Global equity markets had a mixed start to 2021. After continuing the post US election equity market lift-off for most of January, news of a ‘short squeeze’ on heavily shorted US stocks began to cause positions to be unwound across the broader market. The S&P500 peaked on Monday 25 January and then fell 3.7% in the final days of the month. The Australian market rose slightly in January, with the S&P/ASX 200 posting a modest 0.3% gain. Rising COVID-19 cases and lockdown measures saw European markets weaken, with the MSCI Europe (in local currency) falling 1.0%.

Late January sell-off
Late January sell-off
ASX200 and S&P500

Increased inflation expectations saw bond yields higher after the Democrats confirmed control of the Senate in the January 5 run-off election and President Biden talked about fiscal stimulus “in the trillions of dollars”. Commodity markets were mostly higher in January. Iron Ore rallied 7.9% and sits at a decade high of $US168.1/t while Crude Oil also rallied significantly during the month (+9.1%).

Bond yields jump to over 1%
10yr government bond yields (%)

A little bit bubbly
While we remain constructive towards equities on a medium term view, there are currently signs of exuberance in the market.  Retail investor participation has increased significantly, partly spurred by free money stimulus checks.  According to media reports, US commission-free investing platform Robinhood is currently the #1 US iOS App Store download and has attracted 2.2 million downloads in January alone.  Call option volumes have sky-rocketed recently.  There is some evidence that this increased retail participation is leading to excessive valuations in parts of the market, mostly small-cap and technology-related names.  The Goldman Sachs Non-Profitable Technology Index has increased four-fold this calendar year.

Call option volumes
US total call option volumes, stocks and indices

Retail investors squeeze hedge funds
A hoard of small-scale investors using retail trading platforms have banded together via popular online forums to buy small-cap and heavily shorted stocks en masse. This pushed prices higher and directly inflicted losses on hedge funds that were short these stocks.  As more investors follow the pack, hedge fund short sellers faced margin calls to cover losses, with some forced to buy back their shorts and others going further and “degrossing” positions across their portfolios.  Hedge funds have slashed equity exposure at the fastest pace in more than six years, with the selling creating a broader market unwind due to jitters about elevated valuations and the strong recent performance.  Positioning “wash-outs” like this are fairly common in bull-markets, often cleansing the market for its next leg up.

Big rally in non-profitable stocks
Goldman Sachs non-profitable technology index

The medium term outlook for equities remains positive, primarily driven by the prospect of economic re-opening and sustained accommodative fiscal and monetary policy.  The excess earnings yield of stocks over bonds in the US currently stands at 3.5%, still substantially higher than pre-GFC levels (i.e. equities are cheap compared to bonds).  Additional optimism towards the economic growth outlook could compress that spread further towards pre-GFC levels, driving equities higher.  We are now more positively disposed to cyclical and value stocks than we have been.  We also like assets providing inflation protection, including property, infrastructure and gold, and various alternative investments that add diversification to portfolios whilst also helping to achieve income and growth targets.

We encourage you to contact us should you wish to discuss this further or if you have any questions about how these trends are impacting your portfolio.