Market Thinking

making sense of the narrative

Themes and Memes

Print Friendly, PDF & Email

We like to look at markets as being driven by the behaviour of three different groups – the short term speculators, the medium term asset allocators and the longer term investors. Sometimes the three groups offset or partially offset one another and other times they are all pushing in the same direction. This can be particularly true of Thematic Investing. Long term investors will often identify a long term theme as a form of smart Beta – a driver of excess returns – and this will usually, but not always, be a long term growth thematic. In essence this was the old style approach of picking growth sectors or regions or perhaps equity factors such as size (small cap) or value, but as these became more ‘benchmarked’ in that performance was compared to the average of the theme rather than the average of the market, so themes became more focused and specialist – robotics and automation was one we had tremendous success with at my former employer for example. However, sometimes they become a little too narrow and start to drive individual stocks aggressively which brings in the benchmark conscious asset allocators who find themselves chasing the top performing stocks in order to maintain exposure, at which point the long term spreads to the medium term.

At some point, particularly in the realm of emerging technologies, the theme becomes over-hyped and thematic baskets become over-heated. The theme basically becomes a meme and the short term players get involved, both retail and institutional; stocks with only a tangential connection to the theme are bought by the theme funds and the relative success of the funds attracts more capital – to them or their rivals- which in turn is forced into a relatively small basket of stocks, creating a momentum effect. One way to keep an eye on this is to watch publications like Gartner’s Hype cycle. Here we can see the situation way back in 2012 as they (and we) were trying to look 10 years into the future. Note that at this point 3D printing was at what they regarded as the peak of the Hype cycle.

Chart 1. The Hype Cycle can turn a theme into a meme

At the time of this publication in the summer of 2012, 3D systems, (DDD US) the biggest ‘play’ on this theme/meme had seen rapid share price expansion over the previous 2 years, from a little over $3 a share to almost $30. Over the next 18 months it tripled again in price, before dropping almost as sharply as it had risen and by 2015 it was back down to $8 as the meme expired and the momentum/index weighting effect that had driven it up, now went into reverse. Importantly, none of this was really a judgement on the technology, which was always going to disappoint the expectations of those with the shorter term trading mindset and as Gartner pointed out was going to head into the trough of disillusionment. Interestingly it is now up at $44 as the technology starts to come through. Also, note that many of the technologies on the curve are still ‘ emerging’, meaning that much of the investment edge here is not in being first to discover a new technology, but in riding its waves of popularity among different types of investor.

One thing not on the list in 2020, although it was deemd to be close to peaking in 2017, was blockchain. Interesting to see therefore that just as DDD has recovered sharply from the trough of disillusion, so to has blockchain – well certainly the bitcoin part, as Bitcoin passed the 50,000 barrier this week, and a further cohort of retail ‘investors’ has jumped in, excited at the prospect of ‘doubling their money with no effort’ with predictions that 100,000 is next stop. The meme is back.

The chart, courtesy of Kinetic trading, shows the price of Bitcoin in grey and the number of new participants in Orange, showing similarities to the 2017 run up, when every Christmas drinks party (remember those?) was full of people telling you how much they had made – and were going to make – in Bitcoin.

Chart 1: Retail piling back into Bitcoin

Source Kinetic trading, glassnode

Kinetic notes that Bitcoin uber-bear and Gold bug Peter Shiff has conceded that Bitcoin could go to 100,000 – but he also adds that it could go to zero. Indeed he believes that that this is ‘inevitable’. Naturally he also believes you should buy Gold instead and this is one of the interesting aspects of Bitcoin at the moment, it is being taken up by many of the retail investors who used to buy into the Gold narrative every time it began running, the second or third wave who came in late and allowed the professionals to get out. In particular it appeals to those who are anti fiat currency and concerned about money printing and inflation, but unlike Gold, there is also now a cohort who believe Bitcoin will actually replace cash. They are a relatively large group who believe in what the old school gold bugs did when they advocated a return to a Gold Standard. In effect, Gold has lost the ‘ catastrophist’ crowd to Bitcoin.

Bitcoin has usurped Gold as the currency of choice for catastrophists

They will also have been encouraged last week by the fact that Tesla has apparently bought into Bitcoin as a concept, which in turn has also dragged in the Tesla fanboys from the day trading markets who found themselves enriched by Elon Musk last year and have subsequently accorded him a semi divine status. Interesting also that the attempt to roll the squeeze the short sellers in Gamestop into a much more ambitious attempt to corner the Silver market appears to have failed. It’s one thing to take on short sellers in a small stock, quite different to take on the financial establishment in the commodities markets. The Hunt brothers failed in their attempt to control the Silver market back in 1980 and little has changed since then.

Also, as we ourselves noted back in December, Bitcoin is starting to fill the hedging/diversification role previously occupied by Gold and the existence of quasi ETFs such as GBTC as a way of playing this for investors not wanting to get involved in bitcoin wallets etc. As a result it seems to us that Bitcoin will start behaving like Gold periodically has done, a long term theme that periodically becomes a short term meme; very fashionable for a brief period during which the narrative becomes ever more powerful, before falling out of fashion just as quickly.

Bitcoin is currently a ‘meme’ more than a theme. It has picked up the momentum from the Gamestop traders (incidentally currently down 86% from its peak) as an anti-establishment trade and will continue to benefit from this right up until the moment it doesn’t. This is why experienced traders of memes run relatively tight stop limits on their positions on the old adage that ‘they climb the stair and then drop down the elevator shaft’. Unlike Gamestop and the short selling meme, there is currently less leverage employed in Bitcoin beyond the natural leverage from its original creators, but derivative structures are coming. They may well be what pushes it higher – or blows it up completely.

Buying Bitcoin on the basis of the so called fundamentals, in particular a belief that it now represents a new form of money, is similar to the long term fundamentals behind other trading strategies – they don’t work and even if they did they aren’t what is really driving the price at any given moment. Sharp moves are based on sentiment more than fundamentals and as such it’s worth keeping an eye on measures of sentiment.

Chart 2: Sentiment on Bitcoin

Source Redburn, BofA

Chart 2 (courtesy of our friends at Redburn) shows the acceleration in social media conversations about Stocks, Gold and Bitcoin – a useful indicator perhaps of ‘memes’.

Sharp price moves mean more people have bought into the narrative, not that the probability has risen of the narrative being true..

The risk is that the markets confuse the strong price performance of the meme with the probability of the narrative surrounding it being ‘true’, when in fact all it reveals is the increased number of people now buying into it. Which is very much not the same thing. With Bitcoin, the idea that it will replace money as a means of exchange is similar to the Gold Bugs wanting a return to the Gold standard. It won’t and it can’t happen, as it simply can’t work quickly enough or at the scale required. More interesting is that Bitcoin is the currency of the Blockchain and the real value of the blockchain is as a disruptor of existing contracts. Trust is essential in any trading system (ask anyone trying to secure contracts for PPE at the moment!) and the blockchain gets around a lot of these issues.

Commodities – the Oil Irony trade

One of the narratives around Bitcoin is $ debasement – as it always was for gold – and no doubt the weaker $ in q1 so far has encouraged some of the latest buying, as have the more general concerns about inflation being pushed by higher commodity prices. Most obviously, Oil continues to run up on what some are calling “the irony trade” as Texas is plunged into blackouts caused at least in part by the failure of all the expensive alternative energy system – snow on solar panels, windfarms not working etc as well as a failure of the more conventional systems – again in part because all the recent capital expenditure has been on the fashionable theme/meme’ of sustainability. . As well as creating a spike in demand, the Texas weather has also taken out a huge amount of supply by taking out a large part of oil production at the very time when demand for oil and gas is soaring. Thus (the irony is that) in order to prevent global warming we invest in things that only work if we actually get warming – as opposed to cooling.

Medium Term Risks focusing on inflation, the $ and long bonds

In turn, the theme/meme emerging out of this commodity spike is, of course, inflation and perhaps no surprise then that some of the asset allocators wondering what to do at the March options expiry next month (when the real themes for the year ahead are enacted on), have started to sell the US$ and Long Bonds. We noted at the start of the year that the first quarter was a time when all the asset allocators try and actually work out what they will do for the year ahead and it looks like the appearance of a cyclical rise in commodities is helping drive an emerging consensus for a weaker dollar, higher bond yields and a shift towards emerging markets.

These can become self fulfilling of course and this week the US long bond yields pushed through 2% and such is the nature of bond markets trading off spreads against one another that other bonds moved in step. As always with bonds, there looks to be evidence of some automated selling as bond yields broke various resistance levels and assorted structured products had to be unwound. History tells us that when all the leverage in fixed income starts to unwind they tend to take other markets with them in a dash for liquidity. It might be too early to say much on actual inflation at the moment, but we would suggest that Bonds have become one of the bigger medium term risks in markets right now.

Share this article