We have a big week for data, including both ISM reports and a focus on employment. Investors thirst for more data about the strength of the economic rebound. We are also in the heart of earnings season, worried about vaccines, and wondering if Washington will provide more help.

Despite this jam-packed agenda the financial media highlight a story that is much more fun. Someday our focus can return to data and earnings. For now, many are worried, asking: How will the Reddit Rebellion affect my investments?

Last Week Summary

In my last installment of WTWA, I provided some insider tips on the political dynamics that would affect the economy and our investments. These are proving quite accurate as the story plays out.

Key Charts

I always start my personal review of the week by looking at some great charts. This provides a foundation for considering news and events. Whether or not we agree with Mr. Market, it is wise to know his current mood.

Market Story

I am featuring Jill Mislinski’s chart of the market week. Her approach combines several key variables in a simple readable format.

Sector Trends

Sector movement is another important clue to market trends.

Once again, Juan Luque provides us with some words of wisdom from the Incline trading desk, often a different perspective from my own:

The S&P 500 finished this week with a loss of 3.31%. The news this week were mostly focused on the heavily shorted stocks chosen by the Reddit forum “Wallstreetbets”. The volatility created by the spike in some of these names pushed brokerages against the fence. The Energy sector posted the biggest loss in the week among all sectors in the index with over a 6.6% loss. The sector lost over 3% on Friday alone and started losing momentum as it moves along the leading quadrant. The Materials and Industrials sectors were down over 5% and 4% respectively and continue trailing along the weakening quadrant. The remainder sectors were also in red for what has been the worst week for the index since October.

Comment

The market lost 3.3% on the week with a trading range of 4.8%. You can monitor the spike in volatility in my Indicator Snapshot, featured in the Quant Corner below.

Personal Note

As I do on occasion, I am evaluating the content and format of WTWA. I have a commitment to focus on topics of the greatest interest to individual investors. I also have limited personal bandwidth. Much of the work relates to data updates that are often not relevant. I will be doing some experimenting, including reducing the number of posts.

Noteworthy

Corbin Advisors regularly surveys industry professionals to get their viewpoints before the start of earnings season. The results are always interesting, but especially so this quarter. The word cloud shows the change of attention throughout a very eventful year.

The News Overview

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too.

My continuing assessment is that many of the normal economic indicators are not helpful in the wake of the COVID lockdown decline. Too many sources are focused on a change in direction, even if very modest, which has painted an overly optimistic picture. As the economy stalls, there will be a rapid switch in the diffusion indexes. The early signs are emerging. I expect some dramatic shifts over the next month or so.

Good

Corporate Earnings

• With 37% of the S&P 500 reports in, companies are beating expectations at a near-record pace. John Butters (FactSet) calculates that the year-over-year decline has now dropped to 2.3% (from 4.8% last week).

• Brian Gilmartin highlights the positive changes in forward earnings although he cautiously notes the reaction in stock prices.

New Vaccines

The successful trial of Johnson and Johnson’s (JNJ) new one-dose vaccine will help in closing the gap to herd immunity.

Employment

• Initial jobless claims declined to 847K beating expectations of 875K and down from last week’s 914K. Continuing claims also declined to 4.771M. The overall series remains elevated.

Bad

Economic Recovery

The stall in economic growth continues.

• Durable goods orders grew only 0.2% in December, missing expectations of 0.7% and far below November’s 1.2% gain.
• Personal income and spending for December were mixed. Income was up a surprising 0.6% after November’s 1.3% decline. Spending declined 0.2%, butter than the expected decline of 0.5% and November’s downwardly revised -0.7 %. The changing stimulus payments make it challenging to interpret this data series.

Coronavirus and Vaccine Distribution

• The virus remains at near-peak levels.
• Vaccine distribution is beset by problems. Even when vaccine is available, getting an appointment or a second appointment can be a frustrating challenge.
• Scare stories. Suppose you give the vaccine to thousands of elderly celebrities. Would you expect any of them to die? Suppose it is taken by millions of people with a 95% rate. Would you expect any of them to get the virus anyway? 

Calendar

We have a huge calendar featuring all manner of reports on employment and including the widely followed ISM updates on both manufacturing and non-manufacturing. We continue through the peak of earnings season. And finally, eyes will be on Washington as the proposed pandemic relief package works its way through the legislative process. Or not.

Briefing.com has an excellent weekly calendar and many other useful features for subscribers.

Theme and comment

Just as investors were assessing the impacts of the pandemic, business closures, and a recession, a new source of worry appeared. Since it was unanticipated, should it be called a “black swan?” Whatever the label, investors are wondering: Is the Reddit Rebellion a threat to my investments?

Background

Most people find the daily investment report to be boring. It is a compressed “explanation” of what happened in financial markets and, supposedly, why.

This week was different. There was real drama: rich versus poor, underdogs versus giants, massive winnings for ordinary people while hedge fund billionaires were on the run. This includes the key ingredients for a compelling story, launching a familiar pattern.

Financial event becomes a general news story.

Every publication needs to publish on the topic.

Informed analysis, on a proportional basis, decreases.

Interesting speculation and half-baked analyses move to the fore.

Analysis

The most effective way to proceed is to highlight some of the stories from the week and then offer a comment.

What happened? CNBC has a good summary of the week’s events including this chart:

Does the rebellion have a leader? Yes.

Famed GameStop bull ‘Roaring Kitty’ is a Massachusetts financial advisor.

As trading in GameStop (GME) shares reached fever pitch this week, his portfolio updates appeared to encourage other investors to stay in the stock.

“Your steady hand convinced many of us to not only buy, but hold. Your example literally changed the lives of thousands of ordinary normal people,” wrote one user on Wednesday.

And also..

After online brokerages restricted trading in GME on Thursday, Gill posted that he had lost $14.8 million that day alone, but was still up $33 million overall.

That post was met with thousands of replies, with many simply repeating: “IF HE’S STILL IN, I’M STILL IN.”

The NYT has much more background about how Mr. Gill started building followers.

Will Congress get involved? Of course. This is a juicy opportunity to express concern about a matter of interest which many portray as worrisome.

The House and Senate committees that oversee the financial sector will hold hearings on the state of the stock market, giving lawmakers a chance to vent their anger and play up their anti-Wall Street credentials to constituents. The Hill.

Will any legislation result? No. This is a story about symbolism.

Are the Reddit folks engaging in something illegal? Almost certainly not. Cheering on a stock and urging others to join in is a normal practice with a long history. The difference is the reach of modern social media. Proving something like price manipulation would involve quite different actions with a clear central organization.

Is there something evil about short-selling? No. A market price for a security is the net result of investor opinions. Short positions in stocks are part of the process of price discovery. They may also be hedges against option holdings. The short seller may have an overall long position in the security.

How does this process work? Those seeking to sell short must first borrow the stock. Brokers lend shares of stock for this purpose, charging a fee. The fee is typically about 30 bps per year. For the Reddit Rebellion stocks the rate is ranging from 30% to as high as 80%. In general, you cannot sell a stock short without arranging a “borrow” in advance.

Why would investors make their stock available for lending? Most probably do not even know they have. It is a part of the brokerage agreement, definitely if you have a margin account. This is a major profit center for brokerages. That “no-fee” trading must be paid for somehow!

The short interest can be even larger than the float. Some who have secured a borrow may then lend these shares to someone else at a higher rate. Steve Sosnick, Chief Strategist at Interactive Brokers, has an excellent, detailed explanation of this phenomenon.

Do hedge fund losses represent danger to the entire financial system? No. One argument is that those with losses need to meet margin calls and may be forced to sell other holdings. This is a typical way a factual statement can be distorted. It was featured prominently on CNBC’s Friday night emergency special on this topic. Let us guess that the short seller’s losses are about $70 billion. The worldwide equity market value is over $100 trillion. Even if the entire losses had to be covered instantly, it would not require $2 trillion worth of selling, a conservative estimate of the decline in market value.

Is this like the Long Term Capital Management situation, which required a $3.625 billion bailout from big banks orchestrated by the NY Fed? No. The many differences include the following:

• Total global stock and bond markets now exceed $200 trillion.
• LTCM was operating with 25-1 leverage. They also had a side derivative book with a notional value of about $1.25 trillion.
• Many other funds were imitating the LTCM strategies, so they were part of a crowded trade.
• The rest of the Street understood the problem. There was no “friendly” help in exiting positions.
• Because of these factors, the banks were on the hook for amounts much larger than might seem obvious. This is why they were willing to join in the bailout.

Fool’s Gold

This advice to “investors” leaves me in what Mrs. OldProf describes as a rare state: Speechless.

Following the more than 330% jump in shares this week, CNBC’s Jim Cramer said investors should take profits.

“Take the home run. Don’t go for the grand slam. Take the home run. You’ve already won. You’ve won the game. You’re done,” Cramer said Friday on “Squawk on the Street.”

Quant Corner

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.

Indicators

For a description of these sources, check here.

Comment

Technical measures have turned neutral in both short and long-term time frames.

My continued bearish posture for long-term investors is based upon both valuation and fears about the continuing recession. My own earnings analysis suggests that the recession is not reflected in current, bottoms-up estimates. As always, I expect good times – but not yet. This is going to take a lot longer than people expect.

With the addition of important data, it is time for a review of Jill Mislinski’s Big Four Indicators.

Final Thought for Investors

The Reddit Revolution is an interesting story. Those following financial markets rarely get to enjoy drama. The dangers to investors include the following:

1. The temptation to join in. Most investors make an occasional speculation or short-term trade. In this case you might well lose your entire bet. And I say that advisedly. Act like you are walking into a casino.
2. Worry about the increase in volatility. It does not carry a warning signal about the market. Option volatility continues to exceed actual volatility. It is a market with both buyers and sellers.

1. Overconfidence. If last week’s losses were painful, if they felt serious or caused special worry, you should review your positions ASAP. You have too much risk.

The real market risks relate to the economy. My worry is that the gap to the point of herd immunity will not be filled by more help from Washington.

But for now,

Do not get caught up in the drama. Make sure your risk level fits your personal needs.

My Portfolios

I continue to maintain higher than normal cash levels as a cushion against the continuing recession, but I have replaced a few holdings. New positions are selected based on post-recession expectations as well as current prospects.

I am migrating some clients into a bond substitute program to generate reasonable low volatility returns using a highly selective REIT program. I continue to regard bonds, especially bond funds, as riskier than stocks.