Crispin Murray: three issues driving markets and sentiment right now

Pendal's Head of Equities, Crispin Murray


Here’s what’s driving Australian equities this week according to Pendal’s head of equities Crispin Murray (pictured above). Reported by portfolio specialist Chris Adams.

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EQUITY indices fell last week in a remarkable few days of market activity. A frenzy on social media forum Reddit triggered a squeeze on some heavily-shorted US stocks. This forced the hedge funds who were short to de-leverage and sell down long positions, dragging on the US market.

This drawdown was reinforced by concerns over the impact of new Covid strains on vaccine efficacy and the shambles in the EU over vaccine supply. In Australia this led to a large unwind in cyclical stocks.

The S&P 500 was down 3.29%. The S&P/ASX 300 fell 2.88%.

We see three key issues facing markets and sentiment in the near term:

  1. The impact of retail investors, market speculation and views of valuation
  2. Concerns over the vaccine roll-out
  3. Risk of economic slowdown

In our view, we may see some further near-term volatility, but we ultimately expect more positive news on vaccines and the supportive effect of stimulus to win out.

Issue 1: Market sentiment / retail investor impact

Retail investor participation ramped up in 2020 and has recently hit new highs. Sitting at about 15% of US volumes before Covid, lockdowns and stimulus pushed it to 29% mid-year, before it fell back to 23% in September. In recent weeks it has returned to about 30% of daily volume. This has been accompanied by greater use of leverage, which can be seen in option activity.

This retail activity is another feature of current market environment which, alongside stimulus payments and liquidity, is driving speculative activity. Importantly, this activity is concentrated in specific pockets of the market, eg Tesla, Bitcoin, Renewable Energy ETFs and IPOs. Higher retail activity is another symptom.

In our view, this does not imply that the entire market is overvalued or in bubble territory.

Nevertheless, the specific focus on shorted positions was unusual. This coincided with hedge funds being levered up more than usual at gross and net level. This combination led to a huge short squeeze.

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We can compare this to previous short squeeze events to get an idea of the scale. The impact on performance for an investor caught in the wrong part of the market in large caps last week was material. But less so than the post-GFC value rallies in 2009, the 2016 value rally or the surges in positive sentiment on economic recovery or vaccine news in 2020.

The situation was very different in small caps, however. Here the effect dwarfed anything since 1995, except for the Covid recovery surge in mid-2020. This highlights how increased retail activity is focused in the small cap part of the market.

The losses for hedge funds have been material. Fundamental hedge funds are about 9% below the market for January. This triggers the need to de-lever, which forces more selling. The short-term issue is that underperformance means the selling has not yet cut the level of leverage, so this could continue for a few weeks. A short squeeze event like this in early 2016 lasted 4-6 weeks.

The key questions raised:

1) Is this a flag for the overall market; the final demonstration of extreme speculative activity that marks a top?

We don’t believe so. At this point we see a buying opportunity. It could last a few weeks as hedge funds continue to de-leverage and many long-only funds have low allocations to cash. We still see strong market fundamentals – primarily stimulus, plus the release of pent-up demand as vaccines take effect – as a more important factor, which should underpin markets.

2) Does this signal a shift away from momentum stocks?

It’s possible. But right now we are sticking with the economic outlook and bond yields as the best indicator of this. Bond yields are holding at lower levels than most expected, supporting valuations.

3) How long does this retail effect last?

We now have the perfect storm of cyclical and structural factors supporting this activity:

  • Markets have been rising so people are making money
  • Stimulus cheques have just been received with more to come
  • Lockdowns and cold weather give people more time
  • Low-cost, easy investment platforms combined with social media raise interest and insights

We think this means retail participation is likely to remain a factor for next few months.

4) What does it mean for investors like Pendal?

Like the impact of quant, index, ETF and risk parity, this is another factor that can add to volatility which active fundamental investors need to be mindful of. Australia has been less affected by this episode, but there is evidence of impact in the behaviour of some stocks – eg the buy-now, pay-later companies.

Issue 2: Vaccination and re-opening timeline

The key question is whether new data on vaccines — showing lower efficacy to the South Africa variant — and the manufacturing issues in EU delay economic re-opening.

In our view it is likely to cause a small delay — maybe 1-2 months — and may limit the level of international travel for longer. But fundamentally it does not prevent us from reaching herd immunity or diminishing the more serious effects of Covid.

There was a lot of data to digest last week.

The Novavax vaccine trial data showed efficacy as good as Moderna’s — with better tolerance and a great ability to quickly ramp up production. A 65% jump in Novavax stock reflected how well the trial was received. Australia has signed up for 51 million doses of this vaccine.

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Trials in the UK and South Africa showed efficacy fell from 96% for the original strain to 86% for the UK variant and 49% for the South African version (60% for patients without HIV). They plan to develop a booster to deal with this, likely to be available in Q3. But this partial immunity still protects against severe infections — even for the South African strain.

The Johnson & Johnson vaccine was more disappointing. Overall efficacy was around 66% — 72% for the original strain, down to 57% for the South African variant. While it may be less effective than other vaccines at stopping infection, it is still very effective in preventing severe infections. As such, it will play a role in alleviating pressure on health care systems and reducing mortality.

The company is also running two-dose trials which may lead to improved results. This is important because it’s a key part of the European supply and can be rolled out more easily.

There are now two paths countries can go down:

  1. Open up the economy earlier and accept the virus will be prevalent in the community — albeit at a lower incidence level but with severe infection becoming increasingly rare. This is much like the existing flu. We suspect the US and Europe may choose this path, with vaccines such as Johnson & Johnson’s playing a role.
  2. Seek immunity from mild incidence of the disease, wait for boosters and maintain some constraints. This may be where Australia goes.

Despite the concerns, vaccinations continue apace. Rates are accelerating in the US and the UK. Europe is lagging due to supply and logistics.

The rate of vaccinations in the US is up 35% week-on-week – passing Biden’s goal of 1 million per day. The goal is now 1.5 million per day, with the potential to achieve to 2 million per day – the UK’s current run rate.

Lockdown measures have led to a clear improvement in new case numbers. The US is back to early November levels, half that of the peak earlier in January. This is flowing through to hospitalisations. ICU capacity has materially improved in most US states. The pace of improvement could accelerate further as the effects of vaccinations flow on through February.

Issue 3: The risk of economic slowdown

The final concern is whether mutant strains will have a material effect on the path to normalisation and economic growth.

We suspect we are near the nadir on Covid sentiment. In coming weeks countries leading on vaccinations should start to see a material improvement in cases and hospitalisations. This should improve confidence in opportunities for economic re-opening.

The Fed last week made it clear that near-terms risks relating to vaccine distribution and efficacy reinforce their view that they will not be considering balance sheet tapering for a long time.

We also saw the EU show some indications that they may need to cut rates again — recognising specific problems with vaccine roll-out in the region, alongside the strong Euro.

We still see strong near-term drivers of economic demand. In 2020 the relaxation of US lockdowns was accompanied by reduced stimulus. This time around, the relaxation will be in concert with more stimulus. This should be a strong tailwind for demand, through both income growth and use of still high excess savings.


Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and a strong track record leading Australian and European equities funds.

Crispin manages a number of our flagship funds along with one of the largest equities teams in Australia.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

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