In today’s Money Morning…a rout that wiped US$35 billion from markets in span of a few days…shady funds and dodgy deals…why shadow banking matters to you…and more…
Do you know what day it is?
Why it’s April Fools’ Day, of course.
A day to poke fun at and make light of anyone and everyone.
But, if you’ve been keeping track of a selective market meltdown in the US this week, you’ll know that April Fools came early this year. Because as the collapse of Archegos Capital Management has come to light, it is clear that the real fools are all on Wall Street…
If you have no idea what I’m talking about, well, let me explain.
See, over the past week or so, a few very large stocks have taken a massive dive in their share prices. Here are just a few examples:
- ViacomCBS Corporation [NASDAQ:VIAC] — down 51%
- GSX Techedu Inc [NYSE:GSX] — down 61%
- Discovery Communications Inc [NASDAQ:DISCA] — down 41%
- Tencent Music Entertainment Group [NYSE:TME] — down 34%
Quite the extensive sell-off for a list of multibillion-dollar companies.
A rout that wiped US$35 billion from markets in span of a few days.
Which is precisely why people started asking questions — because you don’t see this kind of extreme volatility without some sort of dramatic catalyst.
And dramatic is an understatement.
Because the reason for this huge sell-off was the collapse of a hedge fund.
Shady funds and dodgy deals
Archegos Capital Management is the entity at the heart of this costly farce. A ‘family office’ that is run by a former hedge fund manager known as Bill Hwang.
Now, I don’t have time to go over all of Hwang’s past. But all you really need to know is that he has been previously charged by the SEC with insider trading and stock manipulation. Paying a ‘small’ fine of US$44 million for his misdeeds.
In other words, he has a shady past and got caught out.
That certainly didn’t deter him though. As Hwang went on to found Archegos — a fund that specialised in complex and convoluted strategies.
Total return swaps (TRS) and contracts for difference (CFDs) are just two of the ways in which Archegos aimed to make returns on its US$10 billion worth of capital. Leveraged instruments that extrapolated Hwang’s total market exposure closer to US$50 billion!
Meaning that he was in over his head and trading more money than he actually had.
And last Friday, when US markets took an unexpectedly severe tumble, it was this leverage that exacerbated the fall. With Archegos’ brokers — including Goldman Sachs and Credit Suisse — slapping the fund with a margin call. Forcing Hwang to round up some more cash or sell his stock positions.
As you’ve probably already guessed, Hwang was forced to sell.
Leading to the aforementioned US$35 billion sell-off.
As for Archegos, well they’ve gone into liquidation. A result that will see this fund become just another case study in poor risk management. Not to mention the estimated cost of US$10 billion to the banks and creditors that loaned them money.
A timely reminder of just how opaque this shadow banking underbelly is. Financial systems that have the power to erode retail investor wealth even when you, or the companies you’re investing in, have likely done nothing wrong.
And the scariest thing is that Archegos is likely just the tip of the iceberg. With a whole swath of other undisclosed and unregulated funds likely doing exactly the same thing Archegos did.
Why shadow banking matters to you
Again, the biggest issue with this whole story is that no one could see it coming.
As Dennis Kelleher told Reuters:
‘The markets had no idea how big the (Archegos) positions were, in what stocks, how much was going to be sold, who owned it, what the leverage was.
‘That’s because the shadow banking system remains non-transparent in material respects and much larger than it was in 2008.’
It’s an issue that continues to plague the integrity of the free market. An issue that is not a new phenomenon either. And yet we — the retail investors — have to continue to endure its ramifications.
Furthermore, chances are we will see another GFC-like event. With the US Financial Stability Oversight Council (FSOC) reporting that hedge fund assets totaled US$2.9 trillion last year. Yet gross assets, when taking leverage into account, more than doubled this figure to US$6.3 trillion. Data that doesn’t even include unregulated family offices like Archegos…
So, if all that leverage is jeopardised, expect a market backlash.
Which is precisely why I personally will always advocate for small-cap stocks. Because while they are certainly volatile, they are far less likely to be implicated in some shadow banking scheme. Much too illiquid to be traded by these billion-dollar fund managers and their leveraged bets.
More importantly though, it is why we should all be advocating for a better and more transparent system. One that doesn’t hide the financial misdeeds of unscrupulous actors.
And the only way we’re likely going to get this kind of system is through the blockchain.
An immutable record that can track every transaction or exchange ever made. All while still preserving an individual’s or organisation’s privacy.
The perfect solution to bring shadow banking into the spotlight once and for all.
Because if we don’t, it is likely only a matter of time before we see the next big crash triggered by yet another case of out-of-control leverage. Greed that places risk on all of us, and yet, rewards only a select few.
After all, I think I can speak for us all when I say we’re sick of footing the bill for these fools.
Editor, Money Morning
P.S: Promising Small-Cap Stocks: Market expert Ryan Clarkson-Ledward reveals why these four undervalued stocks could potentially soar in 2021. Click here to learn more.