearranged the energy from almost all the socializing that used to be the norm.
There is also over $3 trillion in cash sitting on the sidelines waiting to be deployed.
In short, it's a perfect storm, not a short squeeze.
It's going to take a while for both professional and individual investors to wrap their heads around this.
WSB members are certainly not as polished as Bill Ackman of Pershing Square Capital, who made a cool $2.6 billion hedging against the pandemic market crash in the early days of economic shutdown. However, underestimating them and dismissing them as market manipulators misses the point.
Before unpacking WSB and GameStop, some housekeeping notes:
Disclaimer: I don't give financial advice or stock recommendations. Investors should do their own due diligence (called DD on WSB) when it comes to the stock market(s), and indeed anything to do with their assets.
Disclosure: I don't own any GameStop stocks [GME], but that doesn't mean that I won't invest in the company anytime from now to whenever.
Rules of engagement (or the low-hanging fruit): investing in financial markets is risky business. There are no guarantees. Investors try to de-risk their investments by any and all means possible. But risk and reward are inversely correlated--the higher the risk, bigger the reward, and vice versa. And using options reduces your risk to a fraction of your full exposure.
Tidbit: The average length of time a stock is "owned"--the span of time between the buy and sell--by the professionals is about 10 seconds.
So, in a nutshell, what happened is this:
The underlying framework and the force that can (and would be) fine-tuned and perfected and deployed again and no one thought even possible is an aggregation of "retail investors" for a common purpose. We call it a "de-fragmentation" of a fragmented market. The basic model has already been tested and proven with the likes of Uber and Lyft, and others like Doordash, and even Amazon's expanding fleet, using gig workers. The core concept is no different. WSB is sort of like a beehive. A single honey bee is both important and irrelevant, but a colony of them can and do produce honey.
Theoretically, if you can defragment a highly fragmented but lucrative market, in this case, the fragmented global retail investors, you are holding the biggest winning lotto ticket ever.
This defragmentation was thought not just difficult but impossible, because retail investors have different risk tolerance profiles and portfolios, and lack the tools that hedge funds (and institutional investors) use to hedge against market volatility.
Some have been calling WSB the "democratization" of the financial markets. But it's actually the weaponization of money and markets by a new aggregation of an old "class" of small investors who can move the markets in either direction. Money has always been a source of power. Now, it's the weapon of choice in hands of all, not just the top 1 or 10 percenters.
Here is the nitty-gritty (or you can just wait for the movie):
Reddit (written as reddit and pronounced as past tense "I read it") is another free social network, founded in the Silicon Valley 15 years ago or so, and now in the US's top 20 most-visited websites with over 50 million daily visitors (according to Alexa). It is privately owned. Advanced Publications is her biggest investor. Other investors are heavyweight VCs like the Sequoia Capital, Sam Altman, Marc Andreessen, Pete Thiel, and others, and as of 2019, the Chinese Tencent Group. The bigger "winner" of GameStop et al. brouhaha was reddit, who just raised another $250 million led by Vy Capital (founded by Alexander Tamas and funded out of Dubai), doubling its valuation to $6 billion.
Unlike other better known social networks, reddit is community-based (called subreddits), where members "assemble" around a common interest. Anyone can form a subreddit, and post and discuss whatever they want. subreddits have moderators who can delete and remove and censor, usually to the outrage of the members. WSB is first and foremost focused on aggressive options trading.
The movie rights to the "story" have been sold, so the full story of GameStop (and other heavily shorted stocks) for beginners has been removed. But, basically, it was not a "short squeeze" as lazy people who only read the blurbs and numbers pontificate, shudder, blast and distort.
Keith Gill, known as u/DeepFuckingValue on WSB and Roaring Kitty on Twitter and YouTube, did the initial analysis on the GameStop. He is a financial analyst and, in his view, (dating back to 2019), GameStop, the largest videogame retailer with thousands of shops in malls, each one doing about a million in sales, was undervalued. At the height of the first GameStop wave, his $53,000 investment in GME (bought when the stock was around $5) became a (almost) $50 million dollars fortune. Kudos!
GameStop had been increasingly losing money in the last decade as more and more videogames started to move online, and with the malls closing during the pandemic, short-sellers started to circle the GME wagons in a zero-sum funeral game.
What triggered the GME's massive rally was the events in January 2021 (among them, the continued political mess on the Capitol Hill) and the remembrance of (now forgotten) financial crash of 2008 when most of the WSB traders came of age and witnessed the devastation that Wall Street wreaked on their families and friends without any punishment. Wall Street was actually rewarded for ruining so many families by being bailed out by the Obama administration.
And let's not forget that about $2 trillion dirty dollars a year are laundered through five global banks: JPMorgan Chase, HSBC, Standard Charter Bank, Deutsche Bank and Bank of New York Mellon.
Short-sellers had shorted the GME stock over 130 to 150% of the actual stocks in circulation. That is on SEC to investigate. But the intention of the short-sellers was "nothing personal." They just wanted to make money by wiping the (stock market) floor with GameStop (a company with thousands of employees out of jobs). That's when WSB mobilized globally and members took a chance on "doing good" and "saving jobs" while making money by buying GME stocks. Basically, hundreds of thousands of small traders around the world risked their life savings to push back on Wall Street. Some sold when they realized massive gains and some held and are holding for the next wave.
At best, short-sellers provide a sanity check on stock analysts hyping their book holdings on big media (CNBC, etc.,). However, at worst, they could be very wrong and cause massive financial damage to good or great companies with faulty analysis. Tesla was among the most shorted stocks ever and every other day there was "news" on how Tesla stocks (TSLA) were worthless. Short-sellers lost billions when Tesla board finally brought in some adult supervision (Larry Ellison) to cool Elon Musk's jets.
GME wave couldn't have happened before the rise of frictionless trading in form of various popular apps like Robinhood. It was lapped up like free ice cream during the hot pandemic, and the initial $1,200 government checks seeded a new generation of small retail investors.
Unlike clunky apps from other trading firms, Robinhood is free and easy to use, especially when it comes to options trading. You link it to your bank account and you are off to the races.
Robinhood is now being sued for halting GME trading during peak volatility. They said they couldn't cover the minimum balance requirements. They got $1 billion dollar cash infusion overnight from private investors, and a total of $3.4 billion from Ribbit Capital, ICONIQ Capital, Andreessen Horowitz, Sequoia Capital, Index Ventures and New Enterprise Associates, raising the valuation of Robinhood to over $20 billion. That makes them the biggest "winner."
In reality, the massive buying of GME stocks and stock options, looked like a typical "short squeeze"--when short-sellers had to cover their shorts. But what actually happened was that after taking some losses during the initial shock, most of the short-sellers covered each other and tossed the stocks around without exiting their short positions to outlast the barbarians at the gates. Others who made massive money were the traditional trading houses like the Fidelity, and the like who took out options as the stock was on the rise.
Gains by WSB members pale compared to the gains by the people who really cleaned out--the same old private VC firms in the Valley, when both reddit and Robinhood added billions to their valuations.
The dip in the GME stock price (in the $50s now) is making it more attractive to those who missed the first round. WSB has grown from a 3+ million members couple of weeks ago to almost 9 million now and growing. They have added over 6 million members in less than a month. Probably some of them work for traditional financial firms.
Even though the VC firms have made the most money here, my bet is on the WSB citizens.
Because it is actually easy to create a social network site (front and backend) from scratch these days. What is hard is onboarding and growing the membership. With WSB track record notably with GameStop and other heavily shorted stocks, it would take no longer than a week to pack up and move to a brand-new network and let the network effect do the rest. Dido Robinhood.
Facebook and Twitter and TikTok and other social network users are "price-takers." They can scream bloody murder if they are pissed, but they have no influence over how those networks operate. WSB, on the other hand, is the very first online "colony" that is a "price-maker." They are not tied to the platform, but to themselves, and can leave reddit and Robinhood and set up shop somewhere else and take on Wall Street without missing a beat.
That's a major shift, with online power base moving from dominant platforms to pesky people.
JE comments: A. J., a parallel remark that might be relevant: last week for the first time in my decades of teaching, I heard three students talking stocks as they walked into my classroom. Most college kids have not been "stimulated" with the government checks, but they seem to possess investment capital from somewhere. Or maybe it's just the allure of trading with a game-like phone app.
I am fascinated by your price-taker/price-maker distinction. Until now, the "makers" were large and institutional. What we are seeing now is the democratization of market manipulation. I nonetheless wonder if Eipper's Rule of Market Information still applies: by the time you find out something that impacts the price of a stock, the price has already shifted accordingly. Is this a classic price-taker mentality?
Jump Market Risk
(Jordi Molins, -Spain
02/11/21 3:05 PM)
In relation to the recent discussion on GameStop, my conclusion is the market is pricing a serious amount of gap/jump risk.
The argument is as follows:
A clever and professionally accomplished friend described to me a financial strategy he is developing, as follows:
He has reached agreements with Hedge Funds he knows well. The Hedge Fund trades in his managed account (so no Madoff risks). Instead of paying the Hedge Fund the typical 20% of profits, he pays them 50%. In exchange, the Hedge Fund must agree to cover the first 10% of any losses arising from their strategy.
My friend has a good risk management system, and he is able to cut the positions of the Hedge Fund when the portfolio is down, say, 8%.
The portfolio never goes below -10%, so the investor never records a loss. Granted, the upside is quite limited, at 3% to 4% per year. But in Europe, many insurance companies may be highly interested in a product that yields in the low single digits, but with a high probability of no loss.
Apparently, this structuring "beats the market." However, and this is my main argument, we all know that by shifting risk one way or another, the market remains efficient. It is true that Jim Simons has been able to beat the market, but not by simply shifting risk.
A reasonable conclusion is that this strategy is able to "hide risk under the rug." And this hidden risk is gap/jump risk, since no risk management system can cut the positions in a portfolio if there is a sudden, unexpected move down in the markets.
My hunch is that the structuring of this strategy is telling us, in a convoluted way, that markets are already expecting some kind of gap/jump risks in the future.
JE comments: I'm learning a lot this week about investments. Do I understand correctly that jump risk is simply the risk of a stock going down massively and quickly? A vertiginous rise in a stock is never a problem, unless you've shorted it.
Jordi, do you believe this "first 10% of loss on us" strategy going to catch on? The downside is, you're giving up 30% of your profits. And the true pain is not in the first 10% of your loss, but in the next ten or twenty (or more) percent.
Ric Mauricio on Short Selling, Fiduciary Oath
(John Eipper, USA
02/23/21 3:23 AM)
Ric Mauricio writes:
I must admit, I have been trying to get my head around Jordi Molins' friend's Hedge Fund strategy. (See Jordi's post of February 11th.)
According to the strategy, if the hedge fund portfolio drops 10%, Jordi's friend is able to exit the portfolio with no loss. The hedge fund covers that loss. Considering that hedge fund portfolios are not insured against losses by any governmental entity, this puts the onus on the full faith and credit of the hedge fund itself. Since hedge funds cannot issue new currency, this faith is as ethereal as well, a belief in religions. But let's look at the positive side. Since the "upside is quite limited, at 3% to 4% per year," I am assuming that since the average hedge fund historic return is 7.3%, that this return of 3 to 4% is 50% of that historic return. OK, considering that the real global inflation rate historically has fluctuated between 3 to 4%, that gives us a return of possibly zero percent. And with the possibility of the hedge fund not being able to cover that 10% loss, I am thinking, "what's the point?" Kind of reminds me of Jesus' Parables of the Talents, where the third servant was so fearful that he just buries the bag of talents. By the way, talents were currencies of silver, but the word "talents" is apropos. There are those who do not fully utilize their "talents," no matter how great or small they are, because of fear.
Yes, I could see where insurance companies would be highly interested in a product that yields in the low single digits. What insurance companies do is sell these products to consumers, then turn around with the premium proceeds and invest in real estate (Buffett invested in companies or stocks) gaining a conservative 10 to 12% return. I'd love to earn 6 to 9% per annum on other people's money. What's the calculated return on utilizing other people's money to invest? Infinite?
I have only shorted one stock in my 50+ years of investing. Why? The risk/reward ratio is not good. For example, I shorted a stock that IPOd at 15, with the first trade at 26 (you should have seen how many rookie brokers placed market orders to buy at the IPO, only to get executed at 26; whoo, the market makers were giddy as they bagged an $11 profit per share at the outset on these foolish brokers/investors). I shorted the stock at 29. Here was the risk/reward scenario: I could bag a $29 profit per share if the stock went to zero or I could lose $100/$200 per share if it kept on climbing. But you see, before the company IPOd, I was at my local ToysRUs store. I noticed the company's Teddy Ruxpin end cap display. And I watched as kids stopped, pushed a button and watched the Teddy Ruxpin bear talk. Did they buy? No. Hmmm. Interesting. Then came Christmas time, and I noticed that a lady brought the Teddy Ruxpin bear back to the store because it didn't work. The ToysRUs staffer brought out new batteries. Didn't work. Brought out more Teddy Ruxpins. Didn't work. Finally, the 10th one worked. Oh boy, is that company in trouble. So thus my first and only short: Worlds of Wonder.
The hedge funds who shorted GameStop know the risks. Do I feel sorry for them? Not a bit. But those who bought to ramp up the price, well, to them it is gambling. It's an all-in bet, but without the skill of professional poker players who calculate the odds. Thus those amateurs late to the game lost big time as well. Hopefully, they'll learn. One person who will never learn, unfortunately, is the guy who killed himself. I think he read his account wrong. Sad.
Having been in the financial industry, I have a bone to pick. Fiduciary duty and its application. The brokerage industry continues to fight the application of this duty to its brokers and analysts. Why? Fiduciary duty is a legal obligation of the highest degree for one party to act in the best interest of another. The party charged with the obligation is the fiduciary, or one entrusted with the care of property or money. As a CFP (and now, retired, so CFP Emeritus), I was bound by the Fiduciary Oath. Before then, even as a stockbroker, I believed in practicing this duty. Even in other capacities, and as a person, I believe we should treat others with highest regard.
In accounting, we have the Sarbanes Oxley rules, which costs millions of dollars and thousands of pages to enforce. To me, that was the biggest waste of resources. Everything in the SOX rulebooks can be summarized in one sentence: Do the right thing. Unfortunately, the brokerage business relies on salespeople, humorously called Financial Advisors, to bring in the funds. Today, as Chief Investment Advisor for my Family Office, I have a fiduciary duty to my family, my kids, my grandkids and subsequent generations to do the right thing. But then, when my kids were growing up, wasn't I always trying to do the right thing for them? When I meet other people, do I not try to do the best for them? As a personal trainer, I subscribe to the medical Hippocratic Oath of doing no harm. And as Jesus taught, "Love your neighbors."
JE comments: Do the right thing. Add to this the Golden Rule, and you've created the perfect society. The rub we've observed over the last few millennia is in the implementation.
Ric, can you tell us more about the Fiduciary Oath? Is it literally something that Certified Financial Planners are "sworn in" with, like physicians with the Hippocratic version? Finance people (except you, of course) are famously cavalier with other people's money, but this impression may be inaccurate. What grade would you give the majority of CFPs?
Europeans are Happy with a 3 to 4% Return
(Jordi Molins, -Spain
02/23/21 1:29 PM)
Ric Mauricio (February 23rd) is right that Hedge Funds yield, on the long term, about 7.3%. Since the Hedge Fund manager of the strategy we have been discussing so far is able to get 50% of the (positive) returns, this means the investor in such a strategy gets about 3 to 4% per year.
The flipside is the Hedge Fund manager needs to post 10% of the assets he will manage as cash in an escrow account. The strategy will be able to draw from that escrow account, if there are losses. So, the 10% guarantee is real.
From conversations with Americans, I see a return of 3 to 4% per year is considered to be irrelevant. However, in Europe investors are desperate to get any guaranteed return (even 0%! cash yields -0.5% nowadays). An insurance company that is able to get, with a high probability, a 3 to 4% return (and with a low capital consumption in Solvency II, due to the 10% guarantee) will find this deal to be an exceptional one. The problem with this strategy, according to my friend, is that it looks "too good to be true."
As discussed, this strategy has its own merits. For sure, it is a better strategy than most. However, it reveals that the market is pricing a non-negligible amount of gap risk. I believe this is mostly unappreciated, so far.
Finally, there is a second unappreciated risk: if the gap risk materializes, the Hedge Funds that now are willing to risk 10% of cash to get the 50% upside could become reluctant to continue to do so. As a consequence, the strategy would cease to be practicable, and my friend should return capital to investors.
JE comments: Jordi, you mention Europe's negative .5% yield on cash. WAISer Bert Westbrook once tried to explain this phenomenon to me (while sitting on this very couch!), but I confess I still don't follow. What is the incentive to pay someone to hold your cash? US 10-year Treasuries yield 1.37%, and a coffee can in the back yard at least gives you a guaranteed zero.
- Certified Financial Planners and the Fiduciary Oath (from Ric Mauricio) (John Eipper, USA 02/27/21 7:16 AM)
Ric Mauricio writes:
To answer John E's question, yes, CFPs are "sworn in" to having a fiduciary duty to their clients. All of the CFPs within my sphere adhere to this, but since it is a small sample base, I cannot make a judgment whether other CFPs adhere to the Fiduciary Code.
However, my experience with stockbrokers is a much larger group. Out of 300 or so "non CFPs," I can state that I could only trust five of them. Let me share a story. One day I was in my cubicle with one of my clients when a broker came rushing over as he was on a cold call. He said he knows why stock mutual funds go up and down, but asked why would bond mutual funds fluctuate? My client asked if he could answer. He explained why. As the broker walked away, he said to me, "I'm sure glad you're my broker." But this wasn't as bad as another broker told a prospective client that a bond mutual fund couldn't go below $15. Another broker and I asked her how she could say this. Her response was that it IPOd at $15 so it couldn't go below that. Ouch!
As a consultant to the many high tech, biotech and VC firms here in Silicon Valley, I have encountered many managers who have no idea how to manage people. They just pretend that they know what they're doing. They cover up their insufficiencies and insecurities by bullying their employees. Known as the "Fixer," I am often brought in to fix the problems.
One of my team members asked why I don't scream at her and make her feel small when she makes a mistake. I told her it's because I'm perfect and I never make mistakes.
Let's change subjects for a moment. A question for Jordi Molins: if the hedge fund drops 20% (eg. a company that recently purchased bitcoin dropped 50% in a few days), then the client loses 10%. Still seems to be a lopsided risk vs. reward deal. I think that most insurance contracts pay that 3 to 4%, with no risk to interest or principal.
JE comments: Ric the Fixer! This sounds ominous, but WAISers know what a sweetie you are. The impression I've always had of traditional brokers is that they have their own interests in mind, not yours. This is probably an oversimplification, but it's also the basis for the Charles Schwab model of the 1970s, which has been imitated everywhere: the best manager of your money is...you.
- Certified Financial Planners and the Fiduciary Oath (from Ric Mauricio) (John Eipper, USA 02/27/21 7:16 AM)
- Europeans are Happy with a 3 to 4% Return (Jordi Molins, -Spain 02/23/21 1:29 PM)
- Ric Mauricio on Short Selling, Fiduciary Oath (John Eipper, USA 02/23/21 3:23 AM)
- When Do Italians Retire? (Eugenio Battaglia, Italy 02/11/21 8:13 AM)
- When Can You Retire? Ric Mauricio's Benchmarks (John Eipper, USA 02/11/21 4:03 AM)