Market Review 01/2021

Equity markets were mostly boring during the first month of the year. In fact, there would be almost nothing to write about if not for the “Reddit’s revolution”. We do not want to go into details of what happened nor do we want to take sides, but the phenomenon itself must be stressed. Yes, it was greater than seeing crude oil futures going negative in April with many important implications.

Vive la Resistance!

For decades, smart money was harsh on retail investors. During dot-com bubble Wall Street dumped worthless companies on unsuspecting people, costing them all their worth. Eight years after that it was borderline fraudulent mortgage disaster. Then came algorithms, high-frequency trading, and user data purchases to front-run the Main Street. On January 2021 retail investors finally hit back.

Just as people use social media to organize protests, traders used websites like “Reddit” to arrange a successful short-squeeze on Wall Street hedge funds. Of course, “big guys” were fast with countermeasures – Robinhood, WeBull and other brokers restricted trading in various stocks (though we cannot ignore vital rules for collateral requirements). Sure enough, angry voices (even from some politicians) and class action lawsuits followed.

European and US equity markets

No happy endings

How does this short story end? The problem always comes when traders eventually do want to sell. “Reddit crew” was / is “paper rich,” however, to convert their shares back into cash, they have to sell but whom can they sell to? These are simple market dynamics – every transaction requires both a buyer and a seller with price being the distinguishing factor. The smart ones have already got out (we all heard stories about people paying out their mortgages and student loans). The rest will find themselves in a very troubling situation. With prices falling heavily, the sellers are crushing the buyers and we have a brutal and fast decline. For those of us who wanted to see the villain suffer (if there is one), well, this is probably another famous story of how the “bad guy” gets away with a few scratches.”

Benchmark 10-year bond yields

US High Yield at all-time high

On far less crazy fixed income market we saw some gains here and there with nothing in comparison to the wild swings of “meme stocks.” Benchmark long-term yields rose 15 basis points for US Treasury notes, and 5 basis points for German Bunds. Investment grade spreads remained flat for US and European markets alike. Even high yield markets had their spreads hovering near lasts year’s lows. Thus, Bloomberg Barclays Pan-European High Yield Index rose 0.58% in January, outmatching the US Corporate High Yield Total Return Index’s meager gain of 0.33%.

One thing of note is that absolute level of US high yield market’s yield to maturity is at an all-time low of 4.18% for the respective index. European index with an average yield to maturity of 3.14% still has some way to go before being on par with the 2017 all-time lows of 2.68%.

Evidently, fixed income markets have reached the point where further upside is limited. However, these levels can be sustained for a while, provided stable benchmark yields and hefty risk appetite. Nevertheless, risks of correction are rising and one should keep that in mind.

High Yield bond Indexes

Silver attempting to start a long-awaited rally

Gold did not do much in January, while silver had quite a month. End of the month saw massive silver buying after trade was «well advertised» with fantastic probable target of USD 1000 per troy ounce. Disregarding “Reddit’s revolution”, we must remind ourselves that for the last 50 years average ratio between gold and silver was around 60, meaning that an ounce of gold was, on average, worth 60 times more than an ounce of silver. Last spring this ratio jumped to historical 120, which meant that either gold was too expensive or silver was too cheap. Sure, averages rarely hold for long periods of time, but they are worth mentioning. Now we finally see a certain normalization with silver catching up.

Gold price, USD/oz

Do not forget about oil

Oil chart has everything in place (from 2008 top to 2020 Covid-19 bottom) for the rally we were pointing at back in May. We cannot ignore what market gives us, and with recent action in silver (though another bout of weakness would be helpful), commodities would make perfect sense in an investment portfolio. This is a long-term play, but price action during the last eleven months is more than impressive. The more realistic scenario would be a move to ~70 dollars per barrel followed by a large correction. First stages of commodities uptrend tend to be slow; and as per the “black gold”, we see 35-40 dollars-per-barrel price zone as «cheap».

A few words on economy

China’s economic recovery stalled in January, with factory activity expanding at the slowest pace in seven months as falling export orders and resurgent Covid-19 cases weakened sentiment. Services sector grew at slowest pace in nine months in January. Still, China reported a larger than expected (6.5%) growth in GDP for the fourth quarter of 2020. On the other hand, China’s fiscal revenue fell 3.9% in 2020 from a year earlier, while expenditure rose 2.8%.

The US economy contracted at its sharpest pace since World War II (3.5% drop), the worst performance since 1946 and the first annual decline in GDP since the Great Recession of 2007-09. Consumer spending, which accounts for more than two-thirds of US economic activity, fell for the second straight month in December after renewed business restrictions and a temporary expiration of government-funded benefits.

The Eurozone contracted by less than expected in the fourth quarter of 2020 – Eurostat said that according to its flash estimate, gross domestic product in the 19 countries sharing the euro fell by 0.7% quarter-on-quarter, for a 5.1% year-on-year decline. Preliminary data showed the second and third largest euro zone economies France and Italy pulled down the overall result with quarterly GDP declines of 1.3% and 2.0% respectively, meanwhile Germany inched up 0.1% from the third quarter and Spain grew 0.4%. Eurozone unemployment was stable at 8.3% of the workforce in December and the manufacturing growth remained resilient.