- Stock prices have become merely numbers for many new traders who ignore the fundamentals embedded in company valuations, according to Peter Tchir, the head of macro strategy at Academy Securities.
- He says this disregard for fundamentals is being driven by greed and was evident before the 2000 and 2008 market crashes.
- Tchir pinpoints the high options-trading volumes among retail traders as the epicenter of this behavior today.
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Of all the reasons why non-professional traders invest, the most troubling one to Peter Tchir is the purchase of stocks solely because of their low dollar prices.
A recent example was the rush to buy shares of companies that the coronavirus crisis pushed into bankruptcy. Stocks like Hertz were super-popular largely because they were trading for a dollar and some change apiece.
Tchir, the head of macro strategy at Academy Securities, says price has become "just a number" to many retail investors. The rigorous yardsticks of what's embedded in the price — things like earnings-growth prospects, competitive advantages, and other value investing tenets — are being thrown out the window.
He says this widespread disregard for fundamentals and focus on price is a relatively rare occurrence — but it is one that usually precedes big market downturns.
"I am not sure when it ends, but from experience, when the 'just' a number trading ends, it ends abruptly and painfully," Tchir said in a recent note. He has a 2,800 target for the S&P 500, which would be about 11% below current levels.
He expanded on the 'just a number' trend by describing it as the product of investor greed and and innovative investment products.
Prior to the dot-com bust, the internet itself was the seemingly irresistible fad, Tchir said. And leading up to the 2008 financial crisis, the innovations were twofold: complex collateralized debt obligations, and so-called Constant Proportion Debt Obligations — instruments that promised the high yields of junk-rated companies with the low risk of quality firms.
In 2020, Tchir pinpoints the options market, where traders earn the right, but not the obligation, to buy or sell stocks at specific prices and within particular timeframes. These derivatives also have the power to amplify gains — and losses — because they bet on the extent of price swings.
Thanks to the free trading revolution, more retail traders than ever have access to these risky investment instruments — and there's ample evidence that they are taking advantage. According to Piper Sandler research, users of the free-trading app Robinhood traded nearly 12.4 million options contracts in the first quarter alone, when the coronavirus crash occurred. Their executions within that timeframe nearly equaled the 13 million stock trades that were made.
The derivatives market has not fallen out of favor since then. Cboe's four options exchanges set single-day volume records during the month of June, according to data released by the firm.
Tchir thinks several of these traders are risking chunks of their portfolios to trade options, and using realized profits to buy even more options. This helps explain the surge in options volume, in his view.
Tchir is watching other signs of an overextended stock market beyond the fervent activity in derivatives. His other concern is that investors are overestimating the amount of extra fiscal stimulus that is politically feasible amid partisan disagreements.
"Be cautious here," Tchir concluded.
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