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Magic number for stimulus - $1 trn: analyst

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As President Joe Biden ponders the Republican proposal for a much smaller COVID-19 relief package, DataTrek Research co-founder Nick Colas tells Reuters' Fred Katayama Wall Street is hoping for at least a trillion dollars.

Video Transcript

FRED KATAYAMA: The major indexes rising more than 1 and 1/2% Tuesday afternoon ahead of the earnings from tech titans Amazon and Alphabet. Well, it's been a volatile year so far, not to mention 2020. Let's find out what all this volatility means for stocks with someone who studied these volatile periods, Nick Colas of DataTrek Research.

Good afternoon, Nick.

NICK COLAS: Good to see you.

FRED KATAYAMA: Good seeing you too, Nick. Yeah, so it's been a wild 2020, and January has been choppy. It's extending into February now with this Reddit-fueled trade, whether it's going up or going down on those squeezes. Based on the past periods that you've studied, how bad is this current period '20 to '21? And how long do these periods last?

NICK COLAS: You know, it's fascinating, because every cycle's a little bit different, but volatility is almost always the same. So if you look back at prior periods, and either whether you look at the VIX or just the number of 1% days the market sees, the patterns are always the same.

It peaks in, say, whatever quarter the peak of the crisis is, we'll call it Q2 of 2020, 38 1% days, for example, or the VIX peaking at 83, it always takes 2 to 2 and 1/2 years to get back to what we would call normal, a VIX of 19 or only having 1 1% day a week instead of-- think of just in the last five days, I think we've had three or four in the last five days. So it's a long grinding process to get volatility back down to levels we would all think of as more normal.

FRED KATAYAMA: That means, if we're talking about, for example, March 2020, we're talking about 2022 when it possibly subsides or, as you say, 2 and 1/2 years extending beyond that. What happens during that 2 and 1/2-year period to the stock market?

NICK COLAS: In general, it rises, because one of the fascinating things about things like the VIX is that it's negatively correlated to stock prices. So when the VIX goes up, stock prices tend to go down. And when the VIX declines, stock prices tend to rise.

And so what happens is markets are just readjusting their expectations of future earnings, future multiples. That takes time. The volatility is a symptom of that debate the market is having about where earnings are really going to settle out. And then finally, when they do, the volatility declines, because earnings power is much better understood than it was a year or two before right after the crisis occurred.

FRED KATAYAMA: Well, Nick, looking at the most recent volatile period, that fueled by those Reddit-fueled stocks, the short squeezes that drove up prices of, for example, GameStop or AMC, or even the silver squeeze that we just saw yesterday, now all those prices are coming down, and coming down sharply. Do you think it's game over for this, you know, amateur day trader social media-fueled phenomenon?

NICK COLAS: I don't think it is over, because I think these traders are learning. And we've seen their learning curve for the past 12 months. They started by just buying stocks in the middle of the downturn. And by the way, were roundly criticized for, oh, they don't know what they're doing buying the airlines, and casinos, and the hotels. Made some good money doing that.

Then they picked up options in the middle of last year. And now they're beginning to understand short squeezes. So you can really see a community of investors learning in real time what tools to use, how to manage risk. And so with that tool set growing, they'll still be here for a while.

FRED KATAYAMA: No longer dumb money, then?

NICK COLAS: No, not dumb money. Look, they were the smartest money on the Street back in March buying when everybody else was selling. They did really well.

FRED KATAYAMA: All right, Nick. And finally, going from Wall Street to Washington, some Senate Republicans presented President Biden with a much smaller fiscal stimulus proposal amounting to around $600 billion versus his $1.9 trillion package. So which, you know, size packs do you think will Wall Street prefer? Will they prefer that he walk over to the-- walk across the aisle and come with a compromised smaller figure? Or is it better if he sticks to the bigger one in terms of investors' eyes?

NICK COLAS: You know, certainly in a perfect world, Wall Street would want to see the bigger package, because it's simply more stimulus for the economy, and it gives you a much higher level of certainty on corporate earnings for Q2 and Q3. However, Wall Street's super pragmatic, and they understand that's not going to happen if Republicans are saying they want a different type or size of package. So I think the Street's absolutely expecting a compromise and will get one.

FRED KATAYAMA: OK. All right, is there any magic number the Street's looking for that's good or bad for stocks?

NICK COLAS: You know, I think just round numbers, a trillion dollars is a good baseline number to think about. Anything more than that's probably mildly positive, less than that's mildly negative.

FRED KATAYAMA: OK, keeping watch on that $1 trillion figure. Thanks a lot, Nick.

NICK COLAS: Thank you.

FRED KATAYAMA: Our thanks to Nick Colas of DataTrek Research in New York City. I'm Fred Katayama in New York. This is Reuters.