Further GameStop Momentum Makes Russell Outperform, But Now Look Out For A Major Market Peak

Summary

  • The GME momentum higher will probably continue for some more days, even weeks. The Russell 2000 will continue to outperform in that case.
  • This GME story is unlikely to morph into a Lehman style of market dislocation. More likely, some type of LCTM rescue/bail-out will be engineered by the Federal Reserve.
  • Some of the short-selling hedge funds will disappear - bankrupted or bought out (likely pennies on the dollar). When that happens, the GME rally/momentum will break.
  • If a GME resolution happens within the next two weeks, it will coincide with the peak in liquidity flows, and the subsequent, seasonal liquidity drought will weaken equities and long bond yields until late March (we will reappraise as more liquidity data comes in).
  • Global liquidity, especially that coming from China, is set to go sideways to lower until late 2021 at least. That will crimp the evolution of cryptos/bitcoin, which will probably end the year lower from the highs we have seen several weeks ago.

Long bond yields (10-year yield) rose strongly on Friday, Jan. 29, giving short shrift to speculations that the GameStop (NYSE:GME) battle between Hedge Funds, which shorted the stock, and so-called "WallStreetBets meme traders" is about to become a systemic risk for the financial markets.

As we argue later in the article, this may not necessarily be true - we foresee a bail-out operation analogous to the LCTM rescue of September 1998. That will destroy some of the hedge funds involved in shorting GME stock, but it also will devastate some, or even many, of the "Reddolutionists" which took on the hedge funds. And resolution of the GME saga will weaken the underpinnings of the market, and that may exacerbate the negative impact of a global and domestic liquidity drought which is due at the middle of February 2021.

We believe that yields are rising because GME, Plug Power (Nasdaq:PLUG) (now composing the largest weightings in the Russell 2000) will likely continue to rise for a little longer, following the sharp rise in yields on Friday, as the chart below illustrates.

Regression of the Covariance of 10-Year Yield, Russell 2000, GME, PLUG

With Yields rising, the Russell 2000 is the best choice to go long equities, if GME and PLUG resume their rise.

Also, for the (much larger) rest of the equity universe, tech earnings season winds down Feb. 2, and Amazon (Nasdaq:AMZN) should have very good/excellent numbers, and those bits and pieces could buoy equities as well - more reason for yields to rise further. Moreover, IRA inflows are due until Feb. 5, inflows which could tip the market balance higher in the very short term.

The various ramifications of the GME saga may not be optimal for other indices (which may be sold to meet margin calls), but that will provide an opportunity for Russell 2000 outperformance. The whippy end of the tech earnings season should also see Nasdaq 100 performing well. The Russell 2000 and Nasdaq 100 March 2021 futures contracts (RTYH1 and NQH1) are what we are buying Monday.

The "Masters of the Universe" not signaling immediate systemic risk

Also, we believe that yields are rising because the bond market and Primary Dealers are not seeing any Lehman Bros. event, but probably a Long-Term Capital Management (LTCM) style bail-out, but with no immediate systemic risks, as said earlier.

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