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bill ackman is a legendary investor in for a great reason since 2004 he has averaged a return of 16.9 per year significantly higher than the s p's average return of 9.6 over the same time frame his expertise led him to make billions from the 2008 recession and turned 27 million dollars into 2.6 billion dollars during the pandemic ackman successfully made billions on the last two market crashes and is now betting big on what he believes will return massive amounts of money even though he is not liked by everyone athens track record has shown that all retail investors should see what he has to say this video will go in depth on his new bet on one of the largest market crashes in history bill ackman utilizes two main strategies to achieve high returns the first one is to use his influence to impact businesses that he has invested in which is also known as activist investing ackman's second strategy is arguably more lucrative which is short-term speculation the second strategy is what we will focus on in this video bill ackman is very intelligent with the ways he bets on short-term movements because he always looks for asymmetric risk investors usually believe that taking on higher risk leads to high reward but that's simply not true hedge fund managers like akman look for asymmetric risk which means low risk and high reward ackman recently found the bet with substantial asymmetric risk everyone knows that inflation is continuing to accelerate despite the fad previously touting inflation as transitory the annual growth rate in consumer prices has accelerated from 1.2 percent in november 2020 to 6.8 in november 2021 that is obviously a drastic increase and for a great reason the federal reserve has been adamant about printing trillions of dollars into the economy with zero percent interest rates and quantitative easing which is when the fed purchases bonds the stock market has risen significantly in response to the fed's actions but this won't last forever in late october bill ackman gave a presentation to the federal reserve explaining why the fed should taper immediately mackman's presentation exposed the inevitable market crash that will eventually result from a few impending factors first of all the government has injected 5.1 trillion dollars of stimulus into the economy since the beginning of the pandemic 5.1 trillion dollars is 25 of the us gdp which is unprecedented in its consequences we can see the level of spending from the federal reserve from this graph of the fed's total assets the fed is continuing to purchase hundreds of billions of dollars worth of bonds which is temporarily saving the economy these actions are delaying future economic problems rather than fixing them we can see this from the fed chair jerome powell's response to inflation which he sees running into next year the stock market never crashes out of nowhere there are always events that intensify to a point that triggers a market crash the fed's actions have left two options that both result in devastating outcomes the first is to raise interest rates and stop quantitative easing for the sake of the economy doing this would almost certainly crash the stock market but save the us dollar from accelerating inflation the second option would be to not taper and keep interest rates at zero percent to let inflation accelerate in other words the second option is to keep the money printer printing this option would be even worse than the first one because inflation would still crash the economy while simultaneously destroying the us dollar bill ackman is advising the fed to go with the first option which is to taper immediately and begin raising rates in essence the market already crashed but now the fed just needs to choose the outcome that isn't as worse ackman elaborated on this by saying we are continuing to dance while the music is playing and it is time to turn down the music and settle down this was in reference to margin call a movie that detailed a hypothetical scenario where the economy was going to crash what you're telling me is that music is about to stop the economy has been booming and bill ackman is continuing to dance while the fed keeps interest rates at zero percent however it is time for the fed to turn off that music and let the economy correct in preparation for this ackman is initiating a short position to hedge his portfolio ackman stated as we have previously disclosed we have put our money where our mouth is and hedging our exposure to an upward move in rates as we believe that a rise in rates could negatively impact our long only equity portfolio there are a few markets that investors can short to hedge their portfolios but there is one particular market that ackman is shorting the market that i'm talking about is the bond market the bond market has risen significantly over the past few decades leading bond yields a decrease to historical lows as some of you may know an increase in bond prices decreases bond yields and a decrease in bond prices increases bond yields the two factors are inversely related so shorting the bond market would be a bet that bond yields will go up the 10-year us treasury bond yield is currently at roughly 1.4 percent which is significantly lower than the inflation rate so the question is why would anyone ever purchase bonds when inflation will almost certainly be higher than 1.4 percent investing in such an asset would be equivalent to lighting your money on fire ray dalio kathy wood and warren buffett have all stated that bonds are in a bubble and i'm sure many others agree as well shorting the bond market is an asymmetric bet because bond yields can't get much lower from here on the other hand bond yields can easily increase substantially to account for the massively increasing inflation rate this is the short trade that michael bury is doing which i'm sure many of you know from the movie names the big short brewery tweeted for what i know i've never shorted any cryptocurrency this is my third bubble in the biggest i've learned a thing or two 30-year treasuries on the other hand buries implying that he is joining the bond market which can be done by outright short selling a bond dtf like tlt which is the ishares 20 plus year treasury bond etf however for high net worth investors like michael burrie he may be using a more complex derivative on bonds that is not available for retail investors like you and me bill ackman is certainly doing so ackman is purchasing two different derivatives credit default swaps and put swaptions which are options contracts to swap bonds there are two types of interest rates a floating interest rate which changes based on the bond market and a fixed interest rate that stays the same no matter what swap options are derivatives that are purchased from the perspective of the bond lender instead of obtaining an interest rate for purchasing a bond owners of swaptions have to pay the interest rate to bond holders a put swaption is a contract to beat the bond lender and pay a fixed interest rate to the bond holder in the events that interest rates increase the owner of the puts option would make profit off of the difference in interest rates in this instance the floating interest rate increased to four percent but the owner of the puts option has a contract to pay a fixed rate of two percent therefore the put swaption owner would be profiting from the difference in interest rates which is two percent this difference would increase the value of the put swaption and therefore allow the swaption owner to make enormous sums of money with low amounts of capital ackman purchased put to options because he can profit immensely in the case that interest rates increase even if interest rates decrease or remain the same he does not lose much money the other derivative that bill ackman purchased is credit default swaps a credit default swap is similar to buying insurance for a house the owner of a credit default swap has to pay a small payment periodically let's say for the sake of this example that the payment is 500 per month a credit default swap is insurance for the borrower's ability to pay monthly payments in the events that the bond defaults the banks would have to start paying the monthly payments on the bond which would be much higher than the monthly payment of just five hundred dollars per month for instance let's say that amount is ten thousand dollars per month while this analogy isn't exactly the same this would be similar to a house catching on fire on insurance because the bank would now have to pay an amount as large as five hundred thousand dollars to repair the house on a 500 monthly payment bill ackman is using both puts options and credit default swaps to make billions of the bond market crashes ackman already successfully profited from this in the 2008 recession in the pandemic now he is doing it once again but with puts options as well pre-financial crisis we were concerned about what was going on in the credit market so we built a very large notional short position in credit by purchasing credit default swaps on the bond insurers on fannie mae freddie mac on the banks um and as a result uh you know s p was down 52 percent in i think 0 8 and i think our peak decline was 18 it was just momentary and we finished the year down only a few percent and we're up 40 the next driven by that hedging gain and the the redeployment of those proceeds and buying stocks and then last year when we became quite concerned about the pandemic in february we did the same thing uh we are we thought the best way to express this concern and and in a risk minimizing way is to again buy credit defaults but a very large notional position in the credit default swap market and then spreads gap very you know widely as uh it became clear that this is going to be a pandemic and then we reversed that position as our portfolio declined in value our stocks went down and our hedge became enormously valuable so the hedge actually on a market market basis mitigated almost our entire market market laws but more importantly uh we were it gave us capital to invest over two billion of capital to invest in a market that was down a large amount and most recently you know our biggest kind of black swan fear for the markets earlier this year we became concerned about inflation we thought inflation could lead to higher rates i thought higher rates could lead to lower values in the equity markets and we built again a very large notional position betting that rates would go higher we did this using swaptions which are sort of a an option on an interest rate swap which is a way to express that kind of bet but these the three things i mentioned are they're small you know the capital commitments are one percent one and a half percent of capital you know numbers like this but they can turn into very very large numbers in the event that the you know sort of outlier event takes place i previously mentioned how the annual growth rate for consumer prices has increased from 1.2 percent to 6.8 percent but that's not necessarily true the rate that i was talking about was tied to the consumer price index or cpi in short form the consumer price index tracks a basket of goods that are weighted to create an average price for consumer goods this sounds great in theory but the data collection for housing prices is inaccurate in the index ackman believes that the owner's equivalent rent or oer is understanding inflation by relying on surveys using a more accurate tracker of rent ackman found out that the annual inflation growth rate should actually be 10.1 percent instead of 6.8 percent ackman tweeted reported inflation is understated owner's equivalent rent relies on owner surveys to estimate inflation and housing costs this is an extremely imprecise metric the single family rental market provides more accurate data oer in today's reported core cpi was 3.5 year-over-year it's certainly quite strange for the oer to be reporting a growth number for rent prices as low as 3.5 percent this is obviously inaccurate and should be replaced with a single family rent prices acme elaborated by saying the largest owners of nationwide single family rentals are reporting 17 year-over-year rent increases oer is 30 of the core cpi calculation and 24 of the reported cpi using the more empirical measure in the calculation increases today's core cpi from four point nine percent to nine percent and cpi from six point eight percent to ten point one percent an inflation rate of ten point one percent would obviously be concerning for the bond market bonded investors would have a net inflation inflation-adjusted return of minus 8.7 percent per year some might say that this inflation is transitory but ackman thinks otherwise he tweeted that housing inflation is unlikely to abate based on supply and demand trends the inflation that households are actually experiencing is raging and well in excess of reported government statistics as if the situation can only get worse the fiscal policy from congress isn't helping at all joe biden plans to pass an infrastructure bill in the build back better bill that may be 2-3 trillion which is around 10 to 15 percent of the entire u.s gdp this will certainly lead inflation to continue to accelerate going forward other market concerns that bill ackman cited included the weakening china growth emergence of new covet variants second order impacts from supply chain constraints geopolitical risk and cyber security risk these events could negatively impact the financial markets going forward and only time will tell if they do so there you have it bill ackman's bet on one of the largest market crashes in history do you agree with ackman's prediction and if so how are you preparing your portfolio if you enjoyed this video please hit the like button and subscribe and i'll see you in the next one
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