2020/08/22

Tesla and its short positioned traders

The chart below shows Tesla's share price rising 390 percent this year.
The blue line and the orange line represent the 'short interest' and 'short interest percent of equity float' which continues to decline as opposed to the stock price.
The surrender of short-selling forces is one of the factors pushing up Tesla's market capital. (Which are down more than 25 billion dollars this year amid the stock's record-breaking rally.
The ratio of short selling to the whole transaction was about 8 percent (the lowest ever) as of the end of last month, but it must have been lower now. However, Tesla is still the largest short in the U.S. market.

Tesla surpassed the $2,000 level for the first time ever. It is the ninth largest U.S. companies at this moment with the market capital of 382 billion dollars.  The short bets have lost another $619 million Friday as the stock continues to climb ahead of its upcoming five-for-one stock split.

Source 1: Traders betting against Tesla are down more than $25 billion this year amid the stock's record-breaking rally

2020/08/20

FOMO (Fear Of Missing Out)

David Choe is not a financially expert, and he is not even in an economic field. David was a graffiti artist. He was scouted by Sean Parker who was working as a vice president in Facebook. The project he had to do was to paint the office in receiving 60 grands which is $60,000. However, Mr.Parker offered him stocks options instead of giving him cash. Later on when Facebook went public, he became a $2 million shareholder of Facebook making him be a millionaire. The only thing he did was to choose the right decision between stocks and cash and hold it for a while.

With the precedent example of an artist becoming a millionaire, a large influx of investors were lead into the stock market, making them be frenzy into buying Facebook stocks. In this blog, I am not talking about Facebook, I'm talking about these irrational investors.

Investors were seeking for riskier assets with high return. There is a phrase called ‘There Is No Alternative (TINA)’ which implies that investors have no choice but to buy higher yields than the bank deposits. Mostly it applies to the stock or high-yield corporate bond market, since the stance of FED was super dovish (central banks all around the world are also holding interest rate low) and FFR remained permanently near-zero. (Mainly stocks are the main target from investors because it is very sensitive to the news. Most news are positive to allure investors to get in to the field.)

However, the market seemed to have shrunk for a while when the COVID-19 crisis broke out, but the combination of the FED's monetary policy and the Treasury's fiscal policy revived the asset price and market significantly.

Shares of Blackrock has risen sharply for profit rise amid economic downturn during COVID-19. It surely means that investors are now looking for ETFs to buy stocks passively and indirectly, since they are looking for higher returns. Please see my blog about Blackrock’s profit rise.

The term FOMO (Fear Of Missing Out) becomes talk of the town again when the investors are worried to miss the rallies that are ascending fiercely. The phenomenon first came out 1996 by marketing strategist Dr. Dan Herman, who conducted research for Adam Bellouch and published the first academic paper on the topic in 2000 in The Journal of Brand Management. (Wikipedia) Later the term 'FOMO' was coined by Author Patrick J. McGinnis let the world know the phrase in a 2004 op-ed in The Harbus, the magazine of Harvard Business School. The term FOMO was first applied as marketing term, "Don't be left behind by trend or fad".

Later the term FOMO is also seen in article or opinion section of stock market explaining the phenomenon about investors seeking for the assets that others are looking for. Paul Krugman used it later in stock market. The term implicates similarly with examples below. (quotation from Wikipedia and Cycling Tips)
Herd Behavior: The behavior of individuals in a group acting collectively without centralized direction. Herd behavior occurs in animals in herds, packs, bird flocks, fish schools and so on, as well as in humans. Demonstrations, riots, general strikes, sporting events, religious gatherings, everyday decision-making, judgement and opinion-forming, are all forms of human based herd behavior. [Wiki Quote]
Lemmings: are small rodents that have been known to follow each other as they charge to their deaths off the edge of cliffs. [Cycling Tips Quote]

Mostly the procedure of FOMO phenomenon (also called behavior) about stock market starts from cognitive bias where people are to follow the crowd, animal spirits to be part of them, participate in the fierce rally and finally lead to irrational exuberance. FOMO causes most of the bubbles and the crash incidents.

The bubbles were also existed in the ancient financial market. In ancient Babylon, commodity prices such as barley and wool took sudden leaps and fall which can't be explained whether the bubble formed due to the weather or the war. However, it is surely clarified that irrational buying and selling shaping the bubble.

In 1720, shares in the South Sea Co. and 88 of other leading stocks skyrocketed all-time highs as speculative investors to chase instant market gains. (The South Sea Co. roared 650%, Royal Exchange Assurance surged 1,243%, London Assurance created 4,220% incline) They had the story which can upend their stocks such as "trade in hair", "import a number of large jack-asses from Spain", and develop an "air pump for the brain". These stories look very unspecified and could be in vain, however, the media spread the market gossip through newspapers. South Sea was "all the talk and fashion" in London. King Goerge I, half the members of Parliament, genius Newton, the poet Alexander Pope were eager to be in a group of popular companies' shareholders. However, those companies took sudden leaps and fall, crashing down between 81% and 96% off the peak.


Nifty Fifty is also the example of the bubble collapse during 1960s when blue-chip companies were trusted by absolute public confidence. The 50 companies included IBM, Coca-Cola, GE, McDonald's, Disney, Xerox etc. Investors were fenzy about them, believing there is no such high price and could afford to take in account whenever risk might occur. They were absolutely sure they could thoroughly earn the profits. The average p/e ratio was formed from 80 to 90, which was sold in 8 to 9 later in 1973. The investor learned the lesson; FOMO will never happen again.

However, when the economy is growing and lays positive mindsets to investors, things happen again. Mass media only carries good news and the stock markets surges. In 1990s, an idea that internet will change the world was slogan of investors, considering there is no such high price of e-commerce and dotcom companies. Stocks were traded not regarding to the p/e ratio. Most of transactions were based on the growth of sales or the visitors of the websites which was standard on estimating the price. The craze has reached the realm of bubbles, and investors have finally conceded defeat as they cannot resist the frenzy called 'dotcom bubble'.

Financial crisis 2007-2009 was formed with the belief that the house price will never fall. In fact, there were only three cases when nominal national housing price Index fell until 1997. Twice fell by about 1%, and once by 2.8%. Thus, the decline in the national real estate price index has never been close to 20 percent after the World War II. Banks or financial institutions lent money to the house seekers by issuing subprime mortgages without the lender's minimum proof of income or evidence of employment. Later these mortgages where combined together with other different grades such as prime or lower. These were trenched into new derivatives or complicated funds; most recognized one is CDO. FED lowered FFR to promote housing markets. Regulators eased the Glass-Stigull Act, which led to three times more leverage, and strengthen uptick-rule to prevent downward bets from short forces. Investors were in FOMO phenomenon; they did not want to miss the rally of house market. Due to the rise in CPI, FED could raise interest rate gradually since there was no sign of dollar being stronger. Decline in borrowers made the housing market weaker. Assets related to the market gradually was bear steepening making investors in panic to sell whatever they have, crying to save them from danger.

These were not limited to the examples above but also happened in Japan after Plaza-accord, Taiwan, China (IPO bubble). In January 2018, U.S stocks soar due to tax-cut by Trump administration, which made fall in February. Bitcoin bubble took place in the same year. The investors think this time is different as they regard the event as special case.

I did not find the bubble until 2019 (may be corporate bonds due to the little yield spread between corporate bonds and treasuries with same maturity). However, COVID-19 has spread all around the world making the countries in lock-down. The decline in supply and demand made the economy deteriorated. Nevertheless, assets have quickly recovered due to the fast response from FED and U.S Treasuries. I can see some of the specific stocks and assets that seems to form a shape of bubble such as electric vehicle and semi-conductor companies, commodities such as gold, bonds, and so on in near days. (Kodak is one of them) May be monetary and fiscal policy can help to change in investor's sentiment positively. However, the policy does not have much card to elevate the stocks in the future, if YCT or negative yield won't be proceeded. (Announcement
effect by future guidance won't be a strategy next time)

I love Mark Twain's quote: History doesn't repeat itself, but it rhymes. Howard Marks have repetitively emphasized the market cycle. Positive events amplify investors' risk-taking tendencies, but when the turmoil arrives, they rush to sell, even though it's a low-cost buying opportunity. According to the article of Jason Zweig, behavior of FOMO and bubble is not a bad thing; it is about human nature.

In conclusion, the winner and the loser in the investment field is determined of how they restrain their instinct and have second-order thinking. This is they way to let our portfolio outperform in the market. There is a word I really love from a janitor (Mr.Read) who made 8 million dollars from small amount of money for 65 years. "Investing is not IQ test, it is test of character". Never be a part of a group of FOMO behavior.

Twitter of Mr.Muthukrishnan
"The risk is never in volatility but in our reaction to it."

Thanks to WSJ article from Jason Zweig and books of Howard Marks, I was able to write this blog.

Source 1: From 1720 to Tesla, FOMO Never Sleeps
https://www.wsj.com/articles/from-1720-to-tesla-fomo-never-sleeps-11594994422

Source 2: Why Stocks Are Hitting Records as Economic Fears Rise: ‘There Is No Alternative’
https://www.nytimes.com/2019/07/11/business/stock-market-record.html

Source 3: The Lemming Effect
https://cyclingtips.com/2010/04/the-lemming-effect/#:~:text=Lemmings%20are%20small%20rodents%20that,off%20the%20edge%20of%20cliffs.&text=This%20Lemming%20Effect%20enables%20entire,phenomenon%20taking%20place%20with%20cyclists.

Source 4: Ancient Babylon
https://economics.mit.edu/files/7258

Source 5: Do You Know the Difference Between Being Rich and Being Wealthy?

Source 6: History of Bubbles
https://archive.org/details/anhistoricaland01andegoog/page/n121/mode/2up

How Blackrock is making profits during COVID-19.

Blackrock, the world's largest asset holding company [$7.3 trillion], reported a 21% increase in revenue. Although it was not easy for financial institutions to withstand the economic recession from COVID-19 and low interest rates, Blackrock seemed to be different. The Fed's purchase of Black Rock ETFs with no commission fees did not help the company itself, Black Rock earned profits in two ways.

1. Revenue from sales of software called Aladdin [Aladdin's financial risk measurement software]

2. Changing Black Rock's Asset Strategy [Focusing on the U.S. Market for Rapid Asset Recovery]
It also focused on active asset management, rather than concentrating only on index ETFs.

 Wall Street Journal says BlackRock is watching for scalability from asset management to software technology sector.

Source : BlackRock’s Profit Jumps 21% as Investors Surge Into Bond Funds
https://www.wsj.com/articles/blackrocks-profit-jumps-on-bond-etf-activity-11594982592

2020/08/17

The exchange rate system: fixed, flexible, managed float

The exchange rate system is largely divided into three types: fixed exchange rate system, variable exchange rate system, and limited exchange rate system, depending on the degree and type of flexibility of exchange rate changes.

Fixed exchange rate system (or sometimes called pegged)
The fixed exchange rate system contributes to stable economic growth by reducing the cost of exchange rate fluctuations and economic uncertainty. When the term first came out, it was fixed with commodity such as gold. It was intervened by governments and central banks in the currency market by intentional selling and purchasing.

It is mostly selected by emerging countries because of the high cost of exchange rate fluctuations due to the lack of financial market development, lack of ability to manage exchange risk, and lack of government confidence.
Meanwhile, some argue that the fixed exchange rate system is inappropriate under the international financial environment, where capital mobility has increased significantly due to the progress of financial liberalization and globalization.

Major countries: Saudi Arabia, Hongkong, UAE, Jordan, Cuba, Qatar etc

However, the fixed exchange rate system is highly likely to be exposed to foreign exchange attacks by international speculative funds like George Soros did by betting British Pound collapse. When the fundamental of the country is deteriorated then it affects directly on the currency that leads to external currency imbalances
* The collapse of the European Monetary System (EMS) in 1993, the instability of the Hong Kong foreign exchange market in 1997, and the Asian financial crisis in 1997.

Flexible exchange rate system (or sometimes called free-floating)
It allows free exchange rate fluctuation fully affected by supply and demand of the market itself. Governments and central banks do not participate in the Forex market at all. The advantages of the floating exchange rate system as follows:

Inducing equalization
Deficit of balance of payments → demand over foreign exchange → depreciation of local currency → increase competitiveness → boost exports, decrease of imports → recovery of international balance.

Prevention to foreign exchange speculation
Free exchange rate fluctuations block foreign exchange speculation due to uncertainty about future currency movements.

Maximizing policy efforts
Because there is no limit to maintaining a certain level of exchange rate (price can be variable anytime), independent economic policies can be implemented and policy efforts can be concentrated on the balance of the domestic economy to maximize policy effectiveness.

Proper management of foreign exchange reserves 
Preventing excessive accumulation of foreign exchange reserves as central banks do not need to intervene in the foreign exchange market to defend specific exchange rate levels.

However, the concept of full free-floating exchange rate system is just theoretical. Indeed, every government or central bank intervenes in the currency market to affect the exchange rate for their advantage of trade. Some countries, such as Japan, Korea, and the United States, intervene in very little.

Managed float regime (or sometimes considered as dirty float)
Governments and central banks often seek to increase or decrease their exchange rates by buying or selling their own currencies. Exchange rates are still free to float, but governments try to influence their values. It is a fixed and variable intermediate-level exchange rate system, which limits the exchange rate fluctuation width to within a certain range (1-2.25% etc.) for a particular currency. Countries such as China choose managed float system.

Source
https://saylordotorg.github.io/text_principles-of-economics-v2.0/s33-03-exchange-rate-systems.html

Relation between country's economic growth [stock & bond market / interest rate] and currency value.

Keynesian theory
Keynesian theory introduced the concept of marginal import-oriented, explaining that if a country's economy continues to grow relatively high, it would increase imports, resulting in trade deficit and devaluation of its currency (over-demand of foreign currencies). Such external expenditure will adjust in trade balance and later on affects in the currency rate.

Global economic growth

However, as global financial market developed, things became different. If the country's economy records higher-than-expected growth, there are three factors of movements of one's currency.

Stock market
First, when the country shows how healthy its economy is, then the stock market is likely to surge. For example, after the Trump's election as 45th president of United States, the company's growth in S&P 500 stands since financial crisis 2008. Tax cut has made the company more profitable, and investors were eager to secure dollars to buy shares, funds, and securities.

Policy rates
Second, the country's market expects its interest rates to rise in the future due to an increase in confidence of its healthy economy. After taper tantrum, Janet Yellen, the former chairperson of FED, started raising up the FFR(Federal Funds Rate), which made US dollar stronger. In fact, U.S dollar was already strong as investor anticipated the FED will likely to hike the rate after austerity in QE. Investors will change their foreign currency into US dollar for their bank depository, since U.S. policy interest is higher globally.

<The more increase in FFR means the more economic growth U.S. have>

Bond investments
Third, when the economy of a country is pretty stubborn, then the government bond (or municipal bond) will probably be safe. Treasury bonds, notes and bills represent the credit of a country. In judging a country's credibility, it's important how much it grows, but it's also important how low the likelihood of bankruptcy is and how stable it is.  Asset management company such as GPIF(Government Pension Investment Fund) in Japan or Blackrock will likely to invest on safe assets such as securities which have above grade A, due to diversification of its portfolio, which will make more demand in the country's currency.
<This graph explains U.S. Dollar movements in correlation and against stock market and policy rate.> 

2020/08/16

What is exchange rate and the forms of it

What is exchange rate
Exchange rate is "the value of one currency for the purpose of conversion to another" and is moving oppositely to each other. (The price of the local currency against other currencies) When you look at the currency pair, you can see base currency and quote currency.
For example, even if Australia's growth makes AUD stronger, when USD surges relatively more than AUD, then AUD weakens as the U.S. dollar strengthens. When regarding USD as base currency and AUD as quote currency, when USD value is higher than AUD, then traders need more AUD to secure USD.
The forms of exchange rate
The forms in which foreign exchange transactions occur can be classified into two major categories: underlying transaction and speculative transactions. 
Underlying transactions contains trade transactions by world trade (service included) and international capital transactions such as FDI(including CAPEX investment, job creations, OPEX etc) or equity acquisition.  Speculative transactions occur simply to obtain trading profits. At this time, foreign exchange transactions based on trade or global capital transactions are called actual demand transactions.

Portion of total foreign exchange market
In the classical concept of foreign exchange market, trade and international capital transactions were understood as the most important causes of foreign exchange transactions, but not now. Rather, speculative foreign exchange transactions have become even more prevalent Forex markets as more countries open their financial market.
Foreign exchange transactions by trade or international capital transactions account for a very small portion. Without speculative foreign exchange transactions aimed at simple trade gains, the pricing function in the foreign exchange market would be very weak. The volume of trade and capital transactions worldwide is less than 10 percent of the total foreign exchange volume and most speculative foreign exchange transactions are heavily involved in the pricing function of the foreign exchange market.

Why is speculative transaction important and what is the role of it
The exchange rate must have a sufficient amount of supply and demand to determine the appropriate exchange rate in the foreign exchange market, which is determined purely by market function, and speculative foreign exchange transactions must exist in order to secure such demand and supply. If speculative trading is prohibited and only underlying transactions are made on demand, the size of the market will not reach a certain level and as a result, the foreign exchange market's exchange rate may be distorted or the exchange rate-setting function may be lost.
For example, lets presume that only underlying transaction is on demand. When the demand of dollar is 2 million and supply is only 1 million, the currency rate will soar up in need for more supply, which will make Forex in extreme volatility.  However, when speculative transaction is traded actively, then the supply problem will be hugely diminished.

Above all, speculative trading serves to provide liquidity in the foreign exchange market by creating a sufficient supply of demand in the foreign exchange market and is a very key role.

Foreign exchange exposure and risk for trading companies and investors.

DXY (U.S Dollar Index - Bloomberg) has sharply risen until 102.82 points in March 20th this year, which made S&P 500 historic low down to 2,237.40 points after Trump's election as 45th president of United States (Dec, 2016). USD to KRW (European Term*) exchange rate hits 1,296 won, highest in 11 years.
European Term: USD is always the base currency in currency pair. (USD/JPY=106.56, USD/HKD=7.75) 
American Term: USD is always the quote(counter) currency in currency pair. (NZD/USD=0.75, EUR/USD=1.11)
[It is due to express the same way of indicating the price of the product. 1 cheese = USD 2.50)
Foreign exchange exposure and foreign exchange risk always have been in danger for trading companies, investors and financial institutions who invest abroad. I will explain the exchange risk with the example of a trading companies in Korea, because Korean companies react most sensitively to the economic cycle and exchange rates.

There are usually two kinds of business in trading companies: import and export.
Importing company: It is different to buy the same 10 USD item for 10,000 KRW and 13,000 KRW. Purchasing in 10,000 KRW is 23.1% more profitable because of a rise in Korean currency value. (Rise of value in the currency means an increase in purchasing power. For import-specialized companies, the actual fall in the USD/KRW exchange rate is more beneficial than the contractual rate.
Exporting company: The company A is trying to sell the product at a 10% of operating profit. However, its profit becomes 3 percent if USD to KRW currency rate drops at 7 percent. (Which means KRW became stronger). Meanwhile, if company B is trying to export at a low margin of 1% due to the contract, but if KRW weakens by 7%, then it will make more 8% of the profit.

This circumstance seems not to take place, but it does happen frequently like the precedent explains when COVID-19 spreads all over the world.

To sum up, the fall of currency exchange rate from USD to KRW would benefit importers and harm exporters. On the contrary, rising exchange rates are good for exporters and damage importer's profit. However, it is impossible to predict the direction of exchange rate. (Only God knows) Nevertheless, exporters and importers should always prepared to manage the downside and upside risks of the exchange rate.

Source 1: Coronavirus Map: Tracking the Global Outbreak (New York Times)
https://www.nytimes.com/interactive/2020/world/coronavirus-maps.html

Source 2: Quote Currency Definition
https://www.investopedia.com/terms/q/quotecurrency.asp#:~:text=Key%20Takeaways-,The%20quote%20currency%2C%20commonly%20known%20as%20%22counter%20currency%2C%22,currency%20is%20the%20domestic%20currency.