US Stock Futures Open Lower; Investors Eyeing Short-Squeeze Volatility Impact on Broad Market

U.S. stock index futures opened lower Sunday evening as investors continued to express concerns over the surge in speculative trading by retail traders and the possibility of a market bubble. Investors are also worried that the fresh volatility may encourage hedge funds to reduce risk by trimming long positions.

Early in the trading session, Dow futures are off by about 200 points, S&P 500 Index futures are down about 1% and NASDAQ Composite futures fell about 1.2%.

Last Week’s Performance

The early weakness is likely follow-through selling tied to Friday’s weak performance that saw the Dow record a 620 point drop, closing below 30,000 for the first time since December. The S&P 500 fell 1.9% and the NASDAQ Composite declined 2%.

For the week, all three major averages slipped more than 3% for their worst weekly performance since October. The blue chip Dow and benchmark S&P 500 also posted losses for January – the first negative month in four – although the NASDAQ did manage to post a gain for the month.

Health of the Market Will Be This Week’s Main Concern

Friday’s sell-off came amid a frenzy of activity by retail investors in heavily-shorted stocks including GameStop and AMC Entertainment, which fueled concerns about the overall health of the market. The excessive volatility in these two stocks raised concerns over new government regulations, which spread to the broader-based markets.

Goldman Sachs noted that the current short squeeze is the worst in 25 years, while Barclay’s analysts don’t see raised concerns of a broader contagion.

The most heavily-shorted stocks have rallied 98% over the last three months, making it the most extreme short squeeze of the last 25 years, according to Goldman Sachs.

In a note to clients David Kostin, Goldman Sachs’ chief U.S. equity strategist, said the recent trading activity that’s sent names like GameStop and AMC Entertainment soaring outstrips prior major short squeezes in 2000 and 2009.

And with retail investors entering the market in record numbers, the firm sees the trading boom continuing.

The wild trading in shares in GameStop – and the stock’s large swings in either direction – captivated the street last week, but Barclays said the short squeeze won’t have larger ramifications for the market.

“The ongoing short squeeze in a few stocks by retail investors has raised concerns of a broader contagion,” the firm said Friday in a note to clients. “While we believe there is more pain to come we remain optimistic that it is likely to remain localized.”

The fear is that the stresses caused by the short squeeze could ricochet to the broader market as shorts are forced to sell. A firm could be forced to sell other positions in order to cover losses from a short, for instance.