Photographer: Daniel Acker / Bloomberg
Photographer: Daniel Acker / Bloomberg
All it started innocently in 2019, with people on message boards exchanging ideas about a chain of shopping stores that they left to die.
Now it’s much bigger: for experts inclined to the dramatic, a David vs. Goliath parable for the era of wealth inequality. Perhaps a vestige of the legacy of Trumpism and the populist reaction against “the elites. “
For parts of the hedge fund industry, it is a existential crisis. For old guard investors who preach discipline and do their homework before clicking “buy”, it’s a horror story that they hope will end terribly. It is at least part of the reason why the entire stock market plummeted on Wednesday.
The saga that is GameStop Corp. it has become nothing less than a national sensation, reaching the doors of the administration of new President Joe Biden and Federal Reserve President Jerome Powell. Each found himself on the receiving end of embarrassing questions about his opinion of a business which sells five used video games for $ 10.
“It’s shaking everyone because everyone is leveraged,” said Matt Maley, chief market strategist at Miller Tabak + Co.
At first glance, it is difficult to explain how a company whose sales must have shrunk in four of the past five years – and is probably about to announce a third consecutive year of losses – has seen its stock price rise nearly 1,800% so far in January and 8,000% in the last 12 months.
Look more closely and it makes more sense. “Buy what you know” is Warren Buffett’s mantra. So it’s easy to see why a bunch of Generation Y traders – trapped at home in the middle of the pandemic, with savings increased by a lack of opportunities to spend money available elsewhere or government stimulus payments – could know one thing or two about games.
Especially when they approach the market as a video game and their strategies include something similar to what players would call a “cheat code” – in this case, coming together and accumulating individual stocks and related options in the way a united 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 shares, raising their price beyond anything that a traditional investor would consider reasonable.
For the group of nearly 3 million “degenerates” who call themselves “degenerates” on Reddit’s WallStreetBets forum and other social media sites where this new army of day traders get together and conspire, the game quickly spread to a myriad of actions they intend to do “the next GameStop. “
There’s Naked Brand Group Ltd., a clothing maker whose stock has grown 618% this month. And AMC Entertainment Holdings Inc., the film company with a gain of more than 800%. Macerich Co., a real estate investment fund, more than doubled this month. This list is endless.
Even so, benchmark stock indexes fell on Wednesday. The S&P 500 plunged nearly 3%, its worst drop since October. How can be? One theory is that hedge funds are being forced to dispose of companies they really love in order to raise money to buy the stocks they hate. Because? Thus, they can close short bets before the losses become too large, as the bullishness goes against them.
Gross leverage, or a hedge fund’s risk appetite meter that takes long and short positions into account, is decreasing. The money was drained from its high and low betting pool over the four sessions through Tuesday at the fastest rate since October 2014, data compiled by Goldman Sachs Group Inc.’s main brokerage unit show.
While there are many examples of notorious small squeezes in the past, including the implosion of volatility in early 2018, there are signs that the current one may have a sustained impact on market dynamics, wrote Michael Purves, founder and CEO of Tallbacken Capital Advisers. In selecting smaller companies with high overdraft interest, he found that there are hundreds of potential targets for retail investors to choose from and that there is evidence that the “contagion of the squeeze” is growing day by day.
This means that it can continue to push long-short hedge funds to undo sales from its short positions and, by extension, deleverage its long books, even if they are not involved with some of the recently targeted names.
“Both deleveraging processes – the long and the short – would have significant implications for market action in the coming weeks and could generate substantial market volatility,” wrote Purves.
History is changing so fast that trying to put all the threads together is useless, but to start: there is the impact of the squeeze on short position sellers and their solvency; the search for the next bull attack target; the challenge of calculating GameStop’s real fair value; what it really means for wealth inequality, considering the super-rich are reap unexpected gains; The impact on Internet-based brokerage firms and the role that their elimination of commissions played in all of this; and even what Biden, Powell, securities regulators and Treasury Secretary Janet Yellen are thinking and doing about it all.
Of course, no short squeeze can last forever. The market will return to some “normal” appearance eventually.
“Despite being the marginal buyer at the moment, retail day traders do not have enough collective assets to continually move global markets,” said Max Gokhman, Pacific Life Fund Advisers‘head of asset allocation. “Small individual stocks? Absolutely. But will this change the entire investment scenario? Unlikely.”