In 2017, Investors Can Either Buy Bubbles or Be Left Far Behind

  • Equal-weighted ‘Bubblicious’ portfolio up more than 120% YTD
  • Chinese real estate, short volatility, duration all rewarded
Tim Graf, head of EMEA macro strategy at State Street, talks about asset bubbles.

The best way to crush the crowd in 2017? Buy the things everyone insisted would never keep going up.

A portfolio stuffed with allegedly over-inflated assets would have returned more than 120 percent so far in 2017, trouncing the S&P 500 Index and underscoring the challenge for investors facing a plethora of pricey securities.

The hypothetical ‘Bubblicious’ portfolio includes Chinese real estate and internet names, a pair of U.S. tech behemoths, a cryptocurrency fund, the ETF industry, bonds that mature decades from now, and a dash of short volatility bets just to make things more interesting.

The out-performance is a testament to the momentum mania prevalent in today’s markets, a dynamic which has prompted the likes of Greenlight Capital’s David Einhorn, Goldman Sachs Group Inc., and Sanford C Bernstein & Co. LLC to mull whether value investing is in the midst of an existential crisis given ultra-low interest rates and abundant liquidity.

With the benefit of hindsight, it’s easy -- and somewhat tautological -- to suggest that investors would have done better had they bought the things that went parabolic. But at any point in 2017, getting into many of these names would have proved a nail-biting endeavor.

Consider the elements that comprise this equal-weighted Bubblicious portfolio:

  • Sunac China Holdings Ltd.: perhaps the poster child of the real-estate frenzy in the world’s second-largest economy, this company’s aggressive acquisition strategy has been met with raised eyebrows among regulators at a time when China is trying to rein in the country’s financial risk.
  • Tencent Holdings Ltd.: A 2,600 percent rise in the past decade? Tencent is the leader of the pack when it comes to Asian tech stocks that have made the sector the biggest component of the MSCI Asia Pacific Index for the first time since the internet bubble.
  • Tesla Inc. and Netflix Inc.: two U.S. tech companies that have both been branded with the b-word by hedge fund manager Einhorn.
  • VelocityShares Daily Inverse VIX Short-Term ETN, ticker XIV: this exchange-traded note is a proxy for the presumed “short volatility” bubble that’s seen investors bet billions of dollars on the prospect of not much happening in markets.
  • Bitcoin Investment Trust, ticker GBTC: the cryptocurrency fund that typically trades at a substantial premium to its net asset value. Bitcoin itself has been called a bubble by bank CEOs including JP Morgan Chase & Co.’s Jamie Dimon, ethereum co-founder Joseph Lubin and many more.
  • ETF Industry Exposure & Financial Services ETF, ticker TETF: this meta exchange-traded product holds a basket of firms poised to benefit the most from the explosion in ETFs -- a proxy for the “passive bubble.”
  • Lots of long bonds: The iShares 20+ Year Treasury Bond ETF has enjoyed $1.8 billion worth of inflows in a year that saw former Federal Reserve Chair Alan Greenspan warn of a massive bubble in the space. Meanwhile yields on German sovereign debt maturing in 2048 and Japanese bonds maturing in 2050 have dipped ever lower, sealing the latter’s reputation as a ‘widow maker’ for frustrated shorts. The portfolio also includes the infamous Argentinian century bond.

Outside of Sunac, the debt-laden Chinese developer, equities in this hypothetical portfolio have traded at valuations many investors would consider prohibitively expensive. Trailing and forward price-to-earnings ratios (in the event that the companies even have earnings to speak of) have been multiples of their respective benchmarks. By now, even Sunac considerably outstrips the Hang Seng Index on both metrics.

For developed-market sovereign debt, generating returns has meant relying on capital appreciation rather than collecting interest in light of yields at near-record lows. In the case of Argentina, buyers had to grit their teeth and cross their fingers, hoping that a country with a long history of defaults would prove credit worthy for longer than actuarial tables might suggest. And then there’s bitcoin, an asset where analysts’ attempts to arrive at an elusive measure of intrinsic value have been exercises in futility, hilarity, or both.

Since accusations of “bubble!” have been flung fast and furious at virtually every asset class, such a portfolio is fairly well diversified. That helps explain why this combination of highly volatile equities and massive duration risk has managed to post a positive total return every month this year. So if you ask a wizened portfolio manager what a bubble is, don’t be surprised by this sharp retort:

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