“Markets are priced on the basis of earnings, hopes, and dreams,” said Sparks, investor, entrepreneur, iconoclast, early to the AI theme. “In 2010, investors were so bearish that they placed a negative value on hopes and dreams - the stock market was so cheap,” he said. “The hopes and dreams of today’s market have been building for years. And between Tesla and now SpaceX, investors are finally able to express all the themes that have captured their imagination.” AI, robotics, space exploration, datacenters, humanoids, robotaxis, and drug discovery. “The end of every cycle is a process, and it may have some time to play out, but it’s started. Hopes and dreams are wildly excessive, and earnings won’t justify these valuations.”
Overall: “Applying yesterday’s valuation of the old Standard Oil shares the market worth of the company’s original stock was almost $2,000,000,000, and John D. Rockefeller became a billionaire overnight,” wrote the New York Tribune on September 29, 1916. Rockefeller had no comment. Bernie Sanders would have given him an earful, but he was just in kindergarten. Rockefeller’s wealth amounted to 2.5% of GDP. No employees owned Standard Oil or Ford Motor Company shares in those days. Henry Ford became America’s 2nd billionaire in 1925. When asked by a reporter how it felt, Ford responded, “Oh sh*t.” Automakers are a different breed. “It’s hard to believe that a little company that started in a warehouse in El Segundo is now going public in the largest IPO ever,” said Elon Musk. “If people had told me this was going to happen, I was like, man, you must be smoking some really good crack, because I think this company is going to fail.” Elon is the world’s first trillionaire if you exclude Putin and Xi, both of whom made their wealth in national takeovers. Elon’s $1.1trln net worth is 3.7% of US GDP. 4,400 of SpaceX employees own stock and are now millionaires, 10% are worth $100mm or more. “Today, Elon Musk, a trillionaire, pays the same amount into Social Security as someone making $184,500. If we end that absurdity and lift the cap on taxable income, we can make Social Security solvent for 75 years and expand benefits by $2,400. My Social Security bill does that,” declared Bernie. And onward rolls America. Decade after decade of booms and busts, bulls and bears, breathtaking breakthroughs. In the mud are our politicians, wrestling to achieve an unstable balance between capital and labor. While our Fed and Treasury paper over cracks in the system with debt and printed paper. And every so often, an entrepreneur comes along, to remind our children and immigrants like young Elon once was, that with hard work, ambition, ingenuity, good timing, and a bit of luck, absolutely anything is possible in America.
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Exposure: “Most investors talk about volatility as something that they seek to minimize,” said the Nobel Laureate. “But volatility is not one thing. There is the risk of a large loss and the risk of a large gain,” he said. “Those are the two tails. And one of them you really must avoid, but as destructive as it is to experience a big loss, it is also extremely painful to miss out on a big gain.” The Nasdaq 100 lost 82% in the dot com crash. The S&P 500 lost 57% peak to trough in the GFC. From those lows, the Nasdaq 100 total return is +2,600% and the S&P 500 is +1,200%.
Exposure II: A small minority of companies has created essentially all the wealth. The vast majority of stocks, over their lifetimes, fail to beat T-bills. The overall market’s return is a right tail. Great equity positions are like options - downside capped at the capital invested, upside unbounded, the payoff often violent. Own upside convexity, the innovators, the compounders, the businesses whose potential futures are vast. Then hedge out your catastrophic risks, because a deep portfolio drawdown can force you to sell your upside equity options before they payoff.
Exposure III: “Reducing excess volatility is the key to compounding,” continued the Nobel Laureate. “Making a little money on the downside and transforming that to the upside is extremely impactful to compounding,” he added. “What happens when you lose 30% or 50%, what will you do?” he asked, not waiting for an answer. “Knowing how you will behave in a drawdown is critical.” Indeed. “Most investors are implicitly selling puts because in a big market sell off, they will be forced to sell assets to meet their capital needs, or margin calls, or both.”
Exposure IV: “The math of the left tail is not symmetric, and it is not forgiving. It doesn’t just take your money. It takes your time. And time is the only thing compounding cannot replace.” If your portfolio draws down 34%, like the S&P 500 did in Covid, you need to make 51% to get back. You lose 57%, like the S&P 500 did in the GFC, and you need 133% to regain the highs. Lose 82% in the dot com crash and you need 455% to get back to your highs. “It’s like our lives,” he said. “It’s not the little things but the big things that we remember.”
Exposure V: “Making money in markets requires an understanding of the constraints of others,” said the Laureate. “In a left tail event, will you need liquidity or will you be a supplier of it?” he asked. “You want to be able to derisk your hedges.” Selling volatility you bought when the sun shone and using those profits to buy securities that distressed investors are forced to sell. “Building your portfolio to preserve liquidity for a phase change from a low-risk environment to high-risk phase is a form of structural alpha. And supplying the market with liquidity is alpha.”
Exposure VI: “Risk management is a form of alpha and a critical for long-term compounding,” continued the Laureate. “And risk management is all about managing tails. It’s about mitigating the left tail and with confidence that you gain to then fully expose your portfolio to the right tail events,” he said. “All your thought must go into market tails. And now with AI, it is even more important. AI is best when it has a lot of data, which is the middle of the distribution. AI will not be good in anticipating the changes in the tails of the distribution. But talented investors can be.”
Anecdote: When I scraped together a small stake during college and set out to trade for myself, it was with no real understanding of this game. I had met many successful men my senior year, to ask about their professions. Most seemed bored by their businesses. And generally arrogant. In Chicago, I met a speculator on the Board of Trade. He had an almost childlike curiosity, a passion for markets, and was humble in such an authentic way that it would take me a few decades to fully appreciate. I felt that if I followed in his path, I’d never be bored. And a life well lived should be the opposite of boring. Back then, I knew nothing about normal distributions, right and left tails. Pit trading was about surviving. Everyone in the pit told stories about the greats. How much they made. What secret strategies they had developed. We all read Market Wizards, which interviewed famous speculators. They spent a ton of time discussing risk management. I could appreciate that. They had learned to survive. In time, I came to learn that it was about much more than that. The longer you live, the more you learn about the market, its structure, its participants, policy makers, and politicians. The more cycles you survive, the more catastrophic errors you see investors make (generally with other people’s money), the more hidden systemic risks you see surface, the more fraudsters and sociopaths blow up. You learn more about yourself, your weaknesses, strengths, insecurities, courage, your fears, greed. And all this knowledge compounds along with connections, access to information, capital. And this means that as the decades pass, the potential monetary value of each new opportunity increases dramatically. But even still, markets exist to destroy those who defy the trading gods and fly too close to the sun. Every survivor has faced numerous near-death experiences, which keeps them humble to their core. And they learn to focus intently on risk management, to survive the left tails, to be alive for the right tails - even one of which can produce a fortune.
Good luck out there,
Eric Peters
Chief Investment Officer
One River Asset Management
Week-in-Review: Mon: China exports YoY 19.4% (15.0%e), imports YoY 27.4% (26.0%e). Japan GDP SA QoQ 0.5% (0.3%e). South Korea GDP 3.8 (3.6%e). Iran, Israel pledge to end attacks that threatened to derail peace negotiations. China export surge tops forecasts as AI propels trade boom. S&P +0.3%. Tue: US existing home sales 4.17m (4.07m e). Mexico CPI 3.94% (4.03%e). China CPI 1.2% (1.3%e), PPI 3.9% as exp. Japan PPI 6.3% (5.6%e). US launched airstrikes against Iran after US Army helicopter is shot down. Pentagon accuses Alibaba, Baidu of aiding China’s military. China weights $295B plan to build AI data centers nationwide. S&P -0.3%. Wed: US CPI 4.2% as exp, Core 2.9% as exp. Bank of Canada rate decision unch 2.25% as exp. Russia CPI 5.31% (5.41%e). South Korea unemp rate SA 2.8% as exp. US military says it started additional strikes on Iran as peace talks have stalled. OpenAI considers drastic price cuts, anticipating war for users with Anthropic. S&P -1.6%. Thu: US init jobless claims 229k (220k e). Mexico IP NSA 2.3% (-0.6%e). ECB hikes main refinancing rate by 25bps 2.40% as exp, deposit facility rate hike to 2.25% as exp. Trump scraps further strikes on Iran, announcing that a deal was close. Trump taps Jay Clayton, former chairman of the SEC, to be the next Director of National Intelligence. S&P +1.8%. Fri: US UMich sent 48.9 (46.0e). UK IP -0.2% (-0.1%e). India CPI 3.93% (4.02%e). China money supply M2 8.6% as exp. SpaceX IPO saw shares climb as much as 31% in their debut, Musk becomes world’s first trillionaire. Oil hits lowest since early March on potential Hormuz reopening, as US and Iran edge closer to an agreement. S&P +0.5%. Sat: US government forces Anthropic to disable Mythos 5 and Fable 5 while they restrict access to foreign persons both in the US and abroad.
Weekly Close: S&P 500 +0.6% and VIX -3.83 at +17.68. Nikkei -0.9%, Shanghai +0.1%, Euro Stoxx +1.7%, Bovespa +1.3%, MSCI World +0.7%, MSCI Emerging -0.1%, Bitcoin +6.7%, and Ethereum +7.1%. USD rose +0.5% vs Turkey, +0.4% vs Canada, +0.2% vs India, +0.1% vs Sweden. USD fell -2.1% vs Brazil, -1.7% vs Chile, -1.7% vs Russia, -1.6% vs South Africa, -1.4% vs Mexico, -0.8% vs Indonesia, -0.5% vs Sterling, -0.4% vs Euro, -0.4% vs China, flat vs Yen and flat vs Australia. Gold -2.9%, Silver -1.6%, Oil (WTI) -6.3%, Oil (Brent) -6.8%, NatGas (US) -3.4%, NatGas (EU) -3.6%, Power (EU) -3.5%, Copper +2.5%, Iron Ore +2.9%, Corn -1.3%. 10yr Inflation Breakevens (EU -5bps at 2.01%, US -4bps at 2.32%, JP -8bps at 2.16%, and UK -4bps at 3.28%). 2yr Notes -7bps at 4.08% and 10yr Notes -5bps at 4.48%.
YTD Equity Index Returns: Korea +83.1% priced in US dollars (+92.8% priced in won), Taiwan +51.4% priced in US dollars (+52.5% in Taiwan dollars), Hungary +32% in dollars (+22.2% in forint), Norway +28.9% in dollars (+21.6% in krone), Israel +28% (+17.2%), Japan +28% (+31.1%), Colombia +24.8% (+15.4%), Thailand +21.3% (+26.4%), Russell 2000 +18.6%, Poland +15.9% (+18.3%), Austria +15.7% (+17.5%), Brazil +15% (+6.2%), Turkey +14.9% (+23.8%), Italy +12.8% (+14.6%), Greece +12.6% (+14.2%), Netherlands +12.1% (+13.7%), Portugal +11.7% (+13.3%), Argentina +11.6% (+9.9%), Belgium +11.4% (+13%), Finland +11.4% (+13.1%), NASDAQ +11.4%, Mexico +10.6% (+5.7%), S&P 500 +8.6%, Singapore +8.4% (+8.2%), Canada +8.2% (+10.2%), MSCI World +8.1% in US dollars, Spain +6.9% (+8.4%), Australia +6.7% (+1%), Sweden +5.4% (+8%), Euro Stoxx 50 +5.4% (+6.8%), UK +5.2% (+5.4%), Saudi Arabia +5.1% (+5.3%), China +5% (+1.6%), Chile +4.4% (+4.2%), Switzerland +2.6% (+3.3%), Ireland +1.6% (+3%), France +1.1% (+2.5%), Vietnam +0.3% (+0.4%), New Zealand +0.2% (-1.1%), Malaysia +0.2% (+0.2%), Germany -1% (+0.6%), South Africa -1.3% (-3%), UAE -1.9% (-1.9%), HK -4.2% (-3.6%), Czech Republic -5.7% (-4.6%), Philippines -6.4% (-2.4%), Denmark -6.4% (-4.9%), India -14.5% (-9.6%), Indonesia -34.6% (-30.5%).
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, converse with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.