Dow Plunged 1,000 Points This Week After Reddit Traders Stormed The Stock Market–What Happens Next?

Despite blowout corporate earnings and more solid news on the vaccine front, the stock market just posted its worst weekly performance in three months after Reddit traders squeezed Wall Street’s elite out of billions of dollars, sending prices of heavily shorted stocks up to atmospheric new highs and fueling concerns over market frothiness–but experts seem in broad agreement that the bull market can rage on. 

Key Facts

Investor sentiment took a massive hit over the “relentless option buying by retail investors taking advantage of a structural weakness in market,” Oanda Senior Market Analyst Edward Moya said Friday, noting that the Dow’s 1,000-point plunge this week was the index’s worst weekly loss since election uncertainty tanked sentiment in late October. 

“The market is not broken, but recent events have revealed some cracks,” says Commonwealth Financial Network Chief Investment Officer Brad McMillan, who thinks one likely result of the week’s frenzy could be that the price of options–which helped fuel some of the outsized meme-stock demand–rise to help curb “price hacking” in the future.

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McMillan eschews concerns from other experts that the Reddit-fueled price mania could be a sign the market is in the middle of a bubble akin to the dot-com era in the late 1990s, but he says “crackdown” by regulators is likely.

The big question surrounding the week’s short squeeze remains around how regulators–and prosecutors–will respond to the volatility, with lawmakers urging the SEC to act quickly on investigations into potential market manipulation by retail traders, brokerages and hedge funds alike. 

Like McMillan, LPL Financial Chief Market Strategist Ryan Detrick is also adamant that the week’s events are not indicative of a market bubble or impending correction, though he concedes recent events point to “excessive optimism in certain segments of the equity markets,” particularly in big-cap names losing capital from institutions covering shorts at sizable losses.

“Don’t forget, overall market breadth is extremely healthy, and the credit markets are functioning just fine—we don’t see a repeat of 1999 like some are claiming,” says Detrick.

Crucial Quote 

“The damage this week is real, but it is also part of the game: Hedge funds and banks routinely make mistakes and suffer for it, and traders losing money is not a sign that the system is broken,” says McMillan. “Another source of worry is that somehow markets have become less reliable because of the price surges–perhaps so, but the dot-com boom didn’t destroy the capital markets, and the distortions were much greater then than now.”

Surprising Fact

Meme stocks GameStop and AMC skyrocketed 400% and 275%, respectively, this week, while the Dow, S&P 500 and tech-heavy Nasdaq all fell about 3%.

What We Don’t Know

How long the retail trading frenzy may continue. Meme stocks largely surged Friday, and Erlam says “a solution for this entire market dislocation will take time, which suggests this insane trading will continue a little while longer.”

Key Background

The bull market rallied to new highs earlier this month in light of fiscal stimulus expectations, vaccine optimism and corporate earnings that keep surpassing expectations. Democrats this week have indicated they’ll move forward with stimulus even if they can’t muster up much Republican support, and–though disappointing–Johnson & Johnson’s vaccine candidate results mean another vaccine could reach the market soon, notes Vital Knowledge Media Founder Adam Crisafulli. Meanwhile, big firms like Apple, Microsoft and Tesla all smashed earnings expectations this week.

 

What To Watch For

Sen. Elizabeth Warren (D-Mass.) has asked the SEC to respond to a list of questions about its GameStop response by February 5. That includes details over whether Reddit traders, hedge funds and brokerages may have influenced the market. With regards to the Reddit crowd, veteran trader Richard Smith, who heads up the Foundation for the Study of Cycles, said Thursday they could “absolutely” be vulnerable to regulatory scrutiny from a pump-and-dump standpoint, but he says it could be years before the mechanisms behind their market influence are leveled. McMillan, meanwhile, says he sees evidence of the “pump,” but doesn’t believe they’re looking to sell anytime soon.

Further Reading

‘Bubble Fueled By Cynicism’: Meme Stocks Surge Again As Reddit Traders Pile Back In—But Dow Falls 300 Points (Forbes)

The Hedge Fund Genius Who Started GameStop’s 4,800% Rally Now Calls It “Unnatural, Insane, And Dangerous” (Forbes)

Robinhood Raises $1 Billion In Emergency Funds As Platform Struggles With Reddit-Fuelled Trading Surge (Forbes)

Not Just GameStop: Here Are The Meme Stocks WallStreetBets Traders Are Pumping Up During This ‘Extremely Erratic’ Reddit Rally (Forbes)

Warren Demands SEC Response To GameStop Frenzy After It Vows To Protect Retail Traders From ‘Abusive Or Manipulative’ Activity (Forbes) Follow me on Twitter. Send me a secure tip

Jonathan Ponciano

Jonathan Ponciano

I’m a reporter at Forbes focusing on markets and finance. I graduated from the University of North Carolina at Chapel Hill, where I double-majored in business journalism and economics while working for UNC’s Kenan-Flagler Business School as a marketing and communications assistant. Before Forbes, I spent a summer reporting on the L.A. private sector for Los Angeles Business Journal and wrote about publicly traded North Carolina companies for NC Business News Wire. Reach out at jponciano@forbes.com.

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Business News 2.8K subscribers Despite blowout corporate earnings and more solid news on the vaccine front, the stock market just posted its worst weekly performance in three months after Reddit traders squeezed Wall Street’s elite out of billions of dollars, sending prices of heavily shorted stocks up to atmospheric new highs and fueling concerns over market frothiness–but experts seem in broad agreement that the bull market can rage on.”The damage this week is real, but it is also part of the game: Hedge funds and banks routinely make mistakes and suffer for it, and traders losing money is not a sign that the system is broken,” says McMillan. “Another source of worry is that somehow markets have become less reliable because of the price surges–perhaps so, but the dot-com boom didn’t destroy the capital markets, and the distortions were much greater then than now.”

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Credit Suisse Bullish On Stocks In 2021 Because It’s Bullish On 2022

NEW YORK, NEW YORK – JULY 23: People walk along Broadway as they pass the Wall Street Charging Bull statue on July 23, 2020 in New York City. On Wednesday July 22, the market had its best day in 6 weeks. (Photo by Michael M. Santiago/Getty Images)

Credit Suisse analyst Jonathan Golub introduced his 2021 price target for the S&P 500 (^GSPC) of 4,050, implying 12.2% upside from Tuesday’s closing levels. Underpinning this upbeat call is his assumption that two years from now, the post-virus economic recovery will have already hit a peak.

“Our 2021 forecasts are designed to answer a simple question: what will the future (2022) look like in the future (end of 2021),” Golub said in a new note Wednesday. “From this perspective, we are forced to de-emphasize the near-term, focusing instead on the return to a more normal world.”

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“As we look toward 2022, the virus will be a fading memory, the economy robust, but decelerating, the yield curve steeper and volatility lower, and the rotation into cyclicals largely behind us,” he added.

Based on Golub’s analysis, economic activity as measured by GDP growth will renormalize at levels slightly above trend, or with quarterly annualized growth rates just over 3%, starting in the second half of 2021.

And the labor market — which as of October was still 10 million payrolls short of pre-pandemic levels — will likely reach “full employment” by the second half of 2022, Golub added.

Since the stock market discounts future events, each of these prospects for further improvement down the line should translate into a higher S&P 500 as investors price in these events.

Analysts have already begun to account for an anticipated improvement in corporate profits, as S&P 500 earnings per share (EPS) have on aggregate sharply topped consensus expectations so far for each of second and third quarter results this year.

“We expect 2020 estimates to rise, 2021 to remain stable and 2022 to moderate,” Golub said.

His 2021 S&P 500 price target of 4,050 is based on earnings per share of $168 next year, for an improvement of 20% over the expected aggregate EPS this year. He expects EPS will then rise to $190 in 2022.

Sector leadership

On a sector basis, Golub rates technology stocks as Overweight for 2021, given their “faster sales growth, superior margins, robust FCF [free cash flow], and low leverage. He also rated financials, one of the laggard sectors so far for the year-to-date, as Overweight, given their propensity to lead during recoveries.

“Consistent with a typical recovery, banks should benefit from improving credit conditions, increasing transaction volumes, and a steepening yield curve,” Golub said. “The group is adequately reserved, likely. resulting in a greater return of capital.”

Golub designated cyclicals with a Neutral rating for next year, saying he is “positively inclined toward economically-sensitive groups and believe[s] their momentum should persist over the near-term.” But he added that he thinks the largest quarter-over-quarter improvements in economic activity have already come and gone, leaving more tepid further upside potential for stocks with profits closely tethered to economic growth.

He rated non-cylicals like consumer staples as underweight, while giving health care specifically an Overweight rating.

“Non-cylicals should lag in an improving economy as falling volatility supports higher P/Es (price-earnings multiples) for riskier assets, and rising rates make their high dividend yields less appealing,” he said. “The one exception is health care, which should outperform given a more robust earnings trend.”

Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck

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5 Years of Market Action In One Year

It has become a cliché during the COVID-19 pandemic to declare that “10 years of change are happening in one year.”

But clichés so often endure because in the end, they’re mostly true.

The almost overnight move to employees working from home pulled forward the expected fracturing of an increasingly digital workforce.

Forced changes to the educational system, to home buying, car buying, grocery shopping, and so on have all brought what had been almost exclusively in-person activities online.

And so any area of the economy or society that technologists had deemed behind the adoption curve pre-pandemic, that industry, consumer habit, or business demand has now been digitized.

Everything, it seems, has happened faster and more dramatically during this crisis than any previous disruption to our economy and daily lives. And so it makes sense to see the stock market essentially go through a multi-year cycle in just a few months.

Torsten Sløk, chief economist at Apollo Global Management, sent around the following chart Thursday morning noting that the global stock market is at a record high with the total value of the world’s publicly trading equities hitting $95 trillion.

Despite a global pandemic, a global recession, and a highly uncertain future, global stocks are at a record high. (Source: Apollo Global Management)
Despite a global pandemic, a global recession, and a highly uncertain future, global stocks are at a record high. (Source: Apollo Global Management)

But as my Morning Brief co-author Sam Ro noted on Twitter, this chart looks almost exactly the same as the stock market from 2008-2013.

And indeed, looking at the S&P 500 from mid-2007 when the market peaked through the end of 2013 when stocks hit new highs for the first time since the crisis, the pattern is almost the same.

The stock market's path from mid-2007 through the market hitting new highs in 2013 looks eerily similar to the market's path this year. It just took a lot longer to play out. (Source: Yahoo Finance)
The stock market’s path from mid-2007 through the market hitting new highs in 2013 looks eerily similar to the market’s path this year. It just took a lot longer to play out. (Source: Yahoo Finance)

These similarities call to mind a favorite idea here at the Morning Brief, which says you can zoom in on any chart and make it scary or zoom out and make it look benign.

Ultimately, what is “true” in financial markets merely depends on your timescale.

But that investor behavior charted a similar course as the financial crisis — but did so in about one-fifth the time — really just sums up how this crisis is likely to be remembered by investors.

As a time when deep uncertainty hit the markets seemingly overnight.

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And almost just as quickly did markets start doing what they do best — look ahead.

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

What to watch today

Economy

  • 8:30 a.m. ET: PPI final demand month-over-month, October (0.2% expected, 0.4% in September)
  • 8:30 a.m. ET: PPI excluding food and energy month-over-month, October (0.2% expected, 0.4% in September)
  • 8:30 a.m. ET: PPI final demand year-over-year, October (0.4% expected, 0.4% in September)
  • 8:30 a.m. ET: PPI excluding food and energy year-over-year, October (1.2% expected, 1.2% in September)
  • 10:00 a.m. ET: University of Michigan Consumer Sentiment, November preliminary (82.0 expected, 81.9 in October)

Earnings

  • 7:00 a.m. ET: DraftKings (DKNG) is expected to report an adjusted loss of 62 cents per share on revenue of $131.74 million

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The Rum Rebellion

Seeing as this is my first Friday rant of the New Year, it’s important to remind you that historically the first five days of market action are indicative of the direction we’ll take for the next 12 months.

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