Are the Squeezers Being Squeezed?

You don’t need me to tell you that the Covid-19 pandemic, or rather the reaction to it, has changed a lot of things. Some, such as the sight of people wearing masks, restaurants with takeout only, and New York City streets virtually devoid of cars, are obvious. Others are more subtle, including a change in the market that looks like it could be turning one of the oldest but most cynical rules for traders on its head. It is a rule that involves and impacts us, the individual traders and investors, and that may have massive implications for stocks over the next few months.

This move is starting to look like one driven by “people power” with small, individual investors putting a squeeze on the big boys.

“Squeezing” markets has probably been going on as long as trading has existed. A lot of the time it is traders squeezing other traders, driving the market in one direction to force those with wrong positions to cut, thus driving the move even further. When traders do that to each other there can sometimes be small distortions to the market in individual securities for short time periods, but it doesn’t have much impact on individual traders and investors. There is, however, another much more cynical type of squeeze. It is an old dealing room adage that on a strong run up, particularly a bounce, the time to get out is when retail money starts to come in.

There is an arrogance to that that drives a lot of people crazy, but unfortunately, as obnoxious as it is, it is also usually true.

Normally, big, institutional money leads the markets. They control trillions and trillions of investable dollars, so inevitably when they are all trading the same way, the market moves with them. The traders that control those massive piles of cash have access to great research and data, enabling them to spot a turnaround early, and they certainly have the funds to make their decisions self-fulfilling prophecies. They might start buying because they think the market is going up, but once they start, it will no matter what.

When stocks collapse and bounce, as they have since the end of February, what normally occurs is that individual investors hang on for a while on the way down, then can bear no more pain and get squeezed out near the bottom. Then, when the recovery begins, they are gun shy and stay on the sidelines too long before being forced back in, usually once the big boys are done buying. Their re-entry is considered a sign that the rally is running out of steam.

This time, though, there is evidence that retail traders are driving this move up, with institutions getting caught in cash and possibly being squeezed into playing catch up.

With casinos closed and no sports to bet on, it appears that gamblers are eschewing the lure of Russian table tennis and Korean baseball and turning to the stock market. They are joining others prompted to trade stocks by zero commission trades and the opportunities inherent in a volatile market to create a flood of new money. Retail brokerage companies are reporting record numbers of new accounts and trading apps are taking off. Most of those individual accounts are presumably small but collectively, they become a market-moving force.

These new players may be gamblers and inexperienced traders, but they aren’t stupid. They know that stocks have always recovered from shocks in the past and will do again. They know that there is a lot of money to be made on the way back up. Most of all, they know that there is risk involved and the greater the risk, the greater the reward.

That could help to explain what I wrote about yesterday, the seemingly senseless triple digit gains in the stocks of bankrupt companies that we have seen recently. Gamblers don’t care about fundamentals, nor do they care about a high degree of risk. When you bet on a sports team it is a binary outcome; either you win or you lose it all, so the massive downside to buying bankrupt stock doesn’t scare them.

Institutional investors, on the other hand, are looking at massive unemployment and the sharpest peace-time recession ever, and at massive civil unrest. They are weighing the risk of a resurgence in Covid-19 as rules are relaxed too, and they are the ones staying on the sidelines.

There is currently over $5 trillion parked in money market accounts, 25% above the high during the financial crisis.

They are waiting for a retracement but the longer we go without one, the harder that is to do. Put yourself in the position of a fund manager. If the market is up 20% and your fund has made 0.01% in a money market fund during that time, how long do you think you can keep your job unless you join in? Sooner or later, regardless of quaint, old-fashioned notions like risk, economic conditions and value, you have to get involved.

The question then is what happens after that?

There are two possible scenarios. Either the economy catches up to the market quite quickly, in which case we will continue up as the evidence of that mounts, then flatline for a while as it does. Or the economy stays depressed, in which case we still go up for a while as that money comes in, but then, at some point, we collapse all over again.

For once, it looks as if Main Street is squeezing Wall Street rather than the other way round, but that doesn’t necessarily mean there will be a happy ending.