Please find below our Investment Market Update as at 29th January 2021.
Blue Sky Investment Market Update
A frenzied week
I was going to write about Infrastructure this week in what was going to be the first instalment of our ‘themes for the year’. However, this will begin next week now because I’m aware some of our readers haven’t had time to catch up with the quarterly update, lengthy as it was.
I know it’s not a light read but I’ve had some very engaging and informative comments back which is very much appreciated. So, I thought I would give a bit more time to catch up and besides, there has been quite a bit going on this week!
Please click on this link to read the quarterly investment update. Strange how some of my comments have begun to play out already!
The short squeeze
US equities posted their worst loss since October in the last few days, before recuperating some of the ground lost. Generally, good earnings figures came through from companies although some well-loved stocks disappointed. Apple shares dipped on a more cautious outlook and Tesla fell on lower than expected profitability.
Unemployment figures in the US were better than expected and data showed an encouraging expansion in the fourth quarter of 2020.
However, volatility was the name of the game as the so called ‘short squeeze’ took effect on market sentiment. It started on Wall Street and then took hold in Europe. Contagion with a difference!
Trading platforms had to restrict activity in stocks such as GameStop and AMC Entertainment, as they had become the topic of conversation across social media platforms, namely Reddit.
AMC, the cinema company, saw its shares jump by more than 200%. GameStop, which was at the heart of this frenetic trading, rose 100%. Members of the public had focused on pushing up stock prices that are the subject of large “short bets” by hedge funds. The disclosure of “shorting” positions by hedge funds in the US is not as transparent as in the UK and Europe, where they have to disclose if they have shorted more than 0.5% of a company’s stock. No wonder activity began to target companies on this side of the Atlantic.
In simple terms, shorting is a bet on a share price falling and if there are enough trades of this format it will drive prices down. You may remember that this is what happened with Northern Rock shares in the financial crisis. Morally, it raises serious questions about whether this should be allowed and decent companies over the years have suffered or indeed collapsed when hedge funds have piled in to make money on the back of a company’s demise.
Online brokers have responded by restricting bets by retail investors in an effort to protect customers and preserve their own stability. One popular brokerage in the US called Robinhood, had to draw on some of its agreed credit facility with the bank so that it had enough money to clear the trades.
On Wednesday, there was a record volume of trades in the US with more than 24bn shares changing hands and 57m share options were traded according to FT.com.
This spike in retail trading just shows how investment markets must adapt to the changing dynamics of trading. The power and knowledge have been in the hands of the institutions but via technology, its now possible for the ‘ordinary Joe’ to influence share prices. Apparently hedge fund managers are desperately searching lists of the most shorted stocks along with message boards such as Reddit for any signs of short bets that could be in trouble.
It has been reported that these are the same retail investors who are likely to have bought Bitcoin and Tesla, liking the disruptive nature of their trades. A mix between being anti-establishment and the desire to make money at someone else’s expense… a bit like the hedge funds!
Whilst the rise in retail trades is likely to continue (especially with people working at home), the brokers can of course change the rules anytime they want to mitigate volatility and potential losses.
How have equity prices reacted?
Ironically all the trades in question were positive for the stocks being heavily traded, leaving hedge funds to frantically make decisions on their next moves to limit their losses. So, why have equities fallen?
The volatility has been the worry, fuelled by the volume of trades which has naturally unsettled markets. Add in weaker than anticipated earnings of Apple and Tesla and this has spooked traders and investors.
Ironically most fourth quarter earnings in the US have been quite strong.
We are pleased about the softening in asset prices!
I’m not suggesting we are pleased about the impact of the online traders and the herd mentality which is associated with internet chat sites. Such volatility does not breed confidence. Brokers, however, have reacted by limiting trading and that will help restore a level of confidence.
A softening in asset prices is not such a bad thing because it reminds us of what risk is and also it prolongs the investment cycle. In our quarterly investment commentary posted last week, I warned of certain sectors which were showing signs of overheating. However, a softening of this sort tends to be indiscriminate which can be painful in the very short-term.
I agree with the sentiment of the chief strategist at National Securities Corp, as reported in Bloomberg: “Earnings are great, guidance is better and we’re picking up the pace of getting vaccines out and eventually we’ll have fiscal stimulus coming out of Washington. The market is trying to digest a lot of things at the same time.”
As for your investment portfolios, we are reminded of the basics of investing; avoid leveraging, look for companies with good balances sheets and predictable earnings. Only invest into markets and instruments that we understand.
A comment on CNBC from Adam Crisafulli, founder of Vital Knowledge, summed it up nicely: “The nonsense stocks continue to dominate a lot of the market conversation. Away from the land of make believe, the macro backdrop remains mostly the same, and mostly positive.”
Don’t worry, this is a temporary softening which is part and parcel of investing.
Have a good weekend!
Gary and the Investment Team
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.