It's been over two months since my last update. Before I get to financial market thoughts I wanted to share a philosophy which I came across fortuitously: the ancient Anglo/Norse concept of Fate. A simple explanation of this belief is contained in a metaphor which starts with leaves falling from the Tree of Life. Some leaves fall onto the ground and are lost, some fall into the Well of Wyrd where they mix with the waters which are then used to water the Tree of Life.
The Tree of Life represents everything while its leaves represent actions of individuals. Some of these actions are significant enough to return to the Tree and change it in an endless recursive cycle. The accumulation of layers of past deeds is called Orlog (meaning primal layers) which forms an individual's character. An individual is shaped by their past and yet at the same time have the power to evolve their Orlog and thereby their destiny through present actions. This idea of Fate is one that is both dynamic and probabilistic in nature with every individual contributing to the fabric of the universe.
This idea resonates deeply with me and I've chosen to name my upcoming hedge fund: Orlog Capital. Once the fund starts mid this year, I will stop blogging here and instead put out quarterly letters which can be found at orlogcapital.com. This blog and those letters will serve as the written record of both mine and the fund's Orlog, useful for future reflection.
The global markets have been on a roller coaster ride over the past two months. To me, there were four major 'representative' events during this time:
Spike in the US long yields
Blow up of Archegos Capital
Continuing exponential growth in crypto assets
Continuing US geopolitical maneuvering against China
I see these events as 1st degree reflections of the primary risks namely: inflation, liquidity, leverage and the struggle for global hegemony. The covid-19 situation and global stimulus programs continue to play leading roles in catalysing and amplifying these risks but interestingly, the markets have been relatively numb to significant news events here - current global infection spikes hasn't impacted the market rebound nor did the previous Biden stimulus announcements + Fed's dovish promises affect the yield spikes and market meltdown in late Feb.
There's little to say on inflation other than tight supply conditions in many key sectors and on-going de-globalisation efforts makes the structural uptrend a high certainty event. Central banks will eventually be forced to act and liquidity will pull back. The market understands this but the music is playing so it keeps dancing (gyrating?). Archegos was the event that caught me most by surprise - I hadn't expected this level of crazy risk taking and leverage blowup by a major institutional player. Previously I thought it was only WallStreetBets (WSB) and perhaps a few small/mid sized funds playing these 'all-in' bets. Archegos showed that there were whales alongside minnows swimming in today's market casino with likely many more still lurking in the depths. It seems ironic that such a vast fortune, a lifetime in the making and survivor of multiple market crashes, should collapse in less than a week in the midst of one of the greatest bull markets ever. The fallout has presented an investment opportunity (discussed later) though its greater value is a reminder that there are so many things in today's market which cannot be predicted - the bus you don't see and the crash you don't expect.
Five or even two years ago, who could have foreseen the world today? Ark/Cathy Woods, Archegos, WSB, NFTs, bitcoin/dogecoin have become emblematic of today just as Andy Warhol and his soup cans were of the pop art movement. Will that madness (all art is subjective!) be transient or longer lasting? Time will tell but I'm less optimistic on madness built on false logic/promises than I am on modern art. The latter will get you laid, the former may bankrupt you or even put you in jail. Maybe Ark/Cathy Woods is the survivor from all these. I wouldn't be the first to be wrong doubting her 'disruptive innovation' investment strategy. For me, I just find it incredibly difficult to believe anyone can predict competition even if the big picture seems obvious. I'm enough of skeptic that I started my short list based off her portfolio and themes.
The record low interest rates and easy liquidity conditions have inflated many asset bubbles. I'm sure most people will agree with this broad statement but I think you'll struggle to find anyone who thinks their investments are a bubble. The year long positive feedback loop between prices and expectations has obfuscated the real (macro) reason for asset performance and replaced it with sexier but false narratives such as: disruptive innovation, great financial reset, green revolution, fuck Melvin, etc. A perfect demonstration of Soros' reflexivity. I wish I was more of a trader and less of an investor to have taken advantage of this realisation back in 2020. Where Soros jumps into bubbles I'm more comfortable reducing risk and waiting them out to bet on the eventual over-correction. March/April 2020 was my type of market and I hope to have the systems in place to be quicker and more aggressive in my participation next time round. As it stands nothing about today's market seems sustainable and growing more extreme day by day. It seems inevitable to me that the real economy will recover, inflation will spike, liquidity will shrink and fear will return again to rebalance greed in markets. When it happens I don't know (maybe it's happening now?) but regardless, the risk/reward payoff for the wider market is so negatively skewed that a single flutter of butterfly wings could set off the next tsunami. Or maybe instead of wings it's bombs and guns which violently ushers in the next chapter in world history?
These are the major changes I've made over the past two months:
Portfolio allocation
Increased equity invested by 5% to 65%
Started a 5% short position in late February which increased to 10% by late March
Equities (%s based on equity invested, not the portfolio)
Sold ~20% of JD in Feb then started buying back shares in late March as JD's share price fell >25%. At today's HK$300/share, JDMall is on teens forward PE based on my estimates of sustainable/normal earnings. It remains my largest equity position at ~20%
Significantly increased my holdings in CNOOC, COSL and CVR Energy as their prices fell back. I believe based on replacement value and/or FCFE multiples, these names offer a minimum 60% upside from current levels
Established a 4% position in iQiyi post fallout from Archegos. My average price is low $16 and I'm continuing to add at $15 and below. I didn't like iQiyi's 2020 performance but the no2 long video streaming platform in China is now being valued at <US$12bn MCap (lowest since its listing) which offers immense value. iQiyi is in a far better place today with video streaming market share stable and the leaders Tencent Video and iQiyi showing rational competition in raising membership prices (currently only RMB16/month). Government policy on competition, IP protection and censorship is favorable. The structural trend towards online and on demand video is recognised but the market is only attributing value to short video platforms at this moment. I actually believe long video platforms are the ones with the big competitive moats and in the future benefit from utility like cashflows. Without cable/media giants competition and with homogeneous content (Chinese), I believe these platforms could eventually achieve higher profitability than their western peers. The key risk to iQiyi is the cash burn but I think their liquidity and access to equity & debt markets is sufficient to sustain them for at least the next two years. Currently iQiyi transaction volumes remain elevated suggesting Archegos counterparties still hold stock but once that selling pressure eases there should be at least a short term rebound to $20-23/ADS (30-50% upside). A 5-6% equity position (3.3-3.9% of portfolio) trimming down to 3-4% on the rebound seems like a reasonable bet structure plan
Short position: these names have been major price beneficiaries over the past year so they are now my interest rate/liquidity hedges. They were shorted into downtrends/chart weaknesses and have staggered stop/loss limits reflecting caution on possible resurgence in animal spirits
EVs: Tesla, Chinese EV players (competition is accelerating!)
Hype: Virgin Galactic, Plug Power
Other: DoorDash, Zoom, Farfetch, Airbnb
Special situations (% of portfolio)
Pershing Square Tontine SPAC: 2% long position with offsetting 18/6/21 short calls at strikes prices of 25, 30, 35. The average entry price, if the calls expire out of the money, is reduced to ~$21.5/share, a low premium to pay for Mr Ackman's skills
VAL bonds/re-capitalisation: ~2.3% after successfully underwriting and taking up my full allocation in their rights issue. Company should emerge from Chapter 11 in 2Q2021
Last words of advice: buy inflation protection today!
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