U.S. stock index futures declined in overnight trading as a surge in speculative trading by retail traders continued to cause hedge funds to take off risk and worried investors about a market bubble. The losses build on last week’s decline, which was the worst for the market since October.
Some traders believe the market’s valuation is stretched and that the recent turmoil fuelled by retail traders is the kind of thing that could spark the start of a correction from these overvalued levels. We think there are vulnerabilities, while we do not know precisely which catalysts might emerge or their exact timing, including some of the recent retail-oriented pushes against heavily shorted stocks), we suspect that they would derail the current rally and provide entry points that may be 10% lower.
The Dow dropped 620 points on Friday, or 2%, to close below the 30,000 level for the first time since December. The Nasdaq Composite also slipped 2%, while the S&P 500 fell 1.9%. For the week, all three major averages slipped more than 3% for their worst weekly performance since October. The Dow and S&P also posted losses for January, the first negative month in four although the Nasdaq did manage to post a gain for the month.
Friday’s dip came amid a frenzy of activity by retail investors in heavily-shorted stocks including GameStop and AMC Entertainment, which fuelled concerns about the overall health of the market. This week’s events may have turned markets on their heads. Still, it’s unlikely that the impact of the short squeezes will ripple through the broader market. The ongoing short squeeze in a few stocks by retail investors has raised concerns of a broader contagion. While we believe there is more pain to come, we remain optimistic that it is likely to remain localized.
Meanwhile, a group of 10 Republican senators sent President Joe Biden a letter on Sunday, urging him to consider a smaller, scaled down Covid-19 relief proposal. His current plans call for USD1.9 trillion in additional fiscal stimulus. The alternative proposal comes after House Speaker Nancy Pelosi said the chamber will move to pass a budget resolution, the first step toward approving legislation through reconciliation. The process would enable Senate Democrats to approve an aid measure without GOP votes.
Elsewhere, another busy week of earnings is coming up with 99 S&P companies set to report. Alphabet, Amazon, Alibaba, Snap, Exxon, Biogen, Pfizer and Chipotle are among the names set to report this coming week. Thursday is the busiest day of the earnings season. In a similar pattern to the previous two quarters, corporate earnings for 4Q20 are exceeding expectations by a significant margin.
Still, a stimulus package as well as investors looking beyond delays in vaccine production and distribution should further boost stocks.