Special Market Update - February 2021


The results of the January 5th Georgia Senate run-offs produced the least predicted outcome among political pundits. Nonetheless, "twin wins" gave Democrats operational control of the Senate, which is now split 50-50. However, Democrats claim the functional majority because of the tie-breaking vote of Vice President Kamala Harris. And yet, despite recapturing razor-thin control of the Senate, many political analysts feel it will not be easy for President Biden to get his agenda through the legislative chamber unfettered.

Republicans will be able to stop many bills with a filibuster (requiring 60 votes for passage), which will likely remain a key parliamentary tool in the new Congress. As it's almost certain that Republicans will stand united against tax increases, Democrats could counter with "reconciliation", which enables legislation to pass via simple majority vote, to achieve tax and budget policy related to personal and capital gains tax rate increases. "However, getting 50 votes is not a foregone conclusion," said Brian Gardner, Chief Washington policy strategist at Stifel Financial and author of an analysis of the impact of the Georgia elections. (1)

What Could the Blue Wave Mean?

A first-term, Democratic President being supported by a unified Democratic Congress is not unusual. In fact the last eight Democratic Presidents served their first two years in office accompanied by a Democratic-controlled House and Senate.

Blue Wave

Surprising to many, the stock market posted above-average performances during the first year of Democratic "trifectas", rising in six of eight times (75%), and gaining an average 11.3% in price. Only Presidents Wilson and Carter saw red ink in their first year in office.

What's more, the S&P 500 recorded above-average returns during all Democratic trifecta years since WWII, gaining an average 9.8%, versus 9.0% for all years, and rising in price 77% of the time, vs 71% for all years.

Finally, GDP increased an average 4.3% during all Democratic trifecta years since 1948 versus an average 3.2% for all years. Therefore, should history repeat (although there's no guarantee it will), investors may be unduly concerned about the effect of a Democratic majority on the equity markets and the economy. (2)

President Biden, who spent decades in the Senate before being elected vice president in 2008, seems confident in his ability to strike deals with Republicans. He has stated repeatedly that he is determined to try to work with both parties to get big things done for our nation.

Short Squeeze - GameStop, AMC and Reddit

Market news at the end of the month clearly centered around GameStop, whose shares soared upwards of 1,700% as millions of small investors, egged on by social media, employed a classic Wall Street tactic to put "the squeeze" on Wall Street short sellers.

GameStop, AMC and Reddit

Short-selling works this way: Investors, who expect a stock price to fall, borrow shares of that company from another investor for a fee and sell it immediately, hoping that when the price does fall, they can buy the shares back cheaply, return them to the original owner and pocket the difference. It's a high risk-reward trade. If the stock falls, the short seller makes a handsome profit on the margin. However, if the stock rises, the short seller is exposed to losses that are theoretically infinite. After all, share prices can keep rising - and historically do just that over the long-term - while they can only fall as far as zero. For that reason, when a bet goes wrong, short sellers rush to repurchase the shares they borrowed so that they can return them and exit their trades before losing too much — a process known as covering. This situation is commonly known as a "short squeeze".

January concluded with millions of amateur traders — many of them followers of a popular Reddit page called WallStreetBets — collectively taking on some of Wall Street's most sophisticated investors and winning in the short term, at least for the moment. Propelled by a mix of greed and boredom, thrilled by an opportunity to "teach Wall Street a lesson" about the risks of short selling, and turbocharged by social media hype, these amateur traders have piled into trades around several companies with high short sale ratios (GameStop and AMC being the most well-known), pushing their stock prices to stratospheric levels (GameStop's market valuation went from $2 billion to $24 billion in a matter of days) and putting the squeeze on at least two hedge funds that had bet these companies' shares would fall.

No one knows for sure how this will end. Some analysts say the intense activity could eventually prompt a wider sell-off in the market by forcing hedge funds on the losing side of these short sell trades to sell a significant portion of their portfolios to raise cash to cover their short sell losses. We feel this is more noise in an ever noisier, news-driven environment. In the long-term, stock prices are driven by business fundamentals. While that doesn't mean there won't be bumpy spots in the road along the way, this too shall pass. The true, underlying qualities of companies (or lack thereof) will be made manifest and investors will get back to what matters.


(1) Mark Schoeff Jr., InvestmentNews.com

(2) Sam Stovall, cfraresearch.com


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