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Did Armchair Reddit Investors Break Wall Street?

The decentralized hedge fund over at Reddit’s Wall Street Bets took down the big boys.

Did anyone have “armchair investors on Reddit beat multi-billion-dollar hedge fund” on their 2021 bingo cards? If so, here are a couple of shares of the memeified BANG (BlackBerry, AMC, Nokia, and GameStop) stocks. The first quarter of the year was a raucous period for the financial markets, with self-proclaimed “degenerates” on a social network eviscerating Melvin Capital. This story certainly deserves a motion picture treatment a la The Big Short or The Wolf of Wall Street. But now that the decentralized hedge fund of 9.9 million online participants has taken down the smartest men and women in the room, the bears on The Street have ostensibly been permanently frightened off from betting against anything at the moment. While this would satisfy investors whom the shorts have burned, will this remove a crucial market function?

The Memeification of the Stock Market

Today’s market conditions are perfect for the short-sellers. Stocks are overvalued, the leading benchmark indices are sitting at all-time highs, and the Warren Buffett Indicator (a measurement of market valuation to gross domestic product) is at nearly 200%. Suffice it to say, elevated valuations, courtesy of the Federal Reserve’s money printer go brrr campaign, should provide ample supplies of ammo for the shorts. Well, not quite.

According to new numbers from Goldman Sachs Group, the median short interest in S&P 500 stocks rests at a 17-year low of 1.6% of market value. Morgan Stanley figures highlight that short-covering among European traders has collapsed bearish bets. JPMorgan Chase’s analytical team has seen hedge-fund longs at their highest levels in years.

On the one hand, accommodative monetary policy, aggressive fiscal stimulus and relief efforts, and the economic recovery should be reason enough to be bullish. On the other hand, consider this fact: Goldman Sachs’ handful of most-shorted stocks has spiked three times as much as the broader financial market this year amid the influx of Robinhooders during the January-March quarter.

The subreddit has crowdsourced stock information that is available to everyone. The one statistic that united a social media page – the percentage of float shorted – is public knowledge. The so-called apes on WSB used this to their advantage and forced the power players to cover their shorts, resulting in billions of dollars in losses for the hedge funds and lots of life-altering gains for retail traders.

While GameStop and AMC captured all the attention, other stocks that have been heavily shorted are still performing well. PubMatic, a cloud technology firm, has a short interest rate of 47%, but shares have rallied 92% year-to-date. GoGo, an airline Wi-Fi provider, has surged more than 13% since the end of March, despite a 30% of floated shorts. KemPharm, a specialty pharmaceutical company, faces an 11% short rate, but shares have surged 53% over the last three months.

“Short selling of what were historically the ‘go-to’ shorts has slowed dramatically and not been replaced by ‘new’ shorts,” Morgan Stanley researchers wrote in a client note. Tesla Motors CEO Elon Musk, who has had quite the beef with the short-sellers, must be smiling.

Will Burning the Shorts Have Consequences?

Contrary to popular opinion, the shorts play a critical role in the stock market. The professional short-sellers are not colluding and conspiring to take down businesses. Instead, they smell something fishy in the equities arena, they notice something wrong with the books, and they see an opportunity to make money. That is how shorts work – and sometimes they get it right, and sometimes they get it wrong.

[memberzone align=”left”] A great example of this is the troubled Chinese coffee company Luckin. Muddy Waters Research downgraded the stock to “sell” before the rest of the market hit the sell button, calling it a “fundamentally broken business.” The firm tweeted in January 2020 that a “number of items per store per day was inflated by at least 69% in 2019 3Q and 88% in 2019 4Q.”

“Luckin shows exactly why we need short sellers in the market,” Muddy Waters founder Carson Block told CNBC. “We believed this report was credible when we read it, and that’s why we took a position.”

On the opposite end of the spectrum, short investors have lost tens of billions of dollars betting against Tesla Motors. Is the stock valuation justified? Perhaps it is not the company per se but the chief trolling officer behind the $700 billion brand. Maybe one day, Musk’s premium short shorts will be bought by vindicated Wall Street traders who were cynical about Tesla’s $720-a-share price. Until then, this bet was a massive black eye for the shorts, requiring a 14-ounce T-bone steak to nurse the bleeding under the skin around the eye.

Overdosing on Market Euphoria?

If the bears have left the party and the bulls are the last ones standing, does this mean euphoria has taken over the entire market? The financial colosseum has endured a once-in-a-century public health crisis, tens of millions of lost jobs, and thousands of shattered businesses. After facing this bombardment of terrible news, it seems like nothing can bring the stock market to its knees. Perhaps a capital gains tax hike, good old-fashioned inflation, and petrified institutional investors will be the banes of distress, forcing everyone into bonds, bullion, bitcoin, and bucks.

~

Read more from Andrew Moran.

Read More From Andrew Moran

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