The Long And The Short Of Investing In 2022

As we head into the second half of 2022, many investors feel like they’re on a rudderless ship, wondering if they’re headed into a bigger squall or finally approaching safe harbor. They face this uncertainty after being tossed all about during the first two quarters of 2022, which were among the worst for equity markets dating back over 50 years. In the fixed-income ocean, things were even gloomier with the six months ended June 30 being the worst in history.

The current environment has made it tough for traditional buy-and-hold investors to make money or even find a place to preserve gains from the longest bull market. So, what happens in the second half of 2022? Some market strategists are predicting a rebound, believing that, after such a large loss, the odds are likely that there will be a bounce. I’m not in that camp at this point because. Although many investments have sold off materially, there are several reasons behind the market declines. While we may not actually be in a recession yet, the equity markets are anticipating one, which is understandable given the Fed’s path of tightening monetary policy. Fed policy and inflationary fears are also causing significant turmoil in fixed income markets, including everything from investment-grade debt to junk-rated issuers and even mortgage markets. Those trends are now also starting to impact confidence among both consumers and companies who are therefore reducing risk-taking.

Market turmoil has similarly affected cryptocurrency markets, where many investors, including several notable ones, thought there was easy money to make. In November, Bitcoin was trading for ~$60,000/token, and the entire crypto market was valued at ~$3 trillion. By July 1, it was trading at just ~$19,000, and its total market value had collapsed to below $1 trillion. We have already seen some big bankruptcies in the crypto space, like Celsius Network LLC and Voyager Digital Ltd., and there are signs of additional stress on the way. Probably most troubling for crypto speculators is the revelation that so-called “stablecoins,” allegedly backed by hard currency, are not so stable.

During Q2, the largest stablecoin, TerraUSD, which was always supposed to be worth $1 USD, fell to under $0.01! Others have also struggled to maintain their pegs to the point where some speculators are now short-selling Tether, another stablecoin pegged to the U.S. dollar.

Around the same time as the stablecoin meltdown, Coinbase CEO Brian Armstrong, in response to a new SEC disclosure requirement which indicates that in case of bankruptcy, crypto assets held for third parties might be considered company assets, sent out a tweet saying, “We have no risk of bankruptcy.” But, telling investors you are not in danger of bankruptcy isn’t the kind of statement that instills confidence. It just makes counterparties wonder whether that is a risk they may have overlooked.

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Because crypto firms are less regulated than most other financial institutions, their success is almost entirely dependent on sentiment, and sentiment looked fantastic when Bitcoin moved from $5,000 to $60,000. Now, that momentum has reversed, and we’re facing a situation where the emperor has no clothes. Thus, we see significant new distress in crypto and should expect more bankruptcies. Usually, wise distressed securities analysts search for things like hard assets and collateral to support valuation. However, valuation is elusive in the crypto arena because traditional analysis doesn’t apply. For example, if a coin loses support among users, the liquidation value of its issuer’s assets may be dismal at best when the dust settles.

What Comes Next?

For the remainder of 2022, investors will be trying to figure out where the chips have fallen and, depending on the asset, whether there’s more room to fall. In many cases, there probably is because it doesn’t appear that we have hit bottom. Typically, to reach that point, you need capitulation, where there’s proverbial blood in the streets and investors are just looking to sell at any price. We haven’t seen that type of panic selling yet in 2022.

We’re looking at an uncertain market for the second half for sure, but it seems to be operating in an orderly way. Still, it’s been difficult for investors to make money anywhere unless they have the knowledge and ability to invest both long and short. As the markets fell, losing money on the short side was hard, which is unusual. Not too long ago, short sellers were having difficulty staying in business, but now the tables have turned.

One company that looks like a prime target for short selling is Bed Bath & Beyond (BBBY). It began the year trading above $30/share and recently traded below $5. Like most brick & mortar retailers, it struggled with online competition and COVID in the last few years but also suffered from a revolving door of executive turnover. In their most recent earnings call, BBBY’s management announced that CEO Mark Tritton had been let go. He was supposed to turn the business around and invested heavily in private label inventory. However, it turned out that the chain’s customers preferred branded goods after BBBY had already spent hundreds of millions of dollars buying inventory that no one wants. Until a new CEO is recruited, the top slot is held by board member Sue Grove, who has extensive retailing experience but also has experience working for a bankruptcy advisory firm. BBBY has around 700 stores in the U.S., but it doesn’t own any of those locations. Instead, its landlords are owed a present value of $1.9 billion in rent for those locations through the term of their leases. That liability, in addition to the company’s regular commercial borrowings, makes BBBY look hopelessly insolvent. Moreover, it’s been burning through what cash it still has, and revenue continues to drop each period. This all makes a restructuring through bankruptcy an increasingly likely outcome for BBBY.

As mentioned earlier, the key for investors in an environment like the current one is the ability to invest both long and short, up and down the capital structure. However, the long opportunities are more difficult to find right now. Throughout the rest of 2022, the best advice to investors is to keep your head down, your eyes open and always do your homework before committing to any investment.

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