Author: Campbell, Macro Analyst

Translated by: Yuliya, PANews

Editor’s note: Recently, the U.S. stock market storage chip sector has become the main line of the technology market, with companies like Micron Technology, SK Hynix, and SanDisk seeing their stock prices continue to soar. Meanwhile, the debate about whether AI has entered a bubble stage has once again heated up. The market is full of varied opinions: renowned chip analyst Dan Niles from the internet bubble era believes that the current development of AI is closer to the mid-sprint period of internet infrastructure construction in 1997, rather than the tail end of the bubble in 1999. He points out that the rise of AI agents is driving a surge in demand for computing power, and while chip stocks' valuations may appear high in the short term, they still have potential in the long run. Legendary hedge fund figure Paul Tudor Jones also predicts that the AI bull market has completed about 50% to 60%, possibly continuing for another one to two years. In contrast, the character prototype from the movie "The Big Short," Michael Burry, has issued a warning, stating that the current market bears a strong resemblance to the eve of the internet bubble's burst in 2000.

In this blend of enthusiasm and concern, with big names holding different opinions, if a bubble truly exists, how should we respond? The author of this article shares a hardcore practical guide on "how to short a bubble" based on personal experience, with the following as the original text of the article:

Honestly, I don’t know whether we are currently in a bubble, and I am not even sure if that is a knowable question. My understanding of the situation is similar to yours: the AI revolution is real.

Although I have given up my professional investment career to go long and have been writing about it for the past three years, I still feel that my long positions are not enough. Like you, I look around and see many people becoming extremely wealthy just by connecting tokens for AI applications (or investing their entire holdings in infrastructure projects that generate these tokens), which gives me chills and breeds envy. This led to a feedback loop where I couldn’t discern whether my views were influenced by envy or if envy was telling me what I already knew: "keep going long."

To some extent, I do feel that "the future is here; we need massive computing power." Therefore, you will indeed want to buy these assets.

I don’t think software stocks have performed well, and the market is selling off these stocks, so there’s no profit to be made there.

Like you, I have also paid attention to the undervaluation of Korean stocks and am very interested in the openness of their market, which is clearly related to the recent stock market rise.

I am also surprised by the authorities quietly easing the supplemental leverage ratio (eSLR), allowing banks and funds to hold less regulatory capital to buy U.S. Treasuries, which is essentially classic quantitative easing in disguise.

• I can imagine a day when interest rates rise enough to end this "liquidity feast," but that day has not yet come.

• I can also imagine that war will end this feast, as the extreme volatility there has shaken me out of the upward trend, so who knows what the future holds.

• I can also envision that Canadian bank stocks with a price-to-book ratio of up to 3 and low volatility are an excellent shorting opportunity, but due to a lack of trading channels and sufficiently long options, I can't write a good piece to provide some insights.

To be honest, there are many things I can't openly state here. Although this does not change my fundamental views on the trend, it does greatly limit the people and events I can discuss here. If you know Andreesen's theory of "stop internal consumption," you will understand that my cautious nature guarantees I will never become a billionaire.

However, there is one thing I know how to do. This is also a bit of Alpha I can give you. We are not discussing whether we are in a bubble today, but rather how you should short a bubble if you wish to do so.

Why is Shorting a Bubble So Difficult?

What is a bubble? If something looks like a bubble, sounds like a bubble, moves in a parabolic trajectory straight up to the clouds, and requires increasingly high expectations and leverage to maintain rising prices, then it is a bubble.

Why is it so hard to short a bubble?

The problem is that the easiest shorts are things whose negative fundamentals gradually become known to the public, leading to a long decline and eventual crash. During this process, you may encounter a short squeeze (where short sellers are forced to buy back to cover their positions, causing a surge), but this provides you with a great opportunity to add to your short position, as this thing will eventually go to zero.

But shorting a bubble is a completely different matter. When an asset's price rises unsustainably, your risk exposure from shorting increases exponentially as the price goes up.

Don't believe me? Ask those who shorted Porsche and Volkswagen in 2008.

Ask those who shorted GameStop.

Or ask those who shorted that unknown shoe company that bizarrely became an AI company and crushed all the shorts a few weeks ago.

If someone who goes long sells out, they can just sit on the sidelines in cash. But if someone who shorts sells out, it means they must buy back to cover tomorrow. If you can make their bill increase fivefold, they will have double the motivation to cover, sometimes even at any cost.

Another reason why bubbles are difficult to short is that it is precisely those characteristics that make bubbles seem so appealing—“the soaring volatility! So great!”—that lead their options to be ridiculously expensive.

If it rises 10% every day, the annualized volatility is 160. For options with volatility up to 160, just buying a call option today would require spending an amount equivalent to half the stock price. Because the hedging value brought by actual volatility is too high, these options are essentially useless for one-sided directional bets.

Therefore, we are left with the following few options.

The only ways to short a bubble are:

a) Find a "wedge"—something that can puncture the bubble from the outside.

b) Short the "victims"—bet against those that are related to the bubble and have depths that are unfathomable when they decline.

c) Wait for "confirmation"—wait for the trend and charts to truly break.

The rest of this article will provide examples of each method.

A) Find the Wedge

The first method for shorting a bubble is not to short the bubble itself directly.

You need to find that thing that can puncture the bubble. Then you buy it to protect your account from the impact of the bubble bursting.

We started doing this today, just before the CPI (Consumer Price Index) data confirmed what we already knew: inflation is rising.

Interest rates are likely to rise as well. It turns out, as Bob Prince has often said, that there are bond-like attributes hidden within stocks.

That’s the “wedge.” You do not short the bubble, you go long on the trend that will kill the bubble. If AI is the bubble, then interest rates are the wedge that will puncture it.

All assets with exorbitant valuations are essentially disguised ultra-long-term assets. When the discount rate (interest rates) rises, the discounted value of the future expectations will be greatly diminished, and those stocks that have soared due to fantasies about cash flows in 2030 will be brought back to reality.

The core principle is: In every bubble, there are some things that must rely on the bubble to survive. As long as the bubble pauses even slightly, the weakest links will break. You are not betting that the market frenzy will end; you are betting that the weakest links cannot withstand the market's pause.

The brilliance of the "wedge" strategy is that you do not need to time it perfectly. The bubble does not even need to burst; it just needs to stop accelerating for a quarter, and those highly leveraged junk assets will begin to crumble.

Where is the current "wedge"? I will tell you what I am watching. Those Canadian banks with a price-to-book ratio up to 3, holding a lot of "negative amortization" mortgages (that is, the payments from borrowers are not enough to cover even the interest, and the difference is added to the principal, resembling PIK loans with capitalized interest), are facing a real estate market that makes the 2007 U.S. housing market appear incredibly restrained.

I cannot buy options for these banks that I want, but I am keeping an eye on them. Moreover, regarding the broad credit market, as we previously wrote in "Observing Credit," the current private credit feels like a "cockroach house," reflecting an overall loosening of lending standards. Once money goes in, it does not come out. When the bubble pauses, the book value of these assets will not change because no one is forced to revalue them. Until they are compelled to face reality one day.

B) Short the Victims

The second method for shorting a bubble is to find things that will go down with the bubble when it bursts—assets that are closely related to the bubble.

Evergrande is a good example. You do not need to short Chinese bank stocks, as that would only cause you to lose money unnecessarily for a decade. What you need to find is that developer that is excessively leveraged and heavily dependent on pre-sales of homes, which can explode even if China's housing market just lightly slows down. The bubble may keep inflating, but Evergrande cannot hold out.

You are looking for “downside convexity” (which means that when these assets fall, they fall faster and further). You cannot directly short things that are experiencing exponential increases because that is equivalent to fighting against double the upward momentum.

But look at its neighbors; perhaps their options volatility has not skyrocketed to 70.

Think back to the airlines before the pandemic. They themselves did not have a bubble, but faced extremely asymmetric risks, they would plunge disastrously. The prices of puts were relatively high at the time, but not outrageous. You still could have bought both ends of the options. So we did just that. In hindsight, it seems reasonable, but at the time, the "bubble" was really just people's blind optimism about "everything is fine."

Also recall the financial stocks from 2007/08. You do not need to short real estate directly (to be honest, shorting real estate directly is extremely difficult and has a very high technical barrier; of course, if you can really find a CDS that defaults on mortgages, that’s impressive). You just need to short Bank of America.

The core principle is: Bubbles create a correlation that only becomes apparent when a crash occurs. The options market usually does not price this correlation until disaster strikes. Your task is to find those “victims” whose options are cheap and are bound to be dragged down by the expensive options of the bubble assets.

As for who the current “victims” are? Honestly, I haven't pinpointed them yet.

C) Wait for Confirmation

The third method demands discipline, which is why most people mess it up.

That is: wait.

I know, waiting is the hardest. Sometimes when you see something skyrocketing, you cannot restrain yourself. But once again, you definitely do not want to get crushed by a train going full speed.

So you need to wait for confirmation signals. What do these signals look like?

Usually, they are a combination of the following:

• Fundamentals start to worsen;

• Buying pressure exhausts, market sentiment fades;

• Trend lines are completely broken.

Note, it is not a minor pullback, but a complete break. It is when something that has been rising well suddenly breaks below a beautiful support line, and everyone starts frantically screenshotting and forwarding it on Twitter. We saw such a break in silver's price action this January (but do not check it now; it has risen back, and we will discuss it in future articles).

Depending on the time frame you are looking at, the information provided by the charts will be completely different.

The most central truth now is that concerning AI, the only situation that is worsening is: too much of its cash flow is dependent on the distant future.

The problem is, you must discount that future pie with today’s interest rates. If inflation rises and policymakers are forced to tighten monetary policy (imagine if oil prices soar to $150 to $200 per barrel, they would certainly do so), then the net present value (NPV) of many such assets will shrink significantly. This logic is exactly like what we wrote during the bond bubble in 2021.

Another aspect to pay attention to is correlation. When what used to work 100% of the time suddenly stops working, and it becomes sensitive to some previously easily ignored factors, that is a warning sign. We might be witnessing such a situation today.

Practical Application and Summary

What did I do today? (On May 13th at midnight Beijing time) Before the market crash, I had already hedged some, but it was not enough. I shorted 5% of the S&P 500 (SPX) and 10% of high-yield bonds (HYG), and then bought some short-term put spreads. After stepping away for a while, I came back to find the situation was terrible.

What exactly did I do? I did not short semiconductors because the core fundamental demand is still there, and the upward trend has not broken. But I indeed shorted more in bonds, directly buying put options on U.S. Treasuries. If the trend line holds and the market rebounds, then I will consider it as spending a little money to buy peace of mind for my “wedge” strategy, which is no big deal. If the trend line does not hold, I will still have cash and protection positions, and only then will I heavily target the specific short opportunities. Oh, by the way, I also sold 5% of my Canadian bank stocks.

Hedge, find the wedge, wait for confirmation, then go in strong.

Listen, I do not know whether we are currently in a bubble. This wave might only be in the fourth inning (probably not, as the price movements have been too intense), or it may have reached the ninth inning (I don’t really believe that, as it would require seeing the demand generated by tokens for underlying computing power being destroyed, but I don’t see any signs of that right now). What I do know is that the feeling of “unstoppable” that AI gives me is very much like the feeling I had in 1999 when I first pieced together my internet stock investment portfolio in high school. Yes, those stocks eventually rebounded, and giants like Amazon were born from them, and if you held on until today, the internal rate of return (IRR) could have been in the double digits.

But I also do not forget the horrific plunge back then.

So, if you have read this lengthy and meandering essay to the end, you might feel anxious. If you feel anxious, the answer is definitely not to short that thing that is shooting up vertically. The answer is: find the wedge, buy puts on the victims, and then wait patiently for the confirmation signals to appear before going in strong.

In the meantime, do not go against the market trend. Do not short those things that are soaring parabolically.

免责声明：本文章仅代表作者个人观点，不代表本平台的立场和观点。本文章仅供信息分享，不构成对任何人的任何投资建议。用户与作者之间的任何争议，与本平台无关。如网页中刊载的文章或图片涉及侵权，请提供相关的权利证明和身份证明发送邮件到support@aicoin.com，本平台相关工作人员将会进行核查。