Historic short squeeze in US stocks and semiconductor constraints

The chart below tweeted by Robeco Asset Management shows the performance of the most shorted stocks in the US and how things structurally changed in 2020 and beyond. Any investor trading these markets and using momentum strategies will have to understand these concepts in order not to be wrongfooted.

What happened has been covered widely and we recommend readers to read through some of the links we have highlighted above. Now we will try to discuss what it means for markets and the future of regulation. A lot of what is happening is driven by the easy accessibility of trading through trading apps such as Robinhood but also the easy access to options trading which temporarily can cause these gamma squeezes when done in large size and heavy put/call skew. Large passive ETF holdings take out outstanding shares reducing the float in many names which causes liquidity constraints which can amplify the moves like the ones yesterday. High frequency trading can then amplify the moves even more due to chasing short-term momentum effects. There is no single solution to many of these phenomena underscoring the rising complexity in financial markets, but our best guess is that we could see a spectacular blow-up in equity markets under the right conditions and that this event will be the necessary wake-up call for regulators to re-design financial markets. One thing is for sure, these topics will be discussed at length this year as we do not think it is over yet.

Semiconductor constraints and reflation

In our Q1 Outlook published today we explain our thesis of why reflation will become the most important market theme to monitor over the next 12 months. There have been many signs the past six months of supply constraints across container freight and commodities, and in general the underlying inflation in the US has been rising steadily with an acceleration in November and December (see chart below). China’s PPI y/y will most likely swing into positive in January and with base effects setting in over the next 3-4 months inflation rates will pick up. Financial Times is covering today the ongoing supply constraints in the semiconductor industry and how it is causing carmakers to halt factories which will impact supply of cars just as demand is rebounding this year. Carmakers do not have the bargain power over other customers at semiconductor manufacturers as they are only 10% of chip demand and carmakers are losing out. This is becoming a national security risk for the US and Europe which are the two geographical areas of the world most affected by the current situation, which has also been amplified by the US sanctions of Chinese semiconductor firms. The semiconductor industry hope that the constraints will have been resolved by the second half of this year.