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.
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.”
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.
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.
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 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.
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.
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.
“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?”
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.
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.
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.”
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.
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 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.
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