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Markets drop as retail investors and hedge funds tangle

February 01, 2021

Thoughts

  • Markets look to rebound this week following the worst week since October, as fading investor confidence and a wild conflict between retail investors and hedge funds outweighed positive earnings surprises and encouraging Covid-19 data. January ended with a fractional loss, similar to the start of 2020. The decline was broad-based, led by areas showing recent strength, including emerging markets and small caps.
  • Investor activity was unusual last year, with an impressive equity market rally despite unprecedented uncertainty. Action this year in certain pockets of the market have turned surreal, with a group of retail investors conducting a coordinated “short squeeze” on heavily shorted stocks, driving their prices dramatically higher. For example, GameStop, the most shorted stock in the market, saw a jump of 1,625% this year, with trading volume last week 25x the average from 2020. The magnitude of the trading volume suggests that the activity was not limited just to retail investors, but institutions as well. Beyond just the equity market, this group seeks to influence cryptocurrency and commodity markets.
  • Volatility remains elevated, with the VIX above 30 despite the S&P® 500 Index being within 4% of a record high as of Friday. This is double the long-term average, and an indication that call options are being increasingly used offensively in addition to defensively. Last week saw record trading volume of call options, increasing investors’ leverage to swings in the market. Heightened volatility has had a notable hit on investor sentiment and market momentum, though stress indicators (credit spreads, interest rates, etc.) remain calm.

News

  • The next phase of fiscal stimulus continues to be negotiated in Congress, with a group of 10 Republican senators and President Biden set to discuss a bipartisan plan. Their $600 billion plan features more targeted $1,000 checks to individuals. Senate Democrats, however, continue to push the $1.9 trillion package, with Senator Sanders convinced they can pass the bill without Republican support, while others are pushing to expand the scope of budget reconciliation to include boosting the minimum wage.
  • Largely forgotten in the loud news cycle this week was a wave of mostly better-than-expected earnings releases. Nearly 40% of the S&P 500 companies have reported, with 82% surprising to the upside, the second-best result on record. Growth is trending to -2%, which would represent the fourth-straight quarterly decline, but is much better than what was expected coming into earnings season. Positive surprises in technology and financials were offset by weakness in industrials. The market is not rewarding beats but is punishing misses less than usual. Companies that beat have seen their stock lose 1.5% in the two days before and after reporting, versus a historical average of 0.9%, reflecting the optimism embedded in the market coming into earnings season.
  • The trend of good news surrounding the Covid-19 outbreak continues, with cases falling to the lowest level since before Thanksgiving. Hospitalizations were down 13% in the past week, with sixteen-straight days of week-to-week declines. Vaccine distribution continues to expand, with an average of 1.5 million doses per day, with Johnson & Johnson set to seek an emergency use authorization this week for their one-dose vaccine, followed by an aggressive production ramp. Biotech firm Novavax said Thursday that its coronavirus vaccine was more than 89% effective in protecting against Covid-19, including 86% effective against the U.K. variant.

What to Watch

  • Economic data next week includes ISM manufacturing on Monday, ISM services on Wednesday, durable goods on Thursday, and the monthly payroll report and consumer credit on Friday.

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Sources

  • This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition, or particular needs of any specific person. Investors should work with their financial professional to discuss their specific situation.

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