With all this extra liquidity that is meant to jolt the U.S. economy out of its Covid induced recession, it seems all the free money and stimulus checks is finding its way into hands of bored stay-at-home millennials and gen-Zs who figured out that since stocks can never go down, might as well find the cheapest stock out there and hope it rallies up 100%+, like GameStop (GME) . Obviously, these traders can't afford to buy shares of Amazon (AMZN) , or the large caps, as that would require too much capital upfront, they have resorted to chasing penny stocks like Saddle Ranch Media (SRMX) that exploded up 3800% in just two weeks. This is but just one example of the ludicrousness of this market, where the name of the game is to find the cheapest most illiquid stock, get a group or retail army day-traders to push it on social media and get a buzz going. This is exacerbated by buying upside call options on these stocks, as they can position themselves 100x more for the same price! Without any consideration of the risks, their aim is to squeeze the shorts, in this case Hedge Funds who hold short positions for "fundamental" reasons. There is a reason why penny stocks are called that. They surely have no fundamentals nor growth or cash or earnings. To see these stocks move up and down 100% in a day is merely absurd.
This is the state of the market these days, where options open interest on cheap illiquid stocks is exploding to the upside and volumes on the larger index, S&P 500 and its names, are falling. The big boys seem to be on the side-lines observing the madness, this game is being played by a bunch of liquidity hungry wanna-be-millionaires. Of course, the market has rewarded them for their decision making, so they can't be to blame. The Fed can! Those of us old enough to remember past exuberant cycles, this seems awfully similar to the 2000 tech boom when everyone was a genius being long. What could possibly go wrong?
As the Fed's balance sheet keeps growing, now at $7.44 trillion and counting, with hopes of the new $1.9 trillion fiscal stimulus coming to pass as Treasury cash balances draw down, the market is well supported no doubt. Inflation according to the Fed is nowhere close to the 2% number they are targeting as they have conveniently taken out all the inputs that actually matter. One just needs to look at the breakeven inflation rates in the market suggesting 2.5% or more compared to the 1.4% CPI print we just saw. The Fed knows no other way but to keep its foot on the pedal till it gets the desired inflation, or growth, whichever comes first. But what if we get the inflation and not the growth? This is something any central banker fears and is hoping will not come, but given the state of the recovery of the economy, it seems like a real possibility.
U.S. bond yields are rising on the supposed recovery hopes. As yields move higher, investors are loading up on the reflation trade blindly. But lower yields and rates have been one of the biggest reasons that asset markets have been supported over the past decade. If yields move above 1.2% and break its long-term downtrend, there could be a messy adjustment period. But no one is prepared for this or thinks it can happen. We can keep moving higher until something snaps, but drawdowns can happen, especially when there is so much leverage in the system as we have now.
The market is pinned to the key 3900 level in February. Thanks to the February open interest gamma expiration coming up next week, this is giving investors a false sense of illusion of support. It is pinned for a reason as dealers need to sell above strike and buy below to keep risk flat. The beauty of derivatives and their real power! With so many signals flashing red, it would be wise to take a step back, avoid chasing four-letter tickers trading less than a dollar, unless you want to be the last man standing when the music stops.