ECONOMY

UBS O’Connor CIO Tries to Stay ‘Million Miles’ From Meme Stocks

Kevin Russell, chief investment officer of UBS Group’s $9 billion hedge-fund unit UBS O’Connor, joined this week’s “What Goes Up” podcast to discuss how he tries to steer clear of day-trader favorites like AMC Entertainment Holdings Inc. He also details the bull case for China, his outlook on inflation and some winning pair trades made at the height of the Covid-19 crisis.

Below are lightly edited highlights. Click here to listen to the full podcast. Subscribe to “What Goes Up” on Apple Podcasts, Spotify or wherever you listen.

Q: Let’s start with this whole revenge of the meme stocks that we’re seeing. Are there opportunities there for someone like you?

A: We try to be about as far from these types of situations as we possibly can. I talked to one of our PMs this morning and I said, “I’d like to be roughly a million miles away from this.” And he’s like, “Well, you realize we’re probably like 999,000 miles away because there’s correlations with these stocks and other stocks that we’re involved in.” So I kind of acknowledged that, but to me anytime you have stock-price moves that are divorced from economic reality or corporate finance changes, that’s like a flashing warning side, a warning sign to us to really be cautious. I’m drawn to it, not dissimilar to rubbernecking an accident on the freeway.

The volume is alarming. And listen, I think there’s this temptation to just completely dismiss this type of activity as irrational and illogical and a casino or a meme stock. And I don’t think that’s true at all. To me, you really have to pay close attention to some of these phenomenons. We analyze companies, we analyze fundamental changes, we analyze what’s going on in the economy. But we’re honest. And we’re saying, you know, sometimes security performance is a function of investor psychology and positioning. And when you have a situation like this, you really cannot take an aggressive stand one way or another.

Q. Are there opportunities that maybe are getting overlooked because everyone is so focused on watching the meme stocks go up and down?

A: So that’s my 999,000-mile analogy because when stocks — whether it’s an AMC or a Bed Bath & Beyond — go up, we see things that go up in sympathy. If people think that AMC and Bed Bath & Beyond are doing well, they get excited about mall owners or strip-mall operators. And the reality is the dynamics of people going to malls and going to strip centers is not changing. It’s not changing based on price action in Bed Bath & Beyond or AMC. So we do see some of the stocks that are related react. And that’s where we tend to look for opportunities to take advantage of the dislocation.

Q: To move on to something I know you guys were involved with, you’re very bullish on China. I’m wondering, with the Biden blacklist possibly being expanded, what do you make of that?

A: I think big picture, there’s a more constructive dialog between the U.S. and China happening now than under the prior administration. And even though there’s potentially a broader list of stocks that are going to be banned, there’s potentially a tightening of existing bans and limiting bans to some of the specific subsidiaries … To the extent that there are these bans, I think they create opportunity more than risk.

If you’re sitting in the U.S. or you’re sitting in Western Europe, you unfortunately tend to think about this from a European or U.S. perspective. Like, the U.S. government is going to discipline the Chinese. But the reality is, there’s always a corollary, a Chinese perspective on these stories, that creates an equally investible theme.

I’ll give you an example. Under the Trump administration, there was this real aggressive pressure on reducing higher-end semiconductor equipment materials and telecom equipment to the Chinese. So what the Chinese government did is react uber-rationally and said, OK, I get this. If there’s some risks that I’m not going to be able to buy high-quality intellectual property from the U.S., I’m going to build my own technology supply chain. And so while most people sat there in 2020 and said, wow this uncertainty about U.S.-China trade and tech supply chain makes me nervous, some of the best performing stocks in the world in 2020 were some of the domestically focused Chinese small and mid-cap technology and semiconductor stocks.

One of the things that makes us the most excited about China — and I’m puzzled because it feels like not enough people are talking about it — is the aggressive market reform agenda passed by China late last year.

Q: You had a really strong run during the pandemic. And one of the things I thought was really interesting was some pair trades where you would short the stocks of some of the companies getting hit hard by the pandemic, but then go long the credit of the same companies. Was that sort of a fleeting, once-in-a-lifetime opportunity to do that type of thing (because of the Fed’s response) during the pandemic?

A: When the Fed came out and went the extra mile to say they were going to support the high yield market, we were staring at each other, like, “Can you believe this? Did they really just say that? It does say high yield bonds, right?” And there was a time when the market didn’t react right away and we were staring at each other, like, this is a really unbelievable historic and special opportunity.

What happened for really the entirety of the summer, because the economic conditions associated with Covid were so severe, it actually had a bunch of companies who had to come out and issue high yield, or investment grade, or convertible debt. I always tell people if you had a wish list of things you wanted for the holidays, and you asked for from the Fed, they gave you all those things. So you had everything you could possibly have wanted, but then there was a ton of issuance. So we could go out and buy a lot of high yield, investment grade and convertible bonds. So, I mean, I’m trying to imagine how that particular fact pattern repeats.

Q. I think someone passed a law somewhere that every interview like this has to include a question about inflation, it’s mandatory. I’m just curious what your take on it is.

A. One of the things that a lot of people forget is we’re getting this rush of economic activity after several years of really lower cap-ex and investment on expectations that growth was going to be low forever. And so, whether it’s industrial metals or oil and gas, there has been a massive, under-investment in cap-ex really the past several years. And so now as the global economy is starting to restart, the commodity markets are just really tight. And the amount of price inflation happening just on the raw material side is massive. And now there’s no shortage of resources in the world. There’s just a shortage of resources that can get put into production right away.

And so we’re definitely in the camp that we’re going to see a supplier reaction. You’re going to get a reaction out of OPEC. You’re going to get a reaction by some of the metal and mining companies, and you’re going to offset some of those short-term price squeezes, but it’s unclear to me whether that’s happening in the, in the second quarter, third quarter or fourth quarter. And so I think there’s a pretty significant probability that there’s an inflation surprise and that it’s difficult for the market on a short-term basis, that’s over the sort of the three month horizon. But I think longer term, I think there’s generally consensus that there’s going to be a supply response and offset some of these transitory pressures. So we’re seeing though this.

(Click here to listen to the podcast in its entirety.)

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