But even in late February, something strange had happened. The sellers of these financial insurance policies made no distinction between riskier borrowers and safer borrowers, and hardly charged more for swaps on lower-rated debt. “The market completely misjudges this.” Ackman told his team on that conference call on Sunday, “Start buying.”
Talthough he didn’t use the word, Ackman called the financial market what it had become clear: a bubble, and one in danger of bursting.
In the 1600s, merchants in Amsterdam were crazy about tulip bulbs. Four hundred years later, it was Japanese real estate, dotcom companies, and suburban homes. Some bubbles are clearly ridiculous even at the moment (see: Beanie Babies) and others only in hindsight, but the pattern is reliably the same: evangelists pile up. Other investors, gripped by the fear of missing out on big profits, follow suit. Frenzied buying pushes the price of an asset far beyond what a sober economic analysis can support. while everyone gets rich.
In the decade leading up to 2020, the same thing had happened, except it focused not on one place, but for almost the entire global financial system.
The S&P 500 gained 400 percent between March 2009 and March 2020 in a historic bull market. Debt became cheap and plentiful. The oddity Ackman had noticed—a lack of attention among bond investors who charged little more interest to the riskier than to borrowers—was growing more. pronounced. Near-zero interest rates set by the Federal Reserve forced investors to invest in anything that might yield a little profit, pushing them further and further into riskier territory. The decade-long economic expansion had blinded investors to risk, forgetting that markets can go down just as easily as up.
Conventional wisdom says that no economic trend has a single cause, but the decade-long bull market that emerged from the wreckage of the 2008 meltdown may well prove it wrong. years after the global financial crisis. That forced investors to look for alternatives. They dive into stocks, corporate bonds, real estate, and anything else that promises a return. So everything goes up.
Skeptics grumbled. By the closing years of the decade, FOMO had replaced fundamentals as the dominant force in financial markets. It was a bubble – not as blatantly absurd as the beanie babies or Dutch tulips rush, but a bubble nonetheless – question marks about what would burst it.
Ackman was waiting, holding out a bucket.
The represented the coronavirus something investors hadn’t seen in over a decade: a shock whose impact was potentially huge and essentially unknown. On February 27, the stock market posted the largest one-day point drop in history. The S&P 500 was now down 12 percent from its peak just a few weeks earlier, officially in what economists call “correction.” Of the twenty-six previous market declines of similar magnitude in history, the average had lasted four months. This only lasted six days.
He emailed Warren Buffettwhose shares Ackman had flirted with selling a few days earlier. Berkshire’s annual shareholders’ meeting, known in the press as “Woodstock for Capitalists,” drew tens of thousands of people to Nebraska each spring.
The billionaire was as folksy as ever in his reply. In an email dictated to his longtime secretary — the octogenarian doesn’t use email — he said he hoped to see Ackman at this year’s meeting, scheduled for May 2, and invited the investor and Oxman to a private brunch. “Unfortunately we can’t include Raika,” he said of Ackman’s baby daughter, “but if she owns Berkshire, I hope she continues to vote for me and Charlie” as members of the board of directors. He added: “I have no idea if the coronavirus will affect turnout, but Charlie and I plan to have a great time.”
Ackman began to feel a bit silly and tried another of the world’s richest men: “I believe I have an accurate and differentiated view of the economic impact of the coronavirus, if you’re interested in comparing notes,” read the email he typed to Bill Gates on the afternoon of February 28. The Microsoft founder had written an op-ed the day before saying the coronavirus was beginning to resemble “the once-in-a-century pathogen we’ve been worried about”.
He never heard anything again.
Bj early March, Pershing Square had bought more than $1 billion in credit-default swaps on broad baskets of bonds. The position cost $27 million, which Ackman says was the bargain of a lifetime.
While credit-default swaps are often compared to financial insurance policies, they differ in one important respect: The event they protect against — a borrower defaulting on their debts — doesn’t actually have to happen for the policyholder to make money. themselves are financial investments that gain paper value the more likely the event they are protecting against seems. All it took for Pershing Square’s bet to pay off was for the market to get scared.
And as the coronavirus spread across Asia and then to the United States, global investors hurriedly frightened. From a high in early March, the corporate bond benchmark index fell 15 percent on March 20. On paper, Pershing Square’s investment was worth more than $2 billion. It was like buying flood insurance for a pittance during a drought year and selling it during a monsoon.
By the time his traders liquidated the position three days later, Ackman had made $2.6 billion in profits in three weeks, a hundred thousandfold return.