June 14, 2021 – As a hedge fund manager and market prognosticator, our predictions often turn out wrong. It is a very humbling profession.
I stated on the February 22nd episode of our Absolute Return Podcast, “Yeah, and this really just concludes the whole GameStop saga. [Meme stonks] continue their descent, falling 92% from the peak. It’s not coming back. It’s over folks. Meme stock investing was fun while it lasted, but let’s go on to different things. Concluding that file, we all had a lot of fun.”
It is time for me to eat some crow here. Not only did meme stonk investing not die, it came back stronger than ever.
This speculative boom in heavily-shorted, near-bankrupt companies was no more apparent than in the shares of struggling movie theatre company, AMC, whose stock is up roughly 2,000% year-to-date.
Two years ago, AMC’s market capitalization was $1 billion. Currently, the company’s equity market value is approximately $25 billion. Are its movie theatres now worth 25x more? Doubtful.
Nonetheless, an odd thing has occurred. Many people from a past life – high school class mates, ex-girlfriends, etc. – have come out of the woodwork to ask me for advice on what they should do with their skyrocketing meme stonk holdings. These are first-time investors whose newly-minted portfolio has been stuffed with securities promoted heavily in online chat rooms such as WallStreetBets.
When asked for advice, I told them what I thought was the best action when holding a dramatically overvalued security – sell all or at least some of it. After the meme stonk holder responded “No”, I decided to dig deeper:
“Do you think AMC’s movie theatres are worth 25x more now and if so, why?”
“No, of course not.”
“OK, then what’s your thesis on continuing to hold the shares?”
“Because it’s going to squeeze”
Historically, security analysis was based on two central tenets:
- Market participants are rational actors.
- The value of a security is the present value of its future cash flows.
It is clear that the previous “rules” governing capital markets have been turned on their heads in the current market environment.
Many securities in the market are being driven by irrational actors who have no view on the intrinsic value of companies. Their main goal is to create a perceived short squeeze, combined with a gamma squeeze, through their concentrated and orchestrated stock and call option buying. This crowd of non-fundamental retail traders is now a significant contingent of the market. Individual investors now account for more trading volume than both mutual funds and hedge funds combined.
The dynamics of the current market fits with the notion of “trading sardines”, as highlighted by Seth Klarman in his book Margin of Safety:
There is an old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, “You don’t understand. These are not eating sardines, they are trading sardines.”
Investors should be aware of the numerous “trading sardines”, also known as meme stonks, active in the current market environment. These meme stonks have made long-short investing in general, and hedging in particular, relatively challenging, especially since meme stonk speculators target low-quality companies with high short interest.
According to research firm S3 Partners, there are approximately 230 firms with a market capitalization of at least $100 million and short interest of 15% or more. More than 80% of these stocks have had positive returns over the past month with the average gain of about 18%, while the S&P 500 Index rose just 2.3%. It is certainly a challenging environment for short sellers, despite record high equity valuations.
Historically, overvalued shares of low-quality businesses have underperformed, but speculators have turned these stocks into trading sardines, leading to significant outperformance of this group of securities.
While no one knows how long this odd dynamic will persist, it is prudent to have one’s bases fully covered and diversify to the greatest extent possible to account for a myriad of potential economic and market conditions.
Accelerate manages four alternative ETFs, each with a specific mandate:
- Accelerate Arbitrage Fund (TSX: ARB): SPAC and merger arbitrage
- Accelerate Absolute Return Hedge Fund (TSX: HDGE): Long-short equity
- Accelerate OneChoice Alternative Portfolio ETF (TSX; ONEC): Alternatives portfolio solution
- Accelerate Enhanced Canadian Benchmark Alternative Fund (TSX: ATSX): Buffered index
It is “steady as she goes” in the Accelerate Arbitrage Fund (TSX: ARB). The fund remains fully deployed in a diversified mix of SPAC and merger arbitrage investment opportunities. The fund finished May down -0.9% as arbitrage spreads widened across the board.
ARB is currently allocated to 240 SPACs, accounting for 79% of the portfolio. Low-risk merger arbitrage accounts for the remaining 21%.
After a brief bear market, we believe SPACs have bottomed. We see positive sentiment returning as the Accelerate SPAC Index finished positive for 9 days in a row.
ARB subscribed to its first SPAC IPO in over two months. This SPAC IPO was the first issue that was upsized since March and was one of the first since the bear market began in late February that actually traded up the first day.
We expect the positive momentum in the SPAC and M&A markets to continue and have our eyes on the start of a new SPAC bull market forecast for late summer.
The value factor continues its recovery, as undervalued stocks outperformed overvalued securities by 3.4% last month. The trend factor notched a 4.2% gain, while long-short quality and operating momentum factor portfolios were both up 1.6%. Price momentum was the only detractor last month, as the short momentum portfolio rallied 4.3% while the long portfolio added just 1.4%
While the factors trended to the positive, HDGE, which has exposure to the USD, declined -2.1% last month primarily due to the decline in the U.S. dollar relative to the Canadian dollar. The HDGE portfolio does not hedge F/X exposure (i.e. it retains USD exposure), which helps cushion the downside, however, can provide headwinds when risk assets are rallying.
The Accelerate OneChoice Alternative Portfolio ETF (TSX: ONEC) fell -3.5% in May, led by the -36.6% fall in the price of bitcoin.
Partially offsetting the loss from bitcoin was gold’s 7.5% surge. The offsetting dynamic of bitcoin and gold is an interesting one to consider, given that the two alternative currencies generally produce returns (or lack thereof) irrespective of broad market dynamics. The uncorrelated nature of these assets makes them truly alternative and the main reason they are included in the ONEC portfolio. We expect both gold and bitcoin to generate positive returns with low correlation to traditional asset classes. The ability to generate returns with low correlation is the crux of diversification.
Other allocations in ONEC that contributed positively in May include risk parity and leveraged loans, which added 2.9% and 0.8%, respectively.
ATSX managed to eke out a small gain, however, the strategy underperformed its benchmark in May. There were two reasons for the underperformance:
First, Canadian multi-factor long-short performance was negative, with all factor portfolios registering losses for the month aside from operating momentum. The quality factor declined -8.1%, as low quality stocks (i.e. the securities we would short) rallied 9.0%, while high quality securities gained just 0.9%.
Second, ATSX was negatively affected by the meme stonk rally due to its short position in BlackBerry, a company that is a good decade past its prime. Nonetheless, given the potentially devastating risk of shorting meme stonks, we have implemented further risk measures to exclude any stocks popular on Reddit forum WallStreetBets from our short portfolio. Not only is the ATSX short portfolio free of high-short interest stocks, but also highly volatile “trading sardines” popular with the retail speculator set.
Have questions about Accelerate’s investment strategies? Book a call with me.
-Julian
Disclaimer: This distribution does not constitute investment, legal or tax advice. Data provided in this distribution should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this distribution is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate Financial Technologies Inc. (“Accelerate”) as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Past performance is not indicative of future results. Visit www.AccelerateShares.com for more information.
