Tesla, the Harry Houdini Quarter

Production, Now You See it, Now You Don’t

The production capabilities Tesla says they now have are much MORE than actual production.

Fremont Model S / Model X 90,000 Production
Model 3 / Model Y 500,000 Production
Shanghai Model 3 250,000 Production

This is on slide 7. They claim 840,000 units of capacity…but actual production and sales are much less.

This means they are underutilizing manufacturing and they cannot say that they are supply-constrained.

One High Bar
“Tesla says its goal of delivering 500,000 cars this year “has become more difficult”: it has to deliver a record 180,000 cars this quarter.” Zerohedge

Unlike the last few quarters, they did not sell out at the end of the quarter.  Warning, inventory grows.  And, satellite images from dealer parking lots around the country confirm this.

Regulatory credits were more than guided.  With their deteriorating share in Europe – where most of these come from, this source of profits should be reduced shortly.

Accounts receivable continue to grow sequentially….which makes zero sense in a business where customers pay before taking cars off the lot.

Outside of the Earnings News

Waymo now has a commercial robotaxi service in Arizona

GM Cruise is applying to have cars without pedals and steering wheels.

It was Tesla that was supposed to have 1 Million robotaxi’s by now.

They are way behind, the current nearly $400B valuation is HIGHLY unsustainable. 

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“Average” Inflation Targeting from Central Banks, Compounds Side Effects

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

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“Averaging” Inflation Does Not Eliminate The Flaws In The Fed’s Policy Approach; It Compounds Them

Larry McDonald with Joe Carson

Federal Reserve has spent over a year conducting a review of its monetary policy strategy, tools, and communication process. The review was an academic re-assessment of an academic experiment called inflation targeting. The new framework of inflation averaging is an extension of the inflation-targeting regime, with a longer timeline.

This decision on inflation targeting moves monetary policy closer to a rule-based framework. A rule-based framework creates the premise that there are no legitimate objectives besides the item being targeted.

Inflation targeting was never supposed to become a rule-based framework. Proponents of the practice argued it would help increase the “transparency” of conventional monetary policy and emphasize the commitment toward maintaining a low and steady inflation environment.

Inflation targeting has never delivered the macroeconomic results that were promised. That’s because it has no practical foundation, focuses on a narrow set of prices that are not entirely market-determined, and creates an uneven playing field between the economy and finance. Inflation averaging will compound the errors.

First, mandating an inflation rate of 2%has no theoretical justification.

There is no such thing as an “ideal” or steady rate of inflation. Policymakers have never offered any empirical evidence to justify a 2% inflation target because none exists.

Research and actual experiences show that an inflation rate too high or too low for an extended period can create imbalances and bad economic outcomes. But that range is very wide.

In the mid-to-late 1990s, reported core consumer price inflation averaged more than 100 basis points above the inflation rate of the last decade, and the macro performance in terms of growth, job creation, and wage gains was far superior.

Policymakers have the freedom to change their operating framework. But any framework should be grounded with solid research and not made up with “alternative” facts to support its use as a policy tool.  

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Second,inflation targetingfalsely assumes there is absolute perfection in price measurement. 

Subtle changes in the prices and quality of goods and services make price measurement at times a “best guess”. Every year government statisticians face new products, changes in old products, shifts in demand, and company pricing strategies.

One of the most complex issues in price measurement is the pervasiveness of item replacements. Item replacement refers to a process whereby government statisticians must select and price a different product because the one previously included could not be found. Previous studies have found that some items are replaced more than once a year and annual replacement rates could be as high as 30% for products.

But item replacements are uneven year-to-year and therefore so too is the judgment component of reported inflation. As a result, price changes that are down or up a tenth or a quarter of a percent from year to the next should be considered nothing but statistical noise. But a rule-based inflation-targeting framework will compel policymakers to fiddle with the stance of policy to account for the noise in price measurement.

How is it that policymakers nowadays have fallen in the trap of placing so much importance on a single statistic to conduct monetary policy?

Third, the Fed’s inflation-targeting regime mistakes indirect measures of inflation for direct ones.

A critical aspect of the design of price targeting is the selection of the price series. The price series must be timely and a direct measure of inflation.

The consumer price index (CPI) is the only direct measure of consumer prices. But policymakers have opted to use the personal consumption deflator (PCE). The PCE deflator is not a direct measure of prices since 70% of the prices come from the CPI. The other 30% is based on non-market prices.

Four of the past 5 years, the core CPI has exceeded the 2% target. The only year it missed was 2018 when it was 1.8%. That small undershoot from the 2% target is not statistically significant and certainty not large enough to trigger a change in the stance of monetary policy.

Over the same 5-year period, core PCE ran nearly 75 basis points below the core CPI rate. Almost all of that difference can be explained by the “invisible” prices, or prices for items that are in the PCE but not in CPI.

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Does it make sense to base policy decisions on “invisible” prices?  

Fourth,inflation targeting lacks balance in anchoring consumer inflation expectations with investor expectations.

The announcement of an inflation target is intended to reduce uncertainty over the future course of inflation and anchor people’s inflation expectations. It is hard to prove that the formal announcement of inflation targeting has had any impact on people’s inflation expectations.

According to the University of Michigan’s consumer sentiment survey, people’s one-year inflation expectations have fluctuated between 2.5% and 3% for the past 20 years, moving above or below the range during an economic crisis or oil shocks. Perhaps people are unaware of the Fed’s 2% inflation target or that “experienced” inflation runs consistently higher than reported inflation.

But investors are readily aware of the Fed’s inflation target. Every little tweak in the Fed’s policy statement on inflation and its impact on official rates triggers almost an instant reaction on the part of investors.

One of the inherent weaknesses of inflation targeting is the inability to balance consumer and investor expectations. That is, as policymakers attempt to simultaneously hit an arbitrary price target and anchor inflation expectations they are inadvertently un-anchoring investor expectations as it eliminates the fear of higher interest rates, encouraging extreme speculation and risk-taking in the financial markets.

Why do policymakers only focus on people’s inflation expectations and not people’s/investor’s asset price expectations as well since both have become unstable at times resulting in bad economic outcomes?

Informal and formal price targeting has been in the Fed’s tool kit for the past 25 years or so. The effects on income and portfolio flows are not similar to conventional monetary policy. At the end of 2019, the market value of equities in people’s portfolios’ stood 3X times workers income, up from 1X times in the mid-1990s.

The shift to inflation averaging compounds the unevenness. That’s because inflation averaging will extend the period of low-interest rates, encouraging more speculation and risk, increasing gains in finance over the economy.

A critical review of the pros and con’s inflation targeting will have to wait for the next crisis. It usually takes three crises before policymakers realize something is fundamentally wrong with their framework.

By then there will be several new academic papers that will highlight the flaws of inflation targeting/averaging, expanding on those that are listed in this article while adding others as well.

After over 40 years researching in the field of economics, with experience on the buy and sell-side of Wall Street, government, and private industry and mostly focusing on financial markets and policy analysis, our long-time friend Joe Carson decided to share his research and opinion on The Carson Report. Please feel free to contact Joe if you have any questions or want to discuss any of his research or opinions. 

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Don’t make it a long dance with the Devil

Warning: Do NOT hold the TQQQ Nasdaq ETF for the Long-Term

Let us be clear, we are discussing the largest casino on the planet earth right now. The 3x Levered, ProShares UltraPro QQQ should come with a surgeon general’s public warning. All one has to do is look at the average trading volume – nearly $5.5B a day for this ETF. It makes the Wynn casino empire’s annual revenues of $6.6B look like child’s play.

We are talking about a borderline scam here? It’s a mathematical fact that this beast is NOT long for this world. Sustainability is the question. It’s a high stakes game of musical chairs, DON’T get caught holding the bag.

TQQQ Total Assets

The TQQQ ETF has lost nearly -35% since the Nasdaq’s September 2nd perch, yet the fund’s total assets have only decreased -16.1% in the same period. This difference is because the TQQQ has seen net-inflows throughout the month of September, the idiots have been buying the dips on this slot-machine with BOTH hands.

TQQQ: “ProShares UltraPro QQQ is an exchange-traded fund incorporated in the USA. The Fund seeks investment results which correspond to three times (300%) the daily performance of the NASDAQ-100 Index.

The popular TQQQ ETF is commonly referred to as a 3x levered version of the Nasdaq. Let’s see how this has played out in action…

Returns: QQQ Nasdaq ETF vs. TQQQ UltraPro 3x Nasdaq ETF

% Return Today (9/24)

QQQ: +0.5%
TQQQ: +1.5%

Makes sense…

% Return Past Month

QQQ: -6.4%
TQQQ: -20.5%

Little more than 3x, but close enough…

% Return Since 2010

QQQ: +520.7%
TQQQ: +6,931.6%

Wait… what?

% Return Since the February 2020 Top

QQQ: +11.3%
TQQQ: -5.1%

Wait… what???

“The scary part of TQQQ is a 10-year chart gives off the impression that a long-term investment is safe.”

What’s Going on?

We must think about the math. If an investment starts at $100 and loses -5%, you are at $95. To get back to $100, you need appreciation of +5.26%. However, if that investment is 3x leveraged, you lose -15%, and instead are at $85. To get back to $100 in this scenario, you now need appreciation of +17.6%. Notice that the 17.6% needed is greater than 5.26% x 3.  

Now, let’s take is up a notch…

Scenario A: Stock XYZ is a non-leveraged stock that falls -33%. The stock needs a +49.25% appreciation to get back to even. $100 would have gone to $67 and a after a +49.25% rally, $67 becomes $100 again.

Scenario A (but 3x leveraged): Stock 3XYZ is a 3x levered version of the same stock. When stock XYZ falls -33%, stock 3XYZ falls -99%. This stock needs +9900% appreciation to get back to even! $100 would have gone to $1 and after a +147.75% (3 x  49.25%) rally, $1 becomes just $2.47!

The Nasdaq 100 Index has NOT seen a -33% drawdown since TQQQ was created in 2010. Once it does, TQQQ’s prior high is likely to NEVER be reached again.”

DANGER: TQQQ UltraPro Nasdaq ETF

ANY financial product that is levered 3x is NOT meant to be held for the long-term. The 10,693% rally in the 3x levered TQQQ Nasdaq ETF from 2010 to the recent peak may NEVER be replicated. The largest drawdown the TQQQ 3x Nasdaq ETF has EVER suffered was -73% from February to March 2020. Although, the -73% TQQQ drawdown was painful, a recovery to new highs was attainable. However, if the Nasdaq had fallen just a few more percentage points and the TQQQ drawdown went past -90%, a recovery back to the highs would have been nearly impossible. The Nasdaq 100 Index has NOT seen a -33% drawdown since TQQQ was created in 2010. Once it does, TQQQ’s prior high is likely to NEVER be reached again.

Long-term Safety Façade  

TQQQ looks great on a 10-year chart, but there is no such thing as a free-lunch in finance. TQQQ’s +6,410.9% outperformance over the Nasdaq 100 since the ETF’s inception in 2010 will not be repeated for a very long time, if ever. This was only possible because since the TQQQ ETF was created, the Nasdaq has not seen over a -33% drawdown… yet.

Keep in mind, the Nasdaq fell -76% from the Dot-Com bubble’s peak to trough. If this were to happen today, the TQQQ would be a penny stock and the 8 billion dollars invested in the fund would be looking around, scratching its head, wondering what just happened.

Unfortunately, the probability is high that inexperienced retail investors lose over -90% of their investment in TQQQ and do not realize they may never get back to an even P/L, regardless of what the Nasdaq 100 Index itself does.

Bottom line: PLEASE do NOT hold the TQQQ for the long-term. If we see anything near -35% drawdown in the Nasdaq, new highs in TQQQ are nearly impossible, the math proves all 3x leveraged ETFs must be traded NOT owned. The scary part of TQQQ is a 10-year chart gives off the impression that a long-term investment is safe…

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Stupid “Rich” Skew in Apple, Greed Breaks Things

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

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Sept 6: What Just Happened over the last Nasdaq 14 days?

1. A Colossal buyer (SoftBank) distorted the price of upside calls on eight stocks.

2. Quants and Robinhood piled on, further distorting markets.

3. Dealers who have been destroyed in recent years (selling vol) holding a small deck, they had to get long more and more stock to hedge upside market risk.

4. As stocks surged, dealers who sold upside calls – must hedge even more as – out of the money options they sold – pick up more delta. Banks buy more stock. Call-put skew reaches record territory on several big-name tech stocks, meaning the cost differential to buy upside vs. protect the downside, reaches all-time wide levels.

5. Nasdaq is nearly 60% 12 stocks, this “three-card monte” game above has a large impact on passive index funds.

6. The original, colossal upside call buyer exits some of their position.

7. Dealers / banks MUST sell stock in size, take off their hedges, sell Mortimer, SELL.

8. Selling brings out more selling, banks take off more hedges as the options lose delta, MORE selling.

9. The little guy / gal gets left holding the bag.

Alert: High and High Closes September 2, 2020
Wednesday, an All-time highest VIX reading on a day with the S&P 500 touching the highest level ever. Of the top 20 occurrences, there were 17 in the 1999-2000 period, and three over the last 7 days. When option traders receive colossal size orders to buy upside calls they have two choices. a) Have your sales force get on the phone to the largest holders of the stock (say Apple and Buffett) and convince them to sell upside calls. b) If they cannot find enough sellers of upside calls, they must buy stock in size to hedge the calls they are selling to the client.
This is taking the street short gamma – likely the largest way all time. As we learned with Lehman, greed breaks things. It’s “high-noon” – the only character missing is Gary Cooper. We are witnessing a battle of wills, high speculation where colossal call buyers are forcing the street to get long more and more stock to hedge their upside risk. It’s the March capitulation selling in reverse. Just the way the street had to BUY downside protection in late March (because put buyers outnumbered call buyers 10-1). Today, they are being forced to BUY upside protection in SIZE (call buyers outnumbered put buyers 10-1). It’s going to break!

Insanity in Options

This post is Part II of New Vol Regime

“As my first boss told me at Merrill Lynch in 1990, ´In options Larry, they show it to you (lush $$ green premium), and then they take it away.´”

LGM

The convexity skew picture on big-name equities like Apple $AAPL has gone parabolically stupid. Let’s keep this simple and draw a conclusion.

“Over the past few weeks, there has been a massive buyer in the market of Technology upside calls and call spreads across a basket of names including ADBE, AMZN, FB, CRM, MSFT, GOOGL, and NFLX. Our friends at Citadel calculate, over $1 BILLION of premium spent and upwards of $20B in notional through strike – this is arguably some of the largest single stock-flow we’ve seen in years, they noted. We agree someone is playing with House Money, and they’re rolling large.”

Bear Traps Report, August 24, 2020

Apple $AAPL Stock near $130

Jan $180 Strike Calls costs $4
Jan $80 Strike Puts costs $1

*Both options are $50 out of the money, approx data, BUT it is nearly 3x more expensive to buy upside risk in AAPL equity. Downside protection normally costs more than upside risk participation, NOT today. What does this mean?

“The public is trapped long and institutions are trapped long and the snowball that was pushed very quickly up the hill and got big is now at risk of becoming an avalanche.”

Julian Emanuel, chief equity and derivatives strategist at BTIG, Bloomberg

Nasdaq Whale Makes a Splash

One large buyer has made a colossal splash in the market and the scent of greed has drawn thousands of other market participants into the dangerous game. Several clients in our institutional chat on Bloomberg have cited SoftBank as the original size buyer. We have NO IDEA if this is true, just that highly credible clients have made this reference several times over the last week. It’s a high-stakes game of musical chairs, the ultimate greater fool theory moment. The colossal call buyer has thrown meat in the water and drawn in the sharks, but unfortunately thousands of Robinhood minnows at the same time. When the large players’ exit, the little guy and gal will be left holding the bag.

Apple closed near $130, while the cost of speculative upside calls is weighted heavily against the buyer. Someone must have reached out to Buffett today because he can make a fortune in selling $AAPL upside calls. Let us explain.

Very Expensive Upside
Call it extremely unusual activity. We have a higher stock price in Apple AAPL with a much higher cost of equity upside. Equity vol usually explodes higher in market crashes, NOT bull markets. As you can see above, in normal Apple equity bull markets – see all of 2019 – AAPL implied vol has been CHEAP, NOT RICH (expensive) like today! In March and April, near the market bottom – the price for puts was more than 4x the price for calls, today we have done a 180, extreme fear to extreme greed. 

In our institutional client chat on Bloomberg, a hedge fund put on this trade and we are sharing it with permission. 

With Apple stock near $130, think of the January 2021 expiration. The client bought the $200 call and sold the $250 call, 1 x 4, and got paid $3.50 to put the trade on. What does this mean? See below.

Extreme Premium to Extreme Discount
Apple $AAPL is near $140 pre-market on September 2nd. In July, the Street’s 12-month price target was $85, now $116. In March, the price target commanded an $18 PREMIUM to the Apple stock price, NOW it’s close to a $24 discount. In classic 1990s fashion, the mad mob of Wall St. analysts cannot raise their stock price targets fast enough to keep up with the equity price appreciation. That is from 44 analysts, Bloomberg data.

The Trade

Apple was worth $1.5T at the end of July and today she stands tall at $2.2T. In order for the client to lose money* at January expiration, the stock has to breach $270 ($130-$136 this week), which would put the company’s market capitalization very close to $5T, by January 2021, that is a little over four months away.

*The mark to market in the short run can be extremely painful though – if Apple equity soars another 10-20% (Apple is up 50% since late July), that is indeed the catch. AAPL is trading nearly 65% above its 200-day moving average vs. 42% in February’s great bull run. 

Cost of Upside is Insanely Expensive
There are a handful of quant funds pushing around a few stocks (with high impact on QQQ, NDX, SPY) in the options markets. The dealers are getting very nervous.  Last 15 days – Imaging being a large market maker in Apple and Tesla equity options. You make a market, bid – offer, you get lifted and lifted over and over again by buyers to the point where you have raised the price of calls vs puts to multi-year extremes. How short is the Street gamma? VERY.

The Ultimate Lesson From Stan

“So, I’ll never forget it. January of 2000 I go into Soros’s office and I say I’m selling all the tech stocks, selling everything. This is crazy at 104 times earnings. This is nuts. Just kind of as I explained earlier, we’re going to step aside, wait for the net fat pitch. I didn’t fire the two gunslingers. They didn’t have enough money to really hurt the fund, but they started making 3 percent a day and I’m out. It is driving me nuts. I mean their little account is like up 50 percent on the year. I think Quantum was up seven. It’s just sitting there… So like around March I could feel it coming. I just – I had to play. I couldn’t help myself. And three times during the same week I pick up a – don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks. and in six weeks I had left Soros and I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to that. I was just an emotional basket case and couldn’t help myself. So, maybe I learned not to do it again. but I already knew that ”

Stan Druckenmiller

When call vs. put skew gets this extreme it can be a solid leading risk indicator.  Join our live chat here, tatiana@thebeartrapsreport.com.

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New Vol Regime

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

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September 2, 2020: All-time highest VIX on a day with the S&P 500 touching the highest level ever.

Equity Market Volatility Divergence

Strange times indeed. This week we observed two spectacular divergences. First, single-name equity option activity relative to indices was near all-time, historic extremes. Second, Nasdaq volatility (VXN) traded at a multi-year premium to the CBOE VIX. What is going on here? This post is from August 28, the latest update is here. 

Nasdaq Volatility Trading Very Rich to the S&P 500
With the Nasdaq QQQs up close to 40% this year, there are lots of gains to protect.  Nasdaq vol has been trading very expensive relative to the VIX. Investors are paying up for protection.

Climax Points

Think of bull and bear market capitulation climax points. At the end of a bear’s mauling, dozens if not hundreds of rallies have failed. Long, exhaustive bear markets break the hope and spirit of more and more investors – until the point of maximum capitulation. There is NO one left to sell, think March 2009. Each failed rally delivers deeper losses to the market participants and every one of the “fast money” tourists have run for the hills. All that’s left is an empty meadow, the genesis of a new bull market is born.

Now, let us think of the beast inside a great bull. Dozens if not hundreds of dips have been bought. With each victory, fast money rookies share their battle stories with more and more friends at cocktail parties. Tourists arrive, busload after busload empty into the market, it’s all good, “this is easy.” With each triumphant buy of the dip, investor confidence turns into a dark shade of hubris and more and more capital pours in. Why not, the mad mob is playing with the house’s money. Now think of 100 hedge funds, all up 3% for the month. Why not take 1% of those gains and buy calls on the largest, highest momentum equities. Worst case you end up 2% for the month, best case you deliver 5%, after all, you take home at least 20% of the profits. One conclusion, month-end (Aug 31) / quarter-end (Sept 30) is about to get very interesting.

August 2020

The first 20-ish days of the month were the quietest in a long time. If we look at ten-day, realized equity market volatility, it plunged to nearly 6 vol, 2020’s nadir. On the other hand, this week as month-end drew closer – we experienced two, 1% trading range days with close to forty handle swings in the S&P 500. For sure, someone is monetizing gains.

VIX Up – S&P Up
On Wednesday and Thursday this week, the  Chicago Board Options Exchange’s CBOE Volatility Index (VIX) was more than 5% higher each day, with the S&P 500 up both of those days. How rare is this? Very. We could only find ten days in the last decade with the S&P up 1% with the VIX closing higher. This is especially rare with the market at all-time highs. In a healthy bull market at its best levels, the VIX should be in the low teens, NOT the lows 20s. 

Two Month vs. 8 Month VIX Futures Contracts
One of our 21 Lehman Systemic Risk Indicators are found in the trading spread between the two and 8-month VIX futures options contracts. To keep this as simple as possible, all we are doing here is measuring the cost of protection. How much more expensive is buying short term vs. long term insurance? The above data is mindblowing. This week, the cost to buy the two-month VIX future reached nearly 5 handles more than the eight-month contract. Elephants leave footprints. When large hedge funds need or want to pay-up for short term protection from a market crash that is one thing, BUT the price they are paying this week is VERY extreme with a market at all-time highs. As you can see above, the 2-8 spread is wider today than nearly every financial panic in the last five years. In a healthy, “risk-on” (where risk is being put on) bull market – this spread should be in “contango” – the two-month VIX futures contract should be ALOT cheaper than the 8-month variety. 

 Paying Up for Upside Risk

Over the past few weeks, there has been a massive buyer in the market of Technology upside calls and call spreads across a basket of names including ADBE, AMZN, FB, CRM, MSFT, GOOGL, and NFLX. Our friends at Citadel calculate, over $1 BILLION of premium spent and upwards of $20B in notional through strike – this is arguably some of the largest single stock-flow we’ve seen in years, they noted. We agree someone is playing with House Money, and they’re rolling large.

“The average daily options contracts traded in NDX stocks to rise from ~4mm/day average in April to ~5.5mm/day average in August (a 38% jump in volume).  Given this group of 7 stocks accounts for a ~40% weighting in the NDX, the outsized volatility buying in the single names is having an impact at the Index level.  So why are Vols moving yesterday/today when this call buying has been taking place for weeks?  Yesterday CRM, one of the names we have seen outsized flow, rallied 26% on earnings – a less than ideal outcome for those short volatility from all the call buying.  As the street got trapped being short vol, other names in the basket saw 3-4 standard deviation moves higher as well – yesterday FB rallied 8% (a 3 standard deviation move), NFLX rallied 11% (a 4 standard deviation move), and ADBE rallied 9% (a 3 standard deviation move).  The most natural place to hedge being short single name Tech volatility is through buying NDX volatility.  As such, there has been a flood of NDX volatility buyers with NDX vols up about 4 vol points in 2 trading days. And if NDX volatility is going up, SPX volatility/VIX will eventually go up too.” Citadel

What are the conclusions? What does this tell us about the path forward? What other instances of this occurrence have we seen historically? Email tatiana@thebeartrapsreport.com for our full report. 

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High Impact in the Gulf

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*MARCO ‘ S CENTER MOVING THROUGH THE YUCATAN CHANNEL :NHC
*LAURA STRENGTHENS NEAR PUERTO RICO :NHC

Gulf Disruption, Where is the Trade?

“Over the last decade, at certain inflection points each year we listen to our best relationships in the advanced weather forecasting space and believe a hyperactive hurricane season is on the
way. A possible 18-22 “named” storms/hurricanes compared to the 30-year average of a 13 storm season. The primary reason? Significantly warmer-than-normal Atlantic surface temperatures are with us. This balmy water is pure lighter fluid, propelling storms all the way from the African Sahel toward the Caribbean and beyond. Hurricanes often cause immense property damage; loss of human life and we hope none of these events transpire. However, for market participants, we offer three scenarios and strategies to hedge against encroaching hurricane risk. Should a hurricane enter the Gulf of Mexico, we believe a strategy of long refiners and short (re)insurers presents the best hedge. However, if the beast aims for the Eastern Seaboard, a combination of long natural gas and short (re)insurers provides the best plan of action.”

Bear Traps Report, August 19, 2020, institutional investors, FAs, RIAs, CIOs, and investment professionals, email tatiana@thebeartrapsreport.com for a copy of the investment thesis and the FULL report.

Here Comes the Story of the Hurricane
“The models are showing something unprecedented this morning, two storms make landfall within 24 to 36 hours in essentially the same spot.”

Aaron Carmichael, a meteorologist with the commercial forecaster Maxar.

The Fujiwhara Effect

If both cyclones perform an elegant dance and slip around each other. They would orbit a common center, with Laura likely propelled west-northwest while Marco’s northward progress could be slowed. – WP


 

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The $400B Front Run with the Index Funds Holding the Bag – Part III

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

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Inclusion Games Chapter III

On Friday, Telsa shares climbed very close to $2100 and a $400B market cap – right on the doorstep of passing Johnson & Johnson JNJ. This would put TSLA just behind Buffett’s Berkshire Hathaway at the #8 spot based on equity market capitalization. We’re looking at one colossal whale for the S&P inclusion team to swallow. An unprecedented amount of selling will be required to make room for this monstrosity.

Looking back at major index inclusions in the last decade, especially with a keen eye on the last 12 months of S&P announcements on constituent changes, we think it’s most likely that the S&P will include Tesla TSLA in the upcoming rebalance in the third week of September. If not, the December rebalance would be the next opportunity for S&P to include TSLA.  Most of the smaller S&P inclusions/exclusions coincide with a corporate event. This could be the completion of a takeover or bankruptcy that frees up space for another constituent. However, the larger constituent inclusions are done with a quarterly rebalance. For example, the Teledyne TDY inclusion in June was done with the June rebalance and the Live Nation LYV inclusion in December with the quarter-end rebalance which occurred that month. Note that one of the biggest additions of the last 10 years was Facebook FB, which was announced on December 11, 2013, for the inclusion on December 20, 2013, coinciding with the quarterly rebalance.

Is this a Scam or a Con game? It Smells to High Heaven
We believe it is likely that the Inclusion Committee at S&P waits until mid-September to announce the inclusion of Tesla in the S&P 500. This would coincide with the quarterly rebalance (Sep 21).

Free Float and Influence

Buying pressure from S&P inclusion: There is approximately $3.9T of pure index capital following the S&P 500. These are mostly index funds, including ETFs and mutual funds that mimic the S&P. TSLA market cap is $400B but Musk owns 18.4% of the stock. The free-float market cap is therefore $326B. Musk’s net worth is getting up there, near $90B, nearly $11B more than Warren Buffett, not bad for the car and battery maker. Keep in mind, at his death in 1947, Henry Ford was worth close to $200B in today’s dollars.

We have over 450 buy-side institutional investors on our live Bloomberg Chat, with more than 50 contributors across nearly all asset classes. If you know a portfolio manager that we should add to our live chat, please let us know tatiana@thebeartrapsreport.com .

Why the Big Move this Week?

The recent runup in TSLA stock was more likely to be related to the 5-for-1 stock split. The split takes effect on August 31 for each shareholder of record on Aug. 21. Market participants were likely clamoring into the stock to be shareholders of record for the split.

The S&P index inclusion has been another source of fuel behind the recent squeeze higher in the TSLA stock. According to our estimates, S&P is likely to assign a 1% weight for TSLA in the S&P. That means passive investors, who track the S&P 500, would need to buy $33.8B of TSLA stock. But every $100 increase in TSLA stock, would force another $1.6B of index tracking capital into the stock. This provides all the elements of a potential squeeze, whereby astute speculators front-run the index inclusion announcement, after which passive capital must buy the stock in a relatively short period of time before the rebalance.

Selling Stock In the Hole

For decades, the convertible bond market has been known on Wall St. as the “last saloon.” You know, the one bar opened until 3 or 4am, where patrons desperate for a late-night cocktail can find refuge. Our research shows, frequent visitors to this arena – where borrowing terms are certainly NOT as friendly as others – have gone on to file bankruptcy a very high percentage of the time.

Less than 18 months ago, Tesla sold TSLA stock on the cheap (near $200 in May 2019 vs. $2100 this month), in a desperation convertible bond offering. Which begs the question,  if you sold shares in size at $200, why wouldn´t you do the same at $2100? We think Elon will, he is NO dummy.

Serial Convertible Bond Issuers

SunEdison*
Chesapeake Energy*
Molycorp*
Lehman*
iStar Financial*
Calpine*
Fannie Freddie**
Enron*
Tyco*
Adelphia*
Six Flags*
eToys*
Avaya*
Worldcom*
Tesla

*Went bankrupt. File under ominous. Tesla is one of the very few, VERY few companies that have come “hat in hand” – in desperate need of capital, multiple times to the convertible bond market, and NOT file bankruptcy. 
**conservatorship

“Tesla should fill all orders with an offering that is announced on the inclusion day. It’s been done before. $15BN equity offering MOC pricing should do it. Every bank; $GS, $C, $JPM, and the buyers themselves are way way ahead of you. They are already talking.”

Andy Constan

Buffett’s Ideas to Avoid Disruption

In prescient from, back in 1999, Warren Buffett observed that the growth of indexation would eventually run into sustainability problems in need of solutions.  Buffett made the point if a very large company were to be added to the S&P 500 it could be extremely disruptive. “If you shorted the companies after inclusion into the index you would be surprised at the (good) returns.” After the market distortions, unnatural demand for shares created by the addition to the index is very disruptive. Buffett came up with two solutions. Option #1, Tesla could offer a large number of shares for sale in a secondary offering which would offset the $34B of index demand. Look out below, $TSLA stock would lose 40-50% in our view in this scenario. Option #2, S&P scales the entry in, say 10bps a month or quarter. To us, this is the MOST likely solution. The index funds don’t swallow Tesla in one bite but a dozen nibbles over 12-24 months.

For perspective, Buffett entered the S&P 500 in 2010. Back then Berkshire and was the 21st largest stock in the Index vs. #9 for $TSLA. More of a shocker, BRK/B was valued at just $170B vs. $390B valuation for Tesla on Friday. In terms of inclusion demand for shares: $14B vs. $35B*. The run-up into inclusion was 26% for Buffett v. 822% for Musk.

*Amount passive indexes MUST buy, WSJ Reuters data.

Lessons from Yahoo
Yahoo was added to the S&P 5000 on December 7, 1999. Its market cap was nearly $92B – then it spent the next 15 years between $5B and $50B valuation. 

We have over 450 buy-side institutional investors on our live Bloomberg Chat, with more than 50 contributors across nearly all asset classes. If you know a portfolio manager that we should add to our live chat, please let us know tatiana@thebeartrapsreport.com .

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