Liquidity Cascades: The Culmination of Suppressed Rates, Passive Mandates, & Excessive Risk Taking

Jason Buck of the Mutiny Fund welcomes Corey Hoffstein, co-founder and chief investment officer of Newfound Research, for an in-depth investigation into the pivotal forces that are shaping markets. Hoffstein argues that rate suppression via the Federal Reserve has forced active investors out on the risk curve in order to beat their benchmarks. Meanwhile, the rise of passive investment vehicles, which as Hoffstein writes “know the price of everything but the value of nothing,” create severe market distortions, which heighten volatility. This insufficient liquidity is exacerbated, Hoffstein continues, by the convex hedging pressures of market makers in the options market who buy as the underlying stock goes up and sell as it goes down. The confluence of these factors create phenomena that Hoffstein calls “liquidity cascades,” or rapid melt-up and melt-downs. For Hoffstein’s report, “Liquidity Cascades: The Coordinated Risk of Uncoordinated Market Participants,” click here: Filmed on February 17, 2021.

Key learnings: Hoffstein argues that a portfolio consisting of out-of-the-money puts and calls, combined with an equity portfolio consisting of trend, momentum, and quality factors, is best prepared to handle a market landscape with frequent liquidity cascades. Hoffstein calls this portfolio “The Daedalus Portfolio.”

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