Equity markets have surged over the past few weeks off the March low. High beta currency pairs such as AUD/USD have pretty much wiped out the losses they experienced at the start of the crisis. Whilst the speculators have largely expected falls, building up large short exposure in for example S&P500 futures, the retail “Robinhood” crowd have been profiting from the rally, helped in large part by Fed (don’t fight the Fed, don’t fight the Fed…). Over the past week, there have been increasing alarm bells of at least some sort of pullback in this exuberance (heard the one about a bankrupt company raising money by selling equity? See Matt Levine’s column discussing Hertz for a great explanation of this).
Typically, retail flow tends to be contrarian and indeed in the past whenever I’ve looked at FX datasets based on retail positioning this has been fairly clear. Why is this different? For one, retail has been a bigger participant in the market over the past few weeks. Whilst this is unusual, it isn’t unique. We saw something similar in the dotcom era. The difference this time is that it’s even easier to get involved. Plus, let’s face it, there’s simply less to do now at this point of lockdown or partial lockdown.
But why have markets have been so disjointed from the economy and where does it leave investors who have been bearish for weeks? First, if you don’t understand what’s going on and markets are behaving in a way you don’t understand, it’s fine not to have a position! Sure there’s FOMO, but it makes it difficult to hold a position if you have no idea why you’re invested in that way. Furthermore which factors are driving markets change over time, sometimes it’ll be trend (like now!) other times it will be very particular economic data etc. Flexibility in pivoting between factors is important to understand markets. The most frustrating thing is to have the right view about a factor or event, but the market fails to response to that particular event.
Ultimately markets are like an opinion poll of where people think the economy is going. I remember hearing this analogy for the first time from my old boss Alexei Jiltsov, and I still think it’s the best explanation of why markets can often be so disjointed from markets. After all, opinion polls aren’t always right, and people continually change their views. In 2020, markets collapsed before growth fully stalled. Historically, the cycles in stocks are more volatile than the underlying economy and can often be out of sync. Markets absorb news and views at a different rate to what is happening in the economy.
Ultimately, markets don’t need to necessarily reflect fundamentals and can simply reflect a flood of money with nowhere else to go. The next leg down won’t necessarily be a result of a change of fundamentals, but a shift of focus from market participants and folks trading as a function of their P&L.