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Market Snapshot

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LIZ ANN SONDERS:  Hi, everybody. Welcome to the February Market Snapshot.

Now that the dust has settled to some degree on the saga that was GameStop, specifically, but heavily shorted stocks, more broadly, I wanted to address it, but put it in a slightly broader context, both in terms of history, but also a little bit more flavor on retail traders and the impact that they’re having on the market. But let’s first start with not a… this is not an intraday stock chart of GameStop. This is actually a five-day percent change. And I took it back more than a year because I wanted to just show that percent change in context, where you see on a five-day basis, you had a jump to as much as up 800%, then you actually dropped down to as much as down about 80%. Now, we’re kind of down in the 45% range or so. And it just shows the extreme behavior, the speculation that just went wild in the latter part of January, up until the peak on January 27th, and, unfortunately, the almost immediate round trip that ensued. And what of course we hope is that not a lot of money was lost, but, unfortunately, anybody that was buying on the top, I think, learned a valuable lesson about speculating in stocks, especially when it’s really based on momentum and not anything attractive from an underlying fundamental perspective. But, again, now is where I want to put it into slightly broader context.

So heavily shorted stocks has been a theme, really, since the beginning of this year. And if you look at… there’s a Goldman Sachs Index, and they’ve created a number of very interesting indexes recently, and this is their Most Shorted Stocks Index. And you can see, really, since the latter part of last year, that yellow line, those most shorted stocks, really started to move parabolic, and that drop down recently was largely not just GameStop, but also AMC and a couple of others. That started to rebound again, but you can see an extreme outperformance relative, in this case, to the S&P 500.

Now, that may send a message to some, boy, this is an attractive area to invest. Look at the extreme out-performance of heavily shorted stocks relative to the S&P 500. But that’s just a recent phenomenon. Now, for those investors also who think let’s continue with this theme, there must be a large group of stocks out there, aside from just GameStop. All we have to do is start screening for heavily shorted stocks, and there is our opportunity base. But as this chart shows, there’s actually a very, very small short interest in terms of the overall market. So this looks at the S&P 500, the Dow Jones Industrial Average, the NASDAQ 100, and the Russell 2000, and it’s the median across all of those indexes of short interest as a percentage of float, so what’s the percentage of all shares outstanding that investors hold short. And as a reminder, when you short a stock, you’re borrowing it to sell at the current price in the hopes of being able to buy it at a lower price down the road. This idea that there is a… sort of a wide list of stocks that fit that bill, this suggests otherwise. And you see a very, very low, in fact, a 17-year low in short interest. So this hasn’t been a popular strategy by hedge funds or others to short stocks. So that’s one message of caution for those thinking that this is some new trend where there are a lot of opportunities within the market.

In addition, if you go back much longer term, and this data goes back to 1993 and breaks the Russell 3000, which is a broad measure of the stock market, it’s the 3000 largest stocks. So it’s well more than just the S&P or the NASDAQ. It’s not quite all publicly-traded stocks, but it’s a pretty wide universe. And this is broken into quintiles, so fifths, based on the amount of short interest. So that dark blue line that’s at the bottom, that’s the highest quintile, meaning, that’s the group of stocks over this period of time where the short interest was highest, all the way down to the lowest quintile, where the short interest was lowest. And what you’ll see here is sort of a perfect kind of stair-step pattern. Historically, it’s the stocks with the highest short interests that have underperformed. So even though they’ve done extraordinarily well in the last month or two, history suggests that if it’s a stock that has a high short interest, meaning a lot of investors, typically professional investors, see enough negative in the fundamentals of the stock to short it. That usually pans out from a performance perspective. They typically are the underperformers relative to those stocks that have a lower short interest.

So don’t just look at the performance recently in GameStop or even an index of most heavily shorted stocks. As a long-term winning strategy, going on the buy side of heavily shorted stocks has not been a winning strategy, and that is suggested by this.

But the other interesting thing that’s been happening is there’s been so much focus on the Reddit-fueled flash mob. And this kind of flash mob has really been roaming in nature, this idea of retail traders, many of them are fairly new, banding together on social media, in particular, on the Reddit Wall Street Bets platform, to drive stocks higher, more recently in heavily shorted stocks. The idea of retail traders being much more active in the market and having a lot of influence in the market is not a brand new phenomenon. You really can go back to last August/September when you started to see that activity pick up in earnest. The difference back in August and September is that the focus by retail traders was in a lot of the dominant stocks that we’re all very familiar with, the FAANG-type stocks, the big five stocks. So it kind of got jumbled in with momentum in the market, driven by lots of other forces, investor and otherwise. It was just earlier this year that sort of the roaming moved into kind of more esoteric, smaller slices of the market, including heavily shorted stocks.

But that wasn’t the only area. There are other areas recently that have attracted the attention and interest of these newly minted day traders, and there’s an overarching theme to them, which I’ll get to in a second. But one of the areas of interest has been specifically what they call penny stocks, very, very, very low-priced stocks, but slightly more broadly just lower priced stocks. And that tends to be the domain of retail traders, because, in general, they tend to have… they make a connection between the price of the stock and its value. The opposite is, actually, fairly true, and it’s part of the reason why institutions don’t tend to spend a lot of time in those extremely low-priced stocks. But year-to-date, which is, obviously, a limited amount of time, but the timeframe and focus here, you can see if you break, again, the same Russell 3000 into deciles by simple share price… this has nothing to do with PE ratio or value of the company, it’s simply what is the price of the stock, and you can see, again, almost a perfect stair-step pattern, with the lowest priced stocks having, by far, the best performance. And just for reference, that sort of top decile, or the lowest priced decile, is represented by stocks that at the beginning of the year were less than $7, in some cases, even less than a dollar, so many of those penny stocks.

Another area of interest, particularly in the last couple of months, have been non-profitable technology stocks. And, again, you see, really, since about the October/November time period, the Goldman Sachs Index of Non-Profitable Technology Stocks has also kind of gone parabolic relative to the performance of the S&P 500, another look at a kind of a subset of stocks that very recently has done well. Again, going back to the October/November period of last year, these are Goldman Sachs indexes that, in the case of the blue line, it’s their index of companies that have strong balance sheets, and then their index of companies that have weak balance sheets in the case of the yellow. And, again, right at that October/November time period, you saw this significant move up by weak balance sheet stocks, and not only caught up to strong balance sheets, but exceeded it.

So you may have already figured out that the overarching theme to some of the hot areas of interest on the part of retail traders in the last few months has been low-quality stocks. And I don’t know how much longer this phenomenon can continue. I will say if you’re a long-term investor, you know that at some point fundamentals have to provide some support for leadership in the market, even if you go through short periods of time where you kind of blow these micro bubbles, as I’ve been calling them, through some of this excess speculative fervor and momentum chasing.


That said, again, more broadly, we can talk about the perils of retail traders chasing this momentum and adopting speculative activity by kind of chasing what the flash mobs are doing in low-quality stocks, that’s a recent phenomenon. Again, back to prior to October/November, retail traders were actually as interested in some of the higher quality companies as other investors were, too. And, overall, retail traders, the kinds of stocks that they tend to be involved with have done quite well.

So one of the misperceptions out there is that retail traders, individual investors, are generically and often called the dumb money. But this actually shows that in the past year or so, the types of stocks that retail traders have been most interested and have traded most, have actually done quite well, notwithstanding the recent experience in the likes of a GameStop. So this is another Goldman Sachs index and they track on a rolling basis and stocks will come in and out of this index, but it’s the 55 or 60 stocks most actively purchased by these retail traders, and it’s an index that they track over time. And you can see, really, since the bear market ended, the pandemic bear market ended last March, those stocks have been doing quite well, particularly more recently.

So, certainly, my hope is that we keep these retail traders actively engaged, but they had learned a valuable lesson about short-term rampant momentum- chasing speculation in individual stocks or subsets of the market where there really isn’t any fundamental underpinning. That’s the ideal kind of transition we go through via the lessons learned over the past month or so. And our long-term goal, of course, is that we hope that these short-term speculators, through education and experience become long-term investors.

Now, in terms of the broader sentiment environment… and I’ve been saying for a while that the success of the market, to some degree, has bred its greatest risk right now, which is some of this sort of speculative overdrive and a sentiment environment that has gotten fairly frothy. And you’re seeing it in most measures of investor sentiment. And there’s two ways to measure investor sentiment. You can look at behavioral measures of investor sentiment, what investor are actually doing in their portfolios, and then, there are also attitudinal measures of sentiment, survey-based data, where you’re asking investors for their opinions about the market. On the behavioral side, we’re still looking at a tremendous amount of speculative excess. This is the equity put-call ratio in the options market, so the ratio between call buying, which is basically an optimistic position, and put buying, which is a more pessimistic position. You can see we’re plumbing levels similarly low to where we were throughout the late ‘90s into the peak in 2000.

Now, as you can see from that past time period, you can stay in sort of this speculative excess overdrive era for extended periods of time. I’ll remind you that Alan Greenspan, the Former Fed Chair’s famous utterance of irrational exuberance to define what the market was doing, that was set in late 1996, and there were still a little more than three years to go in the bull market. So I don’t point this out to say, ‘Look out below, this as a sign of a peak,’ but it is one measure that speculative fervor has gotten a little bit excessive, and that, in and of itself, represents a bit of a risk for the market.

On the offset, though, and this is potentially some good news, is attitudinal sentiment has significantly come off the boil. So this is a well-known sentiment index. It’s survey based. It’s the American Association of Individual Investors. They have tens of thousands of members and every week they survey their members basically asking, Are you bullish about the market, are you bearish about the market, or are you neutral? And you can see a convergence here. So I think what is already happening, given some of the speculation we’ve seen and the perils of that speculation in the case of the roundtrip in many of those heavily shorted stocks, again, GameStop being the poster child of that, is at least attitudinal measures of sentiment are saying, ‘Hmm, maybe we ought to sort of tamp down this euphoria and this speculative excess.’ And that right now, anyway, is a bit of a positive offset to some of the speculative access we’re still seeing in many of these behavioral measures of sentiment.

The last thing I’d also say is market breadth, the amount of stocks that are doing well continues to be healthy, and, historically, that has also served as a positive offset to an otherwise high speculation kind of environment. So I still think it represents a risk, and I think we all, as investors, need to be mindful of that. But there are some offsets that have kicked in recently that suggest even if we’re still sort of inflating some of these micro bubbles, we’re probably not looking at the kind of systemic situation that we ended up with in the late 1990s into early 2000.

So, hopefully, that was helpful. Thanks, as always, for tuning in.

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