It was supposed to be the Teflon stock market, able to absorb political turmoil, a resurgent virus and mediocre data, and keep growing. And all it took was a short squeeze on stocks that few traditional investors care about causing the biggest drop in three months.
The S&P 500 fell 3.3% to 3,714.24 last week, while the Dow Jones Industrial Average fell 1,014.36 points, or 3.3%, to 29,982.62, and the Nasdaq Composite fell 3.5% to 13,070.69. All three suffered their worst drop since the week ended October 30, while the S&P and Dow ended January with a drop of 1.4% and 2%, respectively.
Of course, there was more than just wild trading for the stock market to deal with. Investors found that the United States’ economy grew at a rate of 4%, a decent number in normal times, but not when the economy is trying to recover from Covid-19’s carnage. The long-awaited revelation of
Johnson & Johnsonin
(ticker: JNJ) data on the vaccine – the one that should help rejuvenate the reopening trade – fell short of high market expectations.
But investors were paralyzed by the increase in heavily sold shares, as
GameStop
(GME) and
AMC Entertainment Holdings
(AMC), companies that were left to die, but whose shares certainly were not, thanks to a crowd of investors from Reddit.
The good news: the pain is likely to be short-lived.
Let’s start with the vaccine. Expectations were that J&J would report an effectiveness rate of at least 80%, but it reached just 66%. Its shares fell 3.6% on Friday after the news was announced, and the S&P 500 futures fell sharply amidst all the noise from short-squeeze stocks. The experts were quick to defend the vaccine, however. They noted that it prevented severe symptoms in 85% of patients, meaning that even those who contracted the virus had coughs, sniffles and fevers, but avoided the worst results, while reaching the same level in the treatment of the most contagious South African strain.
“These headline numbers may not be that impressive, but this vaccine has a role to play,” says Dave Donabedian, chief investment officer at CIBC Private Wealth Management.
This must be great news for the US economy. Things – obviously – are not growing right now. Gross domestic product in the fourth quarter grew 4%, slightly slower than the 4.2% economists had predicted, but still solid due to Covid-related shutdowns during the last three months of the year. We’ll also see what January will look like when payrolls are released on February 5 – the US is expected to have added 150,000 jobs last month, compared to a loss of 140,000 in December.
Growth is expected to accelerate in the coming months, thanks to vaccines and fiscal stimulus, which will almost certainly come, in one way or another. Bank of America economist Michelle Meyer expects the US economy to grow 6% in 2021 and 4.5% in 2022. Full employment can also be achieved by the end of 2022, which would raise inflation to the target of the Federal Reserve. And if that’s the case, Fed Chairman Jerome Powell could start raising rates by the end of 2023. “That would clearly be an exceptional outcome,” writes Meyer. “If everything goes as planned, President Powell and [Treasury Secretary Janet] Yellen will be able to bow. “
Powell did nothing to suggest a rate hike or even the beginning of a gradual reduction in bond purchases at last week’s Federal Open Market Committee meeting. He continued to insist that the Fed will remain calm until it exceeds its inflation target and employment growth has recovered. The subtext: The Fed is no longer depending on economic models to assess when to tighten monetary policy, but will try to use the available data to judge the strength of the economy.
This shift contributed to short-term market volatility, says Lakshman Achuthan, co-founder of the Economic Cycle Research Institute. “The Fed gave up on the structure it had and that Wall Street was following,” he says. “Now he is a little free and susceptible to the narrative.”
And what a narrative it has been. GameStop’s short grip quickly became a morality tale of little guys facing the man. I would prefer to see what it really is – a bunch of small investors have discovered the joys and potential profitability of day trading in a way they haven’t discovered since the dot-com boom and bust.
One thing that traders need to profit from is volatility, which has been lacking for many years. But it should come as no surprise that the return of day trading coincides with a market that is not only rising, but also rising rapidly, similar to what investors experienced in 1998 and 1999. One of the things that ended my career negotiations and sent me to journalism was the lack of volatility since 2003.
What’s happening with GameStop is not even so new. Wall Street firms like
Barclays
and
Jefferies
have sent their customers lists of stocks that are having more activity in retail. And the rise in GameStop and other heavily sold names was not much different than the craze for marijuana stocks in 2018, for bankrupt companies like
Hertz Global Holdings
(HTZGQ) in June, or even the increase in electric vehicle stocks in November. Recent trades have only caught the market’s attention in a way that others have not. This is partly because investors didn’t have a “fundamental” argument to buy GameStop for $ 300, the way they could for
Tilray
(TLRY) —just think of all the marijuana that will sell as soon as the marijuana is legalized! —Or the oncoming electric vehicle domain.
But the other big difference is that institutional investors – hedge funds – were heavily sold on GameStop,
Blackberry
(BB), and the rest. They assumed that business was dying, so stocks should be, too. “GME is a reminder not to leave companies in trouble at the start of an economic cycle,” writes Nicholas Colas, co-founder of DataTrek Research. “The packs of retail investors are new, but if you’ve ever sat at a hedge fund trading table, you know that squeezing shorts has been a bloody Wall Street sport for decades.”
This is clear from the way the stocks that make up the lists of the best-selling companies on Wall Street are bursting one by one. But just the fact that short sellers are involved does not cause these stocks to skyrocket the way they rose. The missing element is liquidity. In August, options brokers managed to increase
Apple
(AAPL) and other higher FAANGs – Apple gained 22% during that month before it peaked on September 1 – but the enormity of the companies means that it is harder for a crowd of brokers to sell the shares.
It is not so with GameStop and its peers. Jefferies strategist Steven DeSanctis notes that the best-selling shares in the small company Russell 2000 outperformed the least-sold shares by 28.3 percentage points, the highest on record. The difference for shares in the large-cap Russell 1000 is only 5.4 points, only the ninth biggest difference since 1996. The difference in performance can be explained by the smaller number of shares in small-cap stocks. “The volume has increased, but liquidity has decreased,” says DeSanctis.
But credit must be given where it is due. It may have been a crowd that made GameStop go up more than 1,600% in January, but traditional investors like The Big ShortMichael Burry, head of Scion Asset Management, along with newer ones like “DeepF – ingValue”, have been advocating buying the shares for a few years and putting their money to work. And these negotiations really were of high value, requiring patience to be paid.
But you didn’t have to endure the pain to see that something different was happening to GameStop during the past six months. It rose 24% on August 31, when RC Ventures, managed by Ryan Cohen, first disclosed a 9% stake in the company. She earned 22% on September 16, when she started taking orders for
Sonyin
PlayStation 5. On October 8, it increased by 44% after announcing a multi-year partnership with
Microsoft
(MSFT). The stock traded sideways for a while, but it never came close to testing its pre-October. 8 lows. For a key analyst, the company could look dead in the water. For a technician, it was anything but.
As for the market, you need a break – and you probably will. One of the side effects of short squeeze is that it forced hedge funds to sell the shares they own in order to cover their sold. This includes some like Apple and
Facebook
(FB), which fell 5.1% and 5.9% last week, respectively, despite strong earnings reports. The high volatility of the market also forces some funds to reduce their long holdings as a way of reducing risk.
Although the chances are small, the possibility of contagion is real. At the very least, it will force investors to reconsider what they own and what they want to own in the long run. “We totally hope that this type of retraction will be a healthy buying opportunity,” said BTIG strategist Julian Emanuel. “Revealing some of these speculations is likely to be positive.”
The setback comes at the right time. February is the second month of the presidential cycle, and it is generally terrible, with the market falling by an average of 1.1%. Each sector had an average loss during the second month of the presidential cycle. It is not that every February is bad – the returns were positive 12 out of 23 – it just tends to be so. “You should NOT assume that February 2021 is ‘doomed’ to be a bad month for stocks,” writes Jay Kaeppel of Sundial Capital Research. “What you need to recognize is that when the second month is ‘good’, everything is fine. And when the second month is bad, it is usually very bad. ”
Hold your hats.
Write to Ben Levisohn at [email protected]