With 9.2 million members (or “degenerates” as they are known) and language that would make a sailor blush, the r/wallstreetbets army has become a force to be reckoned with. Reddit CEO Steve Huffman refers to the community as using “crass-at-times language” which is like describing our government as being “mildly susceptible to corruption”.
Their hero is Roaring Kitty, whose name on Reddit won’t be repeated here since this is a family show. His real name is Keith Gill and he became the face of a group of individual traders who took on Wall Street.
In real life, Keith is going to be in court a lot. He luckily has more than enough money now for legal fees.
He’s being sued along with employer MassMutual (who said it was unaware of his outside activities) for violating securities laws, allegedly inciting a rally in GameStop shares which made him extremely wealthy.
This story will play out in congressional hearings and in court in US, with Keith no doubt using his most famous line:
“In short, I like the stock.”
Gill notes that his channel was for informational purposes only. In practice, he endlessly punted a stock to a community of devout followers. Whether or not this is materially different to a sell-side analyst helping institutions reach a conclusion on a particular stock is something that will be decided by the courts.
What does this mean for traders and investors?
The game has changed in offshore markets and particularly the US. There is literally an army of people waiting to cause the next short squeeze, which happens when too many hedge funds have gone short on a particular stock.
This means the hedge funds have placed bets on the price dropping, usually with good reason. Unfortunately, the Reddit crowd don’t need good fundamental reasons to buy a particular stock. They just want to crush a hedgie and make money along the way.
Of course, the music eventually stops and the stock plummets back to where it belongs. Those traders who used call options are ok because they just lose the premium on the options, but inexperienced people buy the shares at the top of the market and find themselves sitting on enormous losses:
So, the first point is that investors need to be extremely careful about buying ordinary shares in a short squeeze. If you don’t sell in time, you will most likely suffer significant losses. This is the “greater fool” argument, which means that the only reason you would do the trade is because there might be a greater fool ready to buy the shares from you at an even more inflated price.
The second point is that traders and hedgies will have to be more circumspect about short opportunities. For example, last week on my radio segment on LM Radio and Magic 828, I point out the likelihood of Palantir’s share price coming under pressure.
It was a perfect storm. In the same week, Palantir released poor results (again) and would see a listing lock-up expire on 80% of the shares in issue.
Such a lock-up is common for a new listing and Palantir only listed in September 2020. It means that long-standing shareholders in the company who wanted to sell their shares would finally be able to do so. The poor results might have been the final straw.
Sure enough, Palantir closed over 7% down on Thursday. All the price action happened in the morning, as the lock-up expired and people dumped their stock. The cost of borrowing to execute a short would’ve been significant, but some traders and hedge funds would’ve profited from this.
Whilst there is no doubt an argument that can be made that Palantir is overvalued, this didn’t stop Cathie Wood’s ARK funds (which will buy practically anything that doesn’t run away) and the Reddit army from climbing in on Friday to attack the hedge funds.
Net result? Stock climbed 15% on Friday. If you shorted the share on Friday morning, you were slaughtered. If you had done it on Thursday morning, you made money.
Will sanity prevail at some point?
US bond yields are climbing and climbing quickly. This means the price of government bonds is falling and that borrowing becomes more expensive for the government and corporates alike.
Yields tend to rise when investors expect inflation to come into the system. This is a concern when stimulus is being pumped into the economy at unprecedented rates e.g. in the form of “stimmy checks” paid directly by the US government to every citizen.
As the economy in the US starts to improve and stimulus potentially slows down, there are a couple of important potential impacts.
The first is that students in their parents’ basements may find it trickier to “YOLO” on options on Robinhood, since the free money in the mail may not be arriving anymore. That could start to limit the power of the Reddit movement.
The second is that share prices may drop in response to better yields on bonds and higher costs of borrowing for companies. Of course, a stronger economy means the fundamental economics may actually catch up to share prices, confirming an equity bull market rather than ending it.
The core message here is that the past 12 months have been extremely easy for equities. Practically anyone could make money, especially in a diversified portfolio. Playing fast and loose, the world’s traders and investors have experienced a bull market against a terrible economic backdrop.
The music is going to stop at some point. When it does, hold on to your seats. The hedgies will be there with their shorts and there may not be enough money on Reddit to win that battle.