Why have stocks been on such a powerful run, overcoming a dangerous pandemic that has rocked our economy? The tailwinds that have fueled the advance include low interest rates, liquidity from monthly Federal Reserve bond buys, the Fed’s owns forecast that rates will remain low for a considerable period, fiscal stimulus, talk of more fiscal stimulus, an expanding economy, and better than expected corporate profits (Refinitiv).
When sentiment becomes overly bullish, any kind of negative surprise can create volatility. That’s exactly what happened at the end of January. And it occurred in a most unexpected way.
Professional hedge funds have heavily shorted several stocks, which they believe to be overvalued based on current fundamentals. Without getting into the particulars, shorting is a very risky way to make money when a stock falls in value. Theoretically, the loss on shorting is unlimited since there is no ceiling on a stock’s price. With hedge funds hoping to profit, young traders using Internet forums (particularly wallstreetbets on Reddit), encouraged each other to pile into several securities. The goal: inflict pain on the professionals while turning a profit.
The stock that received the most attention was GameStop (GME), a struggling video game retailer that’s been heavily shorted (CNBC, MarketWatch) by hedge funds. GameStop was selling below $20 per share in early January but peaked at over $480 on January 28, according to price data from Yahoo Finance. GameStop closed at $325 on January 29.
What worried some investors late last month were fears that hedge funds being squeezed on GameStop might be forced to sell other stocks and raise cash.
Powerful tailwinds have boosted stocks. Mix in social media, an Internet-driven rally, zero-commission trading, and idle hands that have been distracted from their pre-pandemic routines…and unexpected volatility has surfaced.
Volatility can happen for any number of reasons, and a correction can never be ruled out. But the economic fundamentals that lifted stocks over the last year remain in place.
As February began, interest in GameStop had begun to recede and the price fell sharply. Is the insurgency over or might Internet traders look to other stocks?
It’s a question that doesn’t offer an immediate answer. However, we know that longer term, economic fundamentals and economic activity determine stock prices.
As billionaire investor Leon Cooperman said on CNBC late last month, “At the end of the day, the stock market reflects economic progress or the lack thereof. Water seeks its own level.”
Over the longer term, relying on time-tested investment principles and avoiding decisions based on short-term volatility have historically led to the best outcome. We have crafted your financial plan based on many different factors. It is the roadmap to your financial goals.
As I’ve said many times before, the plan is designed to remove the emotional component that may encourage you to sell when volatility strikes. It is also designed to prevent you from taking on too much risk when markets surge and even seasoned investors suddenly feel invincible
If you have any questions or concerns, I’d be happy to have a conversation with you. As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor.