Monthly Market Muhsings - January 2021

Markus Muhs - Feb 01, 2021
Wow, where to even begin with my review of the markets in January? Remember the violent insurrection at the Capitol? That was actually in January too, even though it felt like it was longer ago.
Monthly Market Muhsings
 
Despite all major North American indices (even the TSX Composite!) reaching new all-time highs during the month of January, most finished flat, with the small-cap index still finishing the month strongly.
 
 
 
 
Before the past week I thought the theme of the markets for January would be the general resilience in the face of really weird things happening. The day that a large band of domestic terrorists stormed the Capitol—protesting and trying to undermine the results of an open and fair democratic election—also happened to be the day after the Georgia U.S. Senate run-off vote. Political market pundits going into that vote predicted doom for the markets if Dems won both seats, for the logical reason that a Democratic “blue wave” of Congress paves the way for a more leftist approach from the Biden administration, inevitably higher taxes on corporations and the wealthy. Markets actually went UP quite a bit the next morning, I think based on that it also paves the way for more economic stimulus.
 
When the storming of the Capitol happened, markets buckled a bit, dropping below the all-time highs they reached that morning, but still finished the day positively. Go back to a few years ago and imagine someone told you this would happen in the final weeks of Trump’s Presidency…
 
 
Would you expect the markets to be at and make new all-time highs?
 
There’s a bit of deliriousness in the markets. Maybe more than a bit. No, I don’t think we’re anywhere near the type of euphoria we saw in 1999/2000, and don’t think anyone should be making a bet with their investments that we are. For all we know, we could be only at 1997 levels of euphoria and this hasn’t fully played out yet. The greatest danger to your long term investment returns is sitting out on the euphoria because—love it or hate it—it all forms part of your long term compound annual growth rate. 
 
I might suggest that now is a time to be careful investing money into those asset classes that have run up the most. Yes, you have an opportunity to buy and then sell at an even more inflated value to “the greater fool”, but there are plenty of other assets that haven’t run up as much. Maybe they’ll get their turn sometime in the future? Or maybe everything will come crashing down and you at least won’t get hit as hard: such was the case for investors in good quality value stocks in 2000.
 
If market sentiment and loopyness can be represented in a TikTok video, it’s this one that went viral and was ridiculed by all:
 
 
...which fed perfectly into the environment we’re now in, where young novice traders are storming the markets like figurative bulls in hedge funds’ carefully curated china shops.
 
The most concise explanation I can muster for what’s going on in the markets (note: I’m writing this on the 31st, so the whole thing could turn upside down again over the coming week) is as follows:
 
Someone on a Reddit message board called wallstreetbets (which already was gaining some infamy through the Covid retail investing bull since last spring) determined that GameStop shares were beingly heavily shorted by hedge funds. So much so, that at 140% “short interest” fully 1.4 times as many shares were sold short as were available in the “float” (the number of shares out there that aren’t restricted from being traded)
 
Preet Banerjee actually did a good explainer video on this, including the basics of short-trading, so I'll leave it to him. He's no Margot Robbie (explaining derivatives in The Big Short) but he is presenting in front of a RatemySkypeRoom award-winning background:
 
 
There’s nothing wrong with shorting per se, as it creates extra liquidity (more supply of shares to be bought by those who want to “go long” the shares). In the case of those shorting GameStop, they had a completely reasonable case to do so: it’s a company that sells downloadable content on media (disks) that hardly get used anymore, in brick and mortar stores to which no one wants to go during the pandemic. I mean, all told they do retailing very well, but they face a lot of headwinds, thus are quite short-worthy.
 
Another very short-worthy company is AMC Entertainment (the movie theater company, not the TV channel/network, who also saw their stock pushed higher by errant trades), who are obviously in dire straits right now, with theaters shut down and big movie releases deferring to later 2021 or to streaming platforms. It too was among the most shorted companies out there.
 
In fact, there’s a website that tracks this stuff, and this provided a list of companies for these Reddit nerds to attack. Many of these companies are small-cap companies, with very small floats, so some kids with Robinhood accounts (Robinhood was once a very popular mobile trading app for kids) collectively could make a serious impact on the market.
 
The short squeezes forced shorters to cover their positions, which they could only do by buying more shares, causing them to go even higher. The same goes for those who had sold “naked calls”, who had to buy the shares to deliver on the call options they sold (Preet goes into this a bit in the above video, so I’ll spare you). With expectations of more short-squeezes (or to incite them) many other names on the High Short Interest website saw their prices soar.
 
 
Because the shorters (primarily hedge funds) had to raise money to buy these shares back at such inflated values, they pretty much had to sell everything else, and that seems to be why on days when GME and AMC skyrocket the rest of the market goes down (Wed/Fri last week) and the opposite when the tiny stocks come back down to Earth (Thursday).
 
My opinion on this all is that if there’s any lasting impact from these market movements it’s that shorting stocks just became a lot more dangerous. It has always been dangerous: whereas your potential loss on a long position (when you buy a stock) is capped at 100% of your investment (if the company becomes worthless), the potential loss when shorting is theoretically unlimited because there is no limit to high a stock price might go.
 
Until this month, this was an area of market inefficiency. Most of us didn’t pay much attention to it, and as a result companies were being shorted unproportionately to the fundamentals and the risk involved. Shorters didn’t expect average retail investors to take notice and see an opportunity and they never would have expected a collective “group buy” of their shorted companies. 
 
What I mean to say is that if the threat of a short squeeze coordinated over social media was always present, then these stocks wouldn’t have been shorted quite as heavily to begin with, as hedge fund managers had a better understanding of the inherent risk. Perhaps going forward this is a net positive for share prices, particularly in the deep value space (deep value investing having very little success over the past decade)? Perhaps even companies down on their luck, like the ones mentioned above, will see their shares only slightly shorted instead of heavily shorted and will better be able to raise capital to dig themselves out?
 
 
The last few years notwithstanding, many long/short or market neutral hedge funds have historically been able to generate superior risk-adjusted returns. In a fully 100% efficient market, this should not be possible. Maybe another corner of the market that they were able to capitalize on just became a whole lot more efficient? 
 
At the end of the day, what we’re left with is a very “meme-worthy” market, and I kid you not, this literally is what the stock market is like in 2021…
 
 

(One could replace “target date funds” with anyone following a long-term investment strategy)

 
So, some people are asking whether all this stuff going on is illegal. Shouldn't it be illegal to manipulate the markets in such a way? I'm no expert on such matters, and we'll probably soon learn what the SEC or other regulators have to say about it, but I think one big way this situation differs from usual market manipulation is that it was all wide out in the open.
 
You saw stuff like this if you watched the old 1980s movie Wall Street. Charlie Sheen's character manipulated a stock for Michael Douglas' character (a hedge fund manager/corporate raider) to the chagrin of Terence Stamp's character (another hedge fund manager). I forget exactly what the trade was there, but I think part of it was that Stamp's character got squeezed short.
 
In this case, some kids telegraphed their moves on an online message board before and as they were doing them. A coordinated collective trade is obviously a new and very different entity for market participants and regulators to contend with, so we'll see...
 
 
Investment Advisor & Portfolio Manager
 

 
PS: I just want to share this to show off. I’m not a clairvoyant or anything, but when I attended the Edmonton CFA Society Forecast Dinner last January, still before Covid news became very mainstream, I made a year-end prediction for the S&P 500 of 3750:
 
 
I’m not sure how I came up with that number, as it was actually higher than what every Wall Street strategist predicted the month before, including our own Tony Dwyer, who had 3440. Of course, in the month or two that followed, many strategists retracted their predictions as finishing the year anywhere in the 3000s seemed impossible, from the low-2000s we were at in March.
 
Anyway, again it was pure luck that the S&P 500 ended the year just 6 points higher than my prediction; it’ll probably never happen again. For what it’s worth, for the 2021 forecast (the “dinner” was held virtually this year, with author Michael Lewis speaking to the combined Edmonton/Calgary/Winnipeg CFA societies) I have the S&P 500 finishing at 3750 again (essentially flat), with commodity prices (in turn, the TSX and $CAD) rising through 2021.
 
You know how I feel about prognosticating, and this past year showed just how pointless it is, so it’s all for fun and games!