Archegos Capital Liquidity Crisis - How will this affect your portfolio?

The big news today was a liquidity crisis at hedge fund Archegos Capital, run by trader Bill Hwang. Credit Suisse and Nomura saw their shares decline 11.50% and 14.20%, respectively, after news broke that each would likely experience large losses as counterparties to Archegos’ leveraged trades.

Archegos used derivatives to build large positions in ViacomCBS and other companies. The fund used derivatives instead of simply buying shares for two reasons: It helped the fund leverage up more easily, and also prevented Archegos from having to disclose its holdings in SEC filings.

While it’s still unclear what Archegos’ trading strategies were or exactly what the fallout will be from this episode, there are a few lessons you can take away both for your own trading and for your market outlook going forward.

Market Outlook

The biggest question investors are asking today is if Archegos’ downfall signals more trouble to come. Are several other hedge funds over-leveraged? If so, a downfall in stocks or liquidity issues at one or two large banks could cause a domino effect of margin calls and forced liquidations. 

That’s a difficult question to answer. Especially with obscure derivatives used by hedge funds, it’s difficult for any outsider to know how exposed funds are to different risks. 

For retail investors, the best course of action going forward is to be on the lookout for other signs of systematic risk. This could include large, unexplained downfalls in individual stocks like we saw with ViacomCBS last week.

We’ve known for several months that signs of excess are plentiful. We’ve seen retail investors take outsized risks to chase unbelievable gains in stocks like Penn, GameStop, AMC, and others; Nearly every company that possibly could is going public and experiencing 50%+ gains on IPO day; and a much larger percentage of the population is talking about the stock market than normal.

While these events don’t necessarily mean a correction is coming, they are signs of a bubble and should be monitored. When dozens of stocks are up 1,000%+ in a year, savvy retail investors will recognize that the party won’t last forever.

Takeaways for your own trading

This leads me to the lessons you can take away for your own portfolio management. We caution readers about the dangers of leverage. Yes, you can load up on call options or use 2x margin to chase a quick gain on a hot stock, but investors who routinely do that eventually get wiped out.

Smart investors take risks, but only risks that they will be able to safely recover from if the trade goes poorly. If you put 50% of your account in short-term options on a hot stock, you may look like a genius and make a 300% return in a day. But you also might lose 50% and set yourself back years.

Look at Archegos. They’ve been going along for years, making great returns and pocketing large bonuses. We still have yet to see how much their portfolio benefited from leverage, but in recent weeks, their leverage was clearly too high. They made great returns for a while, but now the game is over and they’re headed to zero.

Would you rather miss out on the most of the 500% quick profit trades but stay in the game for decades, or hit a couple of big ones but get knocked out of the game within a few years?

Stock Picking Service

For those who don’t know, we launched a paid stock picking service last week. The subscription service will be a way for me to highlight my top ideas for paying subscribers. As a background I worked at a hedge fund for several years and achieved outsized returns investing in the smallest, most obscure companies on the public market. The research I will be providing will be institutional quality. In addition, every stock I highlight, I will also be invested in.

The plan is to write-up 1-2 high quality, and actionable stock picks per month that have potential to generate high alpha for subscribers. For the month of March we have written up two ideas.

The first idea has crashed on zero news since I dropped the research report. I have added substantially to my position as I think the company is in play to be sold. There is more risk with this idea that I typically like to deal with (total capital loss from bankruptcy) but if the company is sold you could 2-4x your money. I sized my position accordingly where if I am wrong it will be a small speedbump in the road, but if I am right I will make a lot of money.

The second idea is up 15% since I have written it up. I still believe this stock could potentially double or more if the management team executes. This company should benefit from the gradual reopening of the economy, and if they can keep costs down, they will drive a substantial amount of free cash flow.

For the month of April I will be highlighting another retail investment that I think could go up 200% if the management team executes and also two movie theatre stocks Wall Street has forgotten about, and frankly are in a way better position than AMC over the long-term. The small retail stock with implied upside of 200% (give or take) should be out by this weekend at the latest.

Thanks for your support and feel free to reach out anytime.