The lead up to the market crash of 2021
Disclosure: All opinions presented here are purely my own and do not represent my firm or anyone associated with it. This is not a recommendation. Do your own homework and due diligence before investing in anything.
First posted on my personal website (here).
Been writing about this topic for several months now and every day that passes by, I’m growing more and more convinced this is coming.
A great market crash is upon us.
If you haven’t read my other articles about this topic, check them out here:
Part 1: Power of the Retail Investor — Gamestop stock situation explained
Part 2: How Redditors and retail investors could pop the stock market bubble
Part 3: The Next Big Short Explained — AMC & Gamestop.
Part 4: The Stock Market Crash of 2021 Simply Explained
Part 5: Is Citadel our generation’s Enron?
Let’s walk through how we got here…
June 24, 2016 — the day the Brexit vote passed. I’ll never forget sitting in my parent’s bedroom watching the Brexit vote unfold and seeing the UK leave the rest of the EU. Having studied in the UK at the time while I was finishing medical school, I couldn’t believe what I was watching. I even remember seeing pictures from my friend’s graduation ceremony in St. Andrews. Boris Johnson’s daughter was graduating the same day as the Brexit vote and even caused students to protest at their graduation.
It was the first sign that the world was changing. As much as my generation wants to believe in the future and equality for all, the older generation is still susceptible to propaganda and populist rhetoric.
The Brexiteers used people’s psychology against them to target voters, especially on social media. One of the popular messages was convincing people into thinking immigrants were coming to take over their country and steal their jobs. Obviously, this rhetoric is wrong, but it doesn’t matter. All you need to do is convince enough people of something, even if it’s wrong, and people will believe you.
(Side note — watch the Great Hack on Netflix if you want to learn more about how Brexiteers used Facebook, data and social media to win the Brexit vote).
Then Donald Trump happened using the same playbook that worked with Brexit. The media, the people on the American coasts and most of the world couldn’t understand how this guy became the president of the US. I’m sure he even didn’t think it would happen, but it did.
How?
Lots of reasons but one of the main ones probably has to do with the fall-out of the global financial crisis in 2007/2008.
Watched a documentary recently called ‘Panic: the untold story of the 2008 financial crisis.’ It’s a fascinating documentary for anyone interested in learning about the last financial crisis. One of the main conclusions about it was that Obama was blamed for what happened in the economic fallout of the crash. But he didn’t create the crash; the systems and institutions that were set up during the Bush administration led to that crash.
Didn’t matter because it looked like Obama was responsible.
Then when banks had to be bailed out by the government, the population blamed Obama’s government which only further stoked the divide between the rich and the poor.
What most people don’t actually understand is without a bailout, the entire global financial system would have been in crisis.
Banks around the world would’ve failed. If you’re a person in Greece or Turkey or Thailand or Sweden and all of a sudden the ATMs stopped working because of the US banks failing, that would’ve caused much more problems for the world.
However, in the short term, people can’t see that. What most of the population saw in the US was that these bankers who had created this system and profited immensely were being given a free pass for their mistakes.
The issue is none of the bankers in America spent time in prison or were held responsible for their mistakes. They continued to earn millions of dollars that they pocketed while the rest of the world suffered.
Here lies the central issue: the incentives of the financial system are such that those that make the poor decisions that put the system in crisis are not the ones who pay the price.
This is the major flaw.
Has this system got fixed since that time?
Nope.
In fact, I’d venture to say it’s worse.
Why? Let me explain.
When Trump came into power, one of his big promises that he actually held was a major tax cut. For corporations, he cut taxes from 28% to 21%. This was massive for corporations, but more specifically their executives. Imagine you’re a company that makes 100 million dollars in profit. Under Obama, you would have to pay 28 million dollars to the government. Now under Trump, that number is only 21 million dollars. That’s a big difference.
You would think if you were a business, you would re-invest that money into your company to continue to optimize it. But you know what a lot of people, particularly CEOs, executives and board members did? They paid themselves more while letting their companies stagnate.
So for the last few years since the tax bill has been implemented, the divide between rich and poor has only grown.
Enter Covid.
When the market was crashing in March 2020 because of the uncertainty surrounding Covid, Trump’s government injected 2.2 trillion dollars into the economy by mostly investing in assets.
Do you know who owns the assets? Rich people.
They made more money than ever. Per one source, their wealth increased by $1.9 trillion dollars in 2020.
You think this money is properly getting redistributed to people that need it? Nope. Not when the tax system is set up so that rich people pay even less in taxes than poor people because of all the loopholes in the system.
(Side note — thank god Biden is coming out with a bigger tax plan because money needs to get redistributed from the rich to the poor).
Because of quantitative easing and 0% interest rates, the government gave the banks so much money. When they were lending this money out, the interest on the loan is effectively nil so these banks tended to be a bit riskier. My sense is they gave out more money than they should have.
Quick lesson on Quantitative easing. What is Quantitative easing? Quantitative easing or QE is an unconventional monetary policy where the central bank purchases longer-term securities to increase the money supply and encourage lending and investment. Buying these assets adds new money to the economy and lowers interest rates.
Why?
Bill Hwang. He was worth 20 billion dollars and he lost it all in 2 days.
How?
He got margin called. Essentially the stocks he had bought started dropping, and because he didn’t have enough collateral to cover his positions, the banks had to liquidate everything.
How did this happen, especially when the guy has a history of insider trading?
Because the banks were making hundreds of millions of dollars in fees from this guy.
Why am I mentioning this? Well, the big banks had one of their best years ever during Covid. They’ve been making so much money in fees that they were happy to give out so much leverage to people.
My sense is they’ve done this with hedge funds as well.
It’s great when everything is going up.
But you know what no one is accounting for in the financial system?
The retail investor. Not just a single retail investor but millions of retail investors around the world acting in unison buying together in stocks that have been heavily shorted like AMC and Gamestop.
Because of Covid, more retail investors jumped into the market. People were bored at home with nothing to do and because it seemed like everyone around them was making money in the market, more people jumped in. Apps like Wealthsimple, Robinhood, Etoro and others provide no fees on trading and you’re able to trade stocks off your phone while sitting on a toilet.
This situation has never happened before in history and because of that, most of the financial world can’t see this coming. Most of us tend to look at the past when we’re trying to predict the future but that’s foolish. Life is extremely random. Nicolas Nassim Taleb talks a lot about these concepts in his books (Anti-Fragile, Fooled by Randomness, and Black Swan).
Quick backstory on Mr. Taleb. He was an options trader in the 80s and 90s, made a lot of money, then retired to academia to study and write about probability and risk. Some of the main concepts he talks about is how random life is and how much history is dictated by black swan events — events that are unpredictable, random and have substantial consequences where there is no prior precedent. He’s an incredible independent thinker.
Most of the financial world doesn’t see what’s about to hit them. Everything is connected and because banks have given out more leverage than they should have to hedge funds, which are extremely risky in the first place, most people don’t understand how much this market has been propped up by the government’s quantitative easing.
Everyone is making money now.
Private tech companies out of San Francisco with no products are being valued at 20 million dollars.
There are public biotech companies that have never tested their drugs in patients who are worth 1 billion dollars.
Companies like Tesla at their peak were valued more than the entire global car market.
Coinbase, one of the many cryptocurrency exchanges, was valued greater than the NYSE and NASDAQ, 2 of the biggest stock markets in the world…COMBINED.
Cryptocurrencies have exploded in value. DogeCoin, a meme coin that started as a joke, had a higher market cap at one point than Ford Motor company.
None of this is normal.
Smart investors know we’re in a bubble because they’ve seen this behaviour in the market many times before in history.
Ray Dalio, Warren Buffet, Charlie Munger, Michael Burry, Stanley Druckenmiller, Howard Marks, Jeremy Grantham, etc. These guys know this environment is getting crazy.
They all know we’re in a bubble but they don’t know what’s the precipitating event that’s going to bring it all down.
I do.
It’s AMC, Gamestop and other meme stocks short squeezing causing the rest of the market to collapse.
The market crash of 2021 is coming. Hope you’re ready.
Keep Going, You’re Doing Great
-AK
