HSBC’s $5.55 million autocalls on QQQ offer timely bearish bet, contrarian says

By Emma Trincal

New York, Sept. 22 – HSBC Bank plc’s $5.55 million of bear autocallable Strategic Accelerated Redemption Securities due Sept. 27, 2024 linked to the Invesco QQQ Trust, Series 1 offer a timely trade and competitive payout for bears confident in their view.

The notes will be automatically called at an annualized call premium of 38.05% if the closing level of the ETF is less than or equal to its initial level on any quarterly observation date after six months, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called, investors lose 1% for each 1% gain in the ETF.

The Invesco QQQ Trust, Series 1 is an ETF that replicates the performance of the Nasdaq-100 index.

Rich Magnificent

“It’s a very favorable note. And the timing is very good, too. QQQ is extremely overvalued. It’s concentrated in these AI bubble stocks, which we now call the Magnificent Seven,” said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

The “Magnificent Seven” are seven companies among the top 10 holdings of QQQ whose stocks have driven most of this year’s rally. Those are Apple Inc., Microsoft Corp., Amazon.com Inc., Nvidia Corp., Meta Platforms Inc., Tesla Inc. and Alphabet Inc.

Kaplan is bearish on the market, especially on QQQ.

“You can certainly short QQQ. I myself have a short position on it. The advantage is that your return is not limited to a fixed payout like in this note. However, the 38% annual return is very reasonable, and you can easily get it as long as QQQ doesn’t go up. You have three opportunities to get paid. Chances are you will get this premium at some point,” he said.

Overvaluation

Kaplan’s main reason for being bearish on the underlying ETF was based on fundamentals.

He estimated the fair value of QQQ much below $125 a share.

The deal priced at an initial level of $377.27. That’s triple Kaplan’s estimate of the fair value, which he determined based on historic average prices and profit levels.

“QQQ is not going to trade at $377 a year from now. It’s going to drop and it’s not going back up to the starting point of this note,” he said.

He was not concerned about the opposite scenario (a higher price at maturity) which would lead to losses.

“The risk is very low. It’s certainly possible. But I think I’m more likely to win a medal at the Olympics than to see QQQ in September 2024 higher than it is today.”

Kaplan said that stock prices are determined by fundamentals, not crowds. Sooner or later, inflated prices due to excess speculation end up in bear markets.

“We never had such an overvalued market in history. Insiders are not buying. They’re massively selling,” he said.

The only bear market that came close to today’s was the dot.com bubble of 2000, he added.

“Today’s bubble and the tech bubble of 2000-02 are very similar,” he said.

In both cases, new waves of inexperienced investors entered the market, piling into a few popular stocks pushing up valuations to unsustainable levels before a crash.

In the current cycle, a first wave of newcomers came in during the pandemic attracted by commission-free platforms and apps such as Robinhood, he said.

“Hundreds of millions of inexperienced investors joined the stock market worldwide, all buying tech stocks. Then came the AI bubble, which started more recently,” he said.

Speculation generated astronomical price-to-earnings ratios, he said. Tesla and Nvidia for instance have P/Es of 73 and 100, respectively.

Banking crisis

Paradoxically, the anxiety around the failures of Silicon Valley Bank, Signature Bank and Credit Suisse in March led to even more speculation in the stock market.

“A lot of people panicked, took money out of the bank and put it in the stock market, which is very unusual even in bull markets,” he said.

Both outflows from the banks and inflows to the market hit record highs, he noted.

The share price of QQQ took off around that time. Optimism about AI became the catalyst for a strong rally, giving investors a feeling of safety in Big Tech names.

This sense of confidence for a handful of overbought and overvalued stocks was based on a false perception, explained Kaplan.

“When you use something every day, there’s a psychological perception of safety, consistency, and permanence. You use your iPhone every day. You see the Amazon truck delivering your package in the morning. It feels safe. You believe these are stable companies even if the price of their stocks is ridiculously high,” he said.

Treacherous bounces

Kaplan did not minimize the intensity of the tech rally. He just would not call it a bull market.

QQQ hit a 52-week low of $254.26 on Oct. 13. Its most recent high on July 19 was $387.98. During those 280 days, the ETF soared 52.6%.

Such spectacular bounces are the hallmark of bear markets, said Kaplan, noting that they tend to be extreme and short-lived.

“A real bull market will go up much more gradually. It may take a few years to get these kinds of gains,” he said.

If the notes never get called, investors may lose 100% of their principal at maturity in a rising market.

Kaplan said the risk was worth taking.

“First, the timing is right because we had a huge rebound from October to July. The market may still be up at some point in the next year but not back up to today’s level,” he said.

Another factor was pure arithmetic.

“Bear markets show a consistent trend of big bounces followed by big drops usually of the same size. If you have a 50% rebound followed by a 50% drop, it’s not going to bring you back to your initial point. It’s actually going to bring you back lower.”

Two years out

For Kaplan, the bear market began in November 2021 when QQQ hit an all-time high.

“In almost two years, QQQ has not been able to climb back to its peak of November 2021,” he said.

QQQ is making lower highs and that’s the sign of a bear market. In a bear market, you don’t make a new high,” he said.

The intensity of the market rebound since October has investors “fooled” into believing that a new bull market has emerged, he said.

But it’s ignoring the lessons of history.

“During the 2000-02 bear market, you had huge bounces too. In 2001, from April to the beginning of June, the QQQ rose 49.9%. That was two months. The same year from the beginning of October to December, it jumped 52%.”

Going back much further in history, the year 1931 saw the biggest market rebound in history; it also marked the biggest drop, he said.

Options, rates

The portfolio manager pointed to other signs suggesting that QQQ will likely drop over the next year.

One of them was the record low prices of put options, signaling complacency and overconfidence in the market.

“Buying put options to protect your principal has never been cheaper except going back to 1973,” he said.

Simultaneously, the volume of call buying is at all-time high.

But perhaps one of the most reliable signals of a bear market is the inverted yield curve.

Kaplan said the inversion is especially extreme between the three-month T-bill and the 10-year Treasury.

“We have never seen such a deep inversion. It’s another record. Short-term Treasury yields are unusually high,” he said.

Other parts of the curve are inverted too, but the 10-year minus three-months is the most telling, he said.

“There has never been an inversion of the curve that was not followed by a bear market,” he said.

“We’re in a classic bubble.”

BofA Securities, Inc. is the agent.

The notes settled on Thursday.

The Cusip number is 44328M187.

The fee is 1% for 300,000 units of $10 each, and 1.25% for remainder.

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