The French Revolution of Finance?
These past several days we have witnessed a rise of a new force in the market, one that has threatened the very existence of some of Wall Street’s largest players. Using the website Reddit, and a “subreddit” (an in-group word for message board) called WallStreetBets, an army of relatively small retail traders, along with some more wealthy compatriots, discovered a loophole in the system. They found that if they acted in a coordinated fashion, they could drive up the price of a stock, make money together, and strike a blow to the hedge funds that were betting against that stock. The target? A floundering video game retailer called Gamestop.
Redditors uncovered a fact that more than 130% of this stock’s shares were held short. Without getting too technical about how that is possible, just know that shares can be lent out to be sold short multiple times. It was the most bet-against stock on the street, and some big money hedge funds, including one called Melvin Capital, had highly leveraged bets that Gamestop would continue to decline. Enter the Reddit army.
Using the language of battle, this coordinated band of retail traders, many of them cut off from their normal outlets due to the pandemic, many of them using government stimulus money or extra unemployment cash, and many of them frustrated with years of perceived oppression by corporate oligarchs, began buying Gamestop, mostly on a trading platform called Robinhood. And they continued to buy, hoping to force a phenomenon called a “short squeeze.”
A redditor urges his fellow traders to “hold the line” as the market opens with a gif from the iconic war movie Braveheart.
The squeeze happens when a highly shorted stock begins to rise above the prices where traders had bet against it. As it goes up, those short sellers must close their position by buying back the stock at a higher price. This buying begets more buying as momentum algorithms file in, and eventually the squeeze is on as traders desperately try to exit their positions at higher and higher prices. This happens all the time, but it is usually an organic process. This time it was targeted and coordinated, and the Redditors kept buying. In the extreme, you see what happened this past week in Gamestop. On January 13th, the stock was at $19. A week later on the 20th, it was at $39. A week after that, it was at a high of $396. That is nearly a 2,000% increase in just two weeks.
The year-to-date price chart and the four-year income statement for Gamestop, symbol GME.
Make no mistake, this is a company that is losing money, closing stores, and has no business having a $24B market capitalization. For reference, other companies in the $25B market cap range are Allstate Insurance, The Clorox Company, and Prudential Financial. And now Gamestop.
Melvin Capital (and reportedly other large hedge funds) were forced to seek capital injections from other funds. Melvin got backing from a fund called Citadel to the tune of $2.75B so that they could plug the hole due to Gamestop losses. As of writing, Melvin claims to have closed their short position, but the Reddit army does not believe them. They are still buying. “Viva la Revolution” right?
Not quite. The Robinhood platform promises commission free trades and gives free shares of stock to new users. Well, as the old saying goes, “if you are not the customer, you are the product.” In this case, Robinhood makes most of their money by selling order flow (data on client trades) to hedge funds so that the funds can use high frequency trading to front-run Robinhood traders. One of Robinhood’s biggest clients is, you guessed it, Citadel. This is irony wrapped in irony.
Just as it seemed that the Redditors were going to win and strike a serious blow to the Wall Street billionaire class 10 years after the Occupy protest, you began to see the oligarchy strike back. Robinhood, TD, E-Trade, and other brokers restricted the purchase of Gamestop stock (along with several others the Redditors were targeting), CNBC was doing interviews with former Attorney Generals and the Nasdaq Chairwoman to discuss new regulations and “what to do” about this band of rogue traders. The WallStreetBets chat board was removed from a popular chat server and talks of government shutdowns began. This episode has garnered the attention and agreement of some of the most unlikely of characters.
Progressive Congresswoman Alexandria Ocasio-Cortez and literal richest man on the planet in agreement on Twitter.
The people love a good villain, and a short-selling, multi-billion-dollar hedge fund is not a sympathetic antagonist in this story. However, it is important to note that often the largest clients of these funds are state pension systems like CalPers, or university endowments, and that there are real people on the other end of these trades, not just cackling billionaires. According to Reuters as of 1/29, losses by these short-sellers have topped an estimated $70B this year. These institutional clients have been forced to take on more risk to meet their obligations, because of an artificial interest rate environment that makes investing in fixed income securities all but impossible. But that is a story for another time.
It remains to be seen how this situation will play out. As of writing, Gamestop is back up on most trading platforms after lawsuits were filed and Congressional hearings threatened, and the Reddit army is back at it. One thing is for certain though, we are witnessing a seismic shift of power in our markets. Over the last decade we have seen industry after industry fall under a wave of democratization and decentralization. Retail, media, education, transportation and more have undergone radical bottom-up transformations. It was naïve to think that the wave would not reach markets and finance, and we are seeing that in real-time this past week. I certainly do not want to be short this movement.
