Goldman Sachs: Biggest ‘short squeeze’ in 25 years caused hedge funds to ‘de-gross’ at fastest rate since 2009

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Goldman Sachs said the GameStop saga had hit the wider market, with hedge funds rapidly cutting their positions

The US stock market is witnessing the biggest “short squeeze” in 25 years, forcing hedge funds to withdraw from their positions on stocks at the fastest rate since 2009, according to Goldman Sachs.

Last month saw GameStop shares rise more than 1,700%, “squeezing” hedge funds and others who had “shorted” the stock, costing them billions of dollars. A short position is a bet that a share price will fall.

The surge in GameStop and other heavily shorted stocks was driven by users of the Reddit forum Wall Street Bets, who forced up the price in an effort to make themselves money but also to hammer hedge funds such as Melvin Capital.

Read More: A chief investment strategist breaks down how the GameStop saga could upend long-standing practices on Wall Street – and shares her 4-part advice for navigating the frenzied trading environment

Goldman Sachs analysts this weekend shed some light on the situation in a note. “The past 25 years have witnessed a number of sharp short squeezes in the US equity market, but none as extreme as has occurred recently,” they said.

The equity analysts said a basket of the most-shorted US stocks has rallied 98% in the last three months. Estimates by data provider Ortex on Friday showed that short-sellers were sitting on losses of around $19 billion just on GameStop in 2021 so far.

Hedge funds and short-sellers who had made losing bets were forced to withdraw from the market rapidly at the fastest pace since 2009, in what is known as “de-grossing”.

They had to buy shares in companies such as GameStop and movie theater chain AMC to close their short positions, and sell other stocks to cover their losses.

“This week represented the largest active hedge fund de-grossing since February 2009,” Goldman analysts including David Kostin and Ben Snider said. “Funds in their coverage sold long positions and covered shorts in every sector.”

Kostin and his colleagues said regulations, limits put in place by trading platforms, or sharp losses could bring the amateur trading frenzy to a halt.

“Otherwise, an abundance of US household cash should continue to fuel the trading boom,” they said.

Read More: As Redditors flood the stock market, UBS breaks down 6 options strategies investors can use right now to protect their portfolios 

Goldman said retail investing was thriving because of the large amount of savings built up during the coronavirus period, as well as government stimulus.

“During 2020 credit card debt declined by more than 10%, checking deposits grew by $4 trillion, and savings grew by $5 trillion,” the investment bank’s analysts said.

“On top of these savings, our economists expect more than $1 trillion in additional fiscal support in coming months, including another round of direct checks.”

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How to navigate GameStop madness – The strategy that outsmarted Wall Street – How Reddit traders are driving a populist movement

Hello and welcome to Insider Investing. I’m Joe Ciolli, and I’m here to guide you through what’s been happening in markets, as well as what to expect in the coming weeks. This week is packed with all the GameStop and Reddit content you could ever ask for.

Here’s what’s on the docket:

If you aren’t yet a subscriber to Insider Investing, you can sign up here.

Have thoughts on the newsletter? Just want to talk markets? Feel free to drop me a line at jciolli@insider.com or on Twitter @JoeCiolli.


Your weekly recap and outlook

If you’re reading this, that means you managed to make it through the stock market’s most absurb week in recent memory. You’ll always remember where you were when Reddit day traders banded together and pumped 90’s nostalgia stocks like GameStop to the moon – an unprecedented uprising that sent ripples through every layer of the financial system.

The story starts, of course, with the traders themselves, who conduct their business on r/WallStreetBets subreddit. They threw the exact perfect mix of market savvy, anti-establishment sentiment, and sheer will into a blender and came out with a destabilizing cocktail that left established Wall Streeters scrambling clean up the mess.

The central concept was relatively simple: focus on buying heavily shorted stocks, which will hopefully squeeze those positions until they’re forced to close, pushing the stock up even further. Ideally that inspires people that feel left out to pile in. Rinse, repeat. That these companies – which included Nokia, BlackBerry, and BB Liquidating (formerly known as Blockbuster) – were nostalgic, past-their-prime businesses was an added bonus to the Reddit crowd, who are never ones to pass up a chance at irony.

But the phenomenon goes far deeper than that. Underlying the memes and the hubris rests an anti-establishment streak. For a portion of the WallStreetBets crowd, this undertaking isn’t just about making money. It’s about making Old Wall Street pay, and the group isn’t exactly being coy about that fact. “It seems Occupy Wall Street had the wrong approach,” the official WallStreetBets Twitter account posted on January 26.

So what’s the damage look like on Wall Street so far? Arguably the biggest casualty has been Melvin Capital, which held a short position on GameStop that’s left them down 53% year-to-date – performance so bad that investing titans Steve Cohen and Ken Griffin have had to bail them out

But it hasn’t been all negative. Silver Lake Partners saw a convertible-debt investment strike gold when AMC Entertainment’s stock surged this past week. The firm was able to flip that debt into stock, which it then sold at the peak for a smooth $113 million profit. Some have called it the “trade of a lifetime.”

Then there’s also the matter of the preferred trading platform for the Reddit army: Robinhood. The online brokerage had a week for the ages after restricting further buying of GameStop, then backtracking after backlash from everyone from AOC to Chamath Palihapitiya. There have also been reports that Robinhood was forced to draw on bank credit lines amid the madness. How this impacts the company’s quest to go public this year will be a story to watch in the coming weeks.

So where do we go from here? One thing to watch is how hedge funds react. They were already shedding equity exposure in the early days of the GameStop craze, and it’s possible the market dislocations exploited by Redditors will cause them to retreat further.

Many other questions remain. Who else was caught short and ultimately doomed by WallStreetBets? Who else raked in big returns like Silver Lake? When will the so-called meme stocks come plunging back down to earth? And will the stock market ever be the same? Keep watching this space to find out the answer to those, plus many more.


JOIN OUR LIVE EVENT: A conversation with Insider’s markets gurus on the GameStop and Reddit-trader phenomenon

Join us Tuesday, February 2, 2021 at 1:00 p.m ET as deputy editor Joe Ciolli, markets and economy reporter Ben Winck, and senior investing reporter Vicky Huang discuss the GameStop phenomenon, the influence of WallStreetBets, and how the Reddit-fueled trade might end.

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How to navigate a GameStop crazed environment

GameStop Clerk

Ally Chief Investment Strategist Lindsey Bell says the meme-stock rally could be a good thing for average investors. Still, she says traders who want to play the newest hot stocks should understand they are speculating. Bell also advises investors to have a plan and stick to it when things get strange, and understand how unusual this time is.

Read the full story here:

A chief investment strategist breaks down how the GameStop saga could upend long-standing practices on Wall Street – and shares her 4-part advice for navigating the frenzied trading environment


The intricate strategy GameStop traders used to outsmart Wall Street

gamestop store line crowd

Steve Sosnick – the chief strategist of Interactive Brokers and head trader of its trading unit Timber Hill – breaks down the short squeeze and gamma squeeze Reddit traders put in place for GameStop. He also shares how the massive moves in these so-called meme stocks could permanently alter markets.

Read the full story here:

A veteran options trader breaks down the intricate strategy that Reddit traders used to outsmart Wall Street’s bet against GameStop – and shares 2 ways the parabolic rally could permanently alter the stock market


How Reddit-trader mania represents a full-fledged populist movement

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The Reddit-fueled trading phenomenon lifting GameStop, AMC, and other stocks is backed by populist sentiments. Cries to dethrone the establishment and redistribute wealth resemble those seen at Occupy Wall Street protests in 2011. The trend has all but certainly formed a bubble, but its political messaging can still live on.

Read the full story here:

The GameStop mania driven by Reddit traders isn’t simple market trolling. It’s a populist movement threatening to disrupt the financial system to a degree Occupy Wall Street only dreamed of.


JOIN OUR LIVE EVENT: Execs reveal what’s on tap for the red-hot IPO market in 2021

Join Insider on Wednesday, February 3 at 2:30 p.m. ET as Insider’s chief finance correspondent Dakin Campbell moderates a panel featuring Kim Posnett, Goldman Sachs partner and Internet investment banking chief, Greg Rodgers, a Latham & Watkins LLP attorney and direct-listings expert, and Mitchell Green, a venture capitalist at Lead Edge Capital who backed Uber, Spotify, Asana, and Alibaba.

These IPO experts will discuss what you can expect for the year ahead and how the recent changes have dramatically altered the calculus for startup entrepreneurs. They will also take reader questions. 

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Stock pick central

Seeking experts who are willing to name names? Look no further:

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Reddit day traders are taking on hedge fund giants and winning, and it’s a sign of a new era for markets

WallStreetBets
  • The 4 million-strong WallStreetBets forum on Reddit has officially disrupted Wall Street.
  • They did it by piling into heavily shorted stocks, sparking short-squeezes at the expense of Wall Street hedge funds and large institutional investors.
  • “They are proving to be quite capable of mounting some successful ‘value capture’ against Wall Street institutional investors,” Fundstrat’s Tom Lee said.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

Wall Street hedge funds are scrambling, and it’s all because of a online investing forum that has more than 4 million members who self-describe themselves as “degenerates.”

Reddit’s WallStreetBets forum has surged in popularity after retail investors within the group successfully staged a gravity-defying short-squeeze in GameStop at the expense of hedge funds that were betting the physical video-game retailer was on its last legs. 

A short-squeeze occurs when investors who are betting against the stock are forced to close out their position by buying the stock, further adding fuel to the fire.

As of Thursday morning, GameStop had a year-to-date gain of more than 2,400%. The rally in GameStop crushed Melvin Capital, a roughly $12 billion hedge fund that has suffered a more than 30% decline due to its short position in GameStop.

The hedge fund received an emergency $2.8 billion investment from Steve Cohen’s Point72 and Ken Griffin’s Citadel amid the record surge in GameStop.

Read more: As Redditors flood the stock market, UBS breaks down 6 options strategies investors can use right now to protect their portfolios

Citron’s Andrew Left, a famed short-seller, also felt the heat from Reddit investors after he called for the stock to fall 50% last week. Left ultimately closed out his short in GameStop for a loss, as did Melvin Capital.

Maplelane Capital is another New York-based hedge fund that saw declines of about 30% due to its short position in GameStop, according to a report from The Wall Street Journal.

The developments are remarkable when you consider that retail investors on Reddit likely lack the sophisticated data feeds that multi-billion-dollar hedge funds rely on.

But after spending a few hours on the forum, billionaire investor Chamath Palihapitiya concluded that the Reddit traders can do the same fundamental analysis as hedge funds, if not better. Palihapitiya ultimately followed the retail investors into GameStop, and won big.

Now, Reddit traders are trying to replicate the success of GameStop and are targeting other stocks that are highly shorted by professional investors. And they’re succeeding.

Stocks like AMC Entertainment, Bed Bath & Beyond, and Virgin Galactic have soared this week as Reddit investors piled into the names via both stocks and deep out of the money call options, creating unprecedented demand for the shares.

Read more: A chief investment strategist breaks down how the GameStop saga could upend decades-long practices on Wall Street – and shares her 4-part advice for navigating the frenzied trading environment

“They [retail investors] are proving to be quite capable of mounting some successful ‘value capture’ against Wall Street institutional investors,” Fundstrat’s Tom Lee said in a note on Monday, adding that “large size does not always win.”

But the influence of WallStreetBets on stock moves could wane in the future as systematic funds “adjust” their models to incorporate this new source of volatility, Lee said.

And it’s not only quant funds that could put a dent in the influence of 4 million Reddit traders, it’s also trading platforms.

On Thursday, Robinhood restricted buy trades in a handful of stocks that have seen epic short squeezes and have been targeted by the Reddit group, including GameStop, AMC Entertainment, and Nokia, among others.

Now the question is, according to Lee: “Will their strategies endure?” 

Read more: Morgan Stanley handpicks 18 US stocks to buy for the best business models that deliver market-beating returns for years to come

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Here’s how short-selling works, and how Reddit’s day-trader army spoiled the strategy for GameStop bears

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GameStop. REUTERS/Mike Blake

Short-sellers have taken a hit now that GameStop shares have topped $330, in what analysts have dubbed an irrational rally stoked by the Reddit group “Wall Street Bets.” 

When the market operates rationally, investors have the option to short a company’s stock. In the case of GameStop, Melvin Capital and Citron Research were among the list of short sellers, and they’ve lost their bet, by a lot. The more than 2 million members of the subReddit group have been bidding up GameStop shares in the past weeks, causing the stock to skyrocket more than 1,200% since mid-January. 

And short sellers have lost billions

To short a stock means the investor is betting the price of that company’s shares will decline. (In a normal bet, which is called going long, investors purchase a stock with the hopes of it increasing).

In shorting a stock, an investor borrows shares from a lender, let’s say at $10 per share. The investor then takes the borrowed shares and sells them for that same price. Once the stock goes down, to let’s say $1 per share, the investor buys the shares back and returns them to the lender, pocketing $9 per share. 

“Let’s say you short XYZ company at $100, and the next day it goes to $10. You take $10 out of your pocket and buy back the stock and give it to the guy you borrowed it from. And you have $90 in your pocket,” Michael Pachter, an analyst at Wedbush, told Insider. Pachter added that there’s the added cost of paying the interest on borrowing the stock, though if an investor only holds a short position for a month, the interest would be negligible. 

But sometimes, like in the case of GameStop, the shorts get “squeezed” when the shares go up, said Telsey analyst Joe Feldman, who maintains the Street-high target price of $33 for GameStop. That means short sellers have to buy back the stock at a higher price. So if the shares were borrowed when the stock was $10, and now the stock is $20, the investor loses $10 per share. 

Read more: How hedge funds are tracking Reddit posts to protect their portfolios after the Wall Street Bets crowd helped tank Melvin Capital’s short positions

GameStop short-sellers Melvin Capital and Citron Research lost a lot when the stock started spiking, said Pachter. They’ve both since closed out of their short positions. CNBC reported that hedge fund Melvin Capital ate a huge loss on Tuesday when it closed its short position. Citron managing partner Andrew Left said that the firm’s position was covered when GameStop traded at about $90 at “a loss of 100%.”

“There’s a point where the shorts say, ‘This is crazy I’m getting out,'” Pachter said. 

The problem with shorting the stock at the higher price now, betting it will go back to normal levels, is that analysts are unsure where the irrational share increase will stop. “What if it goes to infinity?” Pachter said.

Joost van Dreunen, who teaches at the New York University Stern School of Business and has an expertise in gaming, said the current valuation of GameStop is “totally disconnected from reality.” GameStop’s record highs prior to this rally were in 2007 and 2013 when the Nintendo Wii and Switch launched, respectively, and pushed the stock to about $60. 

“That was their absolute high watermark, and they haven’t been able to recover it since,” van Dreunen said. “The current situation is just post-modern financial drama totally void of reality.”

“Fundamentally, nothing has changed for the company,” Feldman said. “If anything the fourth quarter was probably a little disappointing.”

Read the original article on Business Insider

Tesla short-sellers lost $38 billion throughout the automaker’s colossal 2020 rally

Elon Musk
Elon Musk.

  • Tesla short-sellers saw $38 billion in mark-to-market losses throughout 2020, Bloomberg reported Thursday, citing S3 Partners data.
  • Short interest in the company’s shares plunged to less than 6% of Tesla’s float from nearly 20% at the start of last year.
  • The losses trounce the $2.9 billion total seen in 2019 and come on the back of Tesla’s 740% surge over the past 12 months.
  • Watch Tesla trade live here.
  • Visit Business Insider’s homepage for more stories.

Investors betting against Tesla lost billions last year, as the automaker’s shares leaped above nearly all estimates.

Short sellers saw $38 billion in mark-to-market losses throughout 2020, Bloomberg reported Thursday, citing data from S3 Partners. Short interest in the shares fell to less than 6% of Tesla’s float from nearly 20% as the company’s rally led investors to close out their bearish positions.

Tesla bears lost more than any other group of short-sellers in 2020. Those betting against Apple saw the second-largest deficit of nearly $7 billion, according to Bloomberg.

Read more: Wall Street’s biggest firms are warning that these 7 things could crash the stock market’s party in 2021

The hefty losses are up sharply from the previous year’s total. Bearish investors lost $2.9 billion in 2019 as Tesla jumped nearly 70% from its June low into the end of December.

Short-selling a stock involves selling borrowed shares and buying them at a lower price. Investors shorting a stock profit from a drop in price.

Tesla shares gained 743% in 2020, boosted by steady profitability, newly bullish analyst outlooks, and outsized demand from retail investors. The rally pushed CEO Elon Musk’s net worth to $158 billion in December and established him as the world’s second-wealthiest person – after Amazon CEO Jeff Bezos.

The automaker split its shares on a five-for-one basis in August after Tesla’s stock price climbed above $2,000. While the action had no effect on the company’s fundamentals, some analysts saw the move as helpful to stoking new interest from retail investors.

The stock most recently charged higher upon inclusion in the S&P 500 index. News of Tesla on the S&P lifted shares in mid-November. Soon afterward, Goldman Sachs analysts noted that institutional investors tracking the index could fuel Tesla’s next leg higher as they look to match the benchmark’s weight.

Musk has repeatedly squared off with short sellers on social media. The chief executive’s latest mockery of the group came in July when he sold red shorts featuring the company’s logo. The “short shorts” – marketed as a sardonic rebuke to the company’s short-sellers – proved so popular on their launch day that Tesla’s merchandise website crashed.

Tesla closed at $705.67 per share on Thursday. The company has 20 “buy” ratings, 44 “hold” ratings, and 19 “sell” ratings from analysts.

Now read more markets coverage from Markets Insider and Business Insider:

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The founder of the world’s first vegan ETF explains how her market-beating fund is naturally built to include the pandemic’s biggest winners – and why industry titans like Facebook and Uber fit the bill

TSLA

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