Volatility has certainly picked up over the past few days, and it’s not just in GameStop. The broader market faced a liquidation phase across the board on Wednesday. Action accelerated to the downside after the Federal Reserve meeting ended, resulting in the largest down day for equities since October. Nothing said was overly negative, but after a massive run higher it doesn’t take much to shake the tree. Contagion fears, from possible hedge fund blowups after short sellers were targeted by retail traders, are prevalent.
The losses were immediately reversed yesterday morning, with the Dow Jones, S&P and Nasdaq posting nearly 2% gains before giving back most of the advance during the final minutes of trading. In total, the S&P and Dow were up 1% and the Nasdaq gained 0.5% on Thursday. Apple# posted record breaking earnings, but that stock didn’t participate, dropping 4% on the day. Most earnings results are coming in handily above guidance followed by little reaction. Again, buy the rumor and sell the news. Markets anticipate the positives by moving stock prices higher prior to actual growth in earnings. In the long run, markets are a discounting vehicle and know more than most investors.
In the short-run, however, many things can happen. We’re at a juxtaposition yet again with respect to heavily shorted names. GameStop is the poster child, but quite a few stocks are acting wildly the past few weeks.
First, some background on this phenomena. An online chat forum hosted by Reddit under the community tabbed WallStreetBets gathered together while focusing on stocks that are heavily shorted. Hedge funds, in particular, sell a stock they don’t own with the expectation they will buy it back at a lower price. They find a declining business line, for instance a brick-and-mortar store that relies on selling hard copies of video games that can now be downloaded from home, and realize the business could go bust in a few years. When buying the stock back later at a lower price, massive gains can be had, especially when using leverage and options to boost exposure.
WallStreetBets investors noticed a massive short position and wanted to exploit it. When hedge funds leverage up to short a stock, even a 10% move can magnify into 50% real dollar losses. They are forced to buy the shorted stock back, raise cash to cover the drop or risk going bankrupt. It creates a vicious cycle and a vacuum upwards in share price.
This game has been around forever, but is certainly exacerbated by the internet. Chat forums can reach a wide mass of people in an instant. Heavy trades placed all at once drive a stock price higher. With zero percent interest rates, Government handouts, no commission trading, time on your hands and leverage, even small investors can move a stock price when they band together. It looks like institutional money has now followed that game, adding more fuel to the fire.
If a few hedge funds recognize massive losses, they have to sell other assets to cover the drop. This is what likely occurred on Wednesday. There was no negative news but a lot of our favorite large cap names were down 5%+ during the day. That’s real money out the door. Fortunately, they recovered most of this yesterday.
Fundamentals have nothing to do with this move by any stretch. In fact, it shows the fragility of this market which can spill over into normal, high quality holdings. GameStop was halted 17 times yesterday alone while trading in a $112 – $483 range. You could have bought shares last year below $3. They closed the day down 45%, but are still up 900%+ for the year. Pre-market trades show another $150 gain as well.
In one of the more egregious moves, the tracking stock for Blockbuster Video is seeing heavy trading too. The company closed up shop back in 2011 and there is just one novelty store remaining in Bend, Oregon. It doubles as an AirBnB you can rent for $4 a night. At one point yesterday, the stock was up 9,000% for the year. No math equation or cash flow analysis will get a price target anywhere near these levels. Gambling is here; many will make money but history shows it is the retail investor left holding the bag in the end. Here’s hoping they can lock in some gains before more trading platforms restrict their favorite names.
On to the regular market, after a 75% run from the pandemic lows, what is next? Everyone knows the vaccine is here. Covid has hopefully peaked. More vaccine supplies are on the way. We don’t know the exact dollar amount but more stimulus efforts are coming. The Fed is not raising rates anytime soon. Homes and autos are in high demand. Most of the jobs lost have come back with more on the way once we reopen. What else can move us higher that isn’t already known?
Looking at the long-term charts, we can gauge where we stand from a price standpoint:
Taking out the pandemic induced drop, there is a consistent uptrend for stocks with a wide trading range going back ten years. When approaching the top of the trend lines, risk / reward is neutral while getting aggressive near the bottom proves to be a solid approach. What this shows is that the easy money has been made here. That does not mean sell everything. What it does mean is that gains from here will not be in a straight line. Many stocks will perform well, but risk is more elevated.
As with GameStop or long-term investing, balancing the risk and reward of every move is paramount. Bulls make money, bears make money, pigs get slaughtered. Whether one is day-trading GameStop or buying Index Funds, history has shown that taking profits along the way and sticking to your asset allocation smoothes out the bumps.
There is plenty of upside left but not all names are created equal. We still have the wind at our backs and plenty to look forward to. It will be up to companies to now out-execute what the market is pricing in. It was easy six months ago as a rising tide lifted all boats. Gains from here will take solid management execution and a clear runway post-Covid. Any near-term correction is likely just another buying opportunity. This elevated volatility creates opportunities on both ends. Some stocks will get over priced while others will fall to attractive valuations. 2021 is off to a fun start!
Oprah Winfrey turns 67 today. Tom Selleck is now 76. Politician turned SPAC Chairman Paul Ryan is 51 today. Lastly, the potential future face of our $20 bill, Harriet Tubman was born today back in 1820.
James Vogt, 610-260-2214