Monetary policy is pushing Americans onto a higher and higher risk curve

Looking back at the financial markets in the past few weeks, especially the stock market, there are many problems. First, there was an epic large-scale air-squeeze battle at the GME. The battlefield of this battle quickly spread to the car rental company Hertz, the oil driller Whiting Petroleum, and the chain department store Jesse Penny. A large number of companies shorted by Wall Street. But soon, the popularity of retail group fights on Wall Street was not maintained for a few days, and it was kicked out by Dogecoin in the cryptocurrency market. The price of this coin rocketed from $0.007 to over $0.08, an increase of about 820%. The skyrocketing price also helped its market value exceed $6 billion at one time. But Dogecoin has not been able to be beautiful alone for too long. As its price fell back to between 2 and 4 cents, investors turned their attention to another altcoin-Ripple, which has never been US$0.30 rose to US$0.75, but still did not hold, and finally fell back to US$0.43.

Although many people are trying to figure out why such stories happened one after another, the explanations that have been reposted more often do not tell you all. Think about it, why a simple stock market transaction can be amplified into a class struggle with rhythm. Since it has risen to the level of class, it is foreseeable that the call for “reform” will be heard immediately. The rhythm of this wave is still grandiosely alluding that the little leeks can also “turn against the wind” and fight against the “big men.” It’s all brought up like this, and politicians naturally have to stand in line and make their position clear.

However, in the dramatic and topical stock market movement last week, there is one more important point, that is: Although WallStreetBets tried to do blank silver ETF-iShares (SLV) efforts failed, this movement seems to be Continue, it’s just that the target of the sniper is no longer the big shorts who are forming gangs. Have you ever wondered how a group like WSB grew up? They were obviously built around taking huge risks, so how come they now speak like grassroots heroes?

The problem with the game station

It must be said that the risks of both sides of the game station battle are ridiculously high.

From the perspective of short-selling, we should consider that since the average share price of Game Station in the past two years is between $10 and $11, the maximum value of the company’s potential earnings should be slightly lower than this range, so it should be It is about 9 dollars to 10 dollars. The size of short positions usually depends to a large extent on the average daily trading volume of shorted stocks. When the squeeze begins, you can roughly estimate how difficult it is to exit the position.

So, what is the average daily transaction volume of the game station? The data in the past two years is between 4 million and 7 million shares. Regardless of other factors, a short position is at most a few million shares smaller, 100, 200 or 300 top days. However, the total size of the short position of the game station Probably more than 60 million shares: Not only is it nearly 10 times the highest value of its daily average trading volume, but it is also 30% higher than the actual publicly available stocks.

To put it mildly, this is an untimely bomb waiting to be ignited.

In many aspects, online retail brokers, including Robinhood, generally require a margin account to open an account of $2,000. In addition to the funding requirements, before customers open an account, they must also evaluate the qualifications of the account owner following the KYC rules of the regulatory authority. Therefore, these brokers are responsible for determining whether an account is suitable for active trading.

In this game station incident, this is a crucial consideration for two reasons: First, although the media racked their brains to portray the long-air war as the 21st century “David vs. Goliath”, no matter what It is the customers themselves, or the evaluation results of the platform show that there is a certain degree of complexity before their accounts are opened and recharged.

Second, the conspiracy theory believes that Robin Man restricts the stock trading of many companies such as Game Station, AMC, BlackBerry, and Nokia because it is said that in some cases, liquidating long positions can protect Wall Street shorts. What a joke, it strongly indicates that the people who said these words do not understand the sample standards in margin trading and brokerage account documents at all.

To sum up, on the one hand, a handful of hedge funds hold a large number of short positions in a small stock that is lightly traded, and the upside of this stock is less than $10. Once the stock trend does not match their bet The same, then, it will take several days and millions of dollars for these hedge funds to retreat from the rising market.

On the other hand, online retail investors are accustomed to jumping from this stock to that stock, looking forward to short-term profit opportunities by taking advantage of insufficient liquidity or other neglected issues: but in margin trading, they face the risks Little is known. Or, to make matters worse, nothing is known about what brokerage companies, clearing companies, or market makers can take to mitigate their own risks.

Of course, these two groups-hedge funds and third-rate retail investors-both have the right to explore profit opportunities under limited conditions: for the former, it is a parameter set by its operating agreement, investors and contributors; and For the latter, it is the risk parameter set by the broker and its execution partners. This is beyond the scope of Game Station, AMC, Dogecoin, SLV and other recent hot products.

Risk tolerance over time

In fact, risk tolerance is improving overall. Although there is no shortage of exceptions, from the perspective of trends in some of the riskiest markets in history, the evidence that can prove this is still visible to the naked eye. The stock market used to be a relatively neutral choice of risk and return, but now the stock market has changed from a supplementary choice of bank accounts or U.S. Treasury bonds to a choice.

What can still be seen in history is that many investment projects are relatively risky in the asset category, but in recent years, the holders of these projects have not only increased, but their popularity has also increased. However, these items do not include options and futures (because they are not really “investments”), and other more exotic financial products (such as DPP), so what do they include?

1. Micro stocks

Investors are obviously more interested in the riskiest sectors in the stock market, just look at the Russell Microcap Index. The index tracks companies ranked from 2001 to 4000 by market capitalization. It is one of the best measurement tools for small business stock prices. It is also an index that tracks large and small stocks that are widely followed in the US market. In the five-year period from January 1, 2015, to March 16, 2020, when the stock market crashed, the two major micro-stock indexes (the other is OTCQB) compared to the three major stock indexes-S&P 500 and Dow The total return of the Nasdaq is shown in the figure below. Please pay attention to compare the total return with the annual equivalent rate:

Subsequently, since the stock market crash in March 2020, the relative returns of the two have changed significantly. Please pay attention to the total return and annual equivalent rate in the figure below:

However, in the five years since the Fed began slowly increasing its interest rate target, large-cap stocks have performed quite well, while micro-cap stocks have fallen sharply. But since the Fed started to lower interest rates in the early days of the COVID-19 pandemic, the smallest and most speculative sectors in the stock market have returned twice as high as large listed companies.

Let’s look at the picture again: after the extreme expansion of monetary policy in March 2020, the price of micro stocks immediately soared.

2. Leveraged, Inverse and Themed ETFs

In 2006, the number of ETFs (Exchange Traded Funds) was less than 400, but it has now increased to nearly 7,000. Many of them are only suitable for long-term investment due to insufficient liquidity. However, the increasing risk appetite of investors and traders happens to be met by adding several types of ETFs with particularly high risks: leveraged ETFs (providing multiple returns within a set time period through the use of derivatives), reverse ETFs (the rate of return is opposite to a given industry or market) and thematic ETFs (associate the assets in the fund with specific investment ideas or trends).

It is worth noting that although thematic ETFs are very bright in January 2021, because one-third of the funds of U.S. equity ETFs have flowed to them, in the past 20 years, after risk adjustment, such ETFs have The loss is actually as high as 5%. Despite this, they still have $142 billion in assets. Also, a large number of assets have recently flowed into environmental, social and corporate governance (ESG) funds.

3. IPO and SPAC boom

Many financial analysts compare the recent surge in initial public offerings (IPOs) with the boom in 1999. The popularity of IPOs that year was almost the same as it is now. This directly shows that investors want to seize new stocks with the greatest growth potential in the short term. , Make a lot of money. The few companies listed traditionally (through the syndicated and underwriting departments of investment banks) exploded as soon as they were issued, making people seem to have seen the peak of the Internet era. For example, the share price of Airbnb was 112% higher than the issue price on the first day of listing; even if analysts slammed the door to the largest food delivery platform in the United States, DoorDash still closed up 86% on the first day; Pop Mart (Pop Mart International) also rose 79% on the first day.

Renaissance Capital, a research institution focusing on newly issued stock ETFs and IPOs, launched a basket of IPO indexes Renaissance IPO Index in 2010. How high speculative enthusiasm is can be seen through this index, especially after the stock market crash in March 2020 and the Federal Reserve After series liquidity injection:

The data shows that the number of IPOs in 2020 exceeds 400. In comparison: 2019-195, 2018-214, 2017-176. The reason why there is such a large gap is out of risk appetite. Regardless of the relationship, or so to speak, there is a two-way causal relationship between the two. Driven by rising asset prices and investors the following suit, the market as a whole continues to rise, and companies have followed the trend to conduct IPOs to reap the benefits of rising valuations.

Once a company has issued an IPO, investors will come to look for their appreciation potential. However, the fact that the stock price soared immediately after excluding the development industry is not mentioned. This obviously shows that investors have no other purpose, but to run for the super high returns that are usually brought by new stock issuance. For the company issuing stocks, this is the point. In fact, it also represents a huge failure. As for the unexplained IPO stock price soaring on the day of its issuance, it shows that the pricing of the IPO is severely undervalued and can earn millions of dollars on the face.

Related to IPO is the boom of special purpose acquisition companies (SPAC). SPAC is a way of overseas backdoor listing, integrating the characteristics and purposes of financial products such as direct listing, overseas mergers and acquisitions, reverse mergers, and private placements. SPAC used to be a very ambiguous financing method, but now it has also seen explosive growth. In 2019, SPAC financing was only about 19 billion U.S. dollars, but it soared to more than 76 billion U.S. dollars in 2020, and in the first few weeks of 2021, the funds raised have exceeded 15 billion U.S. dollars.

Although many reasons can be found to explain why a company will avoid the standard IPO process through investment, or why investors may directly participate in a company, the SPAC craze essentially represents a new degree of risk-seeking. Companies that use SPACs to finance listings are actually so-called “blank check companies.” Whether they are small retail investors or large institutions, they can participate in transactions that replicate the function of private equity.

Of course, some companies are managed by financial institutions and also run by professional business managers. But the rapid rise of SPAC is reminiscent of the “blind pool” of other hyper-speculative eras. Blind pool refers to the fact that the underlying assets have not yet been determined when private equity investment funds raise funds. Because fund investors have blind spots in the underlying assets that the fund will invest in in the future, fund managers are given special discretion in these investments. In any case, the rising popularity of SPAC means that more and more funds are invested in the financial market to find ideas.

There is no doubt that there will be winners in every field, and many companies will survive on SPACs, which are characterized by the real emergence of commercial innovation and a larger investor base over time. But there will certainly be many failures. There is also an index called IPOX SPAC that tells you how optimistic the future trend is. IPOX… But unlike the several old qualification indexes mentioned earlier, this index has only been launched 6 months ago. That’s right, it was only born in August 2020, and the information that can be found is pitiful.

The Federal Open Market Committee (FOMC) should not be surprised by this rapidly growing risk craving. A year ago, CNBC reported on the minutes of the department’s December 11, 2020 meeting, which included their set interest rate target between 1.50% and 1.75%:

Some participants worried that keeping interest rates low for a long period of time might encourage excessive risk-taking, which could exacerbate imbalances in the financial sector… (low-interest rates) might make the next recession worse than (possibly).

But unfortunately, even if it was predicted early, only 4 of the 17 voting members supported an interest rate hike in 2020. And we now know that interest rates will return to the zero interest rate policy (ZIRP) level within 3 months, and short-term attempts to restore interest rates to historical conventional levels, assessment of risks and returns, and countless other financial considerations have all been Hit back to the origin:

If you talk about this, you still don’t quite understand this amazing growth rate in pursuit of high returns; then you can look at the traditional investment channels that have been favoured by risk-averse savers and investors for decades. What is the recent trend? You won’t find it strange after reading it. Almost all investment methods that have been proven to be reliable in history have experienced a huge collapse in the rate of return because successive monetary easing plans have forced investors to inevitably choose higher-risk financial instruments. The following is the recent performance of several traditional investment tools.

1. Deposit certificate

Certificate of Deposit (Certificate of Deposit), abbreviated as CD in English, is a type of time deposit, usually a financial product issued by banks and depository institutions. The deposit certificate is also protected and almost risk-free with the general demand deposit. The difference is that the deposit certificate has a specific deposit period and fixed interest, and the principal and interest receivable can be retrieved when it expires. As a highly transferable bond, the certificate of deposit has strong liquidity in the secondary market. If held in a discrete period, its interest rate will be much higher than that of savings and checking accounts. The chart below shows the rate of return for the six-term deposit certificate since 1990.

2. 10-year U.S. Treasury bonds

For most of the 20th century, U.S. Treasury bonds were the standard for risk-free tools—in fact, the financial model of U.S. Treasury bonds presupposes risk-free tools. Also, it has many advantages such as liquidity, principal and interest are guaranteed, and income is stepwise (meaning that it is composed according to maturity and payment dates), so it can become a standard investment portfolio: income Reliable + moderate returns + low volatility. But wave after wave of dovish monetary policy has pushed U.S. Treasury yields to unimaginable lows. The following is the trend in the yield of 10-year US Treasury bonds in the last 30 years.

Generally speaking, the 10-year U.S. Treasury bond yield has always been higher than the S&P 500 dividend yield. For details, you can see the sharp contrast of red and green in the lower half of the figure below: Red represents that the yield of Treasury bonds is higher than that of S&P. At the time of 500 profit, green means that the former is lower than the latter. See, how big are red and how small are green. The case where the standard 500 yield exceeds the 10-year U.S. Treasury bond yield generally occurs during a financial crisis (such as 2008) or a period of policy change. But the frequency of this situation is very low, and even if it happens, the spread between the two is not big, usually 1.00% or less.

However, since March 2020, the spread has turned to historically abnormal levels. If you take this time out, you can only see the green:

As of July 2020, the dividend yield of all stock indexes (approximately 1.80%) is almost three times the yield on the 10-year U.S. Treasury bond (at the time 0.66%), and also higher than the yield on the 30-year U.S. Treasury bond (at the time of 1.40%) ) Is nearly half a point higher. Such a large spread clearly shows that the simplest funds in history are also experiencing high open and low moves.

At the same time, comparing the trends of these two charts, it is obvious that those investors who were once able to transition from high-risk investment (stocks) to principal-protected, income-oriented low-risk investment (government bonds) now face an A terrible financial choice: Either take more risks, “giving a go, bicycles become motorcycles; gambles, motorcycles become Land Rover”; or continue to choose lower or negligible risks, but you have to look at the currency Expansion consumes all the rewards.

3. Municipal bonds

Highly-rated municipal bonds have long been favoured by investors, first because their yields are usually hundreds of basis points or higher than U.S. Treasury bonds with comparable maturities, and second because they are tax-free. But in the past few decades, their yields have also plummeted. The following is the Bond Buyer 20-Bond General Obligation Index since 1990, which tracks the average weekly yield of 2-year municipal bonds rated at AA and above.

It can be said that these bonds are among the safest municipal bonds, and many typical safe-haven investors regard them as safe-havens. However, the frequent implementation of expansionary monetary policies has also pushed the yields of these bonds to zero.

in conclusion

The recent dramatic events in the financial market, whether it is a game station, Dogecoin, or other objects touted by WallStreetBets, have not only attracted the attention of the public but also aroused everyone’s doubts. A story was quickly made up in which the giants of Wall Street were defeated by the heroic leeks and their small but aggressive slingshots. It sounds very inspirational, unity is strength, and a group can keep warm, but what can actually be more telling in recent weeks? This shows that Americans’ tolerance for financial risks is rising. Faced with the huge returns that may arise, it may be an unbelievably high percentage. The shorts and the longs ignored them and made a bet.

Despite this fact, it is not as eye-catching as “David vs. Goliath”, but it is better than “retail traders just want to make quick money easily” or “a few hedge funds are too arrogant and make a risky bet.” “There is much more depth. In many cases, what is usually regarded as greedy may be better described as despair? Investing in the stock market used to be an alternative to depositing money in banks or investing in lower-risk US Treasury bonds, but now investors are obviously more willing to invest their money in more unstable areas. Risk appetite has generally been artificially pushed up. As far as current investment preferences are concerned, what WallStreetBets has done can no longer be called an anomaly, but a disease.

What the Fed has done in the past 25 years has far exceeded its original intention when it was founded. Will everyone be curious about the consequences of this? Especially when two facts are in front of us: First, the intervention threshold of the Global Mint is getting lower and lower; second, fiscal and monetary policies always have ways to suddenly discover restrictions when ordinary people pay taxes. If you think that because people’s attitudes towards risk are increasing, the Fed will take action to rescue retail investors from failed ETFs, plummeting SPAC prices, and micro-stock delistings, or to save them from the fact that they know very well. Still unwilling to pull out of the swamp that goes up the risk curve, tell you, don’t even think about it. Any lasting solution is more likely to come from the market itself.

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