The Compound and Friends
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.
00:38:40 · Michael Batnick, Alex Altmann, Josh Brown
[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. [00:38:56] S1: Correct. And and by the way, a lot of those people are actually just computers. Right? So you got obviously very sophisticated quant funds that are running sort of real time stat ARP strategies that are looking for the one day or even intraday, you know, price differential. They can play mean reversion. So there's those playing the super short term stuff. You've got the discretionary alpha guys, which are looking for time horizons I'm which is called... Let's call it three to six week, and that's generally on single stock pairs as well for mean reversion around earnings. That's why on earnings day, the majority of of a single stock flow is coming from discretionary. And then on non earnings day, vast majority is coming from quant and retail. [00:39:29] S0: In the media, people are looking at the preponderance of all of this data, and they're coming up with the story that explains it to non market participants who don't appreciate the degree to which this is computers trading with computers. [00:39:43] S1: Yep.