The flood of retail investors piling into markets like the Redditors behind the Gamestop mania has been described as a “harbinger of over-exuberant markets” and evidence of potential equity bubbles brewing.
Down on its luck video game retailer Gamestop took the investment industry by storm at the end of January after an army of amateur traders on Reddit targeted the stock, with the intent of sending its shares “to the moon” and letting Wall Street have it. What followed was a frenetic week of trading which saw other beaten up and shorted stocks US cinema chain AMC and out of fashion mobile phone company Blackberry take off.
At its peak Gamestop was up 1,500% at $483 a share compared to its $17 price tag at the start of the year. Hedge fund Melvin Capital, which was heavily short the stock, lost more than 50% last month.
Since then, the dust has settled, and its shares are back down to $60 with some of the loss of momentum down to brokers Robin Hood, Charles Schwab and Etoro restricting trades as they struggled to cover their positions.
Though the Gamestop bubble appears to have burst, the week of explosive trading activity has some investors worried valuations are looking frothy.
‘When there is ample liquidity and no way to spend it, geysers will emerge’
Ruffer Investment Company likened the situation to prior bubbles formed by speculative trading on margin in its January investment update.
“The David and Goliath nature of the story has captured the imagination of the press but taking a step back it reveals some more interesting insights into market dynamics,” managers Hamish Baillie and Duncan MacInnes wrote.
“The appearance of retail investors at the party is often a harbinger of over-exuberant markets and many previous bubbles have coincided with an increase in investors (or should that be speculators) trading on margin – the equivalent here has been the ease of access for retail players to options and other derivative instruments.
“These events also show that when there is ample liquidity available (cheques dropping through the letterbox) and no way to spend it then geysers will emerge.”
Tesla and bitcoin accused of breaching bubble territory
Gamestop is not the only stock accused of being a speculative bubble. Tesla, which has seen its shares rocket 700% in the last year, has been flagged as being overvalued for months. The electric car maker was also at the centre of a squeeze a year ago which caused a massive headache for short sellers like former Jupiter Absolute Return manager James Clunie.
See also: Jupiter fund conquered by ‘nemesis’ as Tesla soars
Bitcoin has also been hailed as a speculative trade and its violent price swings in 2021 have prompted the Financial Conduct Authority to sound the alarm. Yesterday it smashed a new record high of $44,868.98 after Tesla founder Elon Musk bought $1.5bn (£1.1bn) worth of the cryptocurrency.
Despite raising concerns of bubbles, Ruffer Investment Company owns a 3% holding in bitcoin which it has touted as a new kind of safe-haven asset.
See also: Ruffer defends bitcoin holding amid FCA warnings on cryptocurrency
Reddit trades not enough to ‘destabilise’ markets
Psigma Investment Management head of investment strategy Rory McPherson sees the Gamestop and similar Reddit “hot” stocks as “being unhelpful for market sentiment but not destabilising”.
“It’s often the case that one does see mini-bubbles towards the end of a bull market and while we definitely don’t dismiss this, we don’t think it’s enough to destabilise the equity market.”
McPherson says the speculation has been “fairly tightly contained” in a handful of stocks that had been well-scoped out by investors beforehand as being heavily shorted and ripe for a squeeze.
“The failure of this action to broaden out into silver for instance is encouraging as it suggests that the broader market is still more being driven by stimulus, sentiment around the economy re-opening and corporate earnings,” he adds.
Gamestop was a ‘once in a lifetime’ trade
Tyndall North American manager Felix Wintle thinks equity markets have much further to climb.
Wintle was one of a small handful of professional UK investors to profit off Gamestop during the recent rally. Buying in at $18 a share in December as a recovery play, Wintle sold out gradually when shares hit $90 on 26 January, netting him a 5x return on his initial investment in three weeks, a “once in a lifetime” trade.
“I think we should all expect prices to continue to rise and there to be some big movements because we’re in a post-recession recovery, but we’ve also got all this stimulus, so earnings are going to be great, GDP is going to be great, and inflation is rising,” Wintle says.
On top of this stocks should benefit from incoming stimulus from planned infrastructure spending, the Federal Reserve has pledged to keep rates low, and a weaker dollar, he adds.
Wintle thinks “all the facets for continued short squeezes are there” given the Covid recovery backdrop and the fact people are cooped up at home with stimulus cheques to spare and time on their hands to trade.
“So, if you can find a stock which you think is a good recovery play, now’s the time to be looking for them, and the more heavily shorted they are then the more likely they are to go up.”
Short sellers will have to adapt like active managers did to threat of passive funds
In an analyst note JP Morgan speculated while there are “many analogues” between the Gamestop phenomenon and the flood of retail investors in the late 1990s which culminated in the tech bubble, the recent technical tumble is “likely short-lived”.
“We believe the positive macro setup, improving fundamentals and Covid-19 outlook, strength of the US consumer, as well as the reflation theme remain the bigger forces at play.”
But it added the growing army of online retail traders has changed the game for short sellers. Declining trading fees and commissions for single stock, ETF and options trading, the ease of use of trading apps and “social media spreading Fomo and new trade ideas” have gotten more amateurs hooked on investing.
See also: Hargreaves profits boosted by younger savers with spare cash during lockdown
This trend has only accelerated during the Covid crisis with D2C firms witnessing record numbers of trades across their platforms including during the November vaccine rally. JP Morgan estimates based on retail brokerage filings show peak retail volume represented 30% of total volume.
As such, JP Morgan thinks short sellers will have to adapt to their investment processes similar to how active funds had to respond to the growing threat of cheaper passive products.
“Similar to the 1987 crash, which permanently left a print on the vol surface, the short squeeze risk will likely be more closely monitored and more accurately priced-in going forward, especially in stocks with extremely high short positioning,” it said.
“For example, one may need to systematically analyse social media chatter for stocks with growing retail participation.
“Thus, the investment process will need to evolve with the changing investor composition (ie similar to the impact systematic and passive products have had on equities over the last decade).”
