MAX WIETHE: Hello, everyone. Welcome to the Real Vision Daily Briefing. It is Monday, January 4th at 4pm just after market close here in New York. I am joined by Mike Green of Logica Capital today. Before I talk with Mike, let us kick it over to Haley for today's stories.
HALEY DRAZNIN: Hey Max, Happy New Year. Investors are gearing up for a turbocharged 2021. One evidence, just look at the price of Bitcoin. Only a few weeks ago, it smashed through that 20,000 mark. This weekend, it is soared above 30,000 for the first time ever. After setting a new record above 34,000 on Sunday just yesterday, prices dropped sharply to around 27,000 before recovering to around 31,000 on Monday, but after closing out 2020 with gains of more than 300%, a growing number of traders searching for yield in a low interest rate environment are giving Bitcoin another look.
This hunt for returns and unbridled optimism about the future is not just powering Bitcoin's ascent, investors are bringing that same energy into the 2021 capital markets. Today, we saw however, stocks tumbled on the first trading day of the year. The Dow, S&P 500 and NASDAQ were all down because of this grim pandemic outlook with the spread of the new COVID-19 variants. Hospitalizations in the US jumped to a record high on a Sunday and governments across Europe are extending lockdowns to try to slow the spread of the virus.
Also, traders are jittery ahead of tomorrow's runoff elections in Georgia in the US, which could determine whether Democrats have control of Congress to push President Elect Joe Biden's agenda. Among the individual stocks if we look at it a little closer, Coca-Cola shares fell. The pandemic will of course continue to limit major public events in early 2021, and dining at restaurants, potentially hurting demand for products like Coca-Cola beverages.
Airline stocks, another group that has been hit hard by the pandemic also fell. We saw American Airlines and Delta both losing more than 3%. Hotel operators also retreated. We saw losses with Hilton and Marriott. As investors broadly withdrew from stocks. We saw the VIX surge today to levels we have not seen since June, of course, signaling caution.
Overall, though, I think there will be three forces that should keep powering assets like stocks through 2021, at least the first two quarters, and that is the continued positive impact of stimulus, the distribution of COVID-19 vaccines, and the growing ease with which companies can raise capital on public markets, like we saw with Airbnb and DoorDash just a few weeks ago. In short, the big trends that defines the end of 2020 when stocks reached record highs are expected to have some staying power, but we will keep that close eye on the VIX, especially today. Back to you, Max.
MAX WIETHE: Thanks, Haley. Mike, thank you so much for joining us on the Real Vision Daily Briefing today.
MIKE GREEN: It is great to be back, Max.
MAX WIETHE: All right. You and I spoke right before everybody turned off for the holidays on December 17th, and that piece actually aired today. It was not exactly the most eventful holiday period for markets, unlike some recent holiday periods that we have had but it is important to just take assessment of anything that may have happened at that time that you think is important to update viewers on before we talk about today's action.
MIKE GREEN: The only thing that really would catch anyone's attention is the extraordinary price appreciation of Bitcoin. We have talked about that, that is obviously a favorite topic on Real Vision. It is very interesting to watch and it reminds me very much-- and I have said this previously, that the environment that we are in is very end of 1999, beginning of 2000 framework, people have become extremely convinced of the idea that balance sheet expansion or M1 growth or anything else is explaining the behavior that we are seeing. I remain skeptical of that, but that certainly seems to be the narrative that is broadly adopted at this point.
MAX WIETHE: Okay, we will not focus too much on those big picture narratives in this interview, we are going to be a little bit more short term focus, but I said, to me as a layman, somebody who has never sat in your shoes that today was an interesting day. You asked me why did you think today was interesting, and it led me to believe that that you did not think today was all that interesting. You even said you expected the selloff that we had. Why were you expecting a selloff, and did you think that today was interesting at all?
MIKE GREEN: Well, I think the easiest-- no, I do not think today was particularly interesting. I think by far, the most important thing that happened broadly is that people took profits. They did not want to pay taxes in 2020. They did not want to realize those gains in 2020. A significant number of individuals or taxable institutions likely took some profits today. I would suggest that we saw that behavior, we started off the day positive futures drifted higher, that is very common.
That is very common to occur, it is effectively a function of hedging activity that is occurring overseas, a significant quantity of short volatility that is being hedged by the dealer community where they have either sold calls, and those positions, naturally hedged into a higher delta, as you have been pushed higher. That influenced the behavior of the futures, and then once you went live, the need to take some profits and take some risk off probably dominated.
I would suggest that we saw that broadly across assets, whether that was Bitcoin, or whether that was oil, or various forms of energy, some of the metals, today was definitely one of those days that you look at even the soft commodities that remained positive, things like corn, have some pretty interesting potential reversal tops. Pretty aggressive spike upwards, followed by reversal. It is going to be interesting to see how this plays out.
MAX WIETHE: Okay, and does this sort of profit taking usually, is it a one day affair, or is this something that takes place over the course of a week, a few weeks to start the year when you have so many assets in the green from the previous year?
MIKE GREEN: When you say typical, I do not think anything coming out of 2020 could be viewed as typical. I do think it is important to distinguish, but if you go back and you look at the transition from 1999 to 2000, for example, you saw a very, very similar dynamic where profits that had been generated and accrued in the late stages of 1999, people held on uncomfortable with their risk levels into early 2000 and took some profits in the first couple of days. There is certainly no guarantee that this is going to play out in the same way, but having taken those profits, they then found themselves trying to add back to their positions, to buy back into either related names or into other names that they might find attractive and launch the process that basically carried us through March of 2000.
MAX WIETHE: With that being said, what are you expecting over the course of-- let us just keep it at this week? What are the sorts of things you would be watching for? Then what are maybe the points that could tell you that you need to be looking somewhere else?
MIKE GREEN: The quick answer is I do not trade on weekly timeframes. I do not know what is going to happen over the next week, but my expectation is that sometime over the next couple of days, inclusive of today, is ultimately going to be a buying opportunity as we head into what I think is going to be a more substantial correction occurring later towards the end of this first quarter. That would be my bias, and there is a number of factors that are influencing markets, people tended to get a little bit too excited about the reflation narrative.
I know a number of investors are starting to begin to talk about the dynamics of some regulatory changes that were embedded in the Secure Act that influence the dynamics of 401Ks and the contribution, particularly from small businesses, effectively facilitating multi-employer plans for small businesses that makes it very attractive to generate fairly significant withholdings into 2021. Those are likely going to become significant players, but I do think the rollout and implementation of that is going to take a couple of days at minimum before the money starts flowing in.
The presence of that, taking some profits, creating those conditions, that was to be expected. The challenge that we continue to have is that the markets are increasingly inelastic. People hear me use that word and it just simply means you generate more of an increase in dollar value than money actually comes into the market. If you think about it in a VC term, there is a pre-money valuation and a post money valuation, you add dollars to the valuation. Theoretically, the dollars that came in are the only thing that has influenced the value of the business.
It is very similar in a stock market. If you insert in another dollar, theoretically, the value of the stock market should go up by $1, but because of inelasticity and frictions in the process of doing that your inability to find somebody who is willing to sell you that incremental dollar, which is enhanced by the dynamics of passive that people have heard me talk about until they are probably sick of it. That phenomenon creates a market that is increasingly inelastic. My expectation is those who took profits today are going to be surprised at how hard it is to get their positions back in this market.
MAX WIETHE: Is it quantifiable, like each dollar in is $2 up or $3 up, is there a multiplier effect that you can quantify this to, or does it differ from time period of time period?
MIKE GREEN: I believe that that number is changeable. There is actually some interesting academic research that came out last year, you have heard me refer to the work of Gabaix and Koijen. Gabaix is at Harvard Koijen is at University of Chicago. They have something they call the inelastic market hypothesis, and their assessment is that that number is around five. $5 of market value created for each dollar that goes into the markets. My assessment is that that is both overly simplistic, because it captures a period of time, and I think that elasticity changes.
The second thing that I would suggest is that it varies by investors, which they allude to specifically in the abstract of their paper. They identified that a significant component of financial market fluctuations is a function of different types of investors. Those who have followed my work know that passive investors are incredibly inflexible in their behaviors. As a result, they should generate higher inelasticity, my work suggests that their elasticity is multiples of-- the impact of the dollar flowing into passive is multiples of the dollar flowing into active.
MAX WIETHE: Okay, because of their price insensitivity. Say somebody who likes to buy distressed assets, this effect will be less pronounced because they are already buying when the sellers are available.
MIKE GREEN: Correct, and we hear this all the time. We know this is true. When funds go out and raise a bunch of money for a distressed debt, it becomes very difficult to buy distressed debt, because as they try to deploy the capital that they have raised, the prices go up. Inevitably, you end up with a chasing phenomenon where they decide, well, $1 higher, $2 higher, $5 higher is no longer that expensive in the context of all the prices going up. It turns into a relative value game very quickly.
We are familiar with that within the macro space. We tend not to think about it too much as it relates to stock markets. Because the whole theory of something like the efficient market hypothesis is that markets are highly elastic. In other words, $1 in has almost no impact whatsoever on the value of the market in total, those theories are almost laughably dismissible at this point.
MAX WIETHE: Well, some of what you said seems to be relatively bullish in the short term, as you think that these flows will continue and clearly inelasticity should push us higher, but you used a phrase a more sizable or I might be misrepresenting words, but you said that you expect to see some pullback or correction in the first quarter. What does that pullback or correction look like for you, and what are the indicators that you are going to be watching for trying to figure out when it may actually occur?
MIKE GREEN: Well, for me personally, as you know, I have been on a keto diet. I am thinking like 255 can go to 240 is the pullback that I am hoping for. That is in the first quarter, most of it will be probably towards the end. On a more markets oriented observation, I would suggest that there are a number of factors that begin to play in this first quarter. One of those is the dynamics of tax.
My sense or expectation is that there are many investors who are relatively new to the markets who participated through "free" option trading and are not necessarily aware that options are treated as ordinary income in short term gains. The withholdings that will be required for the gains against options are significantly greater than the holdings that would be required under a normal condition. There is also many investors who have opened their first accounts, and as a result, I just would not expect them to have done this. This was a feature from 2000.
You go back, and you search the newspapers to read lots of stories about employees in the dot-com space, or those who made a ton of money on options suddenly discovering that they had bought a house but forgotten to withhold, to keep enough money to the side to pay taxes on it on the sale of the options. I would suggest that we have a fairly significant risk of that. The second thing is that our friends, the required minimum distributions return this year for the first time since 2018.
The dynamics of the Trump tax cuts, eliminated those for 2019 and 2020. They now return for the first time in 2021. This first quarter should see an element of required distributions from the retirement accounts of those who are now turning 72.
MAX WIETHE: People will be caught upside by their tax bills, and then will have required minimum distributions returning. Is there anything else that you think structurally could be setting us up for a correction?
MIKE GREEN: There is a tremendous amount of space a number of assets that again, I think people have adopted a narrative. It will be interesting to see how they react to the need to sell. That same inelasticity, that works to the top side that when that dollar comes in, causes markets to rise dramatically. You can almost rank markets by their inelasticity. Things like Bitcoin are off the charts, things like passive investments in the United States, there is probably somewhere in between, and active managers who take in money and do not necessarily have to deploy it at all are going to be at the lower end of the scale.
If money is coming out of assets, in order to pay taxes, that money is effectively flowing into the government coffers. That same inelasticity can turn around and fly back in your face, and prices could correct quite sharply.
MAX WIETHE: Quite sharply, so you think that this will be more of a March style correction, or we had some mini corrections here and there, but they were they were pretty rapid over the course of 2020. Is that the new normal, to steal a popular phrase?
MIKE GREEN: I think the new normal is markets that have a disproportionate drift to the top side and extreme inelasticity to the downside. In other words, corrections happen with the speed and ferocity that we are not historically used to. I continue to think that March 2020 is not the outlier event.
MAX WIETHE: All right. Well, we have not really touched on anything beyond the equity markets, is there anything cross asset that you are focused on, commodities, bonds, that you think is important for investors to pay attention to, even if they are just equity investors?
MIKE GREEN: It is premature to know, I do think that there is some really interesting price behavior around assets like the soft commodities, or many of the hard commodities. They have been on a tremendous run, those who listened to my December Outlook are aware that I think that those are mostly tied to supply disruptions. I see very little evidence of excess demand. That could be wrong, but I think the broad narrative that people have attached to it, this idea that prices are going to take off and run to the right, on the idea that Fed printer goes brrr and oh, is this not obvious and simple?
I could very well be overthinking this, but the reality is that even the dramatic price increases that we have seen in things like lumber, where lumber prices have roughly tripled over the past year, the impact that that has on a home package, for example, Lenore I think just came out with some data on this. Their observation was the impact of the increase in lumber prices had taken the lumber set for their typical home from 35,000 to 70,000. Now, that is a huge increase. That is a dramatic increase, but it is not as much as raw lumber itself.
Among other things, that highlights the value added component. When you are cutting lumber to lengths, you are dealing with specific components. The generic lumber contract does not capture that. As a result, it shows greater price volatility. The price of corn has gone from 300 to 485 as of the close today. The impact that that has on a box of Frosted Flakes is zero. It is roughly two cents. The impact, like when you think about that Lenore announcement, you are now talking about the average new house cost going somewhere from 350,000 to 370,000 because Lenore is going to eat some of that in their margin.
They are not going to be able to pass 100% of that through, that increase in price is going to reduce the demand somewhat. The demand for housing is not perfectly inelastic. If prices go up, it will result in reductions in demand. You are actually setting up the conditions with higher prices that both stimulate additional supply and reduce the demand. That tends to be where these things work out. I continue to highlight for people that exactly this activity happened in early 2018.
Exactly this activity happened off of the recovery from February 2016, the early dynamics there and prices corrected quite sharply to the downside. I continue to have as my base case that there is going to be some significant challenges to the reflation narrative.
MAX WIETHE: Compare this time to other periods in the market, is there a specific market period that this most reminds you of at this point in time?
MIKE GREEN: Well, look, I think one of the hardest things to ever do is to say