Market Thinking

making sense of the narrative

It’s only a rort if you’re not in it

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The options expiry on Friday was closely watched thanks to the fun and games in the Gamma markets initiated by Softbank in July and August but was fortunately not too disruptive. A quick recap; by buying a basket of underlying tech ‘narrative names’ such as Amazon, Apple and Alphabet, but also Tesla, Zoom and other Covid ‘winners’ and then going heavily into the options markets in those names, the former derivative traders from Deutsche Bank, who have now reappeared as Venture Capitalists at SoftBank’s Vision fund, hoped that their new Hedge Fund venture could bend markets to their will. To a large extent they have succeeded, helped by a combination of thinly traded markets in July and August and a new breed of  tech savvy, if not necessarily market savvy, RobinHood day traders in the US. The momentum developed by the SoftBank ‘whale trades’ brought huge shoals of smaller fish after them, many also using the options markets. Caught in the middle have been the big banks making markets in options who have been caught in a ‘gamma squeeze’; if you write (sell) a call option (to SoftBank or anyone else) then your risk is unlimited – you have promised to sell them a stock at, say, 100, even if the price jumps to 200. The practical, and actual, thing to do is to manage your risk by buying the underlying stock as well. The hope of course is that you can buy it a little lower down and keep the premium, but as a share price runs away from you, it can trigger a panic to ‘cover’ causing the price to squeeze up further.

Fortunately the unwind of the options doesn’t seem to have caused too much chaos, but important to note that the wider indices are looking weaker from a technical perspective. Both the Nasdaq and the S&P500 are approaching their medium term support lines and Nasdaq has just completed (and broken through) a 23.6% Fibonacci reversal of its rally from the March lows. Many traders consider these highly significant and we pay them due attention. The fact that the weakness occurred with significant volume on both markets is perhaps of even greater significance. Of course, as we discussed last week, VIX generally is trending higher as we run into the US Election, confirming our view that a lot of money is starting to move to the sidelines. The fact that this occurred while the Dollar index actually took some short term support suggests perhaps that this is more domestic than international selling.

Last week we discussed how the New Cold War with China is going to have some unexpected repercussions, particularly with respect to lower competition and higher price. (See going to build a Great Big, Beautiful Fire/tariff wall). There are of course other individual stock specific risks to consider. Today, for example, HSBC is off heavily on rumours that it is going to be placed on some form of ‘not trusted’ list by the Chinese authorities. This of course would be devastating for the company – if true – but it also highlights how dependent so many ‘global’ businesses are on both the US and China. Placing them in a ‘Them or US’ position is a major threat to their business model. The other obvious ‘China license’ plays to watch are the Macau casinos; Sands China* is off almost 9% this month, all of which is in the last week, while Wynn Macau is off almost exactly the same as HSBC. By contrast, as the graph shows, if we index share prices to the start of September, the Hang Seng is down around 5% month to date  (although there is a degree of double counting given the weight of HSBC in the index), while China Merchants Bank (to pick one not seemingly under threat) is actually up 5%

*(Note that Sands China is part of Las Vegas Sands, which is controlled by Sheldon Adelson, one of the biggest backers of President Trump)

Chart 1: Not just China Price, but China License.

Source Bloomberg.

As an interesting aside, we note from the second chart that between 2010 and 2015, HSBC moved within a 30% trading range against the HSI, essentially, + or – 15% around a mid point. Then from 2015 to 2020 it moved in a similar 30% range from the bottom of the previous band. Right now however, it has fallen 44% year to date against the Index.

Chart 2. HSBCs long term decline against the Hang Seng has accelerate dramatically

Source Bloomberg

Elsewhere in terms of market behaviour we had the highly successful IPO of THG in the UK last week, which opened 25% higher,  despite more red flags than a China National Day parade. Retail investors are said to be ‘very interested’ which points to the power of financial PR (of which there was plenty) if nothing else and proper trading starts today. Perhaps they are getting in at the beginning of the next Ocado, but as we used to say as institutional investors, “I am not sure I am getting adequately compensated for being part of the (true) price discovery process”. In the US, there was an even bigger surge in tech IPO Snowflake, which doubled at the opening. US retail investors are thinking perhaps they have the new Zoom, which rose over 1000% in the year after its IPO. This is Bitcoin type stuff going on.

Or perhaps they believe Snowflake can be the new SalesForce.com, which is currently trading at 10x revenues and 55x cash flow (although at least it has some cash flow). Snowflake is a data-warehousing business with close ties to Salesforce who participated in its latest (and last) series F round of financing back in February. That itself was extra-ordinary enough. Prior to the February ‘raise’ the company had a valuation of around $3.9bn, making it one of the more valuable of the so called ‘unicorns’. However, such is the madness of the VC world that by raising $479m from a combination of Salesforce and Dragoneer investments for less than a 4% stake, the company was suddenly ‘worth’ $12.4bn, making it a new thing, a ‘Deca-corn’. Then seven months later, they brought it to the markets – the little people – on a new valuation of $33bn, in other words 10x what it was apparently ‘worth’ at the beginning of the year. After the ‘success’ of the IPO it is now apparently worth $66bn. So those late investors into Snowflake had deployed their $439m for seven months and now it is ‘worth’ $2.6bn. Put another way, assuming they went in 50:50 with Dragoneer, Salesforce earned 25% of their annual net cash flow from doing ‘a real job’ from playing a single pre-IPO ramp. Nice work if you can get it. As the Australians like to say “it’s only a rort if you are not in it!”

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