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Those that follow fractional markets closely already know: for many assets, May wasn’t a banner month.
How we view the month differs based on our view of the markets, our own time horizons, and our risk tolerance. For flippers: unmitigated disaster. For short-term thinkers: pain. For the long-term oriented, though, feelings towards such an environment are more complicated.
For the true long-term thinker, short-term fluctuations should be met with indifference or even with excitement (in the case of downward movements). Large drawdowns would be opportunities for those who like an asset to like it even more, to buy the dip. Some, though, will feel anxiety or a twinge of worry as they consider whether the market is right about their assets. They’ll be left to wonder just how long-term they actually are and how strong their convictions remain in the face of prices trending in the wrong direction.
The unfortunate reality is that the month of May presented a wealth of opportunities for these considerations. Over the course of the month on Rally, Otis, and Collectable, there were 23 instances of an asset trading down over 30% in a single day. There were 61 instances of an asset trading down over 20%, 38 exclusive of those trading down over 30%.
Markets with little volume and little liquidity are volatile. We knew this. That reality is not unexpected in the early days of this alternative asset movement. Still, assets in such freefall with such regularity can be unsettling, even to those with the strongest of hands.
Now, May was tough, but it didn’t trend remarkably worse than the prior month. April saw 20 instances of an asset trading down over 30%, and 44 instances of an asset trading down over 20% (24, independent of instances down >30%). Keep in mind, an additional 42 assets began trading in May, so there was a higher volume of total trading instances during which disaster could occur. We do see a stark contrast to March, however, when fewer assets were trading, but the amount of brutal daily outcomes was vastly lower and the amount of large upside days actually surpassed the later months.
While we often feel the pain of losses more than the joy of victory – psychology at its finest – it’s important to note that the volatility of daily returns has not skewed that heavily to the downside in recent months. In fact, in both May and April, the outsized outcomes were somewhat symmetrical. May even saw more +30% instances than -30%.
Still, from those large downward movements ripple waves of anxiety and doubt. And that anxiety and doubt causes more selling. And that selling causes more large, downward movements. There certainly appears to be an element of self-fulfilling prophecy at play. That self-fulfilling prophecy, set in motion principally by flippers and short-term thinkers, is essentially as follows:
Some assets are going down -> I’m worried they’ll go down more -> I better sell -> See, the price is falling! -> Sell more -> Wow it’s still falling, I was right!
Those movements aren’t totally indiscriminate – the instances of assets moving drastically higher suggest there’s still some discerning activity– but they don't necessarily distinguish asset class. Below is the number of instances of down 20% days by asset class. To contextualize it a bit, we’ve also included labels that display the number of instances as a percentage of the total number of assets trading in the asset class as of the month of May.
Okay, so how do we draw conclusions about what’s driving this and if it really is a self-fulfilling prophecy of the flipper? Let’s drill down a bit further.
It’s worth noting that of those 61 instances of an asset trading down over 20%, 12 instances were the trading debut of an asset. Of the 23 instances of an asset trading down over 30%, 9 were a trading debut.
Now, why on earth are there people happy to escape with 70% or less of the money they happily subscribed with just months ago? Has the asset changed? Has the market changed that much in mere months?
To be clear, there will be situations in which the answer to the previous question is yes. It happens. But this frequently? Across this many asset classes?
Is a first edition, inscribed version of Jack Kerouac’s On the Road really worth 65% less than it was a few months back? Those don’t trade so often, so I’m not sure we can make a case for comps. That exact copy, however, traded with Sotheby’s for $43,750 in 2012, almost $10k above its current level on Rally in 2021. That feels like flippers headed for the exit, reason be damned.
How about a Triceratops Skull? Should we be willing and psyched to get out of there down 30% just four months after we happily subscribed at a $285k valuation? Hard to see a lot of rational cause to embrace that outcome….unless you’re a short term flipper just looking to cash out for a better flip elsewhere. It’s pretty, pretty, pretty hard to think of a more long-term asset than one from the Late Cretaceous period.
There’s real evidence to suggest that it’s the flipper making a frenzied run for the exits and clogging the doors on the way out. Just look at the average first trading day return for Rally assets by month. In late 2020 and early 2021, assets that launched in the summer of 2020 began trading, and it was party-on. Prices were popping higher left and right, just as was the case for sports cards at auction. Subscribe to IPO that sells out in minutes. Sell higher in a few months. Easy. So, in came the flippers, pouring indiscriminately into IPOs they were indifferent to over the long term, chasing that quick short-term pop. As soon as those short term pops showed signs of deflating in February and March, the freefall was on. The space is, in that regard, a victim of its own success. Winning so big, so soon set an incredibly high bar, quickly orienting much of the fractional landscape with a short-term mindset in pursuit of instant gratification. When that instant gratification slowed, markets suffered.
Flippers have been exiting en masse, and importantly, they’ve been doing so at whatever price it takes to be on the right side of the clearing line. This activity essentially re-rates the asset very quickly, and those stepping in to buy need not bid in a way that re-establishes the price higher. Now, the lack of buying pressure is a separate issue and one that merits attention – more, new demand for assets trading on the secondary market would certainly be constructive. Still, the selling pressure created by the flipper exodus is difficult to overcome in a day’s time, particularly when we’ve anecdotally seen willing buyers unable to fund their wallets expeditiously enough to act. Those are learning experiences that eventually smooth over time.
Theoretically, as it becomes clear that the flip play is less viable, IPOs should fill with fewer flippers. The slower pace with which many IPOs are funding may be indicative of just that. Perhaps that's not the ideal outcome for the marketplaces, but it may be healthier in the long run. It should mean that the shareholder composition trend longer term. That’s not to say everybody will be a 7-10 year holder, but the average intended hold should be higher just by virtue of shedding some of those that had a ~90 day intended hold. There should be fewer tourists. That helps to stop the skid, which bled from assets making their trading debut to more seasoned assets, as those who considered themselves longer term when things were going well capitulated as the landscape grew more tumultuous.
Many have heralded the arrival of several buyout offers on Rally as a catalyst to bring the slide to a halt. It’s true – a concrete offer to purchase an asset does provide some grounding in reality for prices. Of course, it begs the question whether that reality is lower than it otherwise would have been due to weak trading activity, but the offers at least begin to construct a floor. Still, the prospect of gain, in a moment where gains have been harder to come by, may have the previously long-term thinker happy to yield for less.
Accepted or not, buyout offers do have the potential to re-introduce stability in the market. For assets with lower populations that change hands less frequently at auction and otherwise, data points are hard to come by. That’s why On the Road and Deaton can drop precipitously with little friction – the reality of their value isn’t at a fingertips distance. It’s not as easy to say, “hey dummy, a Triceratops skull just sold at Heritage last month for $300k.” But buyout offers provide those data points in the most credible way possible, and that can have a grounding effect on the market. Of course, the three recent offers have been specific to comic books, but still, the reminders that there are credible end-buyers out there for these assets are by no means unwelcome.
As we often note, these markets won’t be without growing pains. They won’t be without volatility. That much is abundantly clear. It is important, though, that each participant take stock of their goals, their intended time horizons, and their risk tolerance. If it’s deeply unsettling to endure 30% down days, it may not be the right fit. Volatility will persist, but the frequency and persistence of such large drops may not, particularly as flippers exit, markets mature, and trading systems evolve.
It’s a roller coaster, but hey, aren’t those supposed to be fun?
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