Archegos and the efficient markets hypothesis

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Hello. Wall Street rallied yesterday, then faded. Sentiment is lackluster, and surprisingly strong results from Facebook (still boycotting “Meta” here) after the bell seem unlikely to change that. But readers have suggested many good reasons to be joyful: it’s spring, Trump is out of the White House, and Russia is losing. Let them come. Email me: [email protected]

Archegos and the efficient markets hypothesis

According to an SEC complaint filed yesterday, Bill Hwang and three of his Archegos colleagues did the following:

  1. Bought huge amounts of stocks, in very concentrated positions, mostly using money borrowed from investment banks

  2. Bought tons more of those same stocks indirectly, using total return swaps (again with borrowed money), avoiding public disclosure of his huge, concentrated positions

  3. Continuing to buy those same stocks, directly and indirectly, in manipulative ways that supported their prices

  4. Told lies to get more loans from their banks, which would have refused to provide funding had they known how huge and concentrated Archegos positions were

Then, in the spring of last year, the price of certain stocks fell sharply, there were margin calls and everything exploded.

Like Matt Levine did underline, the most interesting thing about this story, as told by the SEC, is not that some people in finance are liars or that the disclosure rules for swaps could be much better. Interestingly, there is no discernible way that this “fraudulent scheme” (SEC term) could have worked out well for Bill Hwang or his colleagues.

Could the whole operation have been a “pump and dump” program on a scale previously unimaginable? Consider the size of Archegos’ positions in March of last year, right:

Archegos held those $97 billion in shares, along with an additional $63 billion in other assorted positions, with a leverage ratio of 344%, according to the complaint. That is, for every dollar invested, the fund has $3.44 of bank money to back those positions. Concentrate? At the end of March 2022, the company’s exposures amounted to half or more of the outstanding shares of four of the stocks listed above.

I argue that there can’t be enough buyers of these stocks at these volumes that they can be dumped, even cautiously, without damaging prices, triggering margin calls and bringing down the whole front. If any merchants disagree, feel free to email me.

Levine floated the idea that Hwang and his team may have thought the stocks were actually worth the prices their trading would have (allegedly) forced them to. It’s possible, although the stocks they picked (did you look at Viacom’s financial statements last year?) make me a bit skeptical.

But assuming that to be true only makes the four Archegos a little less insane. One thing you learn about your second day as a stock picker is that when you think a stock is grossly mispriced, you’re most often wrong. If you’re only wrong sometimes, you’re smart and you get rich. But because the company’s bets were huge, concentrated and leveraged, they had to be right almost all the time if their trading strategy was going to pan out.

The standard way to explain how people lock themselves into patently unsustainable patterns is that they do it a little at a time. They tell one little lie and then have to tell another to cover up that one, and soon they’re living in a wavering tower of lies. You could apply this theory to Bernard Madoff, for example, and maybe even Enron. But that doesn’t work with Archegos, because these guys grew their portfolio incredibly fast. According to the complaint, gross exposure increased from $10 billion to $160 billion in one year.

Hwang isn’t just (allegedly) dishonest. He is also (apparently) crazy. And he brought at least three other people with him on his trip to Bonkersville.

Crazy people exist. It’s not new. Nor does it excuse the alleged dishonesty of the Archegos team, or the notable stupidity banks that lent money to the company amid various red flags. But whichever version of the efficient market hypothesis you subscribe to, it must incorporate the fact that one or more lunatics can work at a seemingly respectable company, control a huge amount of capital, and, for better or for the worst, being on the other. side of the transaction you are about to make.

China’s ‘impossible trilemma’

China’s zero Covid approach could cause serious damage to its economy and therefore to that of the world. Craig Botham, China economist at Pantheon Macro, pointed out that the country’s economic policy response to its own pandemic policy seems to be in circles:

The State Council on Monday called for the implementation of tax cuts, rebates and fee reductions already announced to support SMEs and manufacturers, including a further reduction in unemployment premiums. These cuts would have been implemented from April, which points to fiscal transmission problems. ..

President Xi [Jinping], speaking at the meeting of the Central Committee for Financial and Economic Affairs, on Tuesday called for efforts to boost infrastructure investment. This confirms our expectations that the government will continue to rely on this favored stimulus tool, rather than capitulating to zero-Covid or the housing sector crackdown. . .

This amounts to the “impossible trilemma” of zero Covid, 5.5% growth and stable debt to GDP

China cannot lock in, hit its growth target, and stop buying growth with debt at the same time (in the long run, the latter two may be incompatible even without the former). The recognition that something has to give resonates throughout an excellent story by my FT colleagues Sun Yu and Tom Mitchell:

Chinese regulators led by Vice Premier Liu He fear the government is underestimating the economic impact of its crackdown on the property sector and Covid-19 shutdowns. ..

Two other vice-premiers – Han Zheng and Hu Chunhua – have sided with the Housing Ministry to keep pressure on developers. ..

Faced with China’s worst economic conditions and outlook since at least the start of the pandemic, financial policymakers have responded in recent weeks with only modest easing measures. Their reluctance stems in part from fears that stronger stimulus measures will have only limited effectiveness, particularly in regions immobilized by Covid lockdowns.

Can Beijing boost exports and growth, dodging the trilemma, weakening the renminbi? Probably not, for reasons Unhedged friend Michael Pettis pointed out on Alphaville. A weaker currency helps manufacturers, but also raises the cost of living, weakening domestic consumption – something China needs more of, not less of, if it is to grow sustainably.

Which horn of the dilemma do you think the government will choose? My money, like Botham’s, says unproductive debt-financed investments will increase before long.

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