After four months of unprecedented liquidity entering micro cap stocks (or penny stocks, those under 5$) between November and March, Penny stocks tanked in March, 2021 and have further eroded so far in April 2021. Penny stocks, including OTC names, declined in the area of 20-30% as a group, and for some names far more.
So why did this occur? It’s really simple actually:
- Mean reversion (speculative penny stocks were severely overbought)
- Pivot to value, cyclicals, financials and energy provided new opportunities for retail investors
- Retail investors pulled from the market as trading slowed due to the end of the pandemic (vaccine rollout)
- Crypto, the rise of Bitcoin fueled a pivot of younger investors from penny stocks (OTC) to crypto plays (e.g. Dogecoin is up 40%)
- GameStop’s volatility increased meme speculation and that tanked OTC daily and weekly trades.
- The pivot to ‘value’ and economic recovery sectors meant a decline of market volatility (the stock market reached all-time highs)
- In essence, too much of a good thing couldn’t keep going. Then in late March SPACs dried up and tanked. Many retail investors playing OTCs had gone into SPACs in early 2020, and so got burnt.
- The peak of liquidity coming into stocks was in February 2021. For OTC and penny stocks it dropped off a cliff and entered a kind of ‘bear market’ where there was a staircase descent for many weeks.
- Penny stocks are notoriously easy to manipulate and in 2021 this took on even more forms with social amplification on Reddit, Twitter, Stocktwits, Facebook Groups and others. Hedge firms hired PR firms to secretly do their bidding to orchestra ‘pump-and-dumps’ while the SEC wasn’t looking.
- Stocktwits at the penny stock peak began to make it easier for users of their app to ban “bears” and “shorts” for no valid reason other than to pump their favored position. This played into the hands of hedge funds manipulating OTCs and names like $MVIS, $GEVO and dozens of others. In essence, a lot of shady things were going on (as happens in market bubbles).
In a nutshell, 2020 attracted a lot of new younger investors and pandemic traders. When that game dried up they either left the market (Robinhood) or pivoted more into crypto, e.g. Robinhood app to Coinbase app.
The market bubble essentially got so frothy, speculators pivoted from penny stocks and small-cap growth stocks into meme stocks, crypto and Bitcoin. Too much of a good thing is not always a good thing.
Much of the cycle’s new investors rode on and were further manipulated by Wall Street hedge funds, who profit on the way up and the way down in extreme times of volatility. OTC stocks are obviously the most volatile. It’s not clear when or if penny stocks will recover in 2021.
In just a few months, at the end of 2022 and start of 2021, we saw an EV bubble, a SPAC bubble, a Green stock bubble, meme stock bubbles and crypto volatility that all impacted the fate of penny stocks and OTC stocks. These waves all attracted new investors to the market, but few of them stayed as traders as the pandemic ended in the U.S. The majority of these Robinhood app users go where it’s hot.
The stock market bubble of 2020 has waves and events that were an accelerated timeline of around 42 months of real time compressed into around 6 months due to huge liquidity pumps and unprecedented equity participation. For penny stocks it was a golden age of the pump and dump and it hit its crescendo in December, January and February.
The best thing for penny stocks and OTC stocks from a macro-economic perspective is if the stock market had another correction, Bitcoin went down and meme stocks came out of favor. They would, in such a scenario, become the hottest play again.
The re-opening of the U.S. also created a scenario where NASDAQ outperformed small-cap (Russell 2000) stocks, as BigTech is seen as the safe haven for value growth. The best BigTech stocks from a value perspective are those companies that are most diversified like Microsoft, Apple and Alibaba and growth BigTech like Nvidia, ByteDance and Amazon.
As for Penny Stocks, there’s likely more pain ahead until mean reversion has been completed. For the vast majority of penny stocks, they are only half way down to their baseline levels. This suggests that without a major catalyst penny stocks should keep going down in the second half of April, May and possibly June as well.
Penny stocks are so cheap they mean more multiples of ROI when the times are good. If you do the math, penny stocks in the range of $0.01 to $0.20 are the most profitable since 1,000%+ gains aren’t super rare. In January and February, they were practically common. Some of the worst pump-and-dumps had in the area of 6,000% gains on ROI.
And in case you are skeptical of Penny Stocks, how do you suppose the best penny stocks performed in times of volatility and win-win liquidity? A basket of the top 10 OTC stocks has returned 24,100% in the past six months, far more than the modest 37% gains for the best S&P 500 performers.
The first week of February, for instance, saw more OTC trading than during the first six months of 2020 combined. It was a frenzy, and mean reversion simply means it’s auto correcting itself.
Meanwhile as the Dow Jones and S&P reach near all-time highs, many investors feel the market is over-optimistic. As Covid-19 hasn’t miraculously disappeared simply due to vaccines, another correction becomes more likely as the stimulus bump eventually begins to wear off.