Market Pulse - 29 January 2021

Stocks end action packed week as GameStop drama continues

The first month of 2021 was dominated by volatility as a wild battle between retail investors and hedge funds ensued. While the market has been fixated on the action in GameStop and other heavily shorted stocks, given the long upswing in markets, investors shouldn’t be surprised by the recent losses. This week, in fact, represents the worst week for the major indexes since Oct. 30, before the election.

The Dow was up approximately 13% from 30 October 2020 through 29 January 2021, and set four record highs in January. The S&P 500 was up 15% in the same span and set five record highs in January.

Stock markets have seesawed in January, dominated by headlines about COVID-19 vaccine supplies and tightened lockdown measures around the world. At the same time, new COVID-19 variants are showing up around the world, raising questions about the effectiveness of the vaccines and lockdowns.

There is a bit of nervousness in the market which is visible in the Cboe Volatility Index. The VIX was up 9% Friday and is up 45% in January.

In bond markets, the benchmark 10-year US Treasury bond yield fell to 1.071%, down from its recent high of 1.134% as investors took some risk off the table.

Bitcoin gained as much as 15% on Friday after Tesla CEO, Elon Musk, mentioned the cryptocurrency in his Twitter account, writing “#bitcoin.” 

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2020 Economic data released

Consumer spending in the U.S. declined by 0.2% in December, according to data from the Bureau of Economic Analysis. It fell for the second straight month due to a rise in COVID-19 cases, although a little less than economists had predicted. Household incomes rose 0.6%, which could prime the economy for growth later this year.

A strong rebound in the second half of 2020 wasn’t enough to overcome the economic shock created by the pandemic earlier in the year. US GDP contracted by 3.5% year-over-year in 2020, the largest decline since just after World War II and the first since 2009 in the wake of the financial crisis. Measured from the fourth quarter to the same quarter a year earlier, the economy shrank 2.5%.

Fourth-quarter US GDP grew at a 4% annual rate, the Commerce Department said on Thursday. That joined a record 33.4% annual rate of growth in the third quarter to further reduce losses from earlier in the pandemic.

China was the only economy in the world to grow in 2020, posting a year-over-year GDP growth rate of 2.3%

Apple posts first $100 billion quarter

Corporate earnings have been broadly strong as earnings season is in full swing. 

Apple posted a blowout quarter with $111.4 billion in quarterly revenue - their best quarter ever. The record numbers were fueled by an uptick in higher-end iPhone 12 sales and a pandemic-induced surge in demand for its laptops and tablets.

Facebook posted record revenue and profit as online holiday shopping increased and use of the company’s platforms during the pandemic drove a surge in its ad business. However, its shares fell as it warned of headwinds to its ad business this year amid new curbs on pulling users' data for ad targeting.

Tesla reported its first full-year profit, powered by a growing appetite for electric cars, although supply-chain costs pulled profit for the October-December quarter short of analysts' expectations.

In other earnings news, Caterpillar reported a smaller-than-expected fall in quarterly earnings but refrained from providing 2021 guidance because of lingering pandemic-related business uncertainty. Starbucks reported that its US same-store sales fell 5% during its fiscal first quarter after a surge of new COVID-19 cases led to harsher dining restrictions. American Airlines reported smaller than expected loss for the fourth quarter. Revenue surpassed expectations, but was still down significantly compared to the same three-month period a year ago. American Airlines got caught up in the short squeeze and surged 70% at one point in after hours trading.

Retail investors vs hedge funds

Although this week has been loaded with important economic and earnings data, nothing dominated the headlines quite like the exponential moves higher in GameStop and AMC Entertainment. 

A wave of at-home traders found each other on the red-hot “wallstreetbets” Reddit chat room, whose members have ballooned to over 5 million. By motivating each other to keep piling into shares and call options, they coordinated a monstrous short squeeze and forced their target hedge fund, Merlin Capital, to close out their large short position at a massive loss.

There has been widespread debate about what should be done to curtail the volatility to protect inevitable pain in these widely overvalued stocks.

Shares of GameStop and AMC bounced back more than 50%, closing the week up 400% and 278% respectively. Despite slipping from highs earlier Friday, the two hot stocks ended an improbable week on a high note.

The market has struggled to shake off the extreme volatility in some of the most heavily shorted stocks in the market. 

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What is short selling?

A short seller borrows shares of a stock and sells these borrowed shares to buyers willing to pay the market price. As the stock price falls, the trader would buy it back for less money, pocketing the difference.

However, when the stock jumps sharply higher, it forces short sellers to buy back shares in order to limit their losses. The short covering or “squeeze” tends to fuel the stock’s rally further.

The rally in GameStop was initially triggered on Jan. 11, when news broke that activist investor and Chewy co-founder and former CEO Ryan Cohen is joining GameStop’s board. The stock jumped on the announcement in hopes Cohen would drive a change in strategy.

GameStop continued to rocket higher as retail traders showed no signs of letting up. Amid the massive squeezes, Melvin Capital closed out its short position in GameStop on Tuesday afternoon after taking a huge loss, the hedge fund’s manager told CNBC’s Andrew Ross Sorkin. Short seller Andrew Left of Citron Research said Wednesday he has covered the majority of his short position in GameStop at a loss.

2021 Outlook

We believe there will be increased short term volatility in markets as the war between retail investors and hedge funds drags on. This too shall pass and will not have a lasting effect on the overall market. We believe this pullback in stocks is healthy and poses buying opportunities in some technology names that have come off their recent highs after posting record earnings and small-cap equities, as there is a high likelihood of a stimulus bill coming into fruition in the coming months.