Head of Equity Strategy
Summary: Yesterday's crazy moves across a large group of heavily shorted US stocks underscore the complex feedback loops have arisen across a new wave of retail investors, easier access to options trading, a fascinating stock forum on Reddit and the massive size of ETFs reducing float in equity markets. We uncover the events and try to discuss the implications for markets. We also discuss the rising evidence of more supply constraints in the global economy now also reaching alarming levels in the semiconductor industry impacting production of cars.
Yesterday was an unusual day in US stocks due to the multiple short squeezes in many of the most shorted US stocks. There is no single cause for these moves as they are likely driven by a complex interaction across many market functions. But one force there has been mentioned is the stock forum r/wallstreetbets on Reddit where day traders discuss stocks where it seems an orchestrated move on the most shorted stocks including GameStop was engineered. The trades were mostly done in weekly call options which if volume is large enough can cause what is called a gamma squeeze (read an explanation here) and something we covered back in September. The moves also forced the hedge fund Melvin Capital to raise $2.75bn from Citadel and SAC to survive the short squeeze. The table below shows some of the most shorted US stocks that were part of this short squeeze.
The chart below tweeted by Robeco Asset Management shows the performance of the most shorted stocks in the US and how things structurally changed in 2020 and beyond. Any investor trading these markets and using momentum strategies will have to understand these concepts in order not to be wrongfooted.
What happened has been covered widely and we recommend readers to read through some of the links we have highlighted above. Now we will try to discuss what it means for markets and the future of regulation. A lot of what is happening is driven by the easy accessibility of trading through trading apps such as Robinhood but also the easy access to options trading which temporarily can cause these gamma squeezes when done in large size and heavy put/call skew. Large passive ETF holdings take out outstanding shares reducing the float in many names which causes liquidity constraints which can amplify the moves like the ones yesterday. High frequency trading can then amplify the moves even more due to chasing short-term momentum effects. There is no single solution to many of these phenomena underscoring the rising complexity in financial markets, but our best guess is that we could see a spectacular blow-up in equity markets under the right conditions and that this event will be the necessary wake-up call for regulators to re-design financial markets. One thing is for sure, these topics will be discussed at length this year as we do not think it is over yet.
Semiconductor constraints and reflation
In our Q1 Outlook published today we explain our thesis of why reflation will become the most important market theme to monitor over the next 12 months. There have been many signs the past six months of supply constraints across container freight and commodities, and in general the underlying inflation in the US has been rising steadily with an acceleration in November and December (see chart below). China’s PPI y/y will most likely swing into positive in January and with base effects setting in over the next 3-4 months inflation rates will pick up. Financial Times is covering today the ongoing supply constraints in the semiconductor industry and how it is causing carmakers to halt factories which will impact supply of cars just as demand is rebounding this year. Carmakers do not have the bargain power over other customers at semiconductor manufacturers as they are only 10% of chip demand and carmakers are losing out. This is becoming a national security risk for the US and Europe which are the two geographical areas of the world most affected by the current situation, which has also been amplified by the US sanctions of Chinese semiconductor firms. The semiconductor industry hope that the constraints will have been resolved by the second half of this year.
2024: The wasted year
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Uncover the shifting focus in 2024's FX markets towards growth resilience and relativity, away from bond yields and inflation stories.
Embrace the metal revolution on the commodity market in the coming year, with a focus on gold, silver, platinum, copper, and aluminum.
The gloominess of geopolitical conflicts and the repetitive nature of political agendas. What else does 2024 hold in store for us?
The disheartening cycle of unresolved geopolitical conflicts, the rise of polarizing political parties, and the stagnation of productivity.
Understand China's political landscape in Q4 2023 and the impact on counter-cyclical initiatives, with a focus on the pivotal Q1 2024.
