Pulse of the Market - August 2021
On July 29, 2021, Credit Suisse held a Board of Directors meeting regarding the blow up of Archegos Capital Management. The bank released a 172 page document that held some unbelievable facts:
Its 2008 All Over Again: Archegos and the Use of Total Return Swaps (Long and Net Short)
Back in April, I wrote about an eccentric hedge fund manager named Bill Hwang. As a quick summary, Hwang ran a family office hedge fund, which was levered up to 10x committed capital (to a total of around 20B AUM) through the use margin from several prime brokers, such as Credit Suisse. Recently, CS published a very long, and quite detailed, timeline and record of events of the fund’s inevitable demise. I would like to point out several mind blowing and revealing facts from the report.
While you probably already heard Bill Hwang was levered up to the max on individual tech stocks like Viacom CBS and a bunch of other Chinese tech stocks you and I have never heard of, did you know he was also short Gamestop?
Of course, the degenerate gambler himself lost over $800 million (or CS lost $800 million because of Bill Hwang) back in January on one short position (per page 115). However, the use of total return swaps makes this narrative of “losing $800mm shorting Gamestop” not as believable.
Per page 43 an example of a Total Return Swap is as follows: As just one example of how such synthetic financing might work, the client would enter into a derivative known as a total return swap (“TRS”) with its Prime Broker. Again, assuming a margin requirement of 20%, the client could put up $5,000 in margin and the Prime Broker would agree to pay the client the amount of the increase in the price of the asset over $25,000 over a given period of time. In return, the client would agree to pay the amount of any decrease in the value of the stock below $25,000, as well as an agreed upon interest rate over the life of the swap, regardless of how the underlying stock performed.”
So Bill Hwang, lost $800 million buying TRS on Gamestop? That doesn’t make sense given that would mean he was synthetically long stock. However, age 43 continues: Ultimately, the trader might seek to enter a TRS in the opposite direction (i.e., with a client who wants exposure to any decrease in the value of the stock).
Now it makes more sense. Bill Hwang purchased a net short TRS from Credit Suisse, using only 20% of his actual capital. But what if he not only shorted Gamestop through a net short TRS, but a bundle of stocks which were packaged together as a “sure bet” to diversify his already high beta, levered portfolio of tech stocks?
Remember 2008, and the packaging of horribly rated mortgages together in order to provide a “diversified, AAA rated” instrument of mortgages to buy? Does this scene from the Big short ring a bell for anyone?
How do all these high short interest names trade in unison, while all being in completely different industries and fundamentally different businesses? Maybe the revealing CS report and the use of packaged net short TRS paints a clear picture. And of course you don’t need to report any TRS or net short TRS on a 13F disclosure (how convenient….). Maybe those short interest numbers CNBC loves to spam aren’t accurate?
How do you cover a net short TRS you may be wondering? Well you can kick the can and roll the swap, while having to buy back some of the underlying securities to meet margin requirements (aka the spikes in the charts) until one day you can’t meet the margin requirements and you close your net short TRS (aka stonks go nuclear 🧨).
The Hive Mind Mentality: The Inevitable Dump and Pump of Crypto
Back in May, I reiterated as much caution as I could regarding crypto’s run while also noting the correction was pretty common place in crypto’s volatile history. Well low and behold Bitcoin is hovering back around 50k, and Ethereum back over 3k.
To show how hedge funds, institutional investors, and other big money players stepped in, its easy to examine per Coinbase’s trading volume in Q2 2021. As shown below, look who increased their trading volume from $215B in Q1 2021 to $317B in Q2 2021. Basically, a bunch of retail investors got fleeced listening to CNBC or whatever news source they consume only to have a bunch of hedge funds scoop up their crypto in record trading volume. How did they do it? My best guess is they used a combination of derivatives to push the price down, hit stop losses, and wipe out the excess margin in the crypto market. This wiped out the “dumb money” on ridiculous 10x to 100x leverage (yes literally 100x leverage on crypto) and then these large institutional investors started to buy when all the blood was in the water.
The Margin Bubble
As expected and discussed multiple times, the margin debt bubble is starting to show signs of weakness. As of June 2021, the level of margin debt per FINRA is actually starting to decrease, not increase at a decreasing rate anymore. Is history gonna repeat it itself just like in 2000 and 2008 where hedge funds, banks, and retail investors were levered up on margin only to get wiped out? Tune in this year to find out 🍿😎
The Federal Reserve (aka Jerome Powell and his printer press)
At Fed’s annual symposium in Jackson Hole, Wyoming (virtual this year), Powell reiterated it was too early to taper the unprecedented amount of monthly bond purchases, which allowed the indexes to rocket higher (surprise surprise) yet he FINALLY let the market now the the Fed will “likely to begin withdrawing some of its easy-money policies before the end of the year, though he still sees interest rate hikes off in the distance”. In simpler terms, JPow is finally warning that the punch bowl at the party may be taken away soon and all the printing of money and purchasing of bonds might not be so dramatic anymore….
Powell Comments at Jackson Hole
I’ve been particular cautious for months now and that fact that’s seen as “crazy” in this market is particularly concerning. I guess the punch bowl may actually need to be taken away (tapering of $120B in bond purchases per month) before people finally realize this market has been propped up by the Fed not since 2020, but since the start of quantitative easing after the 2008 meltdown (see graph).