This should have been the Teflon stock market, capable of catching political turmoil, a rising virus, and mediocre data and continuing to rise. And all it took was a short contraction in the stock that few mainstream investors would have liked to cause the biggest drop in three months.
The S&P 500 Index fell 3.3% to 3,714.24 over the past week, while the Dow Jones Industrial Average fell 1,014.36 points or 3.3% to 29,982.62 and the Nasdaq Composite 3.5% to 13,070. 69. All three suffered their strongest falls since the week ending October 30, while the S&P and Dow were down 1.4% and 2% respectively in January.
Of course, there was more than just wild trade for the stock market to deal with. Investors found that the US economy had grown by 4%, a decent number in normal times, but not when the economy is trying to recover from the Covid-19 massacre. The long-awaited disclosure of
Johnson & Johnson‘s
(ticker: JNJ) data on vaccines – which were intended to help rejuvenate the re-opening branch – fell short of the high expectations of the market.
But investors were fascinated by the surge in stocks such as
GameStop
(GME) and
AMC Entertainment Holdings
(AMC), companies left for dead but whose shares were certainly not, thanks to a crowd of Reddit investors.
The good news: The pain is likely to be short-lived.
Let’s start with the vaccine. J&J was expected to report an efficacy rate of at least 80%, but it came out at only 66%. The stock fell 3.6% on Friday after the news was announced, and the S&P 500 futures declined rapidly amid all the noise from the short squeeze stocks. However, experts were quick to defend the vaccine. They noted that it occurred in 85% of patients, meaning that even those who contracted the virus had a cough, sniff, and fever, but avoided the worst outcomes, while achieving the same level in the treatment of the more contagious South -African kind.
“Those headlines may not be that impressive, but this vaccine plays a role,” said Dave Donabedian, chief investment officer at CIBC Private Wealth Management.
That should be great news for the US economy. Things – obviously – aren’t booming right now. Fourth quarter gross domestic product grew 4%, slightly slower than the 4.2% economists predicted, but still solid given the Covid-related shutdowns in the last three months of the year. We’ll also get a glimpse of what January looks like when payrolls are released on February 5th. The US is expected to have added 150,000 jobs in the past month, compared to a loss of 140,000 in December.
Growth should accelerate in the coming months, thanks to vaccines and fiscal stimulus, which are somehow almost certain to come. Bank of America economist Michelle Meyer expects the U.S. economy to grow 6% in 2021 and 4.5% in 2022. Full employment could also be reached by the end of 2022, pushing inflation up to the Federal Reserve’s target rate. And if that’s the case, Fed Chairman Jerome Powell could start hitting rates by the end of 2023. “This would clearly be an exceptional outcome,” writes Meyer. ‘If everything goes as planned, Chairman Powell and [Treasury Secretary Janet] Yellen will be able to bow. “
Powell did nothing to suggest an interest rate hike or even the start of a tapering off in bond purchases at last week’s Federal Open Market Committee meeting. He continued to push for the Fed to remain calm until it surpasses its target inflation rate and job growth has recovered. The subtext: The Fed no longer relies on economic models to gauge when monetary policy should tighten, but will try to use the available data to assess the strength of the economy.
This change has contributed to shorter-term market volatility, said Lakshman Achuthan, co-founder of the Economic Cycle Research Institute. “The Fed has given up on the framework they had that Wall Street followed,” he says. “Now it’s a bit unbound and amenable to the story.”
And what a story it has been. GameStop’s short squeeze has quickly become a morality tale of little guys taking on the man. I’d rather see it for 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 since the emergence of the Internet market.
One thing traders need to make a profit is volatility, and it has been missing for years. But it should come as no surprise that day trading returns coincide with a market that is not only rising, but doing so sharply, similar to what investors experienced in 1998 and 1999. One of the things that ended my trading career and sent me into journalism was the lack of volatility that started around 2003.
What’s happening with GameStop isn’t even that new. Wall Street companies love
Barclays
and
Jefferies
have sent their customers lists of the stocks most retailers see. And the rise of GameStop and other heavily shorted names hasn’t been all that different from the marijuana stock mania in 2018, for bankrupt companies like
Hertz Global Holdings
(HTZGQ) in June, or even the electric vehicle stock rally in November. The recent trades have just caught the market’s attention in a way that the others have not. That’s partly because investors didn’t really have a “ fundamental ” argument for buying GameStop for $ 300 like
Tilray
(TLRY) – Just think of all the marijuana it will sell once the pot is legal! – or the coming predominance of electric vehicles.
But the other big difference is that institutional investors – hedge funds – had a significant short position in GameStop,
BlackBerry
(BB), and the rest. They had assumed the companies were going to die, so stocks had to be too. “GME is a reminder not to discount troubled companies at the beginning of an economic cycle,” writes Nicholas Colas, co-founder of DataTrek Research. “Wolf packs for retail investors are new, but if you’ve ever sat on a hedge fund trading desk, you know that pinching shorts has been a blood sport on Wall Street for decades.”
This is evident from the way stocks in Wall Street’s list of companies with the most short positions come up one by one. But just the fact that there are short sellers doesn’t make these stocks rise as much as they have. The missing element is liquidity. In August, options traders were able to move
Apple
(AAPL) and other FAANGs higher – Apple gained 22% that month before peaking on Sept. 1 – but the sheer size of the companies means it’s harder for a crowd of traders to push the stock around.
Not so with GameStop and its ilk. Steven DeSanctis, Jefferies strategist, notes that the stocks with the highest short position in small company Russell 2000 outperformed the least shorted, the largest ever. The difference for stocks in the large-cap Russell 1000 is only 5.4 points, only the ninth largest difference since 1996. The difference in performance can be explained by the lower number of shares in small-cap stocks. “Volume has gone up, but liquidity has gone down,” said DeSanctis.
But credit must be given where it is due. It may have been a crowd that got GameStop up more than 1,600% in January, but traditional investors like The big shortMichael Burry, head of Scion Asset Management, and newer ones such as “DeepF-ingValue”, have been arguing to buy the stock and put their money to work for a few years now. And these transactions were really of great value, and they had to be patient to pay off.
But you didn’t have to put up with the pain to see something different happened with GameStop in the past six months. It was up 24% on August 31, when RC Ventures, managed by Ryan Cohen, first announced a 9% stake in the company. It gained 22% on September 16 when it started taking orders for
Sony‘s
PlayStation 5. On October 8, it was up 44% after announcing a multi-year partnership with
Microsoft
(MSFT). The stock traded sideways for a while, but never got close to testing before October. 8 lows. To a fundamental analyst, the company might have looked dead in the water. For a technician it was anything but.
As for the market, it needs a rest – and it will probably get one. One of the side effects of the short squeeze is that it has forced hedge funds to sell the stocks they own to cover their shorts. That includes ones like Apple and
Facebook
(FB), which fell 5.1% and 5.9% respectively over the past week, despite strong earnings reports. The increased market volatility is also forcing some funds to narrow their long-term investments to reduce risk.
Although the chance is small, the chance of contamination is real. And if nothing else, it will force investors to rethink what they own and what they want to own for the long term. “We fully expect this kind of downturn to be a healthy buying opportunity,” said BTIG strategist Julian Emanuel. “Expressing some of this speculation is probably positive.”
The withdrawal is right on schedule. February is the second month of the presidential cycle, and it tends to be pretty dire, with a market downturn averaging 1.1%. Each sector has suffered an average loss during the second month of the presidential cycle. It’s not that every February is bad – the return was positive 12 times out of 23 – that’s the way it usually is. “You should NOT assume that February 2021 is ‘doomed’ as a bad month for stocks,” writes Jay Kaeppel of Sundial Capital Research. “What you DO need to acknowledge is that if month 2 is ‘Good’, it’s okay. And when month 2 is bad, it is often very bad. ”
Hold your hat.
Write to Ben Levisohn at [email protected]