🗞 Not the Best Kind of Crunch

WHILE YOU POUR THE JOE… ☕️
Love the Smell of Fraud in The Morning

Back in the dot com bubble of 2000, Cisco stock reached a high that represented roughly 7% of US GDP. No single stock had ever gotten to that high before, and people got to question the company.

What happened after the bubble burst was the mother of all selloffs, so big that Cisco never recovered to those levels even after two decades.

Today, Nvidia is up to 11.7% of US GDP, and there are reasons to believe some of its financials are a fraud.

Why? The company begged for immunization from prosecution, and its accounting team has threatened to quit.

A time bomb waiting to go off? We’ll dig in and let you know what we find.

Speaking of time bombs, let’s get on with today’s email 📧…

HISTORY REPEATS ITSELF
Two For the Money

Let me take you back to 2007:

Everyone thought the economy was great, everyone and their neighbor was buying a new home and refinancing it a couple months later to buy another home, or a boat and a brand new BMW. 💰️ 

But

Things changed pretty quickly by the end of the year, and it triggered the worst recession since 1929 to start 2008. We weren’t old enough to be watching the different market indicators pointing to troubles, but we are now. 👀 

One of these indicators is money markets, credit specifically.

You see, money and loan instruments are sort of the economic hot potato, and the banks are the ones trading them back and forth.

Until one of them gets burnt and looks to the government for assistance (bailouts sponsored by us taxpayers).

We don’t have a way to tell when the potato is burning hot, but we got pretty close:

This is the SOFR rate, which stands for the Secured Overnight Financing Rate. This is basically how much it costs for banks to lend and borrow money between each other on an overnight basis.

When the rates spike, such as recently and in 2007, it means the banks know their balance sheets are in trouble, and they stop lending to each other.

But

Rising SOFR rates alone don’t mean much unless you compare them to another relative index. We have that for you as well:

The SOFR relative to the OIS, the Overnight Index Swap, is rising by an aggressive pace. 📈 

Not only that, it is back to positive, which means that the SOFR is now the riskiest overnight lending mechanism here, which shouldn’t be the case right now.

The only time this happens is when the banks, like we explained, are unwilling to lend to each other because of some hot potato scenario.

But, before we get to the banks, let’s talk markets.

The Fed’s balance sheet is in contraction. 📉 

That doesn’t sound like the US is looking to boost its liquidity any time soon, right?

It’s because they can’t, banks aren’t there to play ball anymore, and the economy is about to run into a credit and liquidity crunch that we will all have to pay for.

Then there’s the yield curve:

After being inverted for over 2 years, it has now jumped back to positive, here’s what that means in a nutshell:

Rising: Means liquidity is drying up, credit is becoming less available, and deleveraging is occurring overall.

Falling: Just the opposite, it means the economy is taking on leverage and liquidity.

This is bad for the economy and the S&P 500, but it’s a necessary evil.

Back to the banks.

Who is holding - or likely to end up having - the hot potato here? 👀 

Looks like a few of the big names were able to offload some of these toxic potatoes already, as judging by the lower loan / deposit ratios as a measure of liquidity.

The safer ones that offloaded some of the toxicity are:

• Goldman Sachs

• J.P. Morgan

• Citigroup

• Bank of America (sort of)

Then there are two that haven’t been able to properly offload:

• Wells Fargo

• Morgan Stanley

Considering that the toxic potato will probably be the commercial real estate loans going under, I think Wells Fargo held most of these products, while Morgan Stanley acted as the counterparty trading these products.

Not saying this will be written in stone, but definietly watch out. 🫰 

 TRADE OF THE WEEK
Vacancy (Please Book Me)

Don’t be fooled by the thumbnail, I just thought it was cool.

It’s not the end of Airbnb, but it might run into some trouble during its earnings announcement.

Why?

The economy is in terrible shape guys, don’t trust the media and whatever BS presidential campaign they’re shoving down your throat, absolutely nobody in the middle class is having a good time right now.

That being said, here’s what I mean in graphic form:

Job openings for the US economy are down, really down, like 50% down 📉 on the year almost.

Then you have the NFP, which only created 12 thousand jobs for the past month, the worst reading in years.

This is the employment trend in the manufacturing PMI index, down as well, so don’t believe that crap about the hurricanes being at fault for the falling jobs market.

Now here’s how I think that might affect Airbnb in the coming quarter announcement:

• Slower travel domestically in the US

• Unaffordability issues in the company’s listings

• Technical key levels showing lack of buyers

Let’s begin with spreading Airbnb against some close peers:

There you have it, Airbnb trades at the highest forward P/E ratio in the group, that’s in bold, which includes most of the online travel booking sites in the market.

However, there are others, like Expedia, that are set to grow earnings per share (EPS) much more aggressively than Airbnb.

That divergence of 15.6% vs 21.7% in EPS growth is reflected in the forward PEG ratios, where Airbnb is overextended at a 1.8x multiple while Expedia trades much lower at 0.5x.

Here’s a trade structure we can take as a result, by comparing both Expedia and Airbnb.

Correlations

We are currently at the upper range of the correlation matrix between these two, a result of Expedia outperforming Airbnb in the past couple of weeks.

Why?

Well, markets are behaving as if the US is running back into inflation issues, and that’s bad for the dollar and good for the Euro. Given that Airbnb’s revenues come mostly in dollar form and Expedia’s in Euros, there you have the divergence.

However, these correlations are due for a breakdown soon, meaning two things:

1. Either Expedia sells off and Airbnb pushes higher

2. Or Expedia stays on an uptrend, and Airbnb sells off

Given the difference in forward PEG ratios, I think scenario #2 is more likely. 👀 

So here’s how you can game this out.

This is the spread between Expedia stock and Airbnb stock, you can see the sudden spike as Expedia outperformed Airbnb in the past couple of months,

Now, if correlations were to stay higher, then it means Airbnb will have to rally to catch up to Expedia, but fundamentally and technically that makes no sense.

So, as we discussed above, for correlations to break down, Airbnb will have to sell off while Expedia either trends higher or pushes up.

In this case, we want to hedge our bets accordingly so that we can be somewhat okay no matter what happens.

Therefore, a long/short strategy is worth considering here:

According to the delta hedge ratio, we will have to short 0.98 shares of Airbnb for every 1 share we buy in Expedia.

You can extrapolate this to bigger numbers or deltas so that it makes more sense.

For example, I’m looking to buy Airbnb's $125 put options expiring on December 2024. These puts carry a delta of -17.

Then, for Expedia, I like the $195 calls for the same expiration, which has a 16 delta to keep me within normal hedge ranges. While not exact, they give me more room to breathe as they are much cheaper than the Airbnb puts.

Any price at or above $139.5 🎯 looks good for a short entry to me, as the volume starts cutting off there and will likely send the stock down to retest previous volume nodes.

These nodes are found in $130.4 and $116.

Hence, our exit targets for 6.5% return and 16.8% return 🔥, respectively. But then again, we’re doing options, so you can count that number to be much higher.

NOW GO AND MAKE IT HAPPEN
Get Ready Before You Have To

As the economy is about to head into a crunch, and job losses and safety are going to pop up, it is key that you prepare yourself by building a better relationship with money.

Today’s book recommendation 📖 helped thousands of readers build a better relationship with their finances so that they could make it out of the hard times and have some left over to invest in their future selves.

To your success,

G. 🥃