First of all, I sincerely apologize for not updating for almost 3 months especially given how volatile the market has been.
Lots have happened. No excuse. And here’s why/what:
I have been crazy busy at my day job, and I have been building another product in my spare time -- an iOS app called “Investcast” -- a (smart-ish) podcast player for savvy investors/traders -- so this could potentially be a new toy for you too ( hope it’s worth the wait ); and if you are interested, I have put more details at the end of this newsletter.
After my last publication/idea, which is Short Treasury + Long Big Tech + Short Small Cap Growth, or ticker wise Short $TLT + Long $QQQ + Short $IWO, I didn’t really have a clear idea how to play the violent sector rotation better.
On one hand, that idea itself hasn’t been too bad -- see chart below, even if you simply match the notional of each leg, it should give you about 15% return over the last 3 months.
On the other hand, I couldn’t get comfortable jumping onto the long banks + commodities trade myself -- there’s no reason for me to write something I don’t understand/appreciate.
My own portfolio has also experienced severe drawdowns. I guess if you have heavy tech/growth exposure you know what I’m saying.
Firstly I myself lacked the discipline to sell positions that clearly showed top-off patterns; Neither did I put large enough positions of above trade idea to dial down risk.
Secondly (and luckily I didn’t write about this idea), after the initial weakness in late February, I started to sell puts of some of the highly volatile names that I liked, as I saw the implied volatility spiked to a pretty attractive level; I thought selling puts would be a cost-efficient way to buy-the-dip, but the extent of that growth sell-off had gone far greater than I expected, and my portfolio ended up being one levered long growth name after March expiry day, a.k.a textbook catching the falling knife.
I have been pretty upset/regretful/confused about it. Mr. Market always catches you.
So I decided not to write anything until I got myself out of the emotional thinking mode.
So where are we today and what are we talking about ?
Is the rotation over?
My answer is probably not, and that doesn’t matter.
I think the risk of jumping into value trade now is far greater than staying out of it. The “value” is really a bad name, as the rotation is really into 2 major sectors, banks + commodities.
Yes Banks are benefiting from the steeper yield curve that their NIM (net interest margin) is a function of. To be honest, long large cap banks is probably a low risk trade for the short term.
Over the medium term, however, the entire industry doesn’t suddenly become sexy again only because of the rising inflation expectation. Many banking products may actually be facing a few existential risks sooner than people expect: Fintech, central bank digital currency (CBDC), and crypto DeFi. Name a traditional bank service you use not due to the regulatory reason ?
Fintech would replace your day-to-day banking needs from payment to saving & borrowing, DeFi for investing & trading (even for institutional level) and CBDC basically disintermediates the risk assessor/taker role of banks being the middleman.
The commodity/industrial/material sector has the risk that’s called “our supply chain almost definitely always under-reacts & over-reacts to every single shock”. This is the nature of how humans make decisions in front of huge uncertainty and how complex systems usually work. Yes many oil companies just won’t spend a dime on more capex, many raw material importers might keep hoarding goods and foundry factories still can’t make chips quick enough. But that’s never the source of sustainable inflation and it almost is the source for a snap-back.
Note, China again might be the turning point here, as they very recently announced to chase crypto miners (my estimation, at least 30-40% of TSMC last year’s revenue) + raw materials speculators & hoarders.
What do we buy now ? A boring answer.
It may sound a little boring, but I seriously think that S&P500 is your best bet right now. All the beautiful dynamics between market cap weighting + self rebalancing + passive rotation between sectors within a large cap index is working nicely at the moment. Be the leader the financial sector, the big techs or the industrial names, S&P500 will be resilient and enjoy some upside but with much lower volatility than most investment.
Facing the reality that all the easy money has been already made in 2020, I’m reckoning that trying to beat S&P500 consistently going forward is actually pretty difficult.
Even after very serious correction, many growth names still appear to be pretty expensively priced to their forward looking sales. Yes some of the names start to look like they are stabilizing and are ready for another uptrend, nonetheless their super sensitive nature to long term interest rate or inflation expectations doesn’t change. This probably means the uptrend won’t be without significant volatility, and high volatility is NOT friendly for capital compounding.
Similarly, a more sensible bet would be a larger amount of investment on large cap names within the growth/tech sector, rather than smaller amounts on higher risky names.
Please note, to most retail investors, the absolute dollar amount return is far more important than the percentage rate of return. A safer bet under big uncertainty allows you to make a bigger bet, which has better probability turning into a higher dollar amount return.
A fancy footwork can be done, taking advantage of the index level very cheap implied volatility (compared to single name stocks) is that buying some OTM SPY puts to protect yourself. We’ll discuss this in more details but buying a 3month 10-15% OTM put is very attractive.
You should start accumulate ETH
There are 2 sectors’ valuations that do look very attractive, 1) China related tech/growth, 2) ETH or Etherium ecosystem after the crypto storm.
The Chinese tech investment(buy-the-dip) is actually much tricker to analyze and execute, and we will talk about that in a separate newsletter. Spoil alert: both the risk and return would be larger than most people’s estimation.
ETH or Ethereum, is actually a much simpler investment decision to make. Yes the technical side of it is not as simple and not straight forward for many to understand right away, and the tokenomics or the entire concept of investing in the tokens vs. traditional investing an ownership of a company is a rabbit hole to dig into, but that shouldn’t stop one to put a responsible allocation to the asset class.
In short, it is a high risk high reward investment on a computational infrastructure, with many potential use cases in the future, and with DeFi (decentralised finance) being a proven one. Allocate a responsible amount (a portion that you could afford 70% drawdown could be very intellectually and financially rewarding).
In my 5-minute-effort to explain why investing in ETH makes sense, just consider the below illustration just for one use case:
When you invest in a traditional stock market in USD, there’s tons of work done in the middle and you are actually paying them one way or another even if you are not aware. And on top of that, you use and settle USD which is basically backed by the US government who again does tons of work to ensure the credibility of that currency.
But the ETH and the entire ethereum network & ecosystem replace all that work and all you need to trust is using the token itself.
Buying some ETH tokens, given how important “being trustless” is to the nature of financial transactions, will make sense as the protocol layer should and will capture huge value (vs. many other crypto projects/tokens, i’m not fully convinced the value would/should be captured in the protocol/token level).
(Obviously it’s deep deep rabbit hole you will need to dig if you are curious and keen to know how it works) But that basically is, the simplest pitch to invest in ETH, a decentralized computation platform with the financial/investment being its first real use case in scale, and many more potentially coming, with some of smartest people in the world jumping in and developing for you.
I personally have put in between 10-20% of my total portfolio into ETH, and you should assess your own risk tolerance accordingly. With the huge upside, missing it would actually be a major risk. Email me at firstname.lastname@example.org if you’d like a more detailed discussion.
Please note deepyield.io is YET to be updated at the time of writing.
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Below is my quick explanation of what I’ve been building -- Investcast:
The explosion of information and the ways to consume them does NOT help us filter out what's best for us. It's probably even worse for financial contents as tons of news and opinions are coming out every second.
And I actually (as an investment professional) find tracking day to day news is pretty useless for most retail investors to achieve their long term goal. There is however, tons of very high quality contents via the podcast format being freely released and available to everyone. The big question is how to discover, follow, consume and organise them in an efficient way.
This is precisely why we're (my friend and I) building Investcast, a smart podcast player, that brings you the best conversations from the best investment podcasts only. We would like to help you listen less, invest smarter, and grow your financial knowledge and wealth together with us.
The app, using machine learning, will curate and recommend investment podcast highlights to you, that also lets you track all the contents with topics, name entities and investment opportunities. We want to build a productivity tool for savvy retail investors, and hope it becomes a cool new toy for you.
We are opening up limited space to test our iOS app. Join the waiting list here.