What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing today we're doing a video on the big short investor, michael brewery and inflation in may. It was revealed that berry's hedge fund psion asset management, initiated a short position in tesla nominally worth 530 million dollars. He didn't directly short the stock, but instead bought puts, which will benefit from the share price going down. This was a huge position for brewery, as it represented 40 of his portfolio value at the time.

However, it's also important to keep in mind that this is a nominal value of the shares covered by his put contracts based on how far in or out of the money they are. The market value of the position is likely much less than 530 million, but he's still making a big statement by initiating the position. Hedge funds are required to disclose their holdings to the public on a quarterly basis. He added to the tesla short position with his puts covering 731 million dollars worth of tesla stock.

The position actually decreased as a percentage of his portfolio, but what made the most news is his newly initiated short position on kathy wood's arc: innovation etf: this is a much smaller position than the tesla short and only makes up 1.5 percent of his portfolio ark's top Position is tesla, which has a 10 weighting, so berry is short tesla, both directly and through kathy woods, etf. She also owns many other popular growth stocks, including roku, palantir, draftkings and others. On the surface, it looks like he just thinks that tesla and kathy wood's innovation stocks are overvalued and won't live up to the hype, but there's more to it than that. The real reason that bury is shorting.

These stocks has to do with the fed's money. Printing policies and inflation, so how does this have any relationship to tesla or arc? Invest it all comes down to discounted cash flow analysis or dcf? The dcf discounts the present value of future expected cash flows to calculate the fair value today. High growth stocks, like tesla, are very sensitive to changes in the discount rate. We can understand this with a stylized example.

Let's say that tesla will make zero free cash flow for the next few years, as they're investing for growth, but eventually they'll reach scale and become very profitable. These are just made up numbers to show the mechanics of the dcf at a low discount rate of five percent. These future cash flows are worth a lot if you increase the discount rate to 10 percent. The present value of these same free cash flows decreases substantially.

Bury is bidding on the discount rate going up, causing high growth stocks like tesla to derate. Significantly, an increase in the discount rate will negatively impact all stocks, but high growth stocks are especially at risk. A value stock that is generating free cash flow today, but not expected to grow in the future, will see its present value decrease by a lesser amount, simply based on the mechanics of the dcf. So what does inflation have to do with a discount rate? The idea is that, if inflation rises, the federal reserve will be forced to decrease its quantitative easing programs and raise short-term interest rates.

This will increase the yield on the 10-year government. Bond discount rates for stocks are generally calculated as some markup over the 10-year bond yield. So it should cause an unfavorable re-pricing of high-growth stocks. This seems like a pretty sound bet.

The government printed trillions of dollars over the past year, which many economists expect to cause massive inflation. The consumer price index rose at a record annual rate of 5.4 percent in both june and july for brewery's investment thesis to work out, real interest rates have to rise. The real interest rate is the nominal interest rate minus inflation. There are a few reasons why this is highly unlikely.

In our view, the u.s government borrowed trillions of dollars over the past year to combat the pandemic. This has caused the national debt to sort over 28 trillion dollars. Despite the debt skyrocketing to record levels, the government's total interest expense has actually decreased over the past two years, as interest rates have plummeted. This is what makes the debt sustainable, at least for the time being.

The us's debt to gdp ratio has reached about 130 percent. This is the highest level that we've seen since world war ii. It also puts the government in a very precarious position and they can pretty much only stay solvent if real interest rates stay negative or at least very low. The government derives its revenue by taxing the real economy.

If inflation rises, nominal tax revenues will also rise. So the real interest rate is the only thing that really matters for the government. If inflation rises to 10 percent, the fed can raise interest rates to 10. To offset the inflation, this would leave real interest rates at zero.

It's highly unlikely that the fed will increase interest rates significantly above inflation, as this would cause a budget crisis for the government in a financial crisis for the economy. At the same time, the government was borrowing trillions of dollars to fight the pandemic. Corporations were also borrowing trillions of dollars to stay afloat. If the fed were to raise real interest rates significantly, there could be a wave of corporate defaults rivaling the 2008 financial crisis.

But let's just assume that inflation rises to 10 and the fed raises nominal interest rates to 10 percent. This should be enough to crush tesla stock like a souffle under a sledgehammer right, not exactly when inflation rises, the price of all consumer goods will rise. This includes the price of tesla cars. If inflation rises by 10 percent tesla will raise its prices by 10 too, thus preserving the real value of their profits after you adjust the cash flow numbers for inflation.

The discount rate in the dcf is based on real interest rates. It is actually possible that the fed will increase interest rates to less than inflation, which will actually decrease the real interest rate. This could theoretically benefit hydro stocks like tesla in response to michael bury shorting. The arc etf kathy wood posted the following tweet.

She gives burry credit for predicting the mortgage crash of 2008, but he doesn't understand the massive growth drivers behind disruptive innovation companies she's, basically calling brewery a one-trick pony whose new strategy will fail to bury's credit. Tesla has gone down by more than 20 since its highs of this year, depending on when he initiated the position he may have made a profit arc has had. Similarly, poor performance as most of its holdings are highly correlated with tesla, but this is not necessarily confirmation of his investment thesis after peaking at about 1.75. In april, the 10-year treasury yield has decreased sharply down to below 1.3 percent.

This suggests that the market thinks the fed will keep interest rates low. Despite the increasing inflation in the first quarter of 2021, he initiated massive call option positions on inverse leveraged treasury bond etfs. This was a leveraged bet that interest rates will rise significantly and rapidly. Of course, the opposite happened in these etfs tanked in value.

The tmv etf has declined more than 30 since its peak in march, it's possible that his calls expired worthless, as he no longer holds the position. He also owned calls on the tvt etf, which has experienced similarly poor performance in the second quarter. He reduced the size of his position by 79, probably at a huge loss, but he hasn't thrown in the towel on its inflation thesis. Yet he added to his tlt put position, which now stands at 13 of his portfolio.

The tlt is an etf which owns government bonds with durations of 20 years or greater unlike tesla or arc. The nominal interest rate is what matters to this etf. If inflation does in fact rise, nominal yields should go up which will cause the tlt to go down of all of his positions. This one seems the most reasonable in our opinion.

One thing that's curious about michael brewery's. Recent positions is that he uses put options instead of outrage shorting the stocks when a hedge fund shorts a stock, they do not have to disclose this in their filings because they do not own the stock when they buy a put. They do have to disclose this because it is an asset which they own. The only reason we know about gave plotkin's gamestop short position is because he also bought puts it could be the case that michael brewery used puts because he wants people to know about his positions.

If he wanted to get media attention, he certainly succeeded. Alright guys that wraps it up for this video, what do you think about bury's short positions? Why do you think that he is using puts let us know in the comments section below if you enjoyed this content, don't forget to hit the like button and subscribe. So you don't miss future videos as always. Thank you so much for watching and we'll see in the next one wall, street millennial signing out.

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