ABSOLUTE Funds

The Absolute Strategies Fund seeks to achieve long-term capital appreciation with an emphasis on absolute returns and low sensitivity to traditional financial market indices. The Fund is made up of external managers and an internal overlay strategy.

The Fund’s external managers vary their exposures over time in order to manage risk and pursue unique long and short opportunities. Absolute’s overlay is used to adjust the overall sensitivity of the portfolio, allowing the Fund to take advantage of the external managers’ security selection skills across a wide range of strategy types without taking on all of the market sensitivity.

It is difficult to know where to start. It's difficult to write consistent sound analysis of markets that are almost entirely driven by central bank money printing or investor speculation. We now need to add some froth that redefines historical financial manias to our analysis. The latest manifestations of speculative fervor seem unbelievable. We'll try to keep it short.

In the last few months, we've seen wild speculation and stock manipulation in real-time by young retail investors who are trying to "take down Wall Street." They used their gambling and gaming skills to create an impressive network of stock-speculators via the Robinhood trading app, Reddit discussion boards, and other primary social media outlets. The unknown revolutionaries created a popular uprising using a steady stream of social media momentum. This quickly caught the attention professional speculators. Stocks that were high in the sky rose 5-10 times in just a few weeks, before plummeting back to reality. Game Stop was the most notable. The Game Stop stock price rose from $20 to $500 in just 10 days. It then fell to $50 a few days later. Overnight riches became the talk of the country after the story made it to every evening news broadcast. Many retail investors were eventually crushed. However, Wall St was not spared by the gamblers. Many were forced to cover short-term losses, including Melvin Capital Management, a rock-star hedge-fund that suffered a 53% loss in January.

Other speculative themes were not as well covered by the media. The boom in the prices and funding for new finance vehicles, also known as "blank check" companies or special purpose acquisition corporations (SPACs), was accompanied by a resurgence in their stock prices. SPACs are a funding shell for unknown future IPOs. Celebrities and athletes in media started promoting new SPACs to earn fees for billions of dollars raised. In addition to a record-breaking year in 2020 and a total of 300 new SPACs raising $100 billion in the first quarter 2021, this was just one of many. Jeremy Grantham, a long-time investor, called SPACs "a license for investors to rip off."

The mania continued in crypto-world, with Bitcoin rising over 300% in October. Dogecoin (DOGE) was the true winner. DOGE was promoted on social media by celebrities and gained instant hero status thanks to a steady stream of DOGE memes. A meme featuring Gene Simmons, Elon Musk and Snoop Dogg was one of the most popular efforts; DOGE grew by approximately 1000% in just two weeks. There was also the rise in popularity of "non-fungible tokens" (NFTs). The NFTs are a way to place a blockchain identifier onto virtual art and other digital collectibles. They are a way to create artificial scarcity, but they have no real value.

Many of these episodes, and the speculative creativity craze, are comparable to 1999, 2007 and 1929. It has never been easier to speculate on anything, any day or night. Penn National, a gaming stock, has seen a nearly 3000% increase in value since mid-March 2020, but then it dropped to a mere 2700% over the last month. This era is easily compared to the 1637 Tulipmania.

The spectacular fall of Bill Hwang's Archegos Capital Management is perhaps the most important signal event. Market cycles have always resulted in single-fund collapses due to over-leverage and complexity. Marg calls are also a common problem. From more recent bubbles, Long-Term Capital as well as Bear Stearns sub-prime funds come to mind. It's difficult to imagine that a $20 billion hedge fund would simply leverage up high-beta stocks, resulting in such a devastating loss of capital. Hwang used swaps to leverage his investment portfolio to the tune of $100 billion. This is a huge sum. To cover the swap and margin debts, several banks suffered huge losses. Investors should be concerned about what might happen if a more severe, volatile market event occurs, considering this implosion occurred in relatively calm market conditions. This is not only a tip of the iceberg event, but it also raises speculative and hedge fund concerns. It causes banks to tighten their margins and speculative borrowing throughout the investment landscape. This is often a sign of what's coming.

It's been a while since value and price mattered. We are now well above the 1929 and 1999 debt and valuation levels. Amazingly, the total U.S. debt exceeds $77 trillion (or $620,000 per household). The liability at the 2000 bubble peak was $260,000 per household, and $475,000. The vast majority of Americans don't know what these outdated measures actually mean. Professional investors may know what these measures mean, but they don't pay as much attention. It has become almost meaningless to discuss relative valuation statistics at the moment (see chart below, if you are curious). Based on anecdotal evidence of speculation and greed, we can only judge the extent of the bubble environment. These are all indicators that we may be approaching what could be referred to as the end of the larger financial cycle over the past 20+ years. Technically, this means that we are approaching the end of a market Supercycle, which dates back to many decades.

We are keeping our portfolio positioning simple due to the above. The end of this market cycle may be very significant. We think the S&P 500 could reverse down below March 2020 lows and possibly lower. This would result in market losses of at most 50%+. The market has the potential to continue its meltdown, even though it was sparked by the recent stimulus checks. Many investors have tried their luck in small spec stocks, but this money could be used to invest again in large-cap stocks. We have been patient in our position by keeping a large net short position on market indices, paired with shorter-term upside call options. This gives the portfolio a cushion against further speculative impulses and preserves our long-term positioning. We will continue to hold an aggressive short position in the event of a bear market.