January has been an interesting month. Despite many warning signs of an impending recession, the global stock market managed to rise by just over 6% during the period. So, what is driving the recent upward swing in stock prices?
This week we’d like to peak behind the current and show you the source of the recent buying flows. Last month’s rally was driving by three core buyers:
- Retail investors rushing back into “beaten down” stocks
- Hedge funds covering their short positions
- Corporations allocating funds to share repurchases
Retail Investors
Last year the MSCI World Stock Index (the global stock market) lost a bit over 18% while the tech heavy NASDAQ Index declined by nearly 34%. Individual investors have been so conditioned over the last decade to “buy the dips”, they are now rushing back into stocks assuming that once again the Federal Reserve will come to the rescue, cut rates and turn on the liquidity. In the past month, retail investors’ share of total stock market volume has exploded to almost 23% from only 10% during the middle of 2022.
It is always amazing to us how quickly market psychology can change. Just one month ago, the Fear & Greed Index was solidly in the fear range at 38, but now after the heard has begun piling back into stocks they are jubilant
Greed has gotten so strong lately that this past week saw the largest volume of single day expiry call options in history. These options are used to gamble on the daily market direction rising.
Hedge Funds
As we entered 2023, the Hedge Fund community was positioned very defensively. Their overall net long exposure was near the lowest level since the peak of the Covid Crash. Hedge Funds by their nature are short-term focused investment vehicles that shift their allocations quickly. They are not able to withstand longer periods of being out of alignment with the broader market’s momentum. When they put on a short position, it is accompanied by a hard price where the fund will cover or take off the short. Usually that is between 4-6% higher than their execution price. This prevents any one manager from blowing up the fund with one bad short. Remember shorts have unlimited downside, so they must be managed very tightly.
As retail investors piled back into “beaten down” stocks, Hedge Funds began getting carried out of their short positions. Some funds, confident that the retail flows would subside quickly and that the market would return to trading on fundaments, re-shorted their favorite positions. Unfortunately, as we’ve shown above, the retail flows didn’t stop. This created what is known as a short squeeze. A short squeeze is when funds are forced to buy back the stocks they are short at whatever price is available to get out of the trade. It creates a self-reinforcing buying frenzy until all of the shorts are covered.
We just went through a month long short-covering rally, climaxing this week with the largest one day short-covering buy since 2016.
Corporations
January usually has a lower level of corporate share repurchases as most of the month is an SEC required black out period due to year end reporting. This year was different. With many of the largest companies’ stocks down substantially over the last year, mega cap corporations unleashed one of the largest buyback authorizations in history.
Company share repurchases are not representative of fundamental analysis. These companies are deliberately trying to increase the price of their shares as the bulk of corporate management compensation comes in the form of stock and stock options.
CEO confidence is weak right now, so instead of investing in new products or equipment, they are reallocating large amounts of cash flow to buying back their stock.
This triple combination of buying demand—mostly price indifferent demand—pushed stock up over the month. We’ll see how much real support there is for stocks at these prices as these sources of demand begin to slow.
