Recycling the Playbook

When offering my opinions about the market – whether solicited or not — I’ve found myself utilizing a phrase all too often: investors are using the 2020-2021 playbook. 

It is understandable why people would utilize a set of strategies that worked brilliantly for them during one of the great bull runs in history, especially when they seem to be working well once again.  But one must also wonder whether the playing field has changed.  A playbook that worked exceptionally well under one set of rules is hardly guaranteed to have long-term success when the rules of the game have changed.  During much of 2020-21, both monetary and fiscal policies were relentlessly accommodative and the worst of the Covid crisis was disappearing in the rear view mirror.  Now fiscal stimulus is largely behind us, and the monetary policy debate is not whether the Fed will turn restrictive but instead whether it will push us into a recession.  The underlying factors pushing risk assets higher have reversed.

One of the most basic elements of the classic playbook is perhaps the least controversial: buying megacap tech stocks on dips.  Buy-the-dip is basic trading strategy.  Buy low, sell high.  It worked almost perfectly during the period when the Fed was pumping liquidity into the system and stimulus payments were coming to many.  When those stopped, so did the foolproof nature of that strategy.

Yet by late June it was clear that equity markets were oversold, something we noted as a logical reason for a bounce.  A month ago we noted, “It would not surprise me in the least if the next move was higher.”  If you think broad markets are due for a bounce, of course the most heavily weighted stocks would be a logical place to look.  They were among the leaders when we began to lift off the lows and continued to lead when their most recent earnings were better than feared.  Buying market darlings on declines is a strategy that has tended to work well over time.

Amidst the recent strength, however, some other elements of the old playbook have been dusted off.  We recently wrote about the return of meme stocks, noting that the move in AMTD Digital (HKD) had many of the hallmarks of the meme stock craze but a dissimilar genesis.  We didn’t comment about the even quicker round-trip in Magic Global Empire Ltd. (MEGL), which was one of the most actively traded stocks at IBKR last week.  To recap, it IPO’d at $4, closed the next day at $97 after touching $235.95, and closed just above $10 only two days later.  The ferocity of some of these moves is remarkable, though there is much less follow-through than we saw in the original frenzy of January 2021.  As we noted last week, “We noted during a previous meme stock bloom that the half-life of these flourishes seems to be shrinking.  If you participate in these period rallies and trade them profitably, congratulations.  If you notice the eruptions only after they are in full flourish, please be careful.”  This was a profitable play for many and treacherous for many more.  But it has returned once again, only with shorter opportunities for outsized profits.

Last Friday’s trading also drew from the bull market playbook.  We have hopefully all heard the adage “don’t short a dull tape.”  The logic behind most of these old adages is sound.  Markets generally rise over time, so if there is a lack of catalysts and light volume it is more likely that stocks will rise rather than fall.  But a new tactic arose during the recent bull market.  As traders became more enamored with call options, and noticed that if enough of them bought calls in a particular stock, it could eventually push the underlying stock higher.  The same applies even for flagship ETFs.  A summer Friday qualifies as a “dull tape”, and it was clear that traders were buying at-money or slightly out-of-the-money calls in expiring SPY options.  Because of the short time until expiration, they tend to trade at sub-dollar prices by Friday afternoon.  Once SPY began to lift, pushing calls that were one dollar out of the money into the money, many of those traders rolled those calls into the next higher strike, usually just a dollar higher.  It relies on a combination of momentum, FOMO, and gamma.  In April 2021 we outlined how this strategy worked, and we continued to see it reappear on otherwise placid Fridays during that year.  And thus it returned last Friday.

Finally, in a piece of news that just screams “old playbook”, we learned today that Flow, the latest startup by Adam Neumann of WeWork infamy, received a $350 million investment from Andreessen Horowitz.  I’ll leave it to others to sort out the specific ramifications, but the déjà vu element should be quite obvious.

For now, I hesitate to advise traders to abandon a once-useful playbook that worked so well for so long and is working well once again.  But it is crucial to understand why those strategies were successful in the past – and now the present – and examine whether they remain the best set of tactics for the current economic climate.