Topline
Despite blowout corporate earnings and more solid news on the vaccine front, the stock market just posted its worst weekly performance in three months after Reddit traders squeezed Wall Street’s elite out of billions of dollars, sending prices of heavily shorted stocks up to atmospheric new highs and fueling concerns over market frothiness–but experts seem in broad agreement that the bull market can rage on.
“The market is not broken, but recent events have revealed some cracks,” one expert says.
Key Facts
Investor sentiment took a massive hit over the “relentless option buying by retail investors taking advantage of a structural weakness in market,” Oanda Senior Market Analyst Edward Moya said Friday, noting that the Dow’s 1,000-point plunge this week was the index’s worst weekly loss since election uncertainty tanked sentiment in late October.
“The market is not broken, but recent events have revealed some cracks,” says Commonwealth Financial Network Chief Investment Officer Brad McMillan, who thinks one likely result of the week’s frenzy could be that the price of options–which helped fuel some of the outsized meme-stock demand–rise to help curb “price hacking” in the future.
McMillan eschews concerns from other experts that the Reddit-fueled price mania could be a sign the market is in the middle of a bubble akin to the dot-com era in the late 1990s, but he says “crackdown” by regulators is likely.
The big question surrounding the week’s short squeeze remains around how regulators–and prosecutors–will respond to the volatility, with lawmakers urging the SEC to act quickly on investigations into potential market manipulation by retail traders, brokerages and hedge funds alike.
Like McMillan, LPL Financial Chief Market Strategist Ryan Detrick is also adamant that the week’s events are not indicative of a market bubble or impending correction, though he concedes recent events point to “excessive optimism in certain segments of the equity markets,” particularly in big-cap names losing capital from institutions covering shorts at sizable losses.
“Don’t forget, overall market breadth is extremely healthy, and the credit markets are functioning just fine—we don’t see a repeat of 1999 like some are claiming,” says Detrick.
Crucial Quote
“The damage this week is real, but it is also part of the game: Hedge funds and banks routinely make mistakes and suffer for it, and traders losing money is not a sign that the system is broken,” says McMillan. “Another source of worry is that somehow markets have become less reliable because of the price surges–perhaps so, but the dot-com boom didn’t destroy the capital markets, and the distortions were much greater then than now.”
Surprising Fact
Meme stocks GameStop and AMC skyrocketed 400% and 275%, respectively, this week, while the Dow, S&P 500 and tech-heavy Nasdaq all fell about 3%.
What We Don’t Know
How long the retail trading frenzy may continue. Meme stocks largely surged Friday, and Erlam says “a solution for this entire market dislocation will take time, which suggests this insane trading will continue a little while longer.”
Key Background
The bull market rallied to new highs earlier this month in light of fiscal stimulus expectations, vaccine optimism and corporate earnings that keep surpassing expectations. Democrats this week have indicated they’ll move forward with stimulus even if they can’t muster up much Republican support, and–though disappointing–Johnson & Johnson’s vaccine candidate results mean another vaccine could reach the market soon, notes Vital Knowledge Media Founder Adam Crisafulli. Meanwhile, big firms like Apple, Microsoft and Tesla all smashed earnings expectations this week.
What To Watch For
Sen. Elizabeth Warren (D-Mass.) has asked the SEC to respond to a list of questions about its GameStop response by February 5. That includes details over whether Reddit traders, hedge funds and brokerages may have influenced the market. With regards to the Reddit crowd, veteran trader Richard Smith, who heads up the Foundation for the Study of Cycles, said Thursday they could “absolutely” be vulnerable to regulatory scrutiny from a pump-and-dump standpoint, but he says it could be years before the mechanisms behind their market influence are leveled. McMillan, meanwhile, says he sees evidence of the “pump,” but doesn’t believe they’re looking to sell anytime soon.
Further Reading
‘Bubble Fueled By Cynicism’: Meme Stocks Surge Again As Reddit Traders Pile Back In—But Dow Falls 300 Points (Forbes)
The Hedge Fund Genius Who Started GameStop’s 4,800% Rally Now Calls It “Unnatural, Insane, And Dangerous” (Forbes)
Robinhood Raises $1 Billion In Emergency Funds As Platform Struggles With Reddit-Fuelled Trading Surge (Forbes)
Not Just GameStop: Here Are The Meme Stocks WallStreetBets Traders Are Pumping Up During This ‘Extremely Erratic’ Reddit Rally (Forbes)
Warren Demands SEC Response To GameStop Frenzy After It Vows To Protect Retail Traders From ‘Abusive Or Manipulative’ Activity (Forbes)
