The Compound and Friends
00:32:33 · Josh Brown, Alex Altmann, Michael Batnick
[00:32:33] S0: In the great in the great financial crisis, ten years before, there was one Bloomberg terminal at the Fed in Washington. Yeah. There's one person in there looking at the markets. You wanna bet there's a thousand now? [00:32:46] S1: Oh, no. But I I know that the... Both the treasury department have Bloomberg terminals because they ping they ping me. Yeah. And then so so does the New York Fed [00:32:54] S0: as well. Hedge fund manager running it. So I'm just saying, like, everything is the stock market. [00:32:58] S1: Yeah. Can I [00:32:59] S2: show you the stock market chart? I wanna get your thoughts on this. So this has been an interesting year for a million different reasons. And even though there is the relentless bid, AI has caused a lot of on off days. Same with software, same with energy. There are a lot of days where the stock market does X and the average stock goes the other way. So there's this weird negative beta effect. SocGen has a great chart, chart 15 Daniel, that shows they say there are 124,750 possible pairs of companies within the S and P. And at present, 40% are negatively correlated. So they show the average stock correlation within the S and P 500, and they compare that today. So the the red line is the average, and the black line is today. Mhmm. 40 of days, we've seen stocks going different directions in the overall index. It is a very funky time within the stock market. [00:33:56] S0: Yeah. It's a lot less... Like, 2017, every stock went up together. There was no volatility. Zero.
00:33:56 · Josh Brown, Michael Batnick, Alex Altmann
[00:33:56] S0: Yeah. It's a lot less... Like, 2017, every stock went up together. There was no volatility. Zero. [00:34:03] S2: Matter of fact, today's a perfect example. So the last couple of weeks, we've talking about the same thing. Breath sucks. Breath sucks. Breath sucks. And we've been saying, alright. But that's a feature of a bull market. You want the biggest stocks doing the heavy lifting. Usually, when breadth is leading, not usually, the average stock does better in a bear market. Just think about two thousand is a perfect example of this right after the dot com bubble bust. So today, you have the equal weight up 98 basis points. The S and P is down 53. Mhmm. And it seems to be that this is happening more with more and more and more frequency. [00:34:33] S0: Mhmm. [00:34:33] S2: So there's a bad, max seven report, Google today, for example, and the rest of the market catches a bit. [00:34:38] S1: Yep. And you're you're asking [00:34:41] S2: Just just... We're just talking. [00:34:43] S1: We're just talking. Okay. So I can actually give you... There's a there's a pretty good answer for why this is happening. [00:34:49] S2: Oh, yeah. I think it's a mystery. [00:34:50] S1: Oh, I I... I'm curious. [00:34:51] S0: I don't know the answer. What's what's the what's the reason?
00:34:51 · Josh Brown, Michael Batnick, Alex Altmann
[00:34:51] S0: I don't know the answer. What's what's the what's the reason? [00:34:54] S2: Well, I think earlier in the year, it was energy. It was a lot of energy stocks going up when the market went down, and that was this weird negative beta effect. Yeah. And then it was interest rates. Right? Interest rates went up. Consumer staples got killed. REITs got killed. Utilities got killed. Mag Seven was, especially Apple, completely undeterred and Apple's biggest stock in the world. And then it was the software AI days. On, off, on, on, off. I think it's been it's been those three things. What else am I missing? [00:35:19] S1: So there... There's there's like a unified narrative that that basically puts all those together, and it goes back to our friends at, at RV Strategies relative value. Right? So if you think about, multi manager AUM in 2018, 2019 before COVID was around about $300,000,000,000, and today, it's, like, 1,000,000,000,000. [00:35:41] S0: Yeah. [00:35:42] S1: Yeah. Right? So it's basically tripled since COVID. And [00:35:45] S2: So who are talking about? Like, Citadel and and Millennium and those type of companies?
00:35:45 · Michael Batnick, Alex Altmann, Josh Brown
[00:35:45] S2: So who are talking about? Like, Citadel and and Millennium and those type of companies? [00:35:48] S1: Well, name names. Right. But but, you know, multi managers, pods, you know, the... Basically, guys where effectively their job is to isolate idiosyncratic alpha as opposed to be taking large directional bets. Right? So they'll encourage their managers to run high gross, low net exposure. And it makes sense. Right? Why why has there been explosion at AUM since COVID? Well, because... Well, really since 2022 when interest rates went up. And it's because in a high interest rate environment, RV strategies are absolute no brainers. Right? Because I deploy a load of gross on my long side, load of gross on my short side. I actually haven't redeployed a dollar unit, so to speak. I've got plenty of risk, but I take my actual capital haircut for collateral for my PB requirements. And then [00:36:28] S0: you're earning a spread, you're earning an interest rate on the rest. [00:36:30] S1: Correct. Yeah. Right? So whatever your collateral commitments are, let's say, 15% aside or whatever, but you're taking the 70% and you're earning that you're earning that 5%. You probably even get more than that in relatively safe. [00:36:41] S0: That's the low net part. You're offsetting with your longs and and your shorts, and then you're collecting an interest rate on whatever you don't have to allocate.
00:36:41 · Josh Brown, Alex Altmann, Michael Batnick
[00:36:41] S0: That's the low net part. You're offsetting with your longs and and your shorts, and then you're collecting an interest rate on whatever you don't have to allocate. [00:36:48] S1: Correct. And and because these businesses are run so... They're run so efficiently, that's why you're given very strict mandates on what your net exposures can be. Right? Because they... It's not you breaching some horrible limit. It's actually just because as a... As an organization, they want to sort of manage effectively the the... There's a treasury function, essentially. Yeah. And it's a very good business model. It's... You know, for for... And all you're doing is you're trying to isolate that idiosyncratic alpha. Now here's the catch. If everyone's doing it, right, it's not just a handful of funds. Right. Everyone's doing it. Everyone has access to the same risk parameter metrics, so they're neutralizing their value and their quality and their size and their growth and all the rest of it. They're also obviously neutralizing their sector exposures, and they're neutralizing their market exposure. But the number of stocks you can trade has shrunk. We talked about this deequatization already. Right? So [00:37:39] S0: They have, like, 3,000 stocks, basically. [00:37:41] S1: Right. And that number has gone down over time, not up. Yeah. Right? It's been started [00:37:45] S0: in the business with, like, 10,000. [00:37:46] S1: And it's net negative issuance [00:37:47] S2: Yeah.
00:37:47 · Michael Batnick, Alex Altmann, Josh Brown
[00:37:47] S2: Yeah. [00:37:48] S1: In the sense that we're having few... We've had fewer IPOs and more buybacks. So by definition, there's less available stock to trade. Right? So with those combination of factors plus the ballooning of AUM plus leverage from PBs on top, you end up with this crowding out effect. And everyone will say, oh, okay. Hang on a second. It doesn't matter because I've neutralized everything. No. All you've done is push the crowding into other aspects of your portfolio that you are either aware of or unaware of. Right? And this really matters because when you've ballooned the size of the number of strategies, so to speak, you're creating more of these vicious... The propensity for these vicious unwinds. [00:38:24] S0: So every... Everyone unwinds one aspect of a portfolio at once. It hits the stocks three times harder than it otherwise would have. [00:38:31] S1: Correct. Which is why you're seeing very little index vol and an absolute ton of factor vol, single vol, negative correlation. Yeah. [00:38:40] S2: And you see what the stocks that are like... Obviously, Spotify and Netflix are related ish, but for a year, it was the exact same chart, like, identical. And there's a million different stocks like that that trade... That just trade... They're just in the same basket of stocks that people are buying and selling.