Something is very wrong with the stock market, according to a top strategist at JPMorgan.
Equities have stormed back from their 2022 lows as fears of an economic hard landing give way to hope there may not be any landing at all thanks to a robust labor market and declining inflation.
Beneath the surface, however, trouble may be brewing. Marko Kolanovic, chief market strategist and cohead of global research at the Wall Street bank, fears retail traders have failed to heed flashing red signals from the bond market in a mistaken belief that inflation has already been defeated.
“Over 20% of all market volume [is] coming from retail orders,” wrote Kolanovic in a note to clients on Wednesday, adding that this was nearing a record high.
While hobby investors pile into the highest risk assets they can find, such as meme stocks, money managers are quietly taking their pointers from a Federal Reserve that still believes its job tackling inflation is nowhere near finished, he noted.
Bondholders currently demand a 4.6% return to loan out their money for two years in the ultrasafe U.S. Treasury market. This risk-free rate has climbed to a level not seen since 2007 and ought to be drawing more funds into fixed-income, according to Kolanovic.
With investors no longer chasing yield in the stock market, the Nasdaq should therefore be in the process of correcting, he said.
Instead it continues to climb, a fact he ascribed to retail investors. These hobby traders often heed the financial advice of YouTube influencers or forums like Reddit’s WallStreetBets, which lure them in with promises of generational wealth creation.
This encourages investing in troubled companies such as movie theater chain AMC, whose shares have already jumped 30% so far this year. Fitness tech firm Peloton is up 80%, while shares of distressed used car retailer Carvana have nearly tripled in value since the start of 2023.
Last year, Bed Bath & Beyond’s shares were sent on a wild ride after it was designated a so-called meme stock—a trend where a company’s shares skyrocket after gaining viral popularity via social media.
“The prevailing sentiment is of exuberance and greed,” Kolanovic warned of retail investors’ trading patterns on Wednesday.
‘Volmageddon’ 2.0
It’s not just financially ailing companies that are popular among retail investors. High beta names like Tesla and MicroStrategy that offer greater risk and returns than the underlying stock market have also doubled in value over the past six weeks.
Meanwhile, cryptocurrencies like the dog-themed meme token Floki have also soared, and all it often takes is Elon Musk posting a picture of his pet pooch on Twitter to send them ticking upward—behavior reminiscent of the 2021 Shiba Inu coin mania.
Rather than invest in a diversified portfolio using responsible levels of margin, Kolanovic said, these amateur investors are going out of their way to pick a fight with a Federal Reserve intent on cooling off the economy.
“This behavior is not just fighting but also taunting the Fed, with crypto, meme stocks, and unprofitable companies responding best to Fed communications,” he wrote.
He went on to issue a warning about the increasing threat posed by the popularity of high-risk derivatives—such as the “zero days to expiry” (0DTE) contract—favored among many retail investors.
“Volumes in these short-term options are very large,” he added, estimating the notional volume of 0DTE, daily and weekly contracts, approaches $1 trillion every day.
This herd mentality and penchant among amateur investors for placing high-risk bets in volatile stocks and options means that everyone could end up rushing for the exit all at once when a broader correction invariably ensues, he said. This could set the market up for a repeat of 2018’s “Volmageddon” crash, in which a vicious cycle of selling begat more selling.
“While history doesn’t repeat, it often rhymes,” Kolanovic warned.
This story was originally featured on Fortune.com
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Source: finance.yahoo.com