FILE PHOTO: U.S. one hundred dollar notes are seen in this picture illustration taken in Seoul February 7, 2011. REUTERS/Lee Jae-Won
January 29, 2021
By Mike Dolan
LONDON (Reuters) – While everyone was watching the hullabaloo over GameStop and the related short selling pain this week, 10-year U.S. Treasury borrowing costs reversed briefly back below 1% – underlining why stocks are at such lofty levels in the first place.
The pandemic is far from over. Central banks are going nowhere. Government spending will ramp up again sooner rather than later and a vaccine-led recovery later this year is still seen as the most likely outcome – even if delayed and messier than thought a month ago. Digital and clean energy mega-trends roll on regardless.
That’s been the thinking for months behind record high stocks. And it’s not really been changed much by the frenzied game of cat-and-mouse in single stocks across trading apps, message boards and Wall St screens this week.
The question is whether this behaviour is a sign of wider excess with fallout elsewhere.
There may well be ripple effects from the explosion in the bombed-out stock prices of ailing firms – ironically many of them ‘losers’ in the digital disruption that’s driven the tech stock rally of recent years.
Hedge fund losses from coordinated short squeezes by mostly semi-amateur online traders have raised some fear of selling in other areas to recoup losses, or distress seeping elsewhere.
JPMorgan warned of dangerous precedents in this targeted herd trading sparking what they call fragility events – or “a feedback loop between liquidity, volatility and investor flows” – in dozens of other stocks with similar short interest and options market characteristics.
But so far the broad effect has been to lift already elevated stock market volatility, buoy implied risk in equity and the cost of hedging what are already considered expensive stocks. The VIX index of S&P500 implied volatility popped fleetingly above 30% on Wednesday for the first time since just before the U.S. election.
That in itself cools investor demand – even if it arguably also keeps overall exposure in check, and hence measures of aggregate equity holdings to swollen cash liquidity well below previous bubble levels.
But it doesn’t appear to change much about why equity markets are where they are. Above-average volatility levels on their own were not enough prevent the market setting records for the final four months of last year.
The growth of margin debt has been a concern, as TS Lombard’s Oliver Brennan points out, but less so when measured against the ultra-low cost of borrowing.
And despite the biggest one-day S&P500 drop since October on Wednesday, there was no obvious dash for safe havens or even outsize directional bias in otherwise frenetic options market activity.
For a graphic on Excess money?
DAMNED IF IT DOES…
Unless investors think the Federal Reserve or other central banks see this market ‘fragility’ as dangerous speculative froth that urgently requires removal of the fabled monetary punchbowl, the big picture is unlikely to change.
For one, Fed chief Jerome Powell seemed less than convinced what was happening on Reddit boards and Robinhood-type apps was anything to do with the central bank, appearing to give the whole issue a bodyswerve on Wednesday.
Powell stressed – as central banks around the world have insisted for decades – that asset prices were not part of the Fed’s monetary policy mandate and probably shouldn’t be either. He added that the link between low borrowing costs and stock prices was weaker than most people thought.
“If you raise interest rates and thereby tighten financial conditions and reduce economic activity in order to address asset bubbles and things like that, will that even help? Will it actually cause more damage?” Powell said, adding that the Fed relies on ‘macroprudential’ tools when it comes to financial stability.
And for that reason the Fed is always damned if it does and damned if doesn’t in moments of crisis. Whatever it may recommend about stock exposure and limits – or whatever other regulators or tax authorities may opt to do to address the chaos – the central bank is unlikely to change that monetary priority in the middle of a pandemic.
Of course, that conclusion just rattles the cage of long-standing market bears who blame central banks for boosting liquidity into every stock market wobble for decades, underwriting market risk taking and stoking one of the biggest bubbles in history even in the country’s biggest downturn since World War Two.
For them, the single stock frenzy is just another symptom.
“Extreme speculative excess is all too apparent,” wrote Societe Generale strategist Albert Edwards on Thursday. “The madness has now taken a novel twist with a new warrior class of retail investor roaming the equity savannah.”
“This farce is of the Fed’s creation,” he said, adding it should “hang its head in shame.”
Others try to read deeper meaning into organised online trading campaigns – some see a generational battle between unaffiliated millennials angry at years of Wall St excess while their generation lost out during a decade of slow growth alongside easy money and high asset prices. Others talk of a victory for the ‘democratisation’ of markets against a closed cartel of big banks, brokers and funds.
All that said, shifting the profits from one side of Wall St to another hardly seems to even things out – as BlackRock’s reported windfall from the GameStop surge attests.
And yet, GameStop aside, a record high stock market along with deepening inequality has many economists worried that the “Roaring ’20s” ahead may ape the barely-masked iniquities of the 1920s – and threaten similar results.
“The pandemic has shone a spotlight on the inequalities of vulnerability that permeate western societies,” said HSBC economic advisor Stephen King. “From the perspective of the ‘left-behind’ or the ‘suddenly-vulnerable’, a surging stock market offers cold comfort.”
What’s certain is an unlikely move from the Fed to use monetary policy to stamp out speculative excess just now would bamboozle Wall St’s two biggest shorts – those against the U.S. dollar and Treasury bonds. And problems there are of a whole different order.
For a graphic on Speculative short positions in dollars and US Treasuries:
(by Mike Dolan, Twitter: @reutersMikeD. Chart by Saikat Chatterjee; Editing by Kirsten Donovan)