Equity markets struggled for the week as volatility and volumes jumped. Most of the major indices lost about 3% during the week last week, including most European and Asian markets. Large caps in the US held up better than mid and small cap issues, as reflected in the 5.26% decline for the S&P 400 and the 4.56% drop in the Russell 2000. Most of the week’s decline occurred on Wednesday as did the highest volume day of the week.
The increase in volatility and volume occurred when a short squeeze took place with some issues known to be shorted by some of the major hedge funds. A large group of unseasoned investors, posting on various message boards such as Reddit, decided to take on the Wall Street hedge funds by increasing the prices of three stocks highly shorted by the hedge funds. By shorting a stock, an investor is anticipating a stock to fall in price and is considered a bearish strategy. If the price moves higher, the short manager at some point feels compelled to re-purchase the position sold (shorted) earlier and take a loss. It is the opposite of an investor buying a position only to watch it drop in price to the point of selling the position to eliminate the painful emotion of losing. The short seller must buy back the shorted shares, and as he repurchases the stock, the price pushes even higher, adding to his already unacceptable loss. The short squeeze took place on GameStop, a video game retailer, AMC and Blackberry. The business news outlets were full of hedge fund managers crying foul, much to the joy of the crowd determined to squeeze the hedge funds. The fun came to an end by the end of the week when some online brokerages restricted the buying of the issues. The restriction caused the neophyte investors to vent how unjust the game is where only one side is allowed to win. It will be interesting to see how the situation will ultimately be resolved and how additional regulation is expected to reduce the ability of a group of average investors to participate in a free and open market.
Reporting of fourth-quarter earnings continued with 37% of the S&P 500 companies reporting. According to FactSet, 82% of the companies reported earnings per share (EPS) above estimates. The five-year average of companies beating estimates is 74%, and if 82% holds as the final number, it will mark the second highest of positive EPS surprises since FactSet began tracking the EPS surprise number in 2008. The aggregate EPS surprise is 13.6% above consensus estimates, which also outpaces the historic five-year average of 6.3% above estimates. The full report can be found here.1
The Bureau of Economic Analysis released the Q4 GDP estimate of 4.0%, falling short of the median forecast as reported by Market Watch of 4.3%2 and the Q3 increase of 33.4%. For the year, GDP slipped 3.5% compared to an increase of 2.2% in 2019. Initial jobless claims showed improvement, falling to 847,000 from the previous week of 914,000 and beating consensus estimates of 875,000.3 The seasonally adjusted unemployment rate was 3.4% for the week ending January 16. While this unemployment rate seems quite low, it should be remembered that since February, the US has lost 9.8 million jobs including 140,000 in December. There are still over 4.8 million people receiving state and local benefits amid continued restrictions and lockdowns.
On a brighter note, real estate prices rose nation-wide in November by 1%.4 For the 12 months ending in November, housing prices gained 8.7%, with Zillow expecting a gain for 2021.5 The expectation for higher real estate prices is fueled in part by low interest rates and by the immigratory trend from city centers to the suburbs. This week in a statement from Fed Chairman Powell, he mentioned that by some measures, the surge in housing is the strongest it has been since before the housing crisis of 2008 and 2009. The tightness in housing he attributed in part to pent up demand and the fact that people are spending more time at home than normal. He went on further to say the consensus at the Fed was this demand was a one-time situation that would pass in time.6
We continue to believe equity is the preferred asset class with bond rates at current levels. As we did with fixed income a couple of years ago, when we turned to alternative debt as a substitute for traditional bonds, we now believe we should consider alternative equity strategies to protect against what we think will be increased equity volatility going forward.
3 https://www.dol.gov/ui/data.pdf; https://www.pbs.org/newshour/economy/u-s-jobless-claims-fall-but-remain-high-at-847000-as-pandemic-rages
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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