Wed. May 18th, 2022

This time last year, millions of amateur investors leapt in to risky corners of US financial markets in pursuit of riches, firing shares in downtrodden retailer GameStop thousands of per cent higher and leaving professional fund managers baffled.

Now investors large and small are watching the bets that defined a speculative craze deflate as the Federal Reserve retreats from the stimulus program that has kept markets flying high for close to two years.

Prices of meme stocks, cryptocurrencies, cannabis companies and blank-check vehicles known as Spacs have all tumbled as the air hisses out of the assets that encapsulated that furious rally, leaving no doubt that the game in markets has changed.

“The Fed is not in the business of buoy equity valuations or crypto or Spacs,” said John Leonard, global head of equities at Macquarie Asset Management. “Long-duration hypergrowth stocks have been taken out and shot.”

The average stock in the Russell 3000, a broad gauge of the US equities market, is down about 35 per cent from its highest point in the past 12 months, according to data analyzed by the Financial Times.

Line chart of Performance since November 2021 (%) showing In three months, air has seeped out of speculative parts of the market

In the Nasdaq Composite, home to scores of fast-growing companies that were in vogue during the depths of the pandemic, the average decline is approaching 45 per cent.

Russ Koesterich, a portfolio manager at BlackRock, said speculation had been encouraged by “an environment of extraordinary liquidity” since the coronavirus struck.

As the pandemic devastated communities across the globe and sent financial markets reeling, the central bank and US government intervened, pumping trillions of dollars into the economy to forestall a financial crisis.

“That was a big tailwind for all sorts of risky assets: it was Spacs, it was IPOs, it was cryptocurrencies,” Koesterich said. “You’ve seen a pullback in all of those recently and I do not think they’re unrelated. The Fed has been very clear they want to rein in the excess. How far it goes is uncertain but what is clear is that you will not have that same level of support we’ve had. ”

The strain in the market became apparent even before the Omicron coronavirus variant was named a concern in late November when it rapidly spread across the globe.

Shares of lossmaking tech companies had struggled after an initial boom last January and February. But in October and November they had charged higher again, hitting their highest levels in eight months on November 9, the day electric vehicle start-up Rivian priced its initial public offering, according to a Goldman Sachs index. A day later the price of bitcoin surged to a record just below $ 69,000.

The euphoria was shortlived. While Rivian’s market value climbed for several days and briefly eclipsed Volkswagen’s, inflation data jolted the Fed and investors. Markets began to adjust to a new reality where rock bottom interest rates and easy policy were no longer guaranteed.

Shares of previously high-flying stocks including Virgin Galactic, sports betting site DraftKings and plant-based meat producer Beyond Meat all fell more than a third between early November and the end of the year. Bitcoin, which many investors now watch as a gauge of sentiment towards speculative assets, has slid dramatically, at one point halving in value from its November peak.

Ryan Jacob, a veteran tech investor who runs the Jacob Internet Fund and a tech-focused ETF, said the crypto market had “echoes of what happened in the dotcom boom”, when many investors were convinced that a new technology had potential but found it hard to tell which businesses in the new space would take off.

“There are going to be some very large companies coming out of this, but that’s the easy part,” he said. “The tricky part is finding which ones. Ninety percent of the companies may be total garbage. ”

For the companies at the center of the meme stock frenzy, the swings have been particularly violent. Shares of video game retailer GameStop are down about 80 per cent from last year’s record. That is still far above the price that prevailed before day traders on Reddit, some of whom amassed on the r / WallStreetBets message board, helped spark a ‘short squeeze’ to inflict pain on hedge funds betting against the stock. But day traders have largely moved on.

Trading volumes in GameStop and other so-called meme stocks such as cinema operator AMC Entertainment, retailer Express and communications group Nokia have collapsed.

Line chart of Daily value of shares traded ($ bn) showing Trading in meme stocks has plunged

Instead investors have swarmed to other parts of the market, including to options that they had largely eschewed last year. Given the bumpier ride in the market – the S&P 500 and Nasdaq are no longer hitting record-high after record-high – traders this month set records purchasing equity put options. The contracts offer protection and the potential to profit from a slide in the market.

Strategists on Wall Street have noted that many of the new put options have been bought and sold on the same day, indicating traders are not simply trying to hedge themselves from a sell-off. Instead, it signals they are trying to profit from intraday swings in options prices.

Preston Seo, a US-based YouTube influencer, recently surveyed his followers and said most of them claim to be hunting for bargains, but that they are flooding his inbox with messages asking for guidance.

Lots of these younger investors on the surface may seem confident in ‘buying the dip’. But behind closed doors, they are getting anxious because they probably have not faced a downturn like this before, ”Seo said.

The threat of higher interest rates has helped fuel that anxiety. The Fed this week indicated it would in March lift rates for the first time since 2018, with chair Jay Powell leaving the door open to even more aggressive action to tame inflation and cool a fast-growing economy.

“People who put everything in there will find out there’s no shortcut to riches. . . this kind of speculative fervor eventually unwinds, ”said Randy Frederick, managing director of trading and derivatives at Charles Schwab. “The good thing is it has not taken out the whole market.”

Frederick added that the recent reversal would provide a harsh lesson for any new traders who focused their investments in a small number of assets.

“Every generation has to learn those mistakes on their own, no matter how much those of us who’ve been around a while will try to warn them,” he said. “It’s a slightly different game each time but the end is always the same. The hard point is pinpointing when it’s going to happen. ”

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