Capitalogix

Spotting a Bubble

I spend a lot of time doing research ... not the way data scientists do, but I enjoy keeping an eye on the pulse of things. 

Recently, I've noticed increasing talk about bubbles. One of the most obvious potential "bubbles" being the relatively stable bullish performance of the markets, despite the lack of a full economic recovery. 

Interestingly, Ray Dalio's bubble indicator says that stocks aren't at dangerous levels, though it does say the top 5% of the top 1,000 US companies are in an extreme bubble. Many of those companies are emerging technology companies. 

via Ray Dalio

So, without making a prediction, caution is probably fair, but recognize that people aren't blaring sirens and running with their arms flailing in the air. 

Instead of focusing as much on today's bubbles, I thought I'd share a great summary on "how to spot a bubble" by Barry Ritholz. 

He suggests 10 elements: 

1. Standard Deviations of Valuation: Look at traditional metrics –  valuations, P/E, price to sales, etc. — to rise two or even three standard deviations away from the historical mean.

2. Significantly elevated returns:  The S&P500 returns in the 1990s were far beyond what one could reasonably expect on a sustainable basis. The years around Greenspan’s “Irrational Exuberance” speech suggest that a bubble was forming:

1995    37.58
1996    22.96
1997    33.36
1998    28.58
1999    21.04

And the Nasdaq numbers were even better.

3. Excess leverage: Every great financial bubble has at its root easy money and rampant speculation. Find the leverage, and speculation won’t be too far behind.

4. New financial products: This is not a sufficient condition for bubble, but it does seems that each major bubble has new products somewhere in the mix. It may be Index funds, derivatives, tulips, 2/28 Arms.

5. Expansion of Credit:  This is beyond mere speculative leverage. With lots of money floating around, we eventually get around to funding the public to help inflate the bubble. From Credit cards to HELOCs, the 20th century was when the public was invited to leverage up.

6. Trading Volumes Spike: We saw it in equities, we saw it in derivatives, and we’ve seen it in houses: The transaction volumes in every major boom and bust, almost by definition, rises dramatically.

7. Perverse Incentives: Where you have unaligned incentives between corporate employees and shareholders, you get perverse results — like 300 mortgage companies blowing themselves up.

8. Tortured rationalizations: Look for absurd explanations for the new paradigm: Price to Clicks ratio, aggregating eyeballs, Dow 36,000.

9. Unintended Consequences: All legislation has unexpected and unwanted side effects. What recent (or not so recent) laws may have created an unexpected and bizarre result?

10. Employment trends:  A big increase in a given field — real estate brokers, day traders, etc. — may be a clue as to a developing bubble.

11. Credit Spreads: Look for a very low spread between legitimately AAA bonds and higher yielding junk can be indicative of fixed income risk appetites running too hot.

12. Credit Standards: Low and falling lending standards are always a forward indicator of credit trouble ahead. This can be part of a bubble psychology.

13. Default Rates: Very low default rates on corporate and high yield bonds can indicates the ease with which even poorly run companies can refinance. This suggests excess liquidity and creates false sense of security.

14. Unusually Low Volatility: Low equity volatility readings over an extended period indicates equity investor complacency.

via Barry Ritholz, June 9th, 2011

There are many ways to make money trading ... and even more ways to lose money trading.  If it were easy, everyone could do it.  There is a mix of art and science combined with hard-to-quantify factors at play.

But, survivorship bias is big in trading because hindsight is 20/20. It's easy to look at a popped bubble and say "oh, obviously that was a bubble" ... but if it was that easy, trading wouldn't be so hard.

Trends continue until they don't ... but at some point, they don't, and that's where people get hurt. 

My gut tells me it is time to pay closer attention.

Onwards!

 

 

Streaming Wars

Streaming services were big winners during the pandemic.  While that wasn't surprising, their subscriber growth and usage surge are impressive.

VisualCapitalist put together an infographic highlighting the numbers. 

 

via VisualCapitalist

I enjoyed the chart, and had a couple of different takeaways: 

• Many companies tried to capitalize on the streaming wave by launching half-baked streaming services, but it's clear that the pioneers are still extending their lead on the fast followers. 
• Despite Netflix already being the industry leader, they saw a 34% increase in 2020. 
• China's largest provider - Tencent Video - only has 120M users, which is about 8% of China's population. In contrast, Netflix has 74M US users, which is about 23% of the population. 
• The New York times is the only News subscription source big enough to make the list, yet it's at the very bottom with 6M users. Though, it did see a 61% increase in 2020. 
• Disney+ grew 95M in its inaugural year, which is a credit to the brand recognition Disney holds.

Interesting stuff and large numbers!

How will the world re-opening impact those numbers?  How about 5 years from now? What do you think?

Will virtual reality and augmented reality start to impact these numbers?

With that much money and on the line, I expect this to remain an industry segment primed for innovation, growth ... and a few surprises.

 

 

The Power of Naming Things

I remember when my son finally got smarter than our dog. For the record, it took longer than I thought it would.

With respect to human intelligence, language is likely the first domino. It allows "chunking" and makes learning new things more efficient, effective, and certain.

Language is powerful in-and-of-itself. Using language consciously is a multiplier. Today, I want to focus on one such use of language – the power of naming things. 

The Power Of Naming Things

“I read in a book once that a rose by any other name would smell as sweet, but I've never been able to believe it. I don't believe a rose WOULD be as nice if it was called a thistle or a skunk cabbage.” - L.M. Montgomery, Anne of Green Gables

Before I go into detail, I shot a video on the subject, with a few examples from our business. 

 

Having a shared language allows you to communicate, coordinate and collaborate more efficiently. But it's hard to have a shared language when you're discussing something intangible. 

That's where naming comes in. When you name something, you make the "invisible" visible (for you, your team, and anyone else who might care). 

I've often said the first step is to bring order to chaos. Then, wisdom comes from finer distinctions. Naming is a great way to create a natural taxonomy that helps people understand where they are – and where they are going.

I like thinking of it in comparison to value ladders in marketing. 

Each stage of the value ladder is meant to bring you to the next level. By the time someone gets to the top of the value ladder, they're your ideal customer. In other words, you create a natural pathway for a stranger (meaning someone who doesn't know you well) to follow, to gain value, trust, and momentum onwards ... ultimately, ascending to become someone who believes in, and supports, what you offer and who you are. 

Ultimately, successful collaboration relies on common language. That is part of the reason naming is so important.  The act of naming something makes it real, defines its boundaries and potentialities, and is often the first step towards understanding, adoption, and support. 

Creating "Amplified Intelligence"

There are always answers. We just have to be smart enough. - John Green

Here is an example from our business.  When we first started building trading systems, all we had was an idea. Then we figured out an equation (and more of them). Next, we figured out some methods or techniques ... which became recipes for success.  As we progressed, we figured out a growing collection of useful and reliable ways to test, validate, automate and execute the things we wanted to do (or to filter ... or prevent).

For someone who didn't understand the organizing principles, it probably seemed like a mess.  Compounding the problem is that fear, uncertainty, and doubt are inhibitors to potential customers and stakeholders (like the employees working in a business).

Coming up with the right organizing principle (and name) makes it easier to understand, accept, and adopt. For example, many traders and trading firms want to amplify intelligence – meaning they were looking to make better decisions, take smarter actions, and ultimately to perform better (which might mean making and keeping more money).  To help firms amplify intelligence, we created the Capitalogix Insight Engine (which is a platform of equations, algorithms, methods, testing tools, automations, and execution capabilities).  Within that platform, we have functional components (or modules) that focus on ideas like portfolio construction, sensible diversification, alpha generation, risk management, and allocation strategies.  Some of those words may not mean much to you, if you're not a trader, but if you are it creates an order that makes sense and a path from the beginning to the end of the process.

It makes sense. It explains where we are – while informing what might come later.

The point is that naming things creates order, structure, and a contextual map of understanding.

It a compass heading that we can use to navigate and guide in uncertain territory.

Hope that helps.

 

 

 

 

 

Here Are Some Links For Your Weekly Reading - March 7th, 2021

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• This Wild Video Maps the Entire Internet and Its Evolution Since 1997. (SingularityHub)
• These are the Most Desirable Countries and Cities For Workers Looking To Relocate In 2021. (CNBC)
• All Peanut Butter, All the Time: Reese's Peanut Butter Cups Without Chocolate Arriving In April. (USAToday)
• Scientists Made an AI that Reads Your Mind So It Can Generate Portraits You'll Find Attractive. (TheNextWeb)
• New AI Deep Nostalgia' Brings Old Photos, Including Very Old Ones, To Life. (TheVerge)

 

Trading Links:

• A Fed President Predicts the Bitcoin Boom Won't Last. (NYT)
• Why Central Banks Around the World Want To Get Into Digital Currencies. (CNBC)
• Jack Dorsey Trying to Sell 1st Tweet As NFT, Highest Bid at $2.5M. (TMZ)
• NFTs, Explained. (TheVerge)
• We Expect 300,000 Fewer Births Than Usual this Year. (New York Times)

 

 

Here Are Some Links For Your Weekly Reading - February 28th, 2021

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• Why Teaching Robots to Play Hide-and-Seek Could Be the Key to Next-Gen A.I. (DigitalTrends)
• AI Teaches Itself Diplomacy. (Spectrum)
• What is Web 3.0 and How Will It Help You? (MakeUseOf)
• Highest-Resolution Images of DNA Reveal It's Surprisingly Jiggly. (Gizmodo)
• Salesforce Says the 9-To-5 Workday is Dead' and Will Let Employees Go Fully Remote. (TheVerge)

 

Trading Links:

• Here's How Much Wealth You Need to Join the Richest 1% Globally. (Bloomberg)
• Thousands of Bots May Have Played Role In GameStop Hype. (Benzinga)
• Investors are Suddenly Obsessed With 'SuperCycles'. (Fortune)
• Dalio: How To Spot a Bubble. (Ritholtz)
• The Number of Public Listings By Zero-Revenue Companies Valued Above $1 Billion Currently Exceeds the Dot-Com Era. (Markets)

 

Who Can You Trust?

Information is Power.

Consequently, your choice of information source heavily contributes to your perceptions, ideas, and worldview.

Coincidently, news sources are a lightning rod for vitriol and polemic.

I am still a little surprised by the abject hatred I hear expressed towards a particular news source by those who hold an opposing bias.  This often leads to claims of fake news, delusion, and partisan press. Likewise, it is common to hear derision toward anyone who consumes that news source.

Perhaps the reality is that that most sources are flawed – and the goal should simply be to find information that sucks less?

It's to the point where if you watch the news, you're misinformed; and if you don't watch the news, you're uninformed. News sources aren't just reporting the news, they're creating opinions and arguments that become the news.  And many don't care enough to think for themselves - or to extract the facts from the opinion.

Here's a chart that shows where news sources rank on various scales. You can click the image to go to an interactive version with more details.

 

via Ad Fontes Media

I once spent fifteen minutes in an argument about how you know whether the information in this chart is true.  If you're curious about their methods, click here. 

Distrust toward news agencies, big companies, the government, and basically anyone with a particularly large reach is the "new normal." 

Perhaps even more dangerous is the amount of fake news and haphazard research shared on social media. Willful misrepresentations of complex issues are now a too common communication tactic now on both sides ... and the fair and unbiased consideration of issues suffers.  

Social media spreads like wildfire, and by the time it has been debunked (or proven to be an oversimplification) the damage is done. People are convinced ... and some will never go beyond that. 

The reality isn't as bleak.  People agree on a lot more than they say they do.  It is often easier to focus on "us" versus "them" rather than what we agree upon jointly.  This is true on a global scale.  We agree on a lot.  Most Democrats aren't socialists, and most Republicans aren't fascists ... and the fact that our conversation has drifted there is intellectually lazy.

This idea that either side is trying to destroy the country is clearly untrue (OK, mostly untrue). There are loonies on the fringes of any group, but the average Democrat is not that unlike the average Republican. You don't have to agree with their opinions, but you should be able to trust that they want our country to succeed. 

I don't know that we have a solution. But there is one common "fake news" fallacy I want to explain at least a little. 

It's called the Motte and Bailey fallacy. It's named after a style of medieval castle prioritizing military defense.

Launceston Castle via Chris Shaw, CC BY-SA 2.0

On the left is a Motte, an artificial mound often topped with a stone structure, and on the right is a Bailey, the enclosed courtyard. The Motte serves to protect not only itself but also the Bailey. 

As a form of argument, an arguer conflates two positions that share similarities. One of the positions is easy to defend (the motte) and the other is controversial (the bailey).  The arguer advances the controversial position, but when challenged insists they're only advancing the moderate position. Upon retreating the arguer can claim that the bailey hasn't been refuted, or that the critic is unreasonable by equating an attack on the bailey with an attack on the motte. 

It's a common method used by newscasters, politicians, and social media posters alike. And it's easy to get caught in it if you don't do your research. 

Conclusion

As a society, we're fairly vulnerable to groupthink, advertisements, and confirmation bias. 

We believe what we want to believe ... so it can be very hard to change a belief, even in the face of contrary evidence. 

But, hopefully, in learning about these fallacies, and being aware, we do better. 

I will caution that blind distrust is dangerous – because it feels like critical thought without forcing you to critically think.

Distrust is good ... but too much of a good thing is a bad thing. 

Not everything is a conspiracy theory or a false flag.

Do research, give more credence to experts in a field - but don't blindly trust them either.  How well do you think you're really thinking for yourself?

It's a complicated world, and it's only getting more complicated.  But, hopefully, it encourages you to get outside your bubble and learn more about those you disagree with. 

 

Here Are Some Links For Your Weekly Reading - February 21st, 2021

Click here to see some cool photos and videos from the Perseverance rover. 

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• The Texas Freeze: Why the Power Grid Failed. (Wall Street Journal)
• The Two Hours that Nearly Destroyed Texas's Electric Grid. (Finance)
• After Days of Mass Outages, Some Texas Residents Now Face Huge Electric Bills. (NPR)
• For Better Health During the Pandemic, is Two Hours Outdoors the New 10,000 Steps? (WSJ)
• Countries By Life Expectancy. (WorldAtlas)

 

Trading Links:

• Here's Why 'Black Swan' Author Nassim Taleb Dumped Bitcoin. (Decrypt)
• Turns Out Meme Stocks Have Basically Been Around Since 600 B.C. (Marker)
• China Blocked Jack Ma's Ant IPO After Investigation Revealed Likely Beneficiaries. (WSJ)
• Top US Lawmakers Want To Make Cannabis Federally Decriminalized: What To Know. (CNet)
• Top Wall Street Analysts Say Buy Stocks Like Denny's and Cloudflare As Economy Reopens. (CNBC)

 

The Return of The SPACs

I've shared several links about SPACs, in the past few months, as they have gotten increasingly popular and relevant.

SPAC stands for Special Purpose Acquisition Company. A SPAC is a company with no commercial operations, formed to raise capital through an IPO to acquire existing companies, technologies.

A typical IPO creates new public shares of a formerly private company while a SPAC merges a private shell company with an already existing public company. 

It's basically a backdoor way to turn a private company public overnight. Click here to see popular SPACs from 2020. 

They've been around for decades – but SPACs have been increasingly popular recently. Making that point, according to Bloomberg, SPAC dollars raised in 2020 beat the total from the previous 10 years combined.

via RSM

SPACs are becoming popular to businesses because they're seen as a safer way to go public in a volatile environment. They're also becoming popular to investors because the stock value often jumps pre-acquisition.  Nevertheless, the reality is that the average SPAC underperforms the S&P 500 on any given timeframe.

via Bloomberg

The reality is that most "buzz" products underperform the S&P – and most things that become too popular ultimately end up losing their edge. 

Barry Ritholtz put it well in his opinion piece:

The successful products we encounter every day are the result of initial failure. While positive outcomes are all around us, hidden from view is the iterative process of repeated failed attempts that lead to improvement. The world is filled with fantastic products from wildly successful companies, making it easy to overlook the many small gains and occasional big breakthroughs that helped them achieve this success.

For businesses looking for access to capital, SPACs are a legitimate option worth considering.  However, for investors looking for the next new alternative asset class to invest in, SPACs may not be what you are looking for in the longer term. 

What do you think?

 

 

Here Are Some Links For Your Weekly Reading - January 31st, 2020

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• American is the First US Carrier To Use Digital Health Passport. (Simpleflying)
• Tim Cook On Why It's Time To Fight the "Data-Industrial Complex". (GQ)
• Wikipedia Turns 20. (MorningBrew)
• The 2500-Year-old Technique To Make Ice In the Desert. (Medium)
• The San Francisco School District's Renaming Debacle Has Been a Historic Travesty. (MissionLocal)

 

Trading Links:

• Public Market Verdict: the Unicorn Binge Wasn't Crazy; It Was Really Profitable. (Crunchbase)
• Bitcoin Investors May Lose Everything, Central Banker Warns. (Bloomberg)
• The SPAC Boom Rolls On Into 2021. (MorningBrew)
• FAA Clears Way For Commercial Drone Deliveries With New Rules. (ABCNews)
• Apple Overtakes Amazon To Become World's Most Valuable Brand, While Tesla is the Fastest-growing. (MarketWatch)

Wolves of r/wallstreetbets: What Happened With Gamestop & Robinhood

GameStop has been on a steady decline (both as a stock and a company) for many years. It has been like watching Blockbuster get replaced with Netflix all over again.  Why would people go to a retail store when they can consume a wider range of products from the comfort of their home?  Obviously, the pandemic made things worse for them.  As a result, short sellers lined up to bet on their demise.

So, how can you explain the jump in GameStop's share price from $17.50 at the beginning of 2020, to almost $400 on Thursday?

You could argue it started with new leadership from Ryan Cohen and their surprisingly stable financials despite the turmoil. Nonetheless, it would be hard to justify a sudden $28 Billion dollar valuation based on that alone. 

The real reason for the price jump, and the story everyone is talking about, is the war of the retail investor (fueled primarily by a Reddit forum called r/wallstreetbets) on Wall Street. 

 

It's a complicated situation, and news stories tend to have their own biases and agendas, so I thought I would bring you up to speed on what happened, the legality, and the potential ramifications.

What Happened?

Earlier this month, Redditors realized that GameStop's stock ($GME) was shorted to 140% of tradable shares due to positions by several funds including Melvin Capital. Most of those positions are passively held, so the short-interest accounted for 300-500% of the float (actively traded shares).  Theoretically, this shouldn't be possible - but it was allowed by the brokerages and market makers. 

This allowed the Redditors, and other retail investors, to buy the stock aggressively, raising the stock price, and forcing the shorts to cover. This is called a short squeeze. 

By Wednesday, retail investors' actions raised the price 700% to over $300. Melvin Capital was out ~3 Billion dollars and ultimately got bailed out by Citadel and Point 72. 

On Thursday, after calls for help from Wall Street grew louder, several online brokers blocked the buying of GameStop and other stocks that were trending on Reddit (like $AMC, $NOK, and $NAKD) and canceled some trades. Those brokers still allowed users to sell their shares.

 

via Statista

The stock price of GameStop and AMC tumbled as a result and the media went into an uproar.

Questions of legality were raised toward the potential market manipulation of Robinhood, but also r/wallstreetbets. 

Were Robinhood's Actions legal?

Separate from legality, the optics of the situation are very bad for Robinhood. First, Citadel, who bailed out Melvin Capital, is one of Robinhood's vendors. Second, Robinhood's motto is about access to all, and it heavily markets brand beliefs consistent with the ideals of the fictional heroic outlaw, Robin Hood (who took from the rich to give to the poor).

Voices like Mark Cuban, Elon Musk, AOC, and Ben Shapiro all came out against Robinhood for limiting retail's ability to trade. An odd show of unity in these divisive times. There are also several class-action lawsuits and the SEC is reviewing the situation.

Robinhood justified its actions by claiming they were forced due to increased volatility, and risk management with their brokers. Both Robinhood and Citadel strongly denied any market manipulation claims.

Legally, these brokers state in their contracts that they are allowed to restrict trades for almost any reason. As well, they have liability and protection obligations to their consumers, market makers, and clearinghouses.  

The situation with $GME is undeniably risky. Trading is a zero-sum game, and for every crazy win story you see of someone paying their mortgage, someone is losing their house. As $GME gains popularity, or r/wallstreetbets tries to replicate this success with other securities, the late majority are (almost by definition) going to be the least qualified and the most at risk of losing money they probably can't afford to invest. 

This episode shined a light on clear issues with the Stock Market. 

However: 

• Robinhood only limited the ability to buy these stocks, which by design lowers stock prices.
• Before retail investors capitalized on the situation, these same brokerages let institutions short 140% which would have been a death sentence for GameStop. 
• It's on the NYSE (in this case) to shut down the trading of a security, and they only do it for fraud or if there is material information a company hasn't disclosed yet.
• The timing and relationships bring good reason to question the validity of Robinhood's statements.

While the theoretical action of limiting trading is legal for Robinhood - this specific case is questionable at best. 

Were r/wallstreetbets actions legal?

Many big-time bankers have been arrested for market manipulation in the past. It's a point of many of the regulations in Wall Street today. 

This specific example is very complicated. On Reddit, a public forum, many users urged each other to buy stock and to hold in the face of adversity. The initial logic behind buying $GME was based on solid fundamentals, and the observation about Melvin Capital's position - but quickly became a momentum play capitalizing on the mania. You could argue it was collusion, which is bolstered by the disparity between the future value of GameStop as a business and its current stock price.

It's hard to prove that there was a coordinated effort to manipulate stock prices here. To me, it looks like a mob of uninformed investors following the advice of an educated investor and creating a trend. A common theme. Some claim it resembles a classic "pump-and-dump" scheme that you would find by the likes of Jordan Belfort and the penny stock market.

I think it's very unlikely you see anyone charged here - but I do think it's likely you see new regulations as a result of this. 

While the industry is already heavily regulated, the world is changing, and we have to keep up or deal with the consequences. 

New strategies or capabilities push boundaries and test limits in new ways.  In the short term, someone has a new advantage, but in the long term, the system evolves and gets stronger.

The Bigger Picture

I've seen many people concerned with the decision-making behind retail's investment in $GME.  As a practical matter, it doesn't really matter. 

The initial posts on Reddit showed a good understanding of fundamental trading, but most traders who followed that advice wouldn't know the difference. 

I'd argue it's not that different from most of Wall Street. Many don't have an edge, they simply piggyback off of the success of the ones that do, whether by following their trades or starting a new firm with the lessons they learned at a bigger firm. 

The market is not the economy, and while GameStop is a great case study to prove that, at its core, it's not really a unique or new phenomenon. 

Value is an important part of a stock price.  But for many speculators, it is only part of the calculation. And beyond speculators, there are many types of market participants (e.g., governments, institutions, hedgers, etc.) and reasons to buy or sell things (including fun, excitement, a social belief, etc.), and rationales for their decisions (including systematic approaches, momentum, reversion to the mean, etc.) that combine to form the free market. 

A free market isn't necessarily a smart market ... and it doesn't need to be. But, part of what creates a growing and thriving market is the belief that it is safe, reasonably transparent, and reasonably regulated. Consequently, I would expect regulators to re-visit this and for them to re-look at the regulation of margin and other things. 

Expect increased volatility and noise. Expect more runs like this. Plan accordingly. 

Conclusion

Helping the average person take advantage of the Stock Market is a good thing. With that said, the "democratization of access" comes at a time when tech asymmetry is growing. The advantages to Hedge Funds and Institutional Investors are growing - regardless of regulation - due to better tech stacks, smarter algorithms, and teams of PhDs. Information asymmetry is decreasing, but data is only valuable if you can digest it.

The Stock Market is not just a game, and some believe it's worrisome that some retail investors feel like it is. 

In trading, there is a rule of thumb that says a trend continues until it stops.  Well, expect the bubble to pop for $GME (and the other stocks that may follow this pattern).  Why, because trends do stop ... and to quote Stein's Law - if something can't continue it won't.

Actions have consequences.  Many intelligent investors will be fine, but many other investors will be hurt.  To some extent, that is the consequence of a zero-sum market.  But with Democrats in power, I expect to hear more about this.

Perhaps it shouldn't have taken Wall Street getting hurt to start this discussion. Now the discussion has started.  At some level, it's not about what happened ... it is about what you do. 

It's unclear whether r/wallstreetbets will have the win they're looking for or whether Robinhood will get penalized. 

What do you expect to happen?