U.S. equity market faces the risk of correction and greater volatility in the near term as overall stock prices stay close to record highs and speculation activities raise concerns, experts warned.
“We said the market was going to go down and we said it would have a correction in the first quarter. The way to preserve your money would be to be in purely defensive stocks,” said Barry Bannister, head of institutional equity strategy with U.S. brokerage and investment banking firm Stifel.
Speaking at a media briefing on Wednesday, Bannister said it’s very easy for markets to have 5 percent or 10 percent of correction.
Major U.S. stock indexes like the Dow, S&P 500 and Nasdaq all posted more than 3 percent of declines in the last week due to material losses on Wednesday and Friday.
Maintaining the target of the S&P 500 index at 3,800 points, Bannister warned that “this is a very very important time to be cautious.” Bannister said the S&P 500 index has reached a plateau or a possible multi-year top and the only way up is a bubble.
The moves in the share prices of GameStop, AMC Entertainment Holdings, and other heavily shorted stocks are a sign of excessive speculation, which has been facilitated by distorted financial conditions, said Salvatore Ruscitti, U.S. equities strategist with MRB Partners, on Friday.
“Typically, whenever you see extreme volatility in highly speculative stocks it raises the risk of a correction in the broader equity market,” Ruscitti told Xinhua.
Ruscitti noted that if hedge funds feel that their short books are threatened, they will likely raise capital or de-risk their portfolios, which could have spillover consequences for the broader equity market.
The short squeeze of GameStop, AMC Entertainment Holdings and a number of other once penny stocks involving a big number of retail investors and a few hedge funds has resulted in big swings in prices in the last week.
In particular, the stock prices of GameStop surged nearly 400 percent in the last week and grew over 16 times in last month. If the retail investor frenzy in trading speculative stocks continues, it is likely to make the overall market more volatile, warned Ruscitti.
“The problem with an elevated market is it’s like standing on top of a ladder. All that has to happen is for the wind to blow, and you’ll break your leg. And that’s where we are today,” said Bannister.
However, market participants’ attention will likely shift back to earnings, stimulus and rollout of COVID-19 vaccines and the medium-path for the market remains higher, said a research note by UBS AG on Friday.
Larger-than-expected increase in volatility creates opportunities for investors who can use options to gain market exposure and sharp pullbacks in equity markets also create buy-on-dip opportunities, said UBS.
The CBOE VIX Index, a popular measure of market’s expectation of volatility with the S&P 500 index in the next 30 days, shot up to over 37 points on Wednesday and Friday to the highest level since early November in 2020.
Statistics show that the S&P 500 index gained over 13 percent in the last three months with its record high of 3,870.9 points recorded on Tuesday.