There are plenty of lingering questions on Wall Street and not a lot of answers after last week’s dramatics.
Depending on what you read, who’s writing it, and when, the WallStreetBets crowd who collectively commandeered the price action in a handful of misfit stocks last week are a motley crew of gamblers, speculators, rebels, heroes, degenerates, populists, patriots, adrenaline junkies, and/or libertarians.
Some of the commentary surrounding this somewhat dubious episode in market history is couched in almost extraterrestrial terms.
“Who are they?”
“What do they want?”
“Do they even have an ideology?”
“Nihilists! F*** me. I mean, say what you like about the tenets of short-selling, Dude, at least it’s an ethos.”
Now there’s talk of a “silver squeeze” and as the weekend melted into Monday, some were still trying to make sense of the price action in Dogecoin. As if there’s some deep meaning to it.
Those still in possession of their faculties after last week offered some lessons from history which may or may not be applicable this time around.
Nomura, for example, ran some backtests which the bank’s Charlie McElligott characterized as “What happens after finally beginning to purge your LONGS due to mechanical risk management, following some gross-down catalyst [that] rinsed your SHORTS.”
“I think [that’s] close to descriptive of ‘the now’,” Charlie added, in a note dated Thursday.
The figure (below) shows instances when the bank’s hedge fund “Most Crowded Longs” traded down on par with last week’s one-week return, contingent on the past three-month return being “rage positive” (i.e., greater than the 90th %ile).
“The very near-term return window shows more potential for choppy flow,” McElligott remarked, adding that if you look out three-, six-, and 12-, months, they tend to “rip higher” anew as the favorites get rebought. Note (again) that McElligott’s remarks are from a Thursday morning note. Some “stuff” has happened since then, although it’s not obvious to me why that would alter the analysis.
There are, of course, all manner of caveats, including elevated gross exposure for the Long/Short crowd. A lot of “size remains out there,” Charlie added, noting that liquidity (i.e., market depth) remains impaired, as has generally been the case since the February 2018 VIX ETN implosion.
For their part, Goldman noted that over the past two decades, there were 16 months “during which heavily-shorted stocks rallied while Hedge Fund VIPs declined.” Subsequent performance was contingent on the economy.
“In half of those episodes our US Current Activity Indicator signaled an improving pace of US economic growth, and following those episodes the S&P 500, our Hedge Fund VIP basket, and the most-shorted basket all generated positive average returns during the following month,” the bank noted, adding that during the other eight episodes (i.e., periods when economic activity faltered), returns were either flat or slightly negative.
Generally speaking, the assumption is that things will be fine — that “normality” be will be restored.
And there’s certainly something to be said for the notion that everyone (myself included) is thinking far too hard about all of this. I quoted a great piece that suggested as much on Saturday. I’ll do so again here, both because it’s worth the re-quote and because some readers may have missed it. The passage (below) is from Bloomberg’s Katherine Greifeld and Claire Ballentine:
The absurdist morality tale over the unalienable right of Redditors to pump up meme stocks and punish Wall Street has obscured a more reckless impulse. Encouraged by Robinhood’s addictive gamification of day trading and egged on by like-minded Redditors on WallStreetBets, these traders have rejected the tedious, long-term view of the passive-investing crowd. Instead, many are chasing the dopamine high of going all in and getting rich quick on increasingly absurd ’90s-era nostalgia stocks — all while giving the collective middle finger to the Wall Street pros and their valuations.
“We believe in nothing, Lebowski. Nothing.”
For his part, BofA’s Michael Hartnett wrote that the Fed “always eases with [a] Wall Street event.”
He called January hedge fund losses in short positions a “small LTCM event,” flagging “subsequent forced selling albeit without leverage and systemic contagion.”
If anything, Hartnett mused, Wall Street volatility in the first half of 2021 “simply keeps the Fed easy [and] induces bailouts.”
That said, any additional forced liquidation in the QE-fueled bull market leaders (e.g., big-cap tech or investment grade credit) “would be a more sinister development,” he remarked.
