The Case Against MicroStrategy
Earlier this year the Shiller CAPE hit an all time high of 37.45 going back to 1990. This kind of put me on notice. I had been waiting for some signal of a top as I have been running a rather large cash position given the limited opportunities in the market in 2023 and 2024. ($LULU and $PDD were on sale though!) When I saw the market’s reaction to Trump’s tariff announcement, I saw weakness in the market I hadn’t seen since 2022 or 2020. The fear and greed index hit a 4/100 “extreme fear” on Monday.
Fast forward to today: I was listening to Humphrey Yang on YouTube this morning and he casually mentioned that a record amount of auto loans where 90 days delinquent. This jogged my memory about a tweet I saw Tobias Carlisle put out on auto loans corroborating the same thing.
Credit Contraction
This lead me down a rabbit hole to look into these failing car loans and see what I could tease out. Okay for one, checking multiple sources- this information doesn’t really come out as often as I would like. I can find like one source with March data (writing this on April 11th). If you go back to around September of last year, thats really when this conversation started and we hit a record high in February of around 0-1% of all loans being delinquent and ~6% of subprime loans delinquent. From what I can tell, the 0-1% of all loans has gone to around 3% in March. That is a lot.
Credit contraction is a scary thing in the world of fiat currency, specifically for the US. Debasing our currency in 1971 has allowed us to run much larger deficits than we would have otherwise been able to do over that time. On top of that, a uniquely American advantage is being the world’s reserve currency- because so many countries are awash in dollars, (via deficit) they want to do something with those dollars rather than just sitting on them. This results in lots of US debt being purchased by foreign central banks and other foreign entities.
So far, this hasn’t been a problem. The fear is that we create an economy that is over-leveraged to a point that we lose the ability to de-leverage at all. Japan is a fantastic example of this. It’s not that you become the 3rd world or something you just lose your spot in 1st place. I really hate arguments for larger deficits like: “its fine because we have been running deficits forever and its all not real anyway.” If we are running deficits and productivity falls stagnant - it is real and we will feel that. Also, it is not like we can just be like: “oops guys, the breaking point was $35t. We should of stopped there. Lets walk it back!”
Now, back to auto loans. What do the trade deficits and large debt to GDP ratios have to do with the market for auto loans? You see, credit is one person’s liability and another person’s asset. Credit is money- full stop. It’s not like money, it is money. The only hangup is interest- which is effectively borrowing from your future self. If you can borrow from your future self for free and you can make yourself richer by investing in something now, you should do that! This is what we had with 0% interest rates through the 2010s. Now when you start to raise base rates, like we did through 2022, it’s not whether we can get richer at all, you have to considerer if you will still be richer, including interest. This is a drag on the economy that can be felt and measured in different places.
Enough building up to my point! Here it is: if 3% of auto loans are 90 days delinquent, that’s high but we can fix that. If 3% turns into 4% which turns into 8%, we might be in trouble. The banks mark this as an asset so, this would mean that defaults erase those assets and because credit IS MONEY, the money supply would contract there as well.
Now, I am going to skip over a lot of technical banking stuff here but put simply: auto loans represent a small part of consumer credit and commercially are a small part of the financial sectors book. (around 9%) The thing to keep in mind is that the way the modern bank operates is in various states of insolvency. No one, except the Fed, is solvent. That is only because they literally print the money. So if a bank takes deposits (a liability) and then underwrites loans that go to zero with that deposit, you can see how the bank gets squeezed there. For the weaker parts of the financial system, this means death. Any banks that can’t eat those losses and still meet obligations are either liquidating assets in a fire sale or borrowing from other banks, at higher interest rates, to just stay liquid. This isn’t them borrowing from their future selves to make investments to enrich themselves. This is them borrowing just to stay liquid. Those banks borrowing from other banks, means second order effects for banks lending to banks in trouble. For example, if bank number 1 defaults on it’s debt it took out with bank 2, then thats even more credit destroyed now maybe bank number 2 is in trouble and it didn’t even have any auto loans!
Now we are moving from the setup and the facts to speculation. I think there are so many incentives in a post-Great-Recession-2008 world to report as few delinquencies as possible. (I am holding back as much as I can from hijacking the rest of this post to go on a rant about how we changed the CPI to not include housing btw) So, I would be willing to bet that these delinquencies are probably larger in scale than we realize due to insufficient reporting and the lag for all of the two month and one month delinquent borrowers who haven’t shown up in the data yet. This is at a time that our banks have the highest debt to equity ratio going back to the Global Financial Crisis.
via macrotrends
So now you’re caught up to where my head was at around 10am today. So I start thinking about how to play this as a retail investor. I look at the two biggest commercial auto lenders: Ally Financial and Capital One - nothing. Their books were fine. The thing about a bear market is, that when the major indexes sell off, the entire market sells off. This is why I feel like you need to hold cash or bonds if you want to participate in a bear market. If you put your money in anything else as a temporary plug for yield while you find something to buy, there is a good chance that your plug gets marked to market in the downturn haha. When everything sells off, the frothiest most overvalued stuff gets hit the hardest. When the party is over and everyone has to get more realistic about the expected rate of return, consumers have to tighten their belts, and employers are looking for ways to spend less instead of invest more… that marks the beginning of the sell off. When the market sells off you want to be long quality and short anything overvalued or highly levered. Its the latter of those two that I have been doing my homework on.
MicroStrategy
Microstrategy is technically a business intelligence vendor like (Tableau or PowerBI) but their founder became completely obsessed with bitcoin in 2020 & has essentially converted the business into a Hold Co. wrapper for bitcoin with insane amounts of leverage.
Here is how ClaudeAI describes what MicroStrategy does:
"MicroStrategy has transformed its business model since August 2020 by adopting Bitcoin as a central treasury reserve strategy. Under CEO Michael Saylor's direction, the company regularly acquires Bitcoin using available cash and by raising capital through financial instruments, most notably convertible senior notes. These convertible bonds allow investors to either receive their principal plus interest at maturity or convert their investment into MicroStrategy shares at a predetermined price, offering investors indirect exposure to Bitcoin through a traditional security. MicroStrategy has conducted multiple convertible note offerings specifically to fund Bitcoin purchases, sometimes at billions of dollars per round. This approach enables the company to leverage its balance sheet to accumulate Bitcoin without diluting existing shareholders immediately. While continuing to operate its enterprise analytics software business, MicroStrategy has effectively positioned itself as a "Bitcoin proxy" for institutional investors who want exposure to Bitcoin through public equity markets but may be restricted from holding the cryptocurrency directly. The company maintains a long-term holding strategy rather than actively trading its Bitcoin, with its stock price often moving in correlation with Bitcoin's market value, essentially functioning as both a software company and one of the largest corporate Bitcoin holders.”
I would highly recommend you watch Prof G’s interview with the MicroStrategy ($MSTR) CEO who explains their strategy in great detail actually. He is very upfront that this is a levered bitcoin play and that the bonds are basically backed by the equity in $MSTR. So if they ever get pinched, they plan to just dilute all of the shareholders to cover the bonds. It helps that the bonds convert to equity as well so there is a good chance an investor converts their something into potentially nothing a month before or whatever in a doomsday scenario.
I think that doomsday scenario is here. Bitcoin will be around forever and I can’t predict it’s future utility but what I do know is that $MSTR is not the first firm to make use of excessive leverage (aka risk) and claim no downside. SBF claimed this same thing in his pitch to Sequoia for FTX. There is no such thing a a risk free investment. All investment carries risk and usually the return profile reflects that.
MicroStrategy has been doing this since 2020 and so you will find many bull arguments for why they can remain solvent and avoid any liquidity crunches on the basis that they survived through the $BTC volatility in 2022. I think that there is a massive cohort of investors age 35 or younger, who don’t really know what a bear market feels like. Calling 2020 a bear market is like comparing a speeding ticket to a felony. Was it scary? Absolutely. But was there any real pain for investors? Not really. I think the market traded negative for maybe a week before a stimulus package was agreed to and help was on the way. (The biggest stimulus to the US economy ever by the way). A real bear market is a two year ordeal where 10s of large cap corporations fail and seek bailouts or a sale. To be clear, I am not cheering for a correction, I just feel we are heavily overdue and the system needs to be reset. (think housing prices)
In a world where the US has chosen austerity and protectionist economic policies, I don’t like MicroStrategy’s position. I think they need new investors coming in to buy their equity only so that they can dilute them and buy more bitcoin. 48% of their outstanding shares are held by retail who are emotional and have some average level of intelligence around financial assets and likely don’t even understand what they own. The CEO has a cult like following on social media and a personality to match. In a world of free money, their strategy works. In a strong bull market, their strategy works. Bitcoin has been known to move -75% and I am talking about like 3 years ago, not like 2010 or something. MicroStrategy being a levered call option on the price of bitcoin makes them technically legal but what they are doing isn’t unique or innovative. You could create this same financial instrument with oil or tulips or any speculative asset. Nothing about this is specific to bitcoin. They need investors coming into the stock in order to make good on the bonds they have issued. I fear for the teacher’s pension fund who has these bonds in their portfolio and doesn’t know it’s potentially a zero. I think it’s pretty irresponsible for the institutions’ portfolio managers who can’t hold bitcoin directly to go and buy this levered Hold Co. That’s definitely following the letter of the law and not the spirit right there.
For these reasons, I think I am gonna short $MSTR…