On Monday, January 4, 2021, GameStop stock (“GME”) stood at $17.25 per share. But don’t blink, today it is trading at $319.25 per share (up another $172 per share today alone – January 27, 2021). Here’s what is going on. I’ll do my best to explain it in terms most may better understand.
There are three main buying forces driving up the stock price higher:
- Retail investors are buying out of the money call options on GME
- Market makers are forced to buy the stock
- A gigantic short squeeze
That short-squeeze, which forces hedge funds who were short stocks to cover the positions, has sent a handful of stocks to the moon. Notably, Gamestop, a retail store that is on its way to bankruptcy, has been the movement’s poster child.
If you happened to be visiting Mars over the last few days, here is what I am talking about.
AMC Theatres, Blackberry, GameStop, just to name a few, up over 100%+ in 24-48 hours.
That is what a “short-squeeze” looks like when those short a stock have to “buy to cover” at the prevailing market price. It hasn’t been pretty, and the “Wall Street Bets” Reddit group took credit earlier this week for forcing Melvin Capital, a hedge fund short Gamestop, to get a $2.7 billion bailout from its hedgefund friends.
From that moment, it didn’t take long for Wall Street to show its true colors by locking retail investors out of being able to buy Gamestop. Robinhood, Schwab, WeBull, and others all restricted trading in the stock, which resulted in immediate class action lawsuits.
While Robinhood, and other brokers, took a lot of heat for restricting trading in shares of the most heavily shorted names, there was a reason – collateral requirements.
Without getting into all of the minutiae of capital requirements and margin accounts, the simple fact is that the NSCC is required, by SEC rules tracing back to Dodd-Frank, to make sure there is always cash to settle.
Depending on the net of buys and sells, the brokerage (like Robinhood) is on the hook to pay or receive the trading’s net cash. That is simply credit risk. The NSCC takes on that credit risk. To mitigate the risk of a brokerage failure, they demand firms post a deposit of 10% of the collateral.
Here is where the problem comes in. When firms are already heavily on margin (currently at a record level of negative cash balances), sharp changes in the underlying collateral value can lead to immediate demands for more deposits from the brokers.
On Thursday, Robinhood had to raise nearly $1 billion in capital to secure the ability to cover collateral requirements. We also saw margin requirements being adjusted by the DTCC.
Of course, the risk to the markets is that with brokerage firms already running too lean, if a firm like Robinhood failed, the ripple effect through the financial industry would likely rival that seen during the Lehman bankruptcy in 2008.
Such are likely reasons the markets sold off this past week.
With Robinhood ready to resume trading Friday, these stocks jumped sharply in after-hours trading: AAL +12%, AMC +57%, BB +17%, BBBY +15%, CTRM +24%, EXPR +43%, GME +104%, KOSS +102%, NAKD +41%, NOK +9%, SNDL +12%, TR +8%, TRVG +14%.
Investors and policymakers alike lambasted the trading limits, including Dave Portnoy, Alexandria Ocasio-Cortez and Ted Cruz, accusing the trading platform of seeking to protect Wall Street’s interests at the expense of smaller investors. “We need an SEC that has clear rules about market manipulation and then has the backbone to get in and enforce those rules,” added Sen. Elizabeth Warren, a longtime critic of Wall Street. “You’ve got to have a cop on the beat.”
But….
Should a hedge fund be able to get 10x leverage and short 140% of a company in a healthy market? Should mob and herd mentality of rolling into stocks be curbed? Regulators may want to step in on both sides, but government bodies may also be fueling the bubble. Easy money policies from the Fed have also driven consumers out of savings accounts and CDs, encouraging riskier behavior and flows into related products.
Speaking of “easy money”, let’s cover the Fed:
The Fed and M2 Money Supply
The Federal Reserve is trying to stimulate an economy that already had too much debt with yet more debt. No surprise, it’s not working, though it is boosting stock/asset/housing prices.
There is little argument currently that the Federal Reserve is “printing money” without any reservation. The chart below is the “supply of money” as represented by M2.
That massive spike in M2 is from the Government’s gigantic monetary rescue to combat the pandemic-related economic shutdown.
Won’t that produce inflation?
The Federal Reserve has failed to grasp that monetary policy is “deflationary” when “debt” is required to fund it.
How do we know this? Monetary velocity tells the story.
What is “monetary velocity?”
“The velocity of money is important for measuring the rate at which money in circulation is used for purchasing goods and services. Velocity is useful in gauging the health and vitality of the economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions.” – Investopedia
With each monetary policy intervention, the velocity of money has slowed along with the breadth and strength of economic activity.
However, it isn’t just the expansion of the Fed’s balance sheet, which undermines the strength of the economy. It is also the ongoing suppression of interest rates to try and stimulate economic activity.
In 2000, the Fed “crossed the Rubicon,” whereby lowering interest rates did not stimulate economic activity. Instead, the “debt burden” detracted from it.
To illustrate the last point, we can compare monetary velocity to the deficit.
To no surprise, monetary velocity increases when the deficit reverses to a surplus. Financial surpluses allow revenues to move into productive investments rather than debt service.
The Moderna Vaccine
The results showed the vaccine produced neutralizing agents against “all key emerging variants tested,” including the U.K. and Republic of South Africa strains.
That’s important, considering the current global coronavirus-vaccination effort. It implies the process can move forward and drug companies don’t have to go back to the drawing board and begin the process all over again. Moderna said it’s also proactively creating new vaccine versions to address possible future strains.
The more we hear about “the vaccine” – which, of course, is being developed by many companies – the more it sounds like it could end up being used how the world uses the flu vaccine…
With the flu vaccine, different formulas are often given to different parts of the world. People in the Northern Hemisphere get a different shot than those in the Southern Hemisphere, for instance, according to the World Health Organization (“WHO”). Doctors then get together about every six months to review the formulas and perhaps change them, as well as the distribution plans.
It’s not unimaginable that the COVID-19 vaccine will end up being used the same way.
Productive Vs. Non-Productive Spending
Since 1980, there has been a shift in the economy’s fiscal makeup from productive to non-productive investment. To explain this concept, we can take a page from Dr. Woody Brock’s “American Gridlock” to explain the difference.
Country A spends $4 Trillion with receipts of $3 Trillion. This leaves Country A with a $1 Trillion deficit. In order to make up the difference between the spending and the income, the Treasury must issue $1 Trillion in new debt. That new debt is used to cover the excess expenditures, but generates no income leaving a future hole that must be filled.
Country B spends $4 Trillion and receives $3 Trillion income. However, the $1 Trillion of excess, which was financed by debt, was invested into projects, infrastructure, that produced a positive rate of return. There is no deficit as the rate of return on the investment funds the “deficit” over time.
The problem is government spending has shifted away from productive investments. Instead of things like the Hoover Dam, which creates jobs (infrastructure and development), spending shifted to social welfare, defense, and debt service, which have a negative rate of return.
Today, nearly 75% of every tax dollar goes to non-productive spending.
In other words, the U.S. is “Country A.”
However, since that article was published, the debt swelled by $6.2 trillion in 2020. In an economy saddled by $82 Trillion in debt, the debt is no longer productive as more debt is issued to cover ongoing spending needs. This is why “monetary velocity” began to decline as total debt passed the point of being “productive” to becoming “destructive.”
The Federal Reserve’s problem is that due to the massive levels of debt, interest rates MUST remain low. Any uptick in rates quickly slows economic activity, forcing the Fed to lower rates and support it.
the economy set to push a $4.2 Trillion deficit in 2020, the deficit’s deflationary pressure will continue to erode economic activity. As noted, even if the Fed does manage to get a spark of inflation, which would push interest rates higher, the debt burden will lead to an economic recession and deflationary pressures.
Inflation is hard to imagine unless the velocity of money turns higher.
It is hard to overstate the degree to which psychology drives an economy’s shift to deflation. When the prevailing economic mood in a nation changes from optimism to pessimism, participants change. Creditors, debtors, investors, producers, and consumers all change their primary orientation from expansion to conservation.
- Creditors become more conservative, and slow their lending.
- Potential debtors become more conservative, and borrow less or not at all.
- Investors become more conservative, they commit less money to debt investments.
- Producers become more conservative and reduce expansion plans.
- Consumers become more conservative, and save more and spend less.
These behaviors reduce the velocity of money, which puts downward pressure on prices. Money velocity has already been slowing for years, a classic warning sign that deflation is impending. Now, thanks to the virus-related lockdowns, money velocity has begun to collapse. As widespread pessimism takes hold, expect it to fall even further.
The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, has been wrong. It hasn’t happened in 40 years.
Fed Chairman Jerome Powell didn’t need to be told twice, and he used something akin to Bernanke’s Helicopter Money to short-circuit what could have been a disastrous economic collapse. $3.5 trillion from the Federal Reserve and another $3 trillion that included direct checks from Congress launched a potent market rally that saw the S&P 500 gain 70% in just ten months.
It was by far the largest infusion of money supply ever pushed into an economy so quickly. That massive pile of cash may have saved the US economy in the short run, but it also created a profound supply/demand disconnect. Supply of equity (shares of stock) stayed the same, but the demand (dollars chasing those shares) increased exponentially. This imbalance has upset myriad financial relationships established for many decades, upending much of the financial industry.
Because of the Fed’s mind-boggling infusion of cash, valuations have gone through the roof. The S&P 500 has a PE Ratio of 41 (average is 15), while the Russell 2000 has a forward PE Ratio of 69! While through-the-roof valuations won’t cause a market selloff, extraordinarily high PE ratios always result in a far deeper and a far more severe crash when the downturn does come. Reversion to the Mean is the most powerful force in investing, and it can be a cruel mistress when accompanied by runaway share prices.
US Economy
- The January Flash PMI report from Markit surprised to the upside. US manufacturing expansion continues to strengthen, while growth in services remains robust despite the pandemic pressures.
- The nation’s business activity is now outperforming other advanced economies.
- Existing home sales were quite strong in December.
- The number of US homes for sale is at multi-decade lows.
- The market is starting to price in an increase in corporate taxes. Companies that typically pay higher taxes have underperformed since the elections.
- The regional manufacturing report from the Dallas Fed showed some loss in factory momentum this month.
- The gap between wages and home prices continues to widen
- Forward-looking indicators softened such as the Richmond Manufacturing survey.
- However, employment metrics remain robust.
- Outside of the aircraft sector, orders were strong.
- Capital goods orders continued to rise sharply, pointing to a robust CapEx recovery.
- The fourth-quarter GDP growth was roughly in line with market consensus (4% annualized).
- US jobs recovery:
- On an annual basis, home sales hit the highest level since 2006.
- The Kansas City Fed’s regional manufacturing index showed a further acceleration in factory activity this month.
- Bloomberg’s consumer sentiment index ticked higher. The improvement was driven by Democrats and Independents, as confidence among Republicans deteriorated further.
- COVID Hospitalizations are way down.
- Ditto for ICU patients
- Well over 27 million people in the US have had at least one vaccine dose, with about 1.3 million more doses administered each day.
- Consumer spending held up well in December
- Incomes climbed more than expected.
- Pending home sales remained at multi-year highs in December.
Interesting
Households behind on their rent, by state:
Highest-paid public employees:
Apple revenues by business:
Super Bowl appearances and wins for NFL quarterbacks:
Super Bowl ticket prices on the secondary market:
The upward/downward drivers of inflation
All Content is the Opinion of Brian J. Decker
