Weekly Market Recap 2-1-2021

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Last week was one of the craziest for the stock market, in terms of headlines, I may have seen in well over a decade – so this is one weekly market recap you won’t want to skip! The S&P 500 and Nasdaq both started the week strong, hitting new highs on Monday and Tuesday, respectively, before ending the week down. Bubble-like speculation activity and concerns around a slowdown in the real economy were the drivers. You can find all the previous Monday Market Update’s here.

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Monday Market Update 02.01.2021

Last week, the S&P 500 sold off, ending the week down -3.3%, in its worst and most volatile weekly performance of the last three months.

While there was signficant economic news, including

• The first estimate for Q4 2020
• Disposable Income and Personal Consumer Expenditures for December
• Weekly Jobless Claims
• Fed’s regularly scheduled  Federal Open Market Committee and press conference

… the spike in market volatility and sell-off was mostly driven by all the news (and spillover effects) surrounding a handful of stocks, including GameStop, in what has become a battle between retail investors and billion-dollar hedge funds, who were shorting these stocks.

Last Week in the Stock Market

The stock market news last week was dominated by the battle playing out in a handful of names, most notably GameStop, between a group of retail traders, all members of a social media community, WallStreetBets, and hedge fund short sellers. If you want to understand the full saga, read through the pink section below or check out my Live Q&A from Friday. Otherwise, skip ahead to how all of this created spillover effects and ended up with the whole market ending down -3.3% this week.

GameStop Spillover Effects

So why does a crazy spike in price and trading volume in a single or small handful of relatively small stocks, end up causing the whole market to trade off? In a word, volatility.

A short squeeze, especially if short positions are large, requires a hedge fund to put up more cash to hold its position. This forces them to either raise funds from investors, or sell out of other long positions they may hold to raise cash. This is the first source of selling.

Second, when you have a handful of names increasing by triple digits or even 1,000% that increases overall market volatility. The VIX is a volatility index for the S&P 500. It ended the week up more than 50%. Volatility is a key assumption in risk models – both for hedge funds and for brokers as they calculate the margin and collateral requirements on various positions and trades.

An increase in stock market volatility causes all hedge funds with equity positions to pare back positions overall to reduce risk, selling down longs, and covering shorts. The demand by brokers for increased margin and collateral requirements can also drive more selling as funds have to come up with more cash just to sustain existing positions.

And on top of all of that, the behavior of this group of retail traders, emboldened by how they have manipulated the market this week, has reduced people’s overall perception of the stability of the market as a whole. The experience this week, as well as the overall inflated valuation of the market, is being compared to the ‘irrational exuberance’ of the tech market bubble and people are getting nervous about what may lie ahead. A Deutsche Bank survey of more than 600 market professionals indicated nearly 90% believe some financial markets are in a bubble.

In the midst of all of that craziness this week, nearly 1/4 of all public companies reported earnings, and we also had signficant economic data point updates, as well.

The Economic Weekly Market Recap

There were many signficant updates to key economic indicators this week, including the weekly jobless claims update, the first estimate for Q4 2020 GDP, December’s report on consumer spending, and last but not least, the regularly scheduled FOMC meeting and press conference.

Weekly Jobless Claims

I continue to closely watch the labor market for signs of improvement, as it has experienced the most negative impact in the economy, and its recovery is critical to a full economic recovery for everyone. On Thursday, weekly jobless claims for the week ending 1/23 decreased from the week prior to 847,000, though still remain at highly elevated levels and above initial weekly claims seen in the Fall.

Total insured unemployment, under regular state programs, is now 4.8 million people, an insured unemployment rate of 3.4%. However, this is a fraction of those covered under the expanded pandemic and emergency programs at both the state and federal level.

Total insured unemployment under these programs for the week ending 1/9 (this comes at a longer lag) increased from the prior week by 2.3 million, and is currently 18.3 million. As I mentioned last week, the decline the week of 1/2 was likely due to the termination of benefits – not people finding jobs. With the extension of benefits passed at the end of December by Congress, we saw the return of all those who dropped off this list return the week of 1/9.

I also went digging and was able to find a history of this expanded benefits data back to the late 1980s on the Department of Labor’s website. As of the week ended 1/9/2021, we have more insured unemployment under all programs than at the highest point of the Great Recession. It was nearly 2x as high in June 2020. Let the magnitude of that – the impact of this recession on the jobs market – sink in for a moment.

Q4 2020 GDP Under Expectations

The spike in virus cases and resulting increase in lockdowns and business restrictions impacted and slowed the economic recovery in Q4. The first estimate for Q4 2020 GDP, released on Thursday morning, showed real GDP grew at an annualized rate of 4.0% vs. economist’s predictions of 4.3%. Economists also expect even slower growth in Q1 2021, before the recovery accelerates again in the second half of this year.

As of Q4 2020, GDP remains 2.5% below the Q4 2019 peak, a shortfall of $267.9 billion in current dollars at a seasonally adjusted annual rate. For the year, 2020 GDP was down -3.5% vs. 2019. The bulk of the decline in GDP for the year is driven by personal consumption expenditures (-2.63%), concentrated especially in services (-3.44%), offset by Federal governement spending (+0.29%).

Consumer Spending Down for 2nd Month

Consumer Spending is critical because, as discussed above, it is the main driver of GDP, representing ~70% of GDP annually. Consumer spending, or personal consumption expenditures (PCE), was down -0.2%, the second consecutive month of decline, after several months of recovery through the summer and early fall.

This decline came even as disposable income increased, as savings rates continue to be elevated given continued concerns and uncertainty around the economic recovery and jobs market. The implied savings rate in 2020 (PCE less Disposable Income) averaged 19.0% vs. 10% average for the last two decades. While increasing savings is great for each of us individually, it’s also a sign in the lack of confidence in the current environment, and the sharp change negatively impacts the economy in the immediate term.

By the way, these results are consistent with my survey of all of you earlier in the week too. The vast majority of you, in spite (or likely because) of the significant increase in unemployment levels, increased savings in 2020… and you don’t expect your spending to return to normal for another year.

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First FOMC Meeting of 2021

The Federal Open Market Committee (FOMC) is composed of 12 members including the Board of Governors of the Federal Reserve System, led by Federal Reserve Chairman Jerome Powell, the President of the Federal Bank of New York and four of the remaining regional Federal Reserve Bank presidents who rotate annually. This committee holds 8 regularly scheduled meetings annually to review economic data and determine appropriate monetary policy, given the current economic environment.

“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run” – this is their official mission. Currently, they are holding the federal funds rate at 0 to 0.25% and continuing to buy Treasury and mortgage-backed securities to support this mission, given high levels of unemployment currently and low inflation.

They make an official statement after every meeting, which investors closely follow for any changes in wording that might hint when future changes are coming. They also hold a press conference with Q&A. Of most interest is the following exchange:

Steve Liesman, CNBC Senior Economics Reporter:
Mr. Chairman, do you rule out or see as one of your tools in the toolkit the idea of adjusting monetary policy to address
asset values?

Jerome Powell, Federal Reserve Chairman:
So, you know, that’s — as you know, that’s one of the very difficult
questions in all of monetary policy. And we don’t rule it out as a theoretical matter.

But we clearly look to macroprudential tools, regulatory tools, supervisory tools, other kinds of tools, rather than monetary policy in addressing financial stability issues. It’s not — you know, the monetary policy we know strengthens economic activity and job creation through fairly well understood channels. And a strong economy is actually a great supporter of financial stability.

That will mean strong, you know, well capitalized institutions and households will be working. And so we know that. We don’t actually understand the trade-off between — the sense of it is, if you raise interest rates and thereby tighten financial conditions and reduce economic activity.

Now, in order to address asset bubbles and things like that, will that even help? Will it actually cause more damage? Or will it help? So I think that’s unresolved. And I think it’s something we look at as not theoretically ruled out, but not something we’ve ever done. And not something we would plan to do. We would rely on macroprudential and other tools to deal with financial stability issues.

In plain English? Basically, there is a growing number of economic experts and investors who are concerned that the super easy monetary policy – ongoing asset purchases by the Fed and 0% interest rates – is fueling asset bubbles. You are seeing it in housing, with home prices up double digits this year. You are seeing it in the stock market. You are seeing it in Bitcoin. You could also argue we have been seeing it in the student loan / college tuition market for decades as well.

Chairman Powell basically says in response that he’s not entirely sure the Fed’s tools would help to address asset bubbles. And they have no plans to address them currently.

Weekly Market Recap – All Asset Classes

Two things to take note of in Year-to-Date market performance – notice the continued outperformance of small cap stocks – that’s where many of these names targetted by retail traders sit.

Also, as I mentioned last week, in the face of increased fiscal stimulus spending, entirely funded by additional debt issuance, we continue to see treasury prices fall, and yields – the interest demanded on them – increase.

Virus Update

While the vaccine continues to be distributed and rolled out nationwide, we still have many months ahead of us of continued precautions.

For the second week in a row, we saw all numbers head in the right direction. New cases and hospitalizations are all down, with new cases, in particular, seeing significant declines (down double-digits in each of the last two weeks). We did see an uptick in daily deaths, but recall deaths come at a 2+ week lag to new cases, so we would hope to see those follow the cases trend in the weeks to come.

We also saw significant improvement in the vaccine rollout. Bloomberg is tracking the rollout and administration state by state. We saw a 19% increase in vaccines distributed and a 37% increase in vaccines administered last week relative to the week prior. So far, over 5 million people have completed their double dose regimen, representing 1.5% of the population. Many experts believe we need to get to 65-80% vaccinated to achieve herd immunity, which would allow life to resume with some level of normalcy.

Keep in mind, acheiving herd immunity is also dependent on people’s willingness to be vaccinated. Many have hesitations and reservations about the vaccine – so even as many of us eagerly await our turn to receive a vaccine, there is a substantial percentage of people who don’t ever intend to, which could impact efforts to contain the virus and resume economic activity as normal.

The Week Ahead

Look for updates on Initial Jobless Claims and 30-Year Mortgage Rates every week. The biggest economic news coming up this week the Employment Report for January due out on Friday. I also continue to follow this whole retail traders vs. Wall Street saga and the potential SEC response. It is still the thick of earnings season with roughly another 1 in 4 companies reporting earnings this week, so you may see volatility in individual names as they report Q4 earnings results.

For More Information…

For a more detailed history of all the metics shared, check out When Will the Economy Recover – updated monthly, which gives a more detailed overview of market and economic indicators, as well as their historical context. I’ll be working on updating it through the end of January this week.

Questions? Feel free to leave them in the comments below, or in the weekly question box in my Instagram stories.

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