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.