Franklin J. Parker, CFA
chief investment officer
- The Volatility of last week is likely to continue into this week as investors watch for the risk that large fund failures lead to a systemic problem.
- We get a read on the various sectors of the economy in the first half of the week, and a read on the health of the labor market in the back half.
- Though recent volatility may be unnerving, we believe the Federal Reserve remains committed to supporting markets. In our view, the Fed and the promise of further stimulus from Congress keeps an upward bias in prices for the time being. We see the recent downswing in stocks as an entry point for patient investors.
Last week’s big news was a classic David vs Goliath story: an army of retail traders took on big Wall Street hedge funds… and won! Their weapon was GameStop (GME), a brick-and-mortar video game retailer which has been in decline for some time. Hoping to profit on the decline, many hedge funds had sold the stock short. Coordinated through social media, retail traders began furiously buying the stock, pushing the price higher and triggering what is known as a “short squeeze.” In an effort to limit losses and make good on their commitments to return the shares of GME, the hedge funds had to quickly buy the stock back, driving the price of GME still higher and triggering still more short-sellers to buy.
The price of GME was pushed so high that many of these funds, which use quite a lot of borrowed money to leverage their returns, were in danger of bankruptcy. Because bankrupt firms cannot make good on their obligations, investors have begun to worry about the ability of these funds to make good on their commitments to others in the marketplace. It was this danger of systemic risk that pushed brokerages such as RobinHood, E-Trade, Interactive Brokers, and TD Ameritrade to curtail trading in not just GME, but other stocks as well.
I see the market volatility that ended last week as likely driven by investors repricing this systemic risk, and an effort by levered funds to raise cash quickly by selling their higher-quality investments. While this volatility may continue in the near term, and while there are systemic risks in play, it is my view that this downswing will be short lived. Liquidity concerns are likely to be met with Federal Reserve policy, and stimulus payments tend to bolster prices as well. Investors can use this moment as an entry point for cash, or simply wait it out. Of course, as the situation develops, this advice may develop along with it!
Chart of the Week
I have been surprised by the very rapid recovery in US manufacturing. Interestingly, however, the decline in manufacturing was no worse than it traditionally has been in a recession. In fact, 2008 saw a more significant decline in manufacturing, and that was a recession caused by a credit crunch! The recovery has been among the quickest, however, and though a only small piece of the US economy, manufacturing tends to precede other recoveries in other sectors. This bodes well for the fundamental economic outlook.
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