Techtonic shifts

Beware the power of retail investors

Armed with derivatives, they are raising the volatility of tech stocks



The end of the summer often brings about a dose of realism. Children bemoan the end of their leisurely holidays and trudge back to the classroom. Summer-lovers return from the beach. This time of the year often brings stockmarket investors back to Earth, too. On average, since the 1950s, September has been the worst month for American shares.

Could it be happening again? The end of summer has brought a burst of volatility to the share prices of America’s tech giants, especially the five “mega-cap” firms—Alphabet, Amazon, Apple, Facebook and Microsoft—that had driven the Nasdaq, an index of tech stocks, and the s&p 500, a broader index, to record highs in late August (see chart).

After a blistering three-day sell-off, on September 9th stockmarkets rebounded, suggesting investors are still seeing buying opportunities when markets dip. But the dramatic swings have highlighted a shift in market dynamics that may continue to foster instability. It is driven by a rare combination of retail investors and high-octane derivatives trading.

Derivatives have been called weapons of mass destruction. In this case the masses have weaponised themselves with call options, a type of derivative that gives the buyer the right, but not the obligation, to buy a stock at a given “strike” price on a specific date in the future.

Options can have an outsized impact on prices because they leverage investments—a buyer might spend just $1,000 to purchase an option that could give him a position worth $10,000 or $20,000. If a stock price rises above the strike price before the option’s expiry, the holder can buy the share at the lower price and pocket the difference.

Otherwise, the option expires worthless. The total nominal value of calls traded on individual American stocks hit a record high in the last two weeks of August, averaging $335bn a day, according to Goldman Sachs—the first time the average daily volume of traded stock options has exceeded trading volume for the shares themselves. The volume of calls was more than triple the rolling average between 2017 and 2019.



Two types of option activity stand out. The first is institutional trading, in particular the huge option positions purchased by SoftBank, the Japanese conglomerate run by Son Masayoshi. On September 4th the Financial Times reported that SoftBank had purchased $4bn-worth of call options on American tech companies. The notional value was about $30bn.

The second is the rapid growth in purchases of call options by small traders (see chart), dubbed the “Robinhood effect” after the popular platform on which many retail investors punt. Historically, large orders of options—in bundles of more than ten contracts, or around $10,000-worth—were the dominant source of options-buying.

But through 2020 small buyers, who acquire fewer than ten contracts at a time, have taken a bigger share of the market. This trend has been especially pronounced over the past four weeks. Small buyers have spent more than $37bn on call options, giving them a notional exposure probably in the region of $500bn or more. Even with the five “mega-cap” tech stocks worth a combined $6trn, that gives them a lot of clout.




Who bears most responsibility for the volatility? First, small-trader flow is much larger in size, although it was likely dispersed among more listed companies. Second, and more importantly, although both types of buyer purchased options, the trades differ greatly.

The options bought by SoftBank are reported to be long-term (three- or six-month) bets on the biggest tech firms, like Amazon and Microsoft. They were also “delta-hedged”, as is typical for institutional investors, meaning that at the same time as SoftBank bought the options, its bankers also sold the underlying stocks in proportion to the exposure the option gave them.

This is important, because it means that the marketmakers who sold SoftBank the options did not immediately have to hedge their position by buying up shares in, say, Microsoft or Amazon.

This is different to the type of option that retail investors typically buy, which is a call option purchased “naked”, ie without a hedge. Significant volumes of unhedged call options will force the marketmakers to buy up shares in the underlying stocks, creating a positive—and potentially euphoric—feedback loop.

Adding to this dynamic is the short-dated nature of the derivatives. The value of an option that is short-lived moves rapidly as the share price moves. As expiry approaches, any increase in the price of the stock makes the option more valuable.

Moreover, it means that the marketmakers who sold the option will quickly need to bolster the size of their hedges, increasing the upward momentum. These differences make it more likely that retail flows were a bigger driver of momentum in tech stocks in August than SoftBank was.

This heavy use of derivatives may also explain some unusual market dynamics. Because shares tend to inch higher steadily, but drop more rapidly, rising markets usually occur amid falling volatility. However, the leaps in share prices in recent weeks have caused the correlation between falling volatility and rising prices to break down for the first time since 2018.

What does this imply about the future performance of tech stocks? Because of the influential role of turbocharged retail investment, prices can be expected to remain choppy. Moreover, the market is entering a period where typical covid-19-related volatility may be exacerbated by the twists and turns of America’s presidential election.

That said, much of the tech recovery from the lows in March was rooted in fundamental shifts, like policy interventions, or pandemic-prompted changes to consumer behaviour, such as online shopping, that have helped firms like Amazon.

Even if the giddy obsession with tech firms exhibited during the summer fades, there may be little reason for investors to throw in the beach towel yet.

The V-Shaped Recovery Marches On

Despite all of the doom and gloom of the past six months, much of the global economy continues to show signs of a sharp recovery from the pandemic-induced collapse this spring. And while nothing is guaranteed, a number of favorable structural factors make a further acceleration highly likely.

Jim O'Neill

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LONDON – Large swaths of the global economy are exhibiting traditional signs of a V-shaped recovery from the pandemic-induced collapse this spring. The monthly indicators for many countries show vigorous rebounds in June and July, with 10-15% projected growth in real (inflation-adjusted) GDP in the third quarter, all else being equal.

To be sure, there are reasons to question whether the perceived upturn is merely a technical bounce-back – an illusion caused by the sheer depth of the initial collapse. This could well be the case, especially if many countries suffer a strong second wave of COVID-19 infections, or if high hopes for an early vaccine turn out to be misplaced.

No one can know for sure. We will have to wait and see the evidence as countries try to strike a balance between managing the virus and getting their economies back to normal.

Though the United States has struggled more than other countries with the virus, its rate of new infections nonetheless has fallen, making it more likely that its summer economic rebound will accelerate. And in China, the latest indicators point to a high level of infection control and an accelerating recovery.

Given the dominant roles of the US and China in the global economy, such positive developments augur a major recovery for world trade, notwithstanding the two countries’ ongoing conflict over trade and technology.

As for Europe, many countries are showing signs of a second COVID-19 wave, with increased incidence posing a particular threat to Spain’s recovery. But this is not the case everywhere.

Other countries have stepped up their control measures, and if these prove sufficient, they can keep their recoveries on track.

That is what we know now as of mid-September. To be any more confident about the prospects for a sustained economic recovery in late 2020 and into 2021, we will need more evidence of progress toward improved treatments and safe, effective vaccines.

Whenever a vaccine is made widely available, a further acceleration in economic activity can be expected. Those sectors that have suffered the most from social-distancing protocols – including international travel, entertainment, and hospitality – will start to come back to life.

In fact, unless all of the promising vaccine candidates that have already reached Stage Three trials fail, we can anticipate a recovery in these hard-hit sectors sometime in the coming months, at which point hope for a cyclical recovery will become even more justified.

But there are a number of structural issues to consider. For starters, the most pressing question of this fall is whether the G20, currently chaired by Saudi Arabia, can resurrect itself and deliver genuine international cooperation, as it did after the 2008 global financial crisis.

According to the World Health Organization and other international health bodies, roughly $35 billion is needed to ensure that vaccines can be equitably distributed to the world’s 7.8 billion people.

This is a trivial sum compared to what many G20 countries have already spent to support their domestic economies. Yet funding the universal distribution of a vaccine is absolutely crucial for ensuring a global recovery, rather than one that is limited just to those countries where a vaccine is available.

Equally pertinent, though less discussed, is the balance of forces between domestic and external growth. Owing to the anxiety created by the pandemic, many governments, notably in the European Union, have demonstrated unprecedented levels of enthusiasm for fiscal stimulus, and these spending programs have been further supported by extraordinarily generous monetary policy.

Expansionary macroeconomic policies suggest that, barring a sudden and significant fiscal retrenchment, domestic demand will drive this recovery more strongly than it did in the aftermath of the 2008 crisis. This would likely translate into a recovery in world trade above what many commentators currently consider posible.

But that brings us to a third structural issue. When will all the current spending be paid for, and by whom? There already seems to be a reasonably strong consensus across advanced economies that early fiscal tightening should be avoided. I, for one, would welcome a tightening after the crisis has passed.

But, of course, much will depend not just on the scale and speed of the recovery but also on the size of fiscal deficits. Here, it is interesting to note that expectations for additional fiscal stimulus in the US have recently been downgraded as a result of better-than-expected employment data.

As for monetary policy, the US Federal Reserve’s announcement in late August that it will shift to an “average inflation targeting” regime has been greeted as an additional form of support.

But a caveat is in order. Whether the policy change sticks will depend on how inflationary
pressures are actually developing. If financial markets were suddenly to become concerned about an unexpected increase in inflation, policymakers might have to shift their approach once again.

A remaining open question, one that I have raised in previous commentaries this year, is how policymakers will respond to the changes wrought by the COVID-19 crisis. Will they nurture a new business culture geared toward “profit with a purpose,” encouraging (or cajoling) more corporations to pursue decarbonization and solutions to societal challenges like antimicrobial resistance (AMR) and the threat of future pandemics? That would certainly be a welcome development, and it is hardly a step too far for our governments.


Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK Treasury Minister, is Chair of Chatham House.

How Credit Ratings Are Shaping Governments’ Responses to Covid-19

To fund pandemic-related spending, governments around the world will need to take on more debt. If they can.

BY Efraim Benmelech


In 1995, after Moody’s downgraded the credit ratings of both Canada and Mexico, The New York Times columnist Thomas Friedman memorably quipped, “you could almost say that we live again in a two-superpower world. There is the U.S. and there is Moody’s.

The U.S. can destroy a country by leveling it with bombs; Moody’s can destroy a country by downgrading its bonds.”

Twenty-five years later, the quip would look a little different, with China joining the ranks of superpower. But as the world attempts to respond to a deadly—and costly—pandemic, it is clear that the power that ratings agencies such as Moody’s and S&P hold over cash-strapped governments hasn’t gone anywhere. In fact, in a new study with a colleague, I find that ratings have never been more important.

To understand why, consider that credit ratings are not determined arbitrarily by the credit-rating agencies. Rather, they are driven by a country’s economic prosperity, the quality and stability of its political institutions, and its public debt. And over the last few decades, that public debt has exploded.

Among advanced economies, debt to GDP has increased from about 50 percent in 2000 to more than 70 percent in 2019, with countries such as Japan (at 235 percent), Greece (179 percent), Italy (131 percent), and Portugal (123 percent) “leading the pack” in terms of government indebtedness.

Take, for example, France, which in 2000 had a debt-to-GDP ratio of 58.9 percent and now hovers around 100 percent, or the UK, which grew from 36.8 percent in 2000 to 85.9 percent in 2018. And let’s not forget about the U.S., which grew from 55.6 percent in 2000 to 106.9 percent in 2019.

Governments and central banks have responded to the COVID-19 pandemic and the resulting economic devastation using both fiscal and monetary tools on a scale that the world has not witnessed before.

For example, the U.S. fiscal policy response under the CARES Act is currently estimated at $2.3 trillion (about 11 percent of GDP). In Germany and Japan, the fiscal response has been even larger as a percentage of GDP, amounting to 32.9 percent and 22.0 percent of GDP respectively.

To pay for many of these programs, governments around the world will need to take on more debt—and their ability to do so will depend on their access to financial markets.

In a recent study with Nitzan Ben-Tzur of the Kellogg School of Management, I look into the factors shaping the fiscal and monetary policies that have been adopted by various nations. Our study finds that across the world, fiscal spending in response to the COVID-19 crisis is considerable: on average, fiscal spending (including loans guaranteed by the government) is 7.7 percent of GDP. For high-income countries—those with GDP per capita above the world’s median—spending is even higher.



And which factor can be most directly tied to spending?

To find out, we ran a statistical “horse race” between a number of macroeconomic variables such as GDP per capita, population size, debt to GDP, government expenditures to GDP, the number of COVID-19 cases, and the central government credit rating. Of all of the macro variables we considered, we found that one variable showed up consistently as the strongest determinant of fiscal policy—a stronger factor than GDP per capita or even the spread of the virus. And that factor was a country’s pre-crisis sovereign credit rating.

These findings demonstrate that a nation’s ability to deploy fiscal policies is limited by its access to credit markets.

Governments’ credit ratings have been hit hard in this crisis. According to Marc Jones of the World Economic Forum, S&P has already made 19 sovereign downgrades, while Moody’s estimates that the virus will push up debt in the world’s richest nations by close to 20 percentage points.

But once this crisis is over, countries around the world should work hard to improve their creditworthiness. Because, as it turns out, countries with lower credit ratings are not able to use fiscal-policy tools effectively during economic crises. And, after all, you never know when the next crisis will hit.

A Weak Dollar Can Be Investors’ Friend

There are attractive entry points now in stocks that stand to benefit from the trend

By Aaron Back


A weak dollar favors Coca-Cola, which derived 68% of revenue outside North America in its last fiscal year. / PHOTO: ARND WIEGMANN/REUTERS


The era of the strong dollar is likely over. For U.S.-based investors, that needn’t be a bad thing.

There are attractive entry points now in stocks that could benefit from the trend.

The U.S. dollar has been heading lower over the past several months as it has become clear that the coronavirus crisis is hitting the U.S. harder than many other advanced economies, and as the crisis has been met with unprecedented fiscal and monetary loosening. The WSJ Dollar Index is down around 9% since late March, and 6% lower since mid-May.



There are many reasons to expect further weakness. Chief among them is the Federal Reserve’s new policy framework unveiled last month. The Fed has pledged to let inflation run above its 2% target for an extended period to make up for past periods of weak inflation and not to respond to falling unemployment with pre-emptive rate increases.

This is a clear recipe for a weaker dollar over the long term. As TS Lombard macro strategist Oliver Brennan put it in a recent note, this framework would break the traditional relationship between America’s growth and foreign exchange: Investors will no longer respond to better U.S. economic news by bidding up the dollar in anticipation of Fed tightening.

But don’t despair. According to strategists at Goldman Sachs, periods of dollar weakness tend to see better equity performance. They calculate that since 1980, the S&P 500 has on average risen by 2.6% during months when the U.S. dollar has depreciated in trade-weighted terms by at least 1.25%, compared with gains of just 0.7% in months when the dollar has risen by that much.

A weak dollar mostly benefits companies with revenue overseas because it raises the value of those sales in dollar terms. U.S.-based companies that compete abroad with global rivals also can gain a competitive advantage because their relative cost base is lower.

Goldman calculates that, in months of sharp U.S. dollar weakness, sectors with high global exposure such as technology and energy have outperformed, rising on average by 3.3% and 2.6%, respectively. More domestically focused sectors such as consumer discretionary have done less well, rising 0.8% on average.

Individual stocks can vary widely within sectors. Since 1980, during months in which the dollar was weak, Goldman’s sector-neutral basket of stocks with high international sales has outperformed a basket with high domestic sales by 1.4 percentage points.

Within consumer staples, for instance, this means a weak dollar favors Coca-Cola, KO +0.32% which derived 68% of revenue outside North America in its last fiscal year, over PepsiCo, PEP -0.34% at 39%.

In sweets and snacking, Oreo maker Mondelez MDLZ -0.18% earned 73% of revenue outside North America, compared with 11% at the rather provincial Hershey. HSY 0.08% The global colossus of the sector is Colgate Palmolive, with 78% of sales outside North America, while Clorox CLX -0.07% is more domestic, with 84% of sales within the U.S.

Intriguingly, some of these more globally exposed stocks have underperformed recently, largely because they have benefited less from the U.S.’s great pantry-stocking wave of 2020. Coca-Cola is down around 9% so far this year, while Mondelez has performed similarly to the S&P 500, gaining around 4%. Colgate Palmolive is up around 11%, but that is far less than Clorox’s 40% surge.

There is no need for investors to rush into crowded trades such as gold or exotic dollar hedges like bitcoin. Opportunities abound to pick up quality U.S. companies that will benefit handsomely from a weakening dollar.

The red front-line

China’s Communist Party is splurging on new local drop-in centres

Filling them can be a challenge



In shenzhen’s glistening tech district, opposite the headquarters of Tencent, a giant digital conglomerate, the Communist Party vies for attention. “Follow the party, start your business” is etched into a futuristic-looking cube at the entrance to a two-storey building, its walls sprayed with paintings of giant robots.

In the lobby stands a life-size statue of Mao Zedong, flanked by other Communist leaders. But most visitors bypass the exhibit on the party’s history and head directly upstairs.

Xi Jinping Thought is not as appealing as the free classes on offer: calligraphy, kick-boxing, Pilates and Zumba. There are lectures on career-building and buying property in Shenzhen, a city bordering on Hong Kong that is one of the world’s most expensive property markets. At lunchtime, workers can enjoy free massages.

“Most people find study sessions about the history of the Communist Party too dry,” says one of the centre’s staff. “They prefer attending yoga or lectures about blockchain. We even held a speed-dating event recently where we matched 15 couples.”

The building is known as a “party-masses service centre”. In recent years they have proliferated in cities, towns and villages across the country. It has been the biggest effort by the party to develop its physical infrastructure at the grassroots in decades. They are partly intended to be “one-stop shops” at which locals can get access to a wide variety of bureaucratic services that hitherto may have required visits to distant government offices.

In Shenzhen, where they are called “community service centres” in English (perhaps to obscure their Communist links to politically sensitive foreigners), there are more than 1,000 of them. One is at the city’s airport. It offers karaoke, a flight simulator and a library of more than 3,500 books.

Providing entertainment and helping with government paperwork, however, are secondary functions of these centres. Their main purpose is to give ordinary party members space to meet and discuss such matters as Xi Jinping Thought and the party’s latest directives.

The dismantling of many state-owned firms in the 1980s and 1990s stripped the party of much of its grassroots presence. In recent years it has been scrambling to rebuild this by setting up party organisations within private businesses and ngos. But these often consist of just a few people who lack regular contact with higher-level party committees.

The service centres help to bring disparate party bodies under one roof and make it easier to mobilise them when needed, such as to help the public during covid-related lockdowns. The one in the airport describes itself as a “red home” for nearly 10,000 party members working in more than 30 airport-related businesses. It has a dance hall that doubles as a meeting room.

Building and decking out these facilities has not been cheap. In the past two years a district of Dongguan, a city near Shenzhen, has spent more than 190m yuan (about $28m) on them.

Jiayuguan, a far less affluent city about 3,000km to the north-east on the edge of the Gobi desert, has forked out a similar amount in the past five years. Nor has it been optional. Progress made in building them is used to evaluate officials’ performance.

Cities have specified minimum areas for their floor space. In Shenzhen it is 650 square metres for neighbourhood ones, or more than half the size of an Olympic swimming pool. But some officials like to go larger. Shenzhen boasts the biggest neighbourhood-level party-masses centre in Guangdong province, at 8,000 square metres.

Officials have good reason to show enthusiasm. Rebuilding the party at the grassroots has been a priority for Mr Xi since he took over as China’s leader in 2012. On trips outside the capital he has paid several visits to party-masses centres.

During one such in July, in the north-eastern city of Changchun, he paraphrased Mao, saying that effective work at the grassroots was essential for ensuring that the party can “sit tight on the fishing terrace despite the rising wind and waves”—in other words, maintain its grip on power.

In cosmopolitan cities such as Shenzhen, it involves appealing to a young tech-savvy elite that has little time for earnest study of party ideology. Hence the effort to entice people with services such as free advice on starting up a business.

Ryan Manuel of Official China, a research firm, compares the new centres to churches in Western cities that provide busy professionals with a sense of community by arranging sports activities and night classes. In both cases the main aim remains to inspire a belief—in God at the churches, or in the party at the centres.


Even by the party’s admission, the new centres—despite being hailed as the “red front-line”—do not always perform as hoped. An article published in 2018 by the website of the People’s Daily, the party’s main mouthpiece, said many centres were “empty shells”.

In some places, “the hardware is classy but the service doesn’t match and footfall is low,” lamented a county official near Kunming in another online article. In places where the buildings were empty, she wrote, citizens were also devoid of “satisfaction and happiness”.

But the party does not have to worry about attracting recruits, whose swearing-in ceremonies are often held in the new centres. In 2018 only about 10% of applicants were accepted to join the party, which has over 90m members.

“Despite the party trying to be more inclusive and reach out to more people, the party itself remains highly selective in recruitment of members,” says Feng Chucheng of Plenum, a research firm. The party wants the bright tech workers of Shenzhen, but only those who will comply with its orders without question. Karaoke skills confer no advantage.