A Review Of Stock Market Valuations - Part 2

Aside from the proliferation of retail stock-trading accounts, there are several indicators of excessive speculative activity in the US stock market. Firstly, record OTC/Pink Sheet trading volume - these are stocks not listed on the main exchanges: -

Source: Finra, Bloomberg

Another bubble warning sign is the record-high levels of equity margin trading. The chart below shows the evolution of margin balances and the direction of the S&P 500 index up to December 2020: -

Source: Advisor Perspectives

A further worrying sign of excess is the rise of the SPAC - Special Purpose Acquisition Company. This is a blank cheque shell corporation designed to take a company public without going through the traditional IPO process. SPACs allow retail investors to gain access to private equity-type opportunities, particularly leveraged buyouts. A slightly tongue-in-cheek description of the difference between a SPAC and a traditional IPO is that an IPO is a company in search of capital, whilst a SPAC is capital in search of investment.

This chart of the ballooning of US money supply growth may help to explain the allure of the SPAC, along with many other signs of speculation: -

Source: Gavekal/Macrobond

In 2020, SPACs accounted for most of the growth in the US IPO market, raising $80bln from 237 listings. This surpassed the previous record of $13.6 billion raised from 59 IPOs in 2019. The trend has entered a new phase with $38bln raised from 128 listings in the first six weeks of 2021.

Another outcome of the rapid expansion in money supply can be observed in corporate capital raising. Last December The Economist - A year of raising furiously - noted that corporations globally raised more capital in 2020 than ever before: -

According to Refinitiv, a data provider, this year the world’s non-financial firms have raised an eye-popping $3.6trn in capital from public investors Issuance of both investment-grade and riskier junk bonds set records, of $2.4trn and $426bn, respectively. So did the $538bn in secondary stock sales by listed stalwarts, which leapt by 70% from last year, reversing a recent trend to buy back shares rather than issue new ones.

Here is a chart from the first part of this Macro Letter showing the composition of global corporate capital raising in 2020: -

Source: The Economist

This brings us to the story of GameStop (GME) a video gaming retailer with dismal earnings expectations that was trading at less than $5/share in August of 2020 and peaked at $347/share during a frenzy of hedge fund short-covering last month. An excellent description of the time-line and the players involved in the saga can be found in - How Main Street stormed the Financial Capital - the GameStop Story - Vijar Kohli. The GameStop effect spilt over into many small-cap names and pushed the Russell 2000 index to new highs.

The GameStop tale is intertwined with the fortunes of a retail stockbroker with the beguiling name, Robinhood Financial, and an even more beguiling mobile app. This CNBC article from October 2020 - How Robinhood and Covid opened the floodgates for 13 million amateur stock traders – sheds light on this new phenomenon: -

Robinhood has been the fintech darling of Silicon Valley, founded by Vladimir Tenev and Baiju Bhatt in 2013. The app has amassed 13 million user accounts and led the way for zero-commission fee trading. In no time, it has created brand awareness and popularity unlike that of the legacy brokerages such as Charles Schwab and Fidelity, or its app-first competitors like Webull and Dough.

Despite Robinhood being forced to suspend customer purchases of GameStop, together with some other securities – precipitating an SEC investigation and string of Class Action lawsuits - the company has continued to take on new clients. According to Rainmaker Securities, the latest private bids for Robinhood shares puts the company’s valuation around $40bln. This February 2021 article from Yahoo Finance - Robinhood is still the app of choice for retail investors: new data – provides more color. Here is a chart showing the downloads of the Robinhood App last month: -

Source: SimilarWeb, Gavekal

For a more robust economic analysis of the implications of the GameStop saga, Weimin Chen, The Austrian Economic Center - Gamestop Market Mayhem and the Sickness of the Economy is illuminating: The author concludes: -

There will likely be future limitations placed by brokerage platforms, greater calls for government regulation of the markets, more instances of hysteric market actions, and a general scramble for the next Gamestop style speculation. Federal Reserve Chairman Jerome Powell was quick to deflect blame for this week’s market volatility, but this could be just the beginning of more upcoming economic turbulence.

Another feature of the Robinhood Effect has been the dramatic increase in call option trading on single stocks: -

Source: FT, Sundial Capital Research

A common claim is that 90% of options expire worthlessly, but this is based on the fact that only 10% of option contracts are exercised. According to the CBOE, between 55% and 60% of options contracts are closed out prior to expiration. A more reasonable estimate is therefore that 30-35% of contracts that actually expire worthless. Nonetheless, retail investors have still paid option market-makers a vastly increased amount of option premium during the past year.

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