This crash beneath the surface showed something had broken, that the magic had died, that hype and hoopla were suddenly unable to carry the day.
By Wolf Richter. This is the transcript of my podcast recorded last Sunday, THE WOLF STREET REPORT.
Stocks have been in a downward spiral for a while. The S&P 500 Index has dropped 23% from its high on January 3rd, the Nasdaq has dropped 33% from its high on November 22.
But here is the thing: many, and I mean a whole bunch of the biggest high-flyers peaked in February 2021, so about nine months before the Nasdaq peaked, and they have since then collapsed by 70%, 80%, and even over 90%. And it happened very fast, stock by stock. These stocks started getting totally crushed nine months before the Nasdaq headed south.
They include many big-name stocks that have crashed 70%, 80%, or 90% since February 2021.
What many of these companies have in common is that they’re losing lots of money, still, after many years in business. There are a handful in this group that are making money, but most are losing a running ton of money, and by now, many of them have started laying off staff.
Another thing they all had in common is that these stocks reached ridiculous peaks, mind-boggling peaks where any rational human would look at that and say, this crap is in a ridiculous bubble. They were hyped to the nth degree by Wall Street and everyone. And I’ve been calling them the hype-and-hoopla stocks.
On that long list of stocks that peaked in February 2021, and that since then have plunged 70%, 80% or even over 90% are Uber, Spotify, Snap, Pinterest, Zillow, Redfin, Opendoor, MicroStrategy, Twilio, AMC Theaters, Chewy, Virgin Galactic, educational platform Chegg, auto insurer Metromile.
Metromile had gone public via SPAC in February 2021, and that was the high, and it has imploded by 96% since then.
Zoom Video is in this group. It’s down 76% from its ridiculous peak in February 2021. But it’s one of the few companies on this list that made some money.
A bunch of EV makers that had just gone public via merger with a SPAC or via an IPO are on this list, including Lordstown, Workhorse, Faraday Future, and Lucid Motors. They got massacred since their high in February 2021.
Cathie Wood’s Ark Innovation ETF, which tracks a bunch of these hype-and-hoopla stocks, also peaked in February 2021, and has since then crashed 76%.
The Renaissance IPO ETF, which tracks stocks that had their IPOs over the past couple of years, also peaked in February 2021 and has since then crashed 63%.
The Cannabis ETF and the AdvisorShares Pure US Cannabis ETF, both peaked in February 2021 and have since crashed by 87% and by 79% respectively.
By March 3, 2021, 10 months before the S&P 500 Index peaked, this bloodletting beneath the surface that had kicked off in February 2021, was becoming so brutal and so obvious that it gave rise to my first article on this phenomenon. I titled it: “Was That the IPO Stocks Bubble that Just Popped?” I wrote at the time: “When there are suddenly second thoughts in this market powered by so much blind and crazy exuberance, the entire foundation begins to wobble.”
By April 20, 2021, when the EV startup stocks were blowing up, I wrote an article that I titled, “the EV SPAC Hype Boom is Imploding Spectacularly,” and that these stocks were “getting massacred on the edge of the stock market.”
By May 11, 2021, this was getting so obvious that I wrote an article, with the title, “The Most Hyped Corners of the Stock Market Come Unglued.”
And this occurred while all the major indices were still lumbering from new high to new high, driven by the biggest stocks, and while the Federal Reserve was still printing money hand over fist, and while inflation had started to surge.
But this crash under the surface was an indication that something had broken, that the magic had died, that hype and hoopla were suddenly unable to carry the day, that enough investors were bailing out and were dumping this stuff into the laps of the hype-and-hoopla dip buyers; many then got their faces ripped off. And it was a sign that the Big S was starting to hit the fan.
So what happened around February 2021 that caused investors to dump those stocks and abandon them?
Inflation was suddenly surging, while the Federal Reserve was still printing money hand-over-fist and was still repressing interest rates, and while the third round of stimulus checks were getting set up to be sent out in March. And all these inflation issues were vigorously brushed off by the Federal Reserve, by the media, by economists, and most vigorously by hype-and-hoopla Wall Street.
In February 2021, CPI inflation jumped by 0.44% from January. That’s an annual rate of 5.5%. And it came after some big increases in the prior months. In March 2021, CPI inflation spiked by 0.64% from February, which is an annual rate of close to 8%. These were suddenly huge month-to-month inflation numbers, and the Federal Reserve was brushing them off as transitory, essentially telling everyone that it was going to let inflation rip because it would go away on its own.
But even before these CPI numbers were released, consumer prices were rising in all kinds of things that had nothing to do with commodities, such as used cars, new cars, and rents, and other services. And everyone knew that once the stimulus money would reach consumers, they’d spend much of it, and would thereby push up prices further. And investors who chose to see it – investors who weren’t participating in the consensual hallucination – could see it.
Enough investors saw it coming: Sooner rather than later, inflation would get so bad that the Federal Reserve would be forced to crack down, and would be forced to raise rates by a lot, and end quantitative easing, and start quantitative tightening, and everyone knew what that meant: Stocks would spiral down because this entire stock market bubble was a result of money printing and interest rate repression, and to some extent, all that stimulus cash that the government handed out to companies, consumers, and municipal governments. Without all this, stocks would be toast.
Everyone who decided to think about it, knew that stocks would spiral down once the Fed reversed course and started raising rates and unload its assets, and that in fact, markets would spiral down well before the Fed would actually act, because the Fed signals this stuff well in advance, and markets react to those signals. And that’s exactly what happened.
And if you wanted to get out of these hype-and-hoopla stocks, the time was at the ridiculous valuations in February 2021, and not after they’d already started crashing. He who gets out first, gets out best.
At the same time, some big voices out there kept hyping this crap, and kept yelling that “cash was trash,” and that people had to buy stocks to deal with inflation, and they tried to motivate dip buyers, while perhaps the same folks started unloading that hype-and-hoopla crap into the eager hands of the dip buyers, who then got crushed over and over again.
In the spring of 2021, something else was starting to happen: Money market funds that focused on investing in short-term Treasury securities were swelling up with cash. That was a sign that some investors with deep pockets were looking for safety.
These Treasury money market funds have to buy short-term Treasury securities to invest the incoming cash. And the demand for short-term Treasury securities was so huge that the short-term yields were essentially 0% and were threatening to drop into the negative, and briefly did drop into the negative.
But money market funds are fragile, structurally, and if the yield drops below 0%, the fund might, as it’s called, “break the buck,” meaning the value of a share that is pegged at $1 might drop below $1, which could then trigger a run on the fund, where everyone would be trying to yank their money out, which could then cause the fund to collapse and wreak all sorts of havoc across the financial markets.
So by April, these money market funds started to get a helping hand from the Fed, where they lent their cash to the Fed in overnight transactions that matured the next day, at 0% interest, and in exchange, these money market funds took the Fed’s Treasury securities as collateral. The Fed calls these transactions overnight reverse repos, or overnight RRPs. These RRPs are essentially an overnight loan by the counterparties to the Fed.
By early June, the Fed had taken in over half a trillion dollars in RRPs, meaning the Fed had drained over half a trillion dollars in cash from the financial system. These RRPs are the opposite of QE.
QE adds liquidity to the system; RRPs drain liquidity from the system. And the Fed was draining liquidity via RRPs faster than it was adding liquidity via QE.
In mid-June, 2021, the Fed gave some indications that it was taking notice. It said at its meeting, that it had had “discussions about tapering QE, which at the time was still going on full-blast, and it pulled rate hikes closer, and among other things, it raised the interest rate it was paying on RRPs to an annual rate of 0.05%.
That was still near 0%, but it unleashed a flood of cash heading the Fed’s way. And two weeks later, by the end of June, the Fed had $1 trillion in RRPs. In other words, by then it had drained $1 trillion in cash from the financial system.
And the RRP balance kept rising. By the end of December 2021, the Fed had drained $1.9 trillion from the financial system.
This was investor cash that was looking for safety, $1.9 trillion in cash at the end of 2021 that the Fed had absorbed from money market funds. This was like a voluntary form of QT, where the Fed makes this available, and investors jump on it because they’re scared, and the effect is quantitative tightening, and by that time, the beginning of January 2022, stocks began plunging across the board.
As of Friday, the Fed had drained over $2.2 trillion in cash from the system via these RRPs.
What these RRPs show is that, starting in early 2021, enough investors were no longer willing to take risks on hype-and-hoopla stocks. Some had ridden them up, and now it was time to dump them, and then they put some of their cash into Treasury money market funds, even while new investors bought those stocks from them with new cash, including from the stimulus programs, and increasingly from stock-market leverage which began spiking out the wazoo in early 2021, as we can see from the spiking margin debt at the time.
And enough other investors refused to buy these stocks and instead put their cash into Treasury money market funds to ride this out.
These investors knew that inflation, which was beginning to surge in early 2021, would get big and would eventually be met by a response from the Fed that would topple the ridiculously inflated stocks off their sky-high perch one by one, and they knew that they couldn’t wait until the Fed actually acted because it telegraphs its moves well in advance, and markets react to those messages, and by that time it would have been too late to unload the hype-and-hoopla stuff.
And that’s how February 2021 was the beneath-the-surface beginning of what would turn into this brutal bear market.
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