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Weekly newsletter |2 April 2021| When hedge funds implode

Aarinder Lidder - Apr 02, 2021

When hedge funds implode 


Hello and welcome to our weekly newsletter, where I talk about what’s been going on investment markets and what to look out for in the days and weeks ahead. What's been going on this week in equity market is something that's probably going to be talked about for years to come. By the end of last week, it looked potentially like technology stocks, which had been battered to be honest, as part of the reflation trade, might be catching a bid.

We might finally get a bit of stability from which they could potentially rebound from. With technology stocks it doesn't rain, but it pours. Tech stocks took a turn for the worse. The first inkling we got was an aggressive sell off in Chinese technology stocks. We then saw a similar pattern in US technology stocks at the back end of last week. The giveaway that something was going on, was the aggressiveness of the selling but also the batch nature of it. There were billion dollars’ worth of shares in particular companies that were being dumped upon the market.

Speculation abounded about what was going on - has a hedge fund, for example, imploded? In the days that followed, we found out that is exactly what has happened. There was a hedge fund by the name of Archegos Capital, that was using derivatives to make huge bets on certain stocks. It meant they were using leverage provided by investment banks to have these bets. As you recall, we've had a bit of weakness in particular stocks of late, such as technology stocks. It meant the investment banks such as Credit Suisse and JP Morgan, for example, were having to call for more collateral from this hedge fund. This was in order to keep these bets open.

In the end, they couldn’t provide that, so it meant that the investment banks had to start unravelling these huge bets. There's lots of questions now being asked about how this situation arose, given the history of this hedge fund, particularly the person who was at the head of it.

The bets had to be unwound. It meant that $20 billion worth of stocks were sold on mass in particular technology giants. These were in America and in China. It was almost a race by these investment banks to do so and it caused these stocks to plummet in value. We saw another leg lower in technology stocks.

If you've been holding technology stocks last week, you’d been perhaps wondering what was going on because things looked like they could be stabilizing after the sell-off, that we saw from February into March. The net result is that these investment banks, have now become exposed to heavy losses themselves, as a result of the leverage in the derivatives that were behind these huge bets on technology stocks. To give an example, Credit Suisse came out and said that their own losses are likely to run into billions and billions of dollars’ worth. Their share price fell 14% on Monday alone.  

That gives you a hint of the potential impact on market. The question which remains to be honest, is there some kind of systemic risk in investment markets. Could we see another Lehmann's style moment that we then see markets eventually unravel? Now the market is looking beyond this incident because we've seen a bit of stability. This has come from those bank stocks after initial aggressive sell off on Monday. One concern has been that obviously financials have been leading the market higher of late. As part of this reflation trade, and if they show weakness, could it mean the whole stack of Domino's come collapsing down if financials start to turn down lower? I don’t believe this is the case and I suspect we are in the next leg higher in equity markets.

Now we've seen a bit of stability after those initial losses. We have to wait and see whether there is a systemic problem, although the market is moving. This suggests that there isn't a systemic problem. The loss on this hedge fund is being put down as a single greatest loss of personal wealth in history by the person who runs it. This puts the scale of this problem into context.

You add that to the other worries that are out there - COVID-19 is rearing its head again. We're having problems with vaccines rolled out and rising case numbers. This means there are still reasons to be slightly apprehensive about markets. However, if you look at investment markets, we're still seeing that the market is pushing to all-time highs on the Dow Jones. It’s really technology stocks and the growth stocks that are lagging. However, in the last few days, we have seen technology and growth stocks push higher. These are not necessarily sitting on huge losses when you look year to date. In fact, if we run through the year to date returns, then the NASDAQ 100 is up around 3% for the year despite the sell offs. We had a huge rally into February which then pulled back. If you look at the other indices, the Dow Jones is up about 9% and the TSX is up about 6.7% year to date. The S&P 500 is up about 7%. Even Asian and emerging market equities are up around 2 to 3% year to date. That is after they are up about double digits about 12% by the mid-February.

You can see that we've had some pullback; it has come for a high base. Now, despite the sell-off and despite the worries that are out there, the world hasn't ended. What we've had is with the reflation trade and nuance to what’s been going on. It will be interesting to see what happens as we go into the next quarter. This quarter has been particularly tough for government bonds. We saw the US Treasury yield rise from 0.9% at the start of the year to around about 1.75%. The reflation trade at the moment is still on.

We are waiting for more information about Joe Biden's potential stimulus plans in the US. There could be more information on that which could cause some fictional wobbles in the bond market, depending on how he's planning to fund that or the scale of that. That is likely to have an impact on yields in the next few days. As we move into the next quarter, it will be interesting to keep an eye on the 10-year U.S. Treasury bond yield.

Continue to monitor key indices like the Dow Jones as this is a real beneficiary of the reflation trade. The Nasdaq 100 is full of technology stocks which have been a laggard in the reflation trade. The VIX which is obviously the thing people call the market fear index, that's a good steer to see what people are thinking. Now it's still down around the multiyear average. There isn't extraordinary fear out there in the market. In fact, it’s good to look at the CNN market fear and greed index.  This gives you a broad measure, considering lots of factors, such as, is emotion driving the market? Is the market in greed or fear mode? Now, it's largely in the middle probably erring slightly on the side of fear. We're not at the euphoria stage yet. There's plenty going on in the next couple of days and weeks to look out for.


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Kamal and Indy Lidder

Kamal and Indy Lidder