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The Short and Long of Recent Volatility

2021-03-03

The volatile start to 2021—with some heavily-shorted stocks unexpectedly skyrocketing in late January—seemed to have subsided. But with some of these stocks again on the rise, we ask what factors caused this volatility, how likely it is to repeat, what could prevent this, and what it signals about, or for, markets. Allison Nathan, creator and editor of the firm’s Top of Mind report, turns to former SEC Chair Arthur Levitt, Wellington’s Owen Lamont, and Goldman Sachs’ co-head of Global Prime Services, Kevin Kelly, for answers. 

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This. exchanges. Goldman Sachs, where we discuss developments, We shape markets industry. Yes and the global economy? I'm out Nathan from common sacks research creator the editor of the firms top of my report, which focuses on economic issues on the minds of our clients. In this episode we focus on the volatile start to markets and twenty twenty one with a number of heavily shorted stocks, unexpectedly skyrocketing and late January amidst the boom, and we he'll trading. This volatility seems to have subsided somewhat, but many questions remain what factors led to this volatility. Is it likely to repeat itself Finally, given the increased activity of retail investors,
could and should be done to prevent similar episodes in the future. And what, if anything, does this episode signal about the broader market or mean for it? Exploring these questions, is top of. Might we first turned to cabin Kelly Goldman Sachs CO, head of global prime services to break down the factors that led to the equity market value quality and late January? What factors Add to that the period of volatility that we saw slept equities in January. So we have to remind the clock a bit too back in October, where we start to see our prime brokerage adding to their long suppose, at a much faster rate than shorts, driven by the multitude of factors. but deftly the positive outlook on earnings and fiscal stimulus. This was more pronounced the wall Short merely where we observe the longshore ratio, which we measure is class long market value divided by the short value hitting in time high. At the
the two thousand and twenty? we January. We also observed why it's covering nearly five percent over you, a short book, now. This was interesting to us as when we see that type of short covering in our portfolio. It's usually a breed by long selling. Your laundry risky, which didn't happen Jaguar I covering the shorts and not selling their long's. This lead increase Longs exposure after being stretched into your at? With this backdrop, over the first several weeks of January, we did observe when we look the prime brokerage performance, that Longs were underperforming performance while shorts, but that in context as affrati gender, twenty second, our internal, ass meant that we calculate with a brokerage bridge unlike performance Did you two hundred fifty basis points of negative alpha perform its offset by three hundred basis points of positive data, which is realised that exposure to market that acquainted positive fifty basis points for the month, but then, throughout the week of January, twenty fifth
We observed exhilaration acceleration, poor performance all along and short side of our loss or type portfolios. When you look at our, for Mister January S, away the basis we asked there are long short funds without five point: nine percent former lost. There was primarily driven, losses on the short side, which we estimate was five and a half percent for the house. much more modest loss alongside a point. Four percent must short flowed name, in our most your basket, was about forty. Two percent of us is obvious a crescendo and get your twenty seventh would perform instead, seven percent for the month without observer wisely risking by selling longs as well as coverage, shorts, thou We observe the largest notional selling. We have seen since two thousand and eight this risk. It was a majority of the U S story, but we all what did cd risking in Europe and Asia about leverage related to this episode idle,
that leverage played a material role in this bad about volatility and I'll, explain why the community that experience of challenging performance was you Longshore funds generally these have rose exposure is defined as law, market value plus short, not devalue, over equity or their energy of the fun of less than two hundred percent, so more leverage for five six times. This is a modest leverage strategy where the pin point really came from was on the short sighted it specifically concentrated shorts, it wasn't much of an unwise given leverage. It was the performers degradation of shorts that lead to people do arresting and under perform. Given the importance of short selling to these market moves, we then speak you Wellington, management on the march, who published extensively on the topic. During? higher academic career here,
down into short selling dynamics and the role they like me played during the recent volatility. Hot short squeezes work, and when do we typically a short squeezes, usually defined as an increasing in asset price that causes existing short sellers to buy the asset to close their sharp position? Maybe do that, because they are trying to limit their losses because they run out of collateral or some is disrupted their ability to borrow the asset, so you ve got this additional buying by four dollars that push up the price even more and a process that may just happened. Naturally, or perhaps it's the result of deliberate market manipulation. stream version of a short squeeze would be a corner in a corner, Where somebody control of the entire supply of the asset said that too short sellers are forced to buy from that person? Who is controlling the supply in them?
you. The recent volatility, was the product of a short squeeze, but it differed from historical short, squeezing an important ways. Would you sit what occurred in the equity market in the? U S in January to be the product of a short squeeze. Yes, there's! No, that there were a handful of companies that were targeted at short interest and we saw a series of short squeezes in a smaller we'll stocks in the. U S, starting January and arguably continuing to track it similar just history, like the picnic wiggly case these that motor case and books in two thousand and eight one of the largest short with this in history. That, for a couple days, left I'll, try with the largest market in the world and that the peace his moving, but not because of new information about the fundamental value,
was different about January was historically a short squeeze as something that is done by a few large players, and here you had many small traders I would describe happened as a flash mob short squeeze where you have a large number of small players or coordinating and social media? Also, in the case, the Volkswagen, some people had to deliver both wagon chairs and they were able to deliver the shares because of disruptions in their ability to borrow the shares. I dont The destruction of these securities long market was the issue in January, common. Is it to see these types of dynamics in markets beyond equities, most historical examples corners and manipulation come from the equity market, but from the commodity? market and other markets, the hundreds corner of the silver market in eighteen. Eighty
another famous example, as these Solomon squeezed, which involve treasury knots if a market of different institutions but the basic mechanism? Mrs it I've been asked the man about the role that retail traders aid in the recent volatility and whether it were height. Here's his take. I dont think that impact of retail trade and has been over eight years ago. Evidence that mutual trading has grown. There is evidence that retail trading as a percentage of total equity market share as possible we doubled in the past couple years and in the options market reach. Our trading has exploded with respect to their ability to access leverage the options market. There is no doubt that that's part of the story and part of the buying power of individual investors, has been through equity options on individual stocks. One way describe. The events of January was a crowd sourced gamma squeeze gamma squeeze
means that retail investors are buying options and trading in there he's market and the options dealers are hedging. Their exposure buying shares so the way for the retail investors to magnify there on the underlying surprised. Having put the later market dynamics into context. The big question, now is whether heightened retail trading activity, as well as the other factors that contribute the late January events- I like me to repeat, and what that means for markets in Kelly's new, it's difficult to say that markets- have moved completely beyond these dynamics, but he believed that shifts and positioning and awareness of this growing risk factor will leave heads. And nimbler, and better prepared to anticipate and management are the underlying dynamics that drove this episode still intact, or is it likely that we're gonna see this conference of events again
I think it's hard to say we fully moved away from a dynamic, but at the time we were spectacle the late January. Our sense was other form his challenges and be risking was most experience in big from our? U s: angry Alongshore apply a base, which is their confirmed by foreigners data from firefighters as well other hedge fund strategies macro, see a credit. Systematic many points. the positive average returns the month of January and even within the long short mainly in the EU, the performance this budget was very high, with several managers actually pussy deposit returns for once and now, overall risk is lower as positions the most shorted names. The newest has reduced dramatically, for example, constituents, situations of short basket, clumsily sought covering as well sixty five percent you're a date on a unit basis so today Edward Alongshore managers on average have much less exposure to these days
and much less exposed to a sharp rally. A every position, their portfolios to remain nimble? This new market, dynamic Kelly, also emphasised is that, even with record breaking trading volume during this period, the market functions from an execution financing and clearing standpoint, Is there anything about this episode? Are point during this episode where, it seemed like the market wasn't functioning properly? No, the market. should incredibly well as we discuss one of those days. We had a record data volume. Everything went very well from an execution standpoint from a financing standpoint. Clearing everything was working well, so I, The stability and fortitude of the market group is again during the last January, but Le Monde strategies sure squeezes rarely happen and well functioning markets and its concerned that market prices look less and my flight the outcome of an orderly process, so he believed
more volatile. Episodes are likely ahead. Here's the night George squeezes are rare in well functioning liquid markets, We shouldn't have a market where prices are moving so much in response to sentiment. We should have markets that are more robustly reacting to information and academic finance. We're contact called noise trader risk. traitor risk is where you have traders who are doing weird stuff and they're making market prices move all around, and these national traders dont want to bear that risk. They just exit that story, volatility gets volatility and crazy prices and volatility or ourselves enforcing cycle. So. I'm not sure whether it's the liquidity, that's causing volatility today, the volatility that causing the liquidity, but somehow we're in a situation where market prices, at least a handful of names, the amount of work again words just me
It seemed like our system is more fragile. How We are we to see similar episodes in the future. I could imagine more squeezes, especially in liquid. names or in weird. corners of the market? I get it back in flash precious we had a full. crash into ten and other little incidences than so. It seems to me that work in a market where prices are moving a lot probably not that horrible couple stocks every now and then go crazy, but more concerned about the whole system being fragile, finally, forward active on the regulatory implications of the recent volatility we turned Arthur love. It was chair of the efficacy from ninety ninety three through two thousand and one I the internet bubble, levities parallel between then, and now you or chairman of the SSC during the internet ball. What,
similarities or differences? Do you see between the recent equity market volatility in that period or other periods in your career, abortion similarities, between both periods in both instances, people were shooting. I returns. They saw me upward momentum of the market. Rather, fundamental analysis the internet to hide starred. Rooms or social media was price. in both instances. Trading, who is viewed as kinder than entertainment the total divorce uprising, job fundamental research when you think about that Yoda Volatility and the recent, when we experienced in January, do you consider it to be problematic, Jody around in the gradual stocks,
driven by casino. I trading is a by product the cultural extreme risk taking shaking higher returns, and you can typically dead like a global interest rates were a by product of liquidity, I'd, say: liquidity is a problem when chambers can't get any return on bank deposits, you're gonna do as yield elsewhere and chasing. You is all Firstly, people need to be condition to respond. Stability is a long term. Investment we haven't had sustained period market week is chase. Oh wait. No known and most today's gay trading score in college. Yet at that time the boy had been forced to all true
while Leonard, find some aspects of the recent volatility problematic? You think some areas of focus in turn then what's been driving? This volatility deserve more scrutiny like on trading platforms than others? Like short sellers, in light of the testimony is a lot of focus was on retail trading platforms. Do you have any doubts about this There is a low trees trading platforms, air part, the fabric out? Where did she go Here is a brokers. I've been told that their daily mail trades could three but that's misleading. The reality is that investors get nothing for. workers get away a percentage of the difference in the dead man, s grand trading platforms, king. They returns that investors The old saying goes: it shopping spree here,
the product- Unfortunately, the trading platforms, through start trying to, may not always be getting the best deal they're now as you said in your best entrance, that's why we made it consider out at night maybe in the market, more transparent, acquiring those operating in mind. Here we are in the best interests of their customers. The unrest I also make we your focus on whether trading platforms and using this tools social networking platforms addictive. There was also a lot during this episode. Iron short sellers. How you view the role of short valley in the equity markets everything. I an argument that short selling
is actually a way to supply shares to a market where more investors waterhole alarm, Your narrow shares available believe that is true It's a way of allowing those who believe the stockings price. To apply to India a short while Borrowing a shares. Your mouse plans he had a long position, I believe, that short, showing has important role in ensuring proper pricing of stocks in the market. Here there is a barrier to the last hundred years selling should be banned. Often those arguments come from a calculator, the company is restored. resolving prized and being shorter Enron, all that follow two thousand and two sure the stock Van Ryan. Publicly, alerting investors
but I believe the stock was should neither can. We also applies a little over a year later, the seventh largest in America watching bankruptcy, revisions Le Monde, We love it emphasising that despite a common perception, short selling, generates market volatility. It's actually a stabilizing force in the market, but helps push at prices. towards the fundamental value here is more, would limit Do you find the authority should be a good thing. Or a bad thing for a functioning market I think, shorting is a good thing. It has several roles, one role is, short selling too negative information into the market. So optimists. Your pessimists, you want them to come together in a market to find them the price and an important part of our processors to allow them to trade on their views. Second function or
if it short selling, is liquidity for sellers have to buy the asset eventually? And so, if you don't have short time, you're going to decrease market liquidity, how to stabilize markets Friedman sat more than fifty years ago that speculation is inherently stabilizing because speculators by low and so high you think speculators are making money. You think their state and prices ashore, sellers cell, and they by lot. So they do it in a slightly different order. But they're doing the same thing: there pushing prices towards fundamental value is, speculation necessarily stabilizing profit, making speculations gonna be stabilizing, but if you people who are trading for reasons other than profit motive, their trade Four fonder dared? gambling her there. Some sort of anti establishment feeling there they're trying to protein somehow with their trade. That's not true,
when seeking, and you can imagine that kind of speculation would be destabilizing, but I would that short selling is a good stabilizing force in short, sellers, are Part of a well functioning liquid market in, places where you don't have short selling or we're sure falling is temporarily and or restricted. Those places. quickly out duration about equality and prices are farther environmental value still remains. One of the recent volatility suggests a need for new rules or regulations love. It says that ball to episodes have happened in the past and will happen again, but he struggled to define new regulations that could help protect investors from them. obviously the million dollar question that Congress and regular grappling with is whether any
paper regulation should be increased or implemented to help avoid some of these bouts of volatility I don't think I could define new regulations, were they The point you protect investors at this time. of market volatility. We soon period such as this before I see them again. it does not surprise me or worryingly, particularly the limit, does believe. Tat. The new administration and incoming ACC chart very chancellor will be focused and making sure that existing rules and regulations are still appropriate today. Any advocates happy c c play a leading role in educating the public about the risks of investing. Generally speaking, where emigrants the administrations the commission change to anymore,
aggression from an enforcement point of view, that continues remain was to be seen, but I think that Gary guns or there's gotta be a strong action for investors, in Washington extraction to ease up on regulations, but markets are so sensitive We ve been down most to these roads many times during market cycles, Games were understand, he said his world was anybody in America and where I lived in seeking out new corner regulation, I take Sure I'm you see is going to be cancelled. We examining setting, rules and regulations to see. If they are appropriate for today. These markets, you never join.
back in a restaurant. a string regulations that say goodbye he's been done because monitored we are constantly changing I think part of the responsibility of the head. Yes, he seized and see to it that regulations were to totally appropriate for periods. in the past, wait for the present time and I can't, no one better that began to make various judgments, because he is through those markets in the past You were great expertise. beyond regulation. What else could and should be? As you see I do in response to all this The commission has to stand with the investing popular game, public markets, it's important a strange now that areas on the day, a regulator. Looking out
their best interests growth in retail trading may level off after people are able to return the full time work in school It will at last the next courage, three historical pattern. in one sense. Retail trade is good, the more people involved in markets. The more they'll be Chancellor tricky issue such as good Good governance You didn't ask me, etc. People need to be condition to respond. stability is a long term investment? retail trading? Does encouraged that education regulators should went out said the commission. I focused on engaging the public. Can you're kidding reinvesting public through town halls the internet public space
Media I don't think regulated realize they can and should use the boy I'll bet you engage and educate. I'll go as easy chair can do more with public opinion, Sam and from a rule, changes are enforcement actions as making new to grapple with questions following the recent volatility will be sure to keep tabs on the implications for investors and for markets more broadly I'll. Leave it there for now. If you enjoyed this episode, we hope you subscribe. an apple pie, cats and leave a rating or a comment. I am also Nathan. Things for listening to exchanges are common sacks
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Transcript generated on 2021-07-01.