The Private Equity for Families Blog

Guess Who Wrote The “Meme Asset” Cookbook?

I am thrilled for the true believers in the Reddit crowd who have learned to manipulate the stock market. Their formula appears to be working well with notable successes like Hertz, GameStop and now AMC.

In almost every case the cookbook recipe reads like this:

  • Find an asset that is essentially worthless from a fundamental standpoint, but with good name recognition
  • Toss in a scarcity of float and owners in a liquidity crunch
  • No extra spice needed if there is a hedge fund with a massive short position
  • Find a sponsor like Roaring Kitty (a real person) and pump the idea of a coordinated buying on Reddit or other social media
  • Take the pledge to never sell and demonstrate you mean it
  • Then sell some on the way up to get your investment back
  • Mix and Repeat, Mix and Repeat, Mix and Repeat, Mix and Repeat…

I would be even more impressed had these “chefs of the coin” come up with the idea on their own.

Put The Apron On Powell and Mnuchin

Having learned the golden rule that any good investment scheme available to you and me is usually benefitting some really smart guys, I immediately knew Roaring Kitty did not publish this cookbook. He had great inspiration from the Chairman of the Federal Reserve Bank and The Secretary of the Treasury.

In March of 2020, when the world economy hit the brakes, billions of dollars of worthless assets were created almost overnight. Lack of liquidity in trading markets, investor panic, collective ownership through ETFs, and huge counterparty risk on derivative assets like collateralized loan obligations were mixed together in an unappetizing asset goulash. The Chefs on call were Powell and Mnuchin.

Their recipe was dusted off from 2008, and included lowering interest rates for bank short term liquidity. However, the enormity of the appetite for liquidity proved the ’08 salt and pepper seasoning inadequate. This time there were a few more ingredients in the spice rack including special purpose vehicles (SPVs) to buy assets on the open market. It would have been illegal for the Fed to do so if those assets had not been “adequately secured,” so Chef Powell asked Chef Mnuchin to have Treasury make sequential $10 billion equity infusions in several of the most important liquidity providing SPVs.

Without getting caught up in the mind numbing, and possibly illegal, structures, the two Chefs pledged the full printing power of the US Mint as liquidity for every asset class. It was a coordinated worldwide effort to create liquid markets for every asset class, especially those assets which were fundamentally worthless. The Chefs also made it clear that they would keep buying until they were controlling prices in every market. Their SPVs started buying and only stopped when all markets had returned to normalcy.

The Fed Is Now Unwinding at a Profit

While I could not find any information about specific assets or prices, I know Powell and Mnuchin (now Yellen) are quite pleased with the result based on a small invested amount and the high return on investment. Triple C credits were bought in March of 2020 at substantial discounts to par and now the market for junk bonds is treating that same credit like gold. Here is how Brian Chapatta writing for Bloomberg Opinion on June 2, 2021 described the round trip:

The central bank said late Wednesday that it would start to gradually sell the $13.7 billion portfolio of U.S. corporate debt and exchange-traded funds it amassed through its Secondary Market Corporate Credit Facility, which was created during the worst of the pandemic-inspired market meltdown in March 2020. The facility marked an unprecedented intervention for the Fed because it effectively pledged to plow hundreds of billions of dollars into company debt if no one else would. That backstop, even if it wasn’t fully used, quickly restored investor confidence, led to a ferocious rally in practically every corner of the bond market and encouraged record-breaking amounts of debt sales from investment-grade and high-yield borrowers alike.”

There are Fed footprints in the flour, however, and once again speculators have been saved. This time it is primarily weak companies issuing more market debt, albeit at lower interest rates and more favorable terms of payment because of the SPVs. While the Fed did not directly intervene in equity markets, its $120 billion per month purchase of its own debt has created money that ended up in home purchases and red-hot equity markets. In many ways Powell and Mnuchin/Yellen are now executing the pump and dump strategy you see in GameStop and AMC. They are still acting like buyers by printing money, but selling into the inflationary liquidity they have created.  Here is how Mr. Chapatta describes the moral hazard:

“What’s more, the Fed’s facility may have served as something of a stealth rescue of the mutual-fund industry. Just before it was announced on March 23, investors pulled a record $35.6 billion from U.S. investment-grade bond funds, a record $12.2 billion from muni mutual funds, $2.91 billion from high-yield funds and $3.45 billion from those tracking leveraged loans in the span of just a week. Can this kind of exodus happen again if the takeaway from March 2020 is that the central bank is just around the corner? And what are the risks of that kind of complacency?”

Meme Asset Recipe Still Being Written

All I know is the “meme asset” market was not invented by Reddit and Roaring Kitty, and I also know it now has expanded to include many billions of questionable financial assets. If the Reddit crowd thinks imitation is the most sincere form of flattery, maybe they should be getting out like Powell and Yellen before the Fed stops injecting liquidity?

On the other hand, maybe the Fed knows it can’t raise interest rates or remove the “all asset” safety net? In fact, maybe inflation is just the right spice with a sprinkling of yield control to keep interest rates low? The experiments in the kitchen supported by taxpayer checkbooks will likely continue. The aroma from the kitchen is quite appealing, especially to the owners of meme assets.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records Founder and chairman of CapitalWorks, he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CapitalWorks or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.

Private Equity for Families Blog | CapitalWorks Private Equity Cleveland Ohio

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