Like many naughty amateur active investors who should know better, I watched the movie The Big Short with popcorn, envy, and a grin.
Oh how I wished I was one of the movie’s heroes.
One of those quirky, semi-Aspergic, single-minded and misanthropic hedge fund managers who spotted the fatal flaws in the system that precipitated the Great Financial Crisis.
And who then profited mightily from all the mayhem.
After all, I’m quirky and I might be at home somewhere on the spectrum.
Why shouldn’t I be paid billions for being a single-minded misanthrope who watches share prices instead of football games?
I’d be played by Christian Bale, natch.
You can have Steve Carell.
In truth though, a lot has happened since The Big Short came out in 2015.
And most of it happened this week.
Today it’s hedge fund managers who are watching in awe and fretting about what amateur stock traders will do next.
Specifically about whether said retail traders are about to blow up their hedge funds.
In this moment it’s the little guys who are the (anti) heroes of the movie.
Don’t stop me now
By now many of you will have heard of the poster child for this revolution – GameStop.
That’s ‘poster child’ in the sense of an official warning that you’re about to be electrocuted, nuked, or biologically poisoned if don’t get the hell away.
And that’s ‘GameStop’ as in the US video game retailer that’s listed on the New York Stock Exchange.
As opposed to ‘GameStop’, the safe word that’s stammered by hedge fund managers through their ball gags when they’ve taken enough of a beating.
Here’s a graph of GameStop’s share price action recently:
Kind of hard to read, right? Looks almost flat – until you spot that cliff on the right hand side.
Surely that’s where the action is?
Fair enough. Here’s a chart of GameStop’s share price just year-to-date:
No, that’s not much better.
It’s probably easier if I tell you that GameStop began 2021 priced at less than $18. As I type it’s now around $325.
That’s roughly an 18-fold increase in less than a month.
It’s up nearly 10-fold since this time last week.
Wow.
Game for a laugh
An innocent, easily fooled person who believes that human beings and markets always behave in predictable, simply modeled ways – an economics professor, say – might suppose GameStop has enjoyed some kind of super-fortunate change in its business model since the Monday before last.
Perhaps GameStop found all its stores were located on top of gold mines?
Or it’s recovered a password to a lost wallet stuffed with Bitcoin?
Or it’s devised a way to jam Internet access for everyone forever, so people have to traipse to a GameStop shop to buy a disc in a box like it’s 1999?
No, no, no.
In a reality so unlikely it has even seasoned market watchers rubbing their eyes, re-reading the ingredients list on that Kombucha they’ve been mainlining in their lockdown home offices, and deciding that they really need to get out more, mutant virus or no mutant virus – what’s happened is that thousands of members of a Reddit subforum called WallStreetBets have engineered perhaps the greatest short squeeze of all-time1, transforming GameStop from a potentially doomed video game retailer from another era valued at $2bn into a potentially doomed video game retailer from another era valued at $22.5bn.
And brutalised several hedge funds along the way.
And turned some of the Redditors into multimillionaires:
At least for now.
Wall Street frets
Surprisingly to those just tuning in, none of this interruption to normal programming is entirely new.
The gleefully anarchistic punters who populate WallStreetBets have been getting themselves noticed as they chase their favourite stocks via the free trading app Robinhood since at least the beginning of the pandemic.
And the subReddit was amusing itself in spectacularly reckless style for years before then, as this amusing video history recounts:
Monevator has even linked to several relevant stories about all this retail action in our Weekend Reading links over the past year.
Admittedly it’s been more the stuff of opinion columns and wonky commentary.
As opposed to something being of interest to the White House:
There’s also nothing new about the mechanism by which the Redditors drove up Gamestop’s share price – the fabled short squeeze – either.
You can read about this sort of thing in Jesse Livermore’s 1923 classic Reminiscences of Stock Market Operator.
And if you run a hedge fund I suggest you do, because more than 100% of GameStop’s shares were sold short when WallStreetBets came calling.
Yes, more than the entire issued share capital had been sold short by sophisticated and amply remunerated market participants.
Which is rather surprising, even without a horde of Redditors at your gate.
If you wonder what happens when the music stops and more shares are sold short than exist, ask any seven-year old who has played musical chairs.
It might save you having to ask your billionaire hedge fund mates to bail out your hedge fund to the tune of $2.75bn.
Alternatively, read Matt Levine’s vintage take for Bloomberg.
Levine goes into all the detail – and he’s writing about the little squeeze before the big squeeze – but the gist is:
…that these two factors—a short squeeze and a gamma trap, if you like—combined to push the stock up rapidly on Friday. Something started the ball rolling—the stock went up for some fundamental or emotional or whatever reason—and then the stock going up forced short sellers and options market makers to buy stock, which caused it to go up more, which caused them to buy more, etc.
Matt Levine, 25 January 2021, Bloomberg
Talking of hedge funds, while some stock watchers now call for regulators to step in to stop uncouth youths from stiff arming honest, hardworking capital market oligarchs, the reality is hedge funds have been ripping each other to shreds with orchestrated takedowns for about as long as hedge funds have existed.
Rival funds were probably in the mix alongside the Reddit money pushing up GameStop.
Heck, George Soros and Stanley Druckenmiller – and a bunch of other funds that piled on – broke the Bank of England with what was effectively a short squeeze on Sterling in 1992.
And you didn’t see the Queen running to the regulator whining that meanie hedge funds were trashing the value of her coin of the realm then, did you?
No, like any good market player, Regina1926 just logged into an AOL chatroom via Buck Palace’s dial-up and conceded she’d been pwned.
Flows before pros
Perhaps at this point you’re wondering what the hell you’ve been doing with your life?
Why you have been steadily trickling £500 a month into a balanced passive portfolio in an ISA when you could have been whooping it up on Robinhood? Or at least on Freetrade, the UK’s equivalent?2
The game has changed, right? The power is now in the hands of the little guys – provided there’s enough of them.
As Bloomberg’s Tracy Alloway puts it, today’s market is favouring flows before pros.
And retail punters are the ones with their hands on the money hose.
Not so fast.
I know, I know. It seems a lot of fun to ride meme stonks by going YOLO on calls like a pure autist with his eyes only on the tendies, diamond hands clenched tight, barely bothering to do any DD on the way to the moon!
(Translating from WallStreetBets-ease: It sure looks like it would be an enjoyable – not to mention profitable – enterprise to invest every penny of one’s capital into buying call options on a popular stock represented by an amusing image posted on Reddit, just like a gifted but somehow limited mathematical savant would, refraining from selling any of your securities, and focusing only on the six- or seven-digit returns to come rather than being bogged down with due diligence on said stock, all the while looking forward to some delicious chicken nuggets as a reward.)
But if you want to make easy money, do something hard.
We’ve seen this movie before. If following Internet posters into hot stocks was a sure route to enrichment, the Dotcom Bust would have been left with a different name.
We will, we will, rock you
I don’t begrudge the WallStreetBets crowd their fun. It’s been a miserable 12 months, so get it where you can I say.
I may be an active investor for my sins, but I’m not a hypocrite.
I understand the thrill of punting like this (it certainly isn’t investing).
Only with money you can afford to lose, ideally.
Otherwise fine, let’s see this run for a while. I’m enjoying the show.
Right now the day-traders are scanning the lists of the most-shorted stocks in the market in their hunt for new targets.
Some such stocks (sorry, ‘stonks’) are already seeing their prices rise.
Perhaps traders and investors have begun to buy in anticipation of the WallStreetBets eye of Sauron alighting upon them.
Or maybe sophisticated shorters are bailing, covering their shorts, and putting an ‘Out to Lunch’ sign on their door. And who can blame them.
The blast radius is expanding. I even noticed a relatively obscure German battleground stock called Grenke was up 16% yesterday. It’s hard to imagine that’s on the typical Redditor’s radar.
Short fall
This can’t last forever, though. And I don’t even mean regulation.
GameStop isn’t worth $22.5bn. It just isn’t. The company should try to raise capital while it can at this price, because it won’t stay here.
It seems a poor short to me – originally the epitome of a crowded trade, it also has net cash, a billionaire cheerleader, and while you wouldn’t want to start today with a load of shops in malls, games aren’t exactly a fading force – but nevertheless, it won’t be the new Amazon anytime soon.
Eventually fundamentals and prospects will – at least vaguely, in the hand wavey look-into-my-eyes way of the stock market – be reasserted.
That’s not to say a precise intrinsic value will be reflected in the stock price.
But something within – oh, I don’t know – say 200% of what it’s worth.
And you really don’t want to be holding the bag on the way down to there.
Eventually you’ll run out of greater fools to sell to.
Flashy mobs
What I haven’t got much time for is all the FinTwiterrati proclaiming Something Must Be Done, This Isn’t Capitalism Dear Boy.
There’s talk of a disorderly market. Of the breakdown of true price discovery. Of big losses to come in the aftermath.
But as I said, hedge funds have been taking advantage of opponents caught offside forever.
Why shouldn’t retail traders have a go for a change?
Perhaps the only thing that’s truly different is the risk tolerance of the newbies.
A hedge fund that’s short a particular stock can’t afford to see its assets go to zero. It has a fiduciary duty, as well as more practical limits on its losses.
But the WallStreetBets army? They have a cavalier attitude to losing money at the best of times.
Perhaps the mathematics of tens of thousands of coordinated punters being ready to lose $100-10,000 does change things a little bit.
Maybe new risk controls are needed at funds. Maybe the mechanics of options trading need a rethink. Perhaps there will be regulatory tweaks – whether advisable or not.
But that’s something for the zero sum traders to figure out among themselves.
Personally I think the market will take care of it – in brutal fashion – eventually.
The rest of us are best off watching with a bag of peanuts from the gallery. Or at the most having a flutter with some fun money.
I’m an active investor. But I’m the old-fashioned sort who expects to see long-term gains achieved over a few years, or even a few months.
At least a few weeks!
I don’t expect to get rich in an afternoon. Day trading is not and has never been a profitable way to wealth for nearly all who try it.
Bet on the horses. Bet on ‘stonks’, if you must.
But invest for the long-term in stocks.
My unexpected piece of the Gamestop action
Here’s a fun postscript.
I thought I’d be ending this article bemoaning that I wished I had some GameStop shares. Simply so I could sell them.
Well, it turned out I did own some GameStop shares!
It’s around this time every week that Freetrade tells me if anyone followed my affiliate link to bag their free share for signing up via my referral – granting me a bonus share in the process.
Imagine my surprise when I fired up the app to see if anything had come in – only to discover my single largest holding on the platform was GameStop.
It wasn’t my number one holding last week. It wasn’t even yesterday.
Truth be told I hadn’t even known I owned any GameStop shares. (I typically just let my free bonus shares be.)
But there they were. Two of them! Awarded to me when they were priced at less than $5.
Now priced at $330. Up around 70x.
Freetrade handily reminded me that GameStop had been on a bit of run:
What to do next? Should I evaluate the prospects for GameSpot’s future like a serious investor?
Cling onto my shares in a mini-me version of a WallStreetBets’ YOLO trade and ride the company to the moon – or to zero?
Reader, I hit hammered the sell button:
A huge shout out to whoever signed up to Freetrade and randomly granted me this windfall.
And I’ll add something that nobody has said for most of the past five years…
…I hope you got a GameStop share, too.
Sign up to Freetrade via my link and maybe we’ll both get another free share that’s going to the moon. No promises, mind.
Great article TI – I’ve been following the madness this week and was hoping you would comment. Loved hearing about your Freetrade surprise too
Correct my accounting if it’s wrong, but I think WSB is in for a nasty shock here.
If you manage to pull off a short squeeze then you’re forcing short sellers to buy at more than the stock is worth. So the way to make money is to sell to them at that price. But that’s not what WSB is doing. They’re still buying, and therefore they’re going to lose just as much money as the short sellers.
Who’s selling? My guess would be even bigger hedge funds, with deep enough pockets that they don’t fear the squeeze. When all is said and done this fiasco will add up to a transfer of wealth from WSB and the small funds to the big funds.
If you want to see what irrational exuberance looks like, this is it.
I don’t claim to fully understand it, and it’s certainly not for me, but I feel lots of young, naive daytraders are setting themselves up for a massive fall at some point. Couple of people I know went in at $30ish as a ‘bet’ with a small % of their total holdings, fair enough if they want to do that and benefit, but lots of people will be getting a very hard lesson at some point, I suspect.
Although I’ve never really understood shorting and certainly not defending the short selling hedge funds, but asset companies like BlackRock have done very well out of it, so it’s hardly sticking it to the big man and ‘that’ll show them’ by all these redditors based on pure speculation. The business fundamentals of GameStop just aren’t there. But I guess that is not the point.
I’d wager the majority of those involved are likely to be young enough to have not experienced a proper full cycle yet (dotcom, 08 crash), other than the recent sharp drop and correction last year and is, I think, made worse by the no-cost trading platforms giving people currently with too much time on their hands, with more disposable income than they would usually have as everything is shut (if they have it), the ability to buy fractional shares too easily without any real knowledge of the situation. Of course, some have and will do well on both sides, some (both big and small investors) will be having a heavy lesson fairly soon I’m sure.
I haven’t experienced a full cycle yet – only really started investing in 2015, and strongly from 2018 onwards, but always mindful of the bigger picture, naturally a cautious person in it for the long game and expecting a significant drop to come fairly soon partly because of these daytraders prolonging or exacerbating this artificial situation, alongside many, many other factors. (But who knows? I don’t!)
@Oscar — Yes, as I say in the piece at some point you have to sell. The WSB crowd need to get out while the going is good, but as you say last night at least some of them were talking of hanging on to $1,000 for GME. At some point (which I suspect we’ve already passed) it stops becoming a short squeeze and it starts being a game of hot potato!
@AndyJ — Thanks so much. I’ve been resisting as it’s all a bit off-topic for Monevator these days, but @TA of all people has been encouraging me every day to get something written as I have been sending him dispatches. He enjoys these war stories more than the average active trader I think, safe from his passive bunker! 🙂
@UKValueInvestor — Crazy times.
This was a fun to read! Great article, TI.
What’s worrying for those of us that are trying to just watch it from the gallery with a bag of peanuts is this: could this be the 21st century equivalent of spotting the shoeshine boy giving stock tips? I have done a lot of Monte Carlo simulations/back testing of my very diversified portfolio and the worst drawdowns are survivable and we’ll within my risk tolerance. But it is all based on historical data and what we know now about market dynamics. Can this time be really different? I guess nobody knows and this is the risk we’re all forced to take if we want to keep invested. But then again, it is only really worth to worry about what you can control and act on.
Fascinating stuff, well done getting the article out just as its hitting the general zeitgeist. I think this and Finumus 1 mil ride on the bitcoin train have really livened up the past week!
Absolutely classic that you had a couple of free gamestop shares – thats karma!
I think the fundamentals are that the shorts have to buy back more shares than actually exist, this means whoever owns the shares can hold and name their price. As the price rises higher and higher the shorts losses grow larger and larger and it costs more to keep their position open (see news of capital infusion into Melvin). This is also known as a short squeeze. In my view, the biggest ‘bag holder’ is the hedge funds that sold 140% of the outstanding shares at $10 and now have to buy them back at $440+ (price at writing) to close out their position.
There is also the factor of the younger generation which was negatively impacted by the 2008 crisis getting back at some of the people that were responsible for it and were bailed out (by taxpayers). This is a way to punish them where it hurts by playing by their rules and without the benefit of a compliant media and the ear of policymakers. From what I can tell a lot of retail are happy to lose whatever they put into this – for them it’s about sending a message and giving the big guy a bloody nose for once. This is just my interpretation of events, I don’t have a horse in this race but I’ve been captivated with it for about a week now.
@Tom — Yes, that’s as I describe in the article above. 🙂 You can’t really ‘name your price’ though with options. The WSB crew are sitting there with ‘calls’ to buy the stock at a particular strike price. As people like me sell our GameStop stock at whatever price we’re won over by, presumably some covering (I expect a lot) is taking place. The value of the call options varies as ordinary stock holders / shorters interplay like this. But it really can’t go on forever.
The best thing for GameStop to do as a business here (if it’s allowed) would be to do a massive share issuance to raise many billions at this elevated price.
Of course at the same time that would create loads of new shares, enabling shorters to cover, so it would be both good for the long-term share price (because billions more capital would be on the balance sheet) and bad for the short-term price (because more opportunity to cover). Here’s one the market did earlier, that I link to obliquely in the piece above:
https://www.ft.com/content/0a58b63a-4294-3e07-8390-c3aabef39a26
@Rhino @T-BDW — Well I’ve now been told on Twitter than I have ‘paper hands’ for selling my windfall GameStop shares and the stock is at $440 in the pre-market, so what do I know. 😉
As a passive investor, I also really enjoy these active trading stories! It’s like reading about EVE online – great fun to read about, less fun if it was my time and money on the line.
Actually I’ve just remembered short-sellers are possibly not allowed to buy shares directly in share offerings.
Here’s how one fund previously came unstuck: https://reuters.com/article/bc-finreg-short-selling-rule-105-idUSKBN1DG30L
So I’m not certain of the mechanics to be honest. But absent GME raising $10bn I’m confident this cannot hold.
Lucky you, with your GameStop free shares and good for you that you didn’t sell them back then, just to offload ‘worthless’ shares!
Diamond-ish hands rather than paper hands!
The Investor, yes you’re right, the only thing I would say is that the ‘presumably some covering’ part might turn out to be wishful thinking. I’ve seen posts that imply the short interest hasn’t really budged and the daily volume isn’t enough to push the needle on it. Therefore there are millions of shares that need to be supplied to call option holders come Friday and not enough shares to buy (without drastically push up the price – as we’ve seen).
I partly agree with the GameStop equity issue, although a small part of me thinks why should they help the shorters that tried to bankrupt their business for profit. Totally agree that this can’t go on forever, to me it looks like a game of who will blink first. I hope it doesn’t come across that I’m endorsing any of this, it’s just simply fascinating to me to watch it all unfold in real-time. Thanks for covering this in your post. Tom
Well it wouldn’t be hugely helpful to a short thesis, in that GameStop with say $2bn more in the bank is worth at least $2bn more than it was (a double on a few months ago). 🙂
I should stress perhaps I’ve nothing against short-selling. I don’t think they are ‘trying to bankrupt stocks for profit’ in most cases. Rather they are speculating on companies being overvalued. Sometimes this can lead to undue pressure on businesses and second order effects, but only really in a limited class of firms (such as banks, for example, where you can get bank runs). And very often short price discovery is prescient and useful.
Also shorting is harder than going long even at the best of times (maximum losses uncapped, as we’re seeing!) so it’s not like there’s not a lot of risk/reward involved.
“I should stress perhaps I’ve nothing against short-selling.”
Same here, however, I’m going to nitpick and say that the problem with GameStop could go deeper than benevolently shorting for the benefit of price discovery and into the realms of naked short selling. This is illegal and might help to explain how the hedge funds have managed to sell more shares than actually exist and why they find themselves in such a pickle now!
@Tom — I’m not saying it’s benevolent. Hedge funds short stocks for profit. I believe in incentives. Good luck to them — provided as you say that they do it within the rules of the game.
It has been a very exciting, and stressful, week with my holdings in GameStop. I, finally, managed to pull out yesterday (once Trading 212 stopped blocking all executions) with a 400% profit, a couple of months pay worth, which will mostly be going into my boring old index trackers 🙂
Amazing luck with the Gamestop shares! Loved reading today’s article. As a long-term r/wallstreetbets fan I’ve enjoyed the last week immensely. Its been hilarious fun and riveting watching the graphs go stratospheric. Hats off to the guys who have got lucky with this. Pretty sure it can’t be repeated and it’s only the folly of the hedge funds shorting more than 100% of the shares that created this situation.
Wish I’d been brave enough to go in on Gamestop like all the others but have done ok this week with other ‘meme’ stocks.
Worth reminding everyone that if you can’t afford to lose the money then you shouldn’t be trading….
This reminds of Japanese housewife currency speculators
https://www.thetimes.co.uk/article/the-kimono-traders-56dgv8jvckf
https://www.japantimes.co.jp/news/2019/09/23/business/financial-markets/army-japanese-eager-make-extra-money-rocking-global-currency-markets/
It’ll be interesting to see the fall out of these platforms (Robinhood, T212 etc) blocking trades of GME, BB, AMC and NOK. I see AOC has tweeted about it now.
Monevator to the moon
I have a vaguely formulated theory about about creation and destruction of capital in capital markets. Or… let me rephrase. The theory totally works in the ILS market, but I believe it also applies, in a way, to mainstream capital markets.
With the monetary policy everywhere the way it is and has been for the past 12 years, there’s just too much capital kicking around. As the mainstream becomes increasingly crowded, innovators have to go further and further out to the edge, take on risks that are increasingly complex and poorly understood (that’s the very definition of innovation in financial markets!) with payoff scenarios backed by simulations rather than experience. If the narrow set of circumstances supporting positive outcomes hold for long enough this then gets co-opted into the mainstream, and off we go again to yet another frontier. The issue is pervasive across the board, but let’s take quake bonds as an example. We (the humankind) don’t have sufficient data to reliably model earthquakes, and yet, when you read the prospectuses, you’d think the issuer has built the effing planet – crust and all. Pension funds buy them because when you have a few billion of AUM, losing 0.1% of it investing in shit you don’t understand is not a big problem. And that, according to my theory, basically applies to all financial instruments everywhere. Shorting shares of actual existing companies that have actual shops and inventory in actual existing shopping malls is pretty vanilla in the scheme of things.
Bottom line: I think winter is coming, and I wish I knew when exactly it is going to arrive.
Doesn’t the GameStop business model look awfully like Blockbuster ? If these people are trading on margin, the onset of margin calls will produce an avalanche. If you ran a hedge fund, shorting them now looks attractive surely?
I didnt have GameStop but i have a few that have had some great gains recently. My positions are only in £500 parcels but its great fun and you get to make some nice money as well. Of course it wont last but enjoy the ride while it lasts.
“Regina1926 just logged into an AOL chatroom via Buck Palace’s dial-up and conceded she’d been pwned.”
lolzzz
but good on ’em redditors
An old work colleague had a special interest in rare, but dangerous, risk events and I remember a seminar he gave on the ways short selling of single stocks had the potential to precipitate market mayhem. Within a year one of the scenarios emerged exactly as he presented in the Porsche/VW takeover debacle, which cost hedge funds billions.
Porsche was secretly, but legally, building exposure to VW shares via cash settled options (they already held a significant equity stake). In the meantime hedgies got drawn into what they saw as a glaring “What could go wrong?” opportunity over the inexplicable price of the VW ordinary shares. They borrowed and sold. Then on a weekend Porshe announced that they would be exercising their options and buying VW shares in the market. The difficulty was that about twice the number of shares were shorted than were available for purchase in the market. The following week VW shares went stratospheric as the shorts tried to close out and VW briefly became the most valuable company in the world. The situation was unwound by Porsche selling some shares, but not before hedge funds took a hiding.
This would have been a seismic event in itself, but is often overlooked as it was eclipsed by other stuff going on at the time (Lehman’s had just gone bust). I remember it being discussed that other shorts the hedgies had at the time may saved some of them from going bust, as more generally this was a great time to be short – just not sort VW shares.
Time and again people, even those who should know better, seem to forget the old adage, “If it sounds too good to be true, it probably is”. I used to think of it as “If it sounds too good to be true, you have probably overlooked some risks”.
Congrats on the GameStop windfall.
I’ve included a link to the full version of CNBC’s interview of Chamath Palihapitiya talking about Wallstreetbets vs the big hedges and handing the interviewer’s ass to him in the process.
I’d like to see him as Governor of California.
Loved this article. Freetrade signups and user numbers themselves have done a GME themselves throughout all of this and gone nuclear the last 24hrs with nearly 50k signups which was 10% user growth in a day! I hope you took part in some of these early Freetrade Crowdcube rounds TI because they are looking like another UK unicorn before long and will see some great paper returns for early crowd investors. Well I hope so anyway as one who took part early doors.
We’ve been here before very recently. Motley Fool chatrooms, not Reddit. Internet stock fever. Day trading as a job. Dotcom crash. I think people even used the sad faced emoji in 2001-2002
Cause: central bank money printing; both times
Result: misery for some
Everything changes, everything remains the same
@TI, I just noticed your comment on Porshe/VW, the FT article you linked to explains what happened very well, much better than I did.
I don’t agree that “shorting is harder than going long even at the best of times”. Most of the time the strategy works well simply because more stocks under perform the market than out perform. Finding stocks that under perform is easier than finding those that outperform. The difficulty comes in with the infrequent times that shorting goes spectacularly wrong. The question then is whether the asymmetric payoff, the sum of the 99 small gains and losses to the 1 large loss, is profitable. The answer is not really knowable, but philosophically it is like playing Russian roulette. You can do well over a short period, but one bullet can put you out of the game forever.
I am in two minds whether the shorting of individual stocks should be allowed. I accept that it can aid price discovery, but I question whether that is sufficiently useful to outweigh the potential market and economic instability that shorting can cause. If someone does not like a stock, they can always weight it at zero. How much more useful to the market is it to allow someone to have a negative weight?
Thanks all for the comments. The madness continues, so I’ll probably have a few more thoughts in tomorrow’s Weekend Reading. Don’t blame me — it’s all anyone is speaking about in market-land right now.
A few quick follow-ups:
@Flashb @Weenie and others — Thanks!
@hosimpson — While not having exactly the same take as you, I agree this situation is much more complicated than just a bunch of retail investors banding together to take on Wall Street, or even a single clever trade, or smart money versus smarter money. There’s something systemic here. More (very briefly!) on that tomorrow.
@MrOptimistic — That’s been essentially the short thesis forever.
@Steven John Tait — I can’t make my mind up about Chamath. Obviously I get the appeal, and agree with a lot of what he says. Especially the rhetoric about remembering where you came from when you make it (rather than pulling up the drawbridge). On the other hand, he appears to be somewhat full of it, in that his actions don’t follow his words. His venture fund didn’t seem to be run on the principles he espouses. And he was telling everyone to stop feeding their monkey brain with social media posting and yet now is as thirsty as any Instagram influencer. Maybe he’s on a learning curve. Lots to like, but not undecided. I’d even add he’s as good a claim as anyone to be the New Warren Buffett… as his track record grows it is looking a lot less like luck.
@Naeclue — With respect, have you ever tried to do any shorting over a period of months, let alone years? Your explanation is epistemologically on-point but would founder on the rocks of pragmatism. Shorting is more difficult outside of basically one environment – a crashing bear market. (Not just because stocks are going down, but because frauds tend to be unmasked and IMHO frauds are the best shorts.)
It’s true most stocks underperform the market over the very long term, but investors don’t live in the very long-term — and especially shorters do not. There is a meaningful ongoing cost of shorting (you pay to borrow shares) and there is a risk control issue (stocks doubling or tripling before reverting to the sub-par mean can blow up your fund).
Off the top of my head the only legendary investor who got that way consistently shorting was Jim Chanos. I guess there’s some macro guys (Soros etc) but that’s another situation really.
Short funds have been closing for years as the bull market has rolled on. It’s also smashed the returns of the likes of Einhorn, who whatever one thinks of him or active investing is best of breed at least with respect to traditional ‘value’ investing.
If you believe you’ve seen a gap in the Matrix, go make billions! 🙂
@TI, I have never shorted the market but spent a career working in and for companies that did. Very few simply go short, they go long the market and short the securities they don’t like. Gear that up to whatever limits your risk management allows. A rising or falling market is irrelevant.
@Naeclue — Yes, I understand that and how it works. 🙂 I think if you call up one of your former colleagues and say — outside of frauds — is going short a harder decision to get a pay-off from than longs, they’ll agree with me. (Harder being the totality of everything: return, risk, volatility, perhaps even career risk in their case, etc).
@lenahan — Wow, 50,000 sign-ups! I was feeling good because a handful of people took up the referral offer in the article above haha.
Yes as I’ve said a few times on Monevator I am indeed a pretty early investor in Freetrade, though not in massive size.
I was even there for their first round pitch, but when I asked him the enthusiastic CEO didn’t seem to know about CGT reporting rules regarding turnover, which was a pretty minor detail but enough for me to make it a pass.
I look for any excuse to pass on start-ups, typically, just because there are so many of them and so many go bust you need to filter, but in this case history is showing it was an expensive snap decision. 🙂
@hosimpson. It’s not just a decade of low rates or QE. People blame it on that but it’s actually savings rates. In 2020 those savings rates exploded higher and are way beyond anything seen post WW2. We’ve experienced a massive fiscal transfer from the public to private sector. That money creation has only been partially sterilized through bond issuance.
So the private sector is awash with cash and has nothing to do with it. The bulk still goes into various assets classes, like govt bonds or S&P, pushing them up. But when US retail get their helicopter money from the US Govt, some of it gets gambled on Bitcoin or some minor stocks. That’s multiplied many-fold by easy access to leverage. Anyone can get a margin account. It doesn’t take much to squeeze illiquid products like these.
The issue is what happens when the lockdown unwinds. What happens when people decide to go back to consumption and have to raid their savings to do that? What happens if the govt sterilize that money creation through higher taxation? I find it very easy to believe that the environment for asset prices will be much tougher in the recovery than in the crises.
Great write up 🙂 Apparently, the GME gang were selling merch t-shirts too! What a time to be alive…
> Yes, more than the entire issued share capital had been sold short by sophisticated and amply remunerated market participants.
I recently learned (thanks Twitter) that the number of shares sold short cannot be more than those outstanding unless you’re not counting the fact that the lending creates an additional share “long” in the float. The best explanation I’ve found so far is this:
“Say a company has 100 shares outstanding, but short interest is reported to be 150%(!) of the outstanding. On the brokers’ books there will be 250 shares long and 150 shares short. The net amount (250-150) will always equal the actual shares outstanding.”
So short interest is not really 150% but 60% (150/250).
@Foxy — Thanks for the further thoughts. Yes, that’s roughly as I understood it, though this market mechanic stuff is not my expertise. But anyway I think both statements (yours and mine) are true, no? 🙂
@TI, Yes, that’s true. The number of shares short can be very high assuming enough lending (some re-lent on margin too!). But when people say 120% shorted they use the wrong denominator (outstanding shares) instead of (outstanding shares + number of long positions increased thanks to shorting). Just wanted to clarify that.
Not my expertise either, I was just very curious!
On another note, a notable difference between Freetrade – Robinhood worth mentioning is that Robinhood apparently sells their order flow to other institutions. FT don’t do that and not sure it’s even legal in the UK.
Really regretting not loading up on FT shares in early rounds as I think they don’t sacrifice integrity for numbers (so far!).
If anyone is interested in the mechanics of why Robin Hood suspended and reinstated trading in certain meme stocks yesterday, this short Twitter thread is an easy read:
https://twitter.com/JohnStCapital/status/1354992356437721089
@TI, a conversation I have had many times. If I ask those I knew who engage in long/short strategies whether it is easier to make money by simply going long, the answer is always “Absolutely not. On a risk adjusted basis long/short wins hands down – just look at the track record”. They would also say that it is far easier to identify companies they think will under perform than out perform. But then they would say that wouldn’t they?
My own personal opinion is that, whatever their track record shows, long/short is unlikely to give better risk adjusted returns on a long term basis. The track record does not properly account for the yet to be observed periods of poor performance, the infrequent very expensive blow ups and the drag from borrowing fees. Like all active fund management, this is largely a game based on survival of the luckiest, so at any point in time the track record always shows, on average, survivors with good track records.
@TI, Warren Buffet’s view on shorting individual stocks is interesting and backs up what the long/short crowd say.
https://www.google.com/amp/s/finance.yahoo.com/amphtml/news/warren-buffett-explains-why-no-204005627.html
“.. while being short is tempting, as most investors will see ‘way more stocks that are dramatically overvalued’ than stocks that are ‘dramatically undervalued,’ during their careers, it is a ‘very tough business because of the fact that you face unlimited losses.'”
@Naeclue — Your position/contention seems to be morphing. But anyway, you write:
Fine but this isn’t shorting. If you look again at my responses, I’m specifically talking about the actuality of shorting stocks in a fund/portfolio, as in taking money and betting stocks will fall, not backtesting against the market or saying “find me 10 likely outperformers and 10 underperformers” or considering whether most stocks underperform over 30 years or anything else.
Shorting stocks = shorting stocks. 🙂
Shorting is IMHO harder (which was all I said initially) because of what I (and Buffett 😉 ) say about the asymmetry of risk/return. It’s harder because it’s costly. It’s harder because of time horizons. It’s harder on one’s emotions, outside of rare bear markets. Even shorting frauds, which is the best short, has special challenges.
But anyway I’ve said my piece and this isn’t really a thread about shorting.
More than happy to agree to disagree. 🙂
Yesterday saw many prime brokers report the largest book degrossing move in equities since late 2008 as longs/shorts were cut hugely. Another one of those 8-10 sigma moves we expect once per universe but get every decade.
I don’t think shorting is necessarily expensive in operational terms. I don’t do equities but I can’t imagine the haircuts are that large and funding costs will be low given how willing banks are to lend money at very thin spreads over Fed funds. Clearly, this all depends on the ability to ‘locate’. Where borrowing becomes hard, expect a brutal repo squeeze.
The problem simply comes down to the positive skew. 55% of equities underpeform cash over the long-term. So, typically, if you short a random stock, you’ll make money. The problem is 85%+ of the returns are produced by 5% of the stocks. Do it for long enough and one day most will accidentally short Apple, Amazon, Alphabet etc.
Of course this only applies in equities. Most asset classes and financial products are not super-log, they are intrinsically more symmetric/normal. Shorting in those is no more or less risky than being long.
Apparently there was a small community of investors researching GameStop as a value play long before WSB got involved. The Bloomberg Odd Lots podcast had a fascinating, and very humble, interview with one such investor.
https://www.bloomberg.com/news/audio/2021-01-29/how-to-make-the-score-of-a-lifetime-on-gamestop-podcast
The real news here might be that is the funds shorting GME were simply wrong and the company was not only sound, but undervalued. Of course, now it’s overvalued and in a speculative frenzy… but WSB pumping this isn’t the whole story.
@Andrew — Sure, that might get you from $5 to $10 or even $30 a share. As I said in my piece, it seems a weird conviction short to me, though in reality it wouldn’t have been seen as a make-or-break the fund position until this craziness started.
But anyway, when the stock has 10x-ed beyond a reasonable re-rating and is moving up and down by 300% *intraday*, as it did yesterday, then for now WSB is the whole story. 😉
@all — Unfortunately it seems Freetrade has been caught up in the outage/carnage now:
https://twitter.com/freetrade/status/1355161107699273729
It’s disabled US stock buying today and blaming third-parties. (FX provider and their bank)
If anyone feels this isn’t actually all very weird, you should also know there’s a sea shanty revival aspect to this TikTok trading activity, which has inevitably come to GME, also:
https://twitter.com/JoshConstine/status/1354697609366016001
@TI
Thank you for the sea shanty link. Made me chuckle. I needed it today.
Now could somebody with relevant skills pretty please plaster GME T-shirts on these guys and overlay the audio?
If we all traded on distributed blockchains then we wouldn’t have to worry about these brokers denying us our rights to access the markets!
(tongue in cheek)
Very interesting times and great post. Why can’t the Gamestop board, founders or employees (who hold shares) sell some/all of their holding at these elevated prices and build a cash reserve to re-invest it in their business. They can probably buy back the sold shares at lower prices when the madness end. That would probably be a sweet revenge against the short-sellers who were trying to bankrupt gamestop.
Yes, you could almost *feel* it, at the sake of sounding ridiculous. Suspect similar is going on today. Vix seems quite elevated.
Unfortunately unlike previously this week it’s all very orderly so far. Haven’t so far spotted any fun dislocations in stocks I’ve been wanting to own.
@TI, I actually agree with you and disagree with those who practice long/short who claim they get better risk adjusted returns that way and it is easier to do so than with long only.
Most of the time and provided the portfolios are properly run, long/short can work well, with no more angst than with an active long only fund. Probably not true for many retail investors though who lack proper risk management and for the reasons you state.
But when long/short does go wrong, as is the case here, it can end far worse than with long only (unless geared).
It must be very harrowing as well. You have a short that goes up by a factor of 5. Your analysis suggests this is purely as a result of a short squeeze. Fine, you have plenty of collateral, the price is mad and will likely settle in a few days as sellers are lured into the market. Next day it doubles and you have to put more stuff up as margin. This is crazy and clearly unsustainable. Why would anyone hold at this price? Best to hold out as a snap back to a sensible price would give a big boost to portfolio value. Next day it doubles again, another margin call but you are not buying because at the current price this is the best short you have ever seen, well worth the risk, surely this cannot go any higher?
What is cruel here is that the shorter is absolutely right, the analysis is probably correct and the price most likely will come down, but will they run out of collateral before that happens? They are now in survival mode. What have they missed in their analysis? Is it best to start buying now so that you can at least salvage something and stay in the game?
At least with ungeared long only a market crash cannot take you below zero. With a crash you still hold the shares and are not a forced seller, unlike the situation when a short blows up and you become a forced buyer.
@Naeclue ^your words there remind me of Frankies magnificent 7 at Ascot back in 97 from the bookies point of view. His 7th horse should have been something like a 10>20/1 shot on any normal day but a wall of mug money and all the multis rolling over had crushed the priced to something around the 2/1 mark. Alot of the bookies had no way to get rid of the liabilities at what they see as the correct price and in fact a few went all in on the basis it was the lay of a lifetime when they got to lay that last runner at 2/1 when he should have been x5 to x10 that price. We all know what happened next haha.
A truly mind blowing situation, I tried to purchase at 18 back at the start of Jan. But delays with my pension payment from work meant that I was unable 🙁
@JDW #4 – re:
“I haven’t experienced a full cycle yet – only really started investing in 2015, and strongly from 2018 onwards, but always mindful of the bigger picture…”
As some friendly advice, you don’t have to have lived it to be familiar with it. The history of price – in any asset class – is a matter of public record, and history most definitely repeats itself in this game.
As much as things may seem different, they aren’t. You just need to be familiar enough with what happens at each stage of a cycle to anticipate it —
that means studying price movement religiously, across numerous asset classes, for a very long time. And if you’re slightly off (or completely wrong) on the entry, just hold the asset/position until you’re right — leaving yourself room for other investments in the meantime.*
*Part of the cycle can include periods of 7+ years with little to no movement, at the lowest price points.
Well GME got made into a (bad) movie.
Almost 3 years on now, it’s clear it was a starting flare for the madness of 2021, illuminating a crazy hell scape of pump and dump meme coin littered fury which began to unravel over the year, but never quite gave up the ghost entirely, even as, over the course of 2022 and 2023, Terra /Luna imploded, SBF/FTX crashed and burned and eventually even Binance took a plea on DoJ/SEC action. I have more sympathy for the r/WSB crowd than I’ll ever do for the crypto / coiner grifters.
There was a real and legit opportunity in GME, and they took it. Paraphrasing Matt Dillon (as Bob, in Gus Van Sant’s 1989 masterpiece), with GameStop they “played a game you couldn’t win… to the utmost.”
I look back on my comment on Chamath and cringe.