What now?
That’s one question shell-shocked investors and traders are likely asking themselves, after a week that found the broader market posting its largest weekly loss since October, while a handful of misfits surged into the stratosphere in what one pro called an “infinity squeeze.”
“This week demonstrated that unsustainable excess in one small part of the market has the potential to tip a row of dominoes and create broader turmoil,” Goldman said Friday night, reiterating that “large short squeezes led investors short these stocks to cover their positions and also reduce long positions, leading other holders of common positions to cut exposures in turn.”
That’s a problem, and not just for hedge funds. As one reader asked, in the comments of “Populism Comes For The Stock Market,”
I wonder how many of those people on Robinhood who claim they are the champions of the poor realize how their “sticking it to the rich /Hedge Funds” could potentially end up damaging the accounts of those of us who are living in the middle?
It’s a good question. And, if you accept the premise that those who participated in this week’s drama likely weren’t representative of the forty-five to fifty-four, white demographic that’s experienced acute suffering in America, and almost surely not representative of African American and Hispanic youths, whose daily reality is often defined by stark poverty, you’re left to wonder whether this much celebrated “coup” was anything more than headline fodder.
That’s not to take anything away (figuratively speaking) from the Reddit traders. In fact, I’ve argued repeatedly that they should probably cash out now so that somebody (either regulators or the platforms they trade on) doesn’t try to take something away from them (literally). You have to wonder, for example, about the psychological state of anyone who doesn’t lock in gains after an 1,816% weekly rally (for Koss).
In any case, going forward, Goldman seems to believe it’s at least possible that this kind of thing could become a recurring phenomenon, if not a fixture of markets.
The bank’s prime desk noted that despite “the largest active hedge fund de-grossing since February 2009,” net and gross exposures are still “close to the highest levels on record, indicating ongoing risk of positioning-driven sell-offs.”
Meanwhile, it’s possible that the retail crowd keeps coming back for more. While I continue to have doubts about the extent to which the poor and lower-middle class are inclined to frequent Reddit message boards in the interest of getting stock tips, what I don’t doubt (at all) is the media’s capacity to create a self-fulfilling prophecy.
How many articles about overnight riches does it take, for instance, before people who otherwise wouldn’t have dreamed of putting their stimulus check into, say, shares of AMC, do just that? And when they do, they’ll unwittingly be buying shares at prices that aren’t just detached from fundamentals, but are in fact detached from anything that even approximates the reality of the underlying companies.
“Regulatory actions, broker risk limits, or unexpected losses could all dampen the activity and market impact of retail traders, as Thursday’s temporary reversal made clear, but otherwise, an abundance of US household cash should continue to fuel the trading boom,” Goldman went on to suggest. The bank’s David Kostin also noted that during the height of the dot-com boom in 2000, the previous year saw household credit card debt jump by 5% while checking deposits fell. Due to pandemic dynamics, the situation is entirely different in 2021. Credit card debt fell by more than 10% last year, while checking deposits grew by $4 trillion, Kostin said. Savings were up $5 trillion.
When you consider the prospect that the media frenzy around this week’s short squeeze could materially increase the public’s propensity to funnel stimulus payments into the stock market, there’s scope for additional tumult.
When it comes to leverage, Goldman’s Kostin wrote that “although the level of net margin debt currently represents 0.9% of US equity market cap, similar to the 1.0% share in 2000, it reached 1.2% in 2018.” Adopting a somewhat cautionary cadence, he added that “the 35% increase in margin debt during the past 12 months pales in comparison to the 150% rise in 1999.”
Still, the trajectory of the broader market following historical short squeezes has generally depended on the economy. So, as long as things don’t go awry in a broader sense, concerns about Reddit-induced short squeezes and attendant de-leveraging from hedge funds may be overblown.
Then again, who knows anymore.
I don’t think this will a long term thing. If you play Russian roulette enough, by definition, the number of players goes down.
If they picked a bright start-up getting the short squeeze and said company knew how to play it also they could create a contender.
The Goldman Prime desk estimates of net and gross positioning differs radically from the low overall exposure level touted by JPM earlier this week. So vol-driven risk parity type funds must have exposure low enough to offet the hedge funds?
These measures are not necessarily comparable.
That chart from JPM, for example, appeared to use the rolling beta feature on the Bloomie with one of HFR’s indices, and an in-house measure of systematic exposure.
You can use HFR’s indices with that beta feature on the Bloomberg to proxy for exposure levels across all manner of strategies.
That could be consistent, inconsistent, kinda consistent, or anything in-between versus data from one bank’s prime desk, depending on what that data is actually capturing.
Noted but that complicates the establishment of a narrative/an objective look at whether HFs (say, equity long short esp) are highly leveraged on a gross basis or not…
Well, yeah. Hence: “In our view” and “in our opinion.”
Fair enough. Thanks for the explanation, H.
I anticipate an attempt to diffuse this movement will include co-opting the leadership (if any exists )… similar to the occupy movements.. Governments and Systems primary instinct is to retain power and tactics vary . These type populist movements are not new and ample Research exists in the agencies and think tanks as to how to remedy these events.
I guess that it turned out that the stock market was more efficient than the hedge funds thought.
They got way too greedy- shorting up to 140% of an already beaten down stock- even if their premise was based on solid fundamentals- they took it too far.
I also agree that Robinhooders were not doing anything other than reacting to the hedgefunds’ stupidity/greed (minimal fundamental analysis needed).
If “Robinhooders” took it too far in the other direction- then next time, hopefully, both sides will be a little less greedy.
This would be good for all involved, including bystanders.
Buy the dip.
I agree this is likely short lived and will diffuse (not w/o losses though ) .. It is likely a buy the dip moment but there is a lot of water to navigate till we get to that point… ” Don’t fire until you see the whites of their eyes…”
Re “I wonder how many of those people on Robinhood who claim they are the champions of the poor realize how their “sticking it to the rich /Hedge Funds” could potentially end up damaging the accounts of those of us who are living in the middle?,” a quick check and a Jan 8, 2019, CNBC article popped up. In one year in the last 10 (2018 and back) did hedge fund returns beat the SP500. I presume this includes the 2 and 20 fees.
I don’t buy the idea that hedge funds are the friend of police, firefighter, and teacher, pensions. I do suspect they would love to suck more fees from these honey pots.
There must be some studies about the aims of hedge funds and if these funds have net, positive contribution to society’s collective well being. I would suspect one such measure in any studies would be whether or not they have the tendency to increase the future, productive capacity of the economy.
Some years back, 20 maybe, I was recruited by a well-known consulting firm looking to start a macro hedge fund operation. I told the guy I was ashamed that some of the actions I had taken in the past to help force less-prosperous nations to devalue their currencies and, thereby, raise the price for many consumer staples that the vast majority of people relied on to live. The conversation ended there.
Flash mobs, McBundy standoffs, stop the steal, Hertz stock run up, Occupy Wall St, the Tea Party, Arab Spring and on and on. Societal anxiety is going up. The flareups are going to continue to escalate in my opinion. The internet is the communication tool that allows diverse groups to organize and ‘take action’. In one way or another all these movements are expressing anger over the status quo, particularly for those under 40 who too often see a bleak future based on what their lived experience has shown them. It’s a global problem (or challenge if you are the glass half full type). I’m not sure it will diffuse without a lot of destruction, which history shows is SOP. You can use the distribution of wealth charts to see which way we are heading.
Now here is a thought experiment. Can r/WSB crash the market this way–start running a threat about buying puts on SPX triggering a gamma vortex to the downside. The instinct is to say “no” because it is one thing to trigger a move in an illiquid stock with a high short interest, but quite another for something like the SPX. The other observation is more mundane–given these events, does not this kind of activity trigger a general risk reduction, a deleveraging of risk, given the uncertainty of the outcome? Would appreciate any thoughts?