Photographer: Daniel Acker / Bloomberg
Photographer: Daniel Acker / Bloomberg
Everything started innocently enough, way back in 2019, with people on bulletin boards exchanging ideas about a retail chain left for dead.
Now it’s much bigger: for experts prone to the drama, a David vs. Goliath Parable for the Age of Inequality in Wealth. Perhaps a rudimentary legacy of Trumpism and the populist backlash against ‘the elites. “
It’s one for parts of the hedge fund industry existence crisis. For old-school investors who preach discipline and do your homework before clicking ‘buy’, it’s a horror story that they expect to end horribly. It’s at least part of the reason the entire stock market tanked on Wednesday.
The saga GameStop Corp. has become nothing short of a national sensation, reaching the thresholds of both the government of new president Joe Biden and Federal Reserve Chairman Jerome Powell. They all got tough questions about their vision of a company selling five used video games for $ 10.
“It shakes everyone up because everyone is being used,” said Matt Maley, chief market strategist at Miller Tabak + Co.
On the face of it, it’s hard to explain how a company whose sales are expected to shrink in four out of the past five years – and is likely about to announce a third year of losses in a row – its stock price by nearly 1,800% so far in January and 8,000% over the past 12 months.
Look closer, and it makes more sense. “Buy what you know” is Warren Buffett’s mantra. So it’s easy to see why a bunch of millennial traders – trapped at home in the midst of the pandemic, with savings bloated by a lack of opportunities to spend throwaway money elsewhere or government incentives – would know a thing or two. about gaming.
Especially when they approach the market like a video game and their strategies include something akin to what gamers would call a ‘cheat code’ – in this case, they bundle and pile into individual stocks and related options like a tight-knit team attacks a room full of dragons in “World of Warcraft.” All with the aim of forcing short sellers and derivatives traders to buy the stock, making the price higher than what a traditional investor would find reasonable.
For the nearly 3 million group of self-described “degenerates” on Reddit’s WallStreetBets forum and other social media sites where this new army of day traders converge and conspire, the game has quickly spread to a host of stocks they plan are to make “the next GameStop. “
There’s Naked Brand Group Ltd., a clothing manufacturer whose inventory is up 618% this month. And AMC Entertainment Holdings Inc., the movie theater company with a profit of more than 800%. Macerich Co., a real estate investment fund, has more than doubled this month. This list goes on and on.
And yet the benchmark stock indexes plummeted on Wednesday. The S&P 500 was down nearly 3%, its worst drop since October. How can that be? One theory is that the hedge funds are forced to ditch the companies they really like to raise money to buy the stocks they hate. Why? So they can end short bets before the losses get too big as the rally goes against them.
Gross leverage, or a measure of hedge fund risk appetite that takes long and short positions into account, is declining. The money poured out of their pool of both bullish and bearish bets over the four sessions through Tuesday at the fastest pace since October 2014, according to data collected by Goldman Sachs Group Inc.’s prime brokerage unit.
While there have been plenty of examples of notorious short-term bottlenecks in the past, including the volatility implosion in early 2018, there are signs that the current one could have a continued impact on market dynamics, wrote Michael Purves, founder and CEO of Tallbacken Capital. Advisors. Screening for smaller companies with high short interest rates, he found that there are hundreds of potential targets for retail investors to choose from and there is some evidence that “the squeeze contagion” is increasing day by day.
That means it could continue to push long-short hedge funds to phase out their short sales and, by extension, phase out their long books, even if they are not involved with some of the recently targeted names.
“Both processes to reduce leverage – the long and the short – would have a significant impact on market action in the coming weeks and could lead to significant market volatility,” Purves wrote.
The story changes so quickly that it is useless to collect all the parts, but for starters: there is the impact of the pressure on short sellers and their solvency; the search for the next bull-raid target; the challenge of calculating GameStop’s actual fair value; what it really means for wealth inequality, given the super rich harvest windfalls; the impact on internet-based brokers and the role their elimination of commissions has played in this; and even what Biden, Powell, securities regulators and Treasury Secretary Janet Yellen think and do about it.
Of course, no short squeeze can last forever. The market will eventually return to some appearance of “normal”.
“Despite being the marginal buyer right now, retail day traders don’t have enough collective assets to constantly move global markets,” said Max Gokhman, Pacific Life Fund. Advisorsmain asset allocation. “Small individual stocks? Absolutely. But will that change the entire investment landscape? Unlikely.”