Revolution or Rumble on Wall Street?

Revolutions have a habit of starting from seemingly innocuous events in the least expected places led by unlikely protagonists. The unfolding “clash” between Reddit’s r/WallStreetBets (r/WSB) Davids pitted against Wall Street institutional hedge fund Goliaths is more than a story of one or two stocks in play; it is having an impact on broader market sentiments.

Boom

The touch-paper might be the recent developments in the US equity markets with regard to GameStop’s (GME) wildly gyrating share price in the last two weeks and ensuing market turmoil. It is the result of a r/WSB retail investor led ‘short squeeze’ of institutional, short selling, hedge funds. It has all the hallmarks of a revolution in the making.

Are we reliving history? “Boom” - the thudding sound of a falling share price or; salvo of change?

This clash between r/WSB Davids pitted against Wall Street institutional hedge fund Goliaths is more than a story of one or two stocks in play; it is having an impact on broader market sentiments.

The r/WSB “degenerates” inspired retail investors are more than blowers of asset bubbles; their aspirations and actions may well create longer lasting change. Sadly, amongst the winners, there will be casualties.

This unfolding drama has many layers, some darker and more enduring than others; that may well have an influence on the portfolio of today’s investor and future investment strategies.

For investors trying to understand the immediate effects that this Wall Street drama may pose; a list, while not comprehensive, is provided below to stimulate a dialogue and review – a 15 second scan. For those readers curious as to the dynamics and issues at play a longer read awaits after ”Rage”.

Possible implications for investors in (US) Equities

The following themes and time-frames are worthwhile considering

·       The immediate term

o   Individual (stock and investor) trading of “rocket” and “meme” stocks is possibly restricted

§  The ability to access r/WSB target companies, aka “rocket stocks” (essentially high short sold with strong forum attention), will be restricted.

§  This restriction may extend beyond rockets (eg BB, PLTR) and memes (eg; AMC and SPCE) to venerable stocks; such as Starbucks and General Motors,

§  Margin requirements may well increase to 100%.

§  The liquidity and volatility of these rocket stocks will be reduced.

§  Thus, the ability to realise very high daily returns is limited.

o   The terms&conditions of the trading platforms may be changed; either with increase restrictions and/or costs.

o   The valuation of the overall market may soften. Already a perceived trend due to small increase in bond yields. It is likely to reinforced as the large hedge funds and institutions in a defensive move rotating out of the current Technology based stocks, a number of which are favoured by the r/WSB cohort.

o   Fundamental analytical tools may not give much comfort, as trading by ‘flows’ becomes the way to navigate frothy markets.

o   Trading does not equal investing.

·       Medium term

o   Formal reviews may seek regulatory changes that limit the access to certain trading platforms and products

o   Trading costs may well increase.

o   The transparency and availability of market Information will be reduced. Most of the institutions are the source of this data and self-interest will led to limitations with regard to its distribution.

o   The Equity markets may see a short-term boost in values.

o   The use of Options will be utilised by more retail investors as is provides a mechanism of entry/exit, risk management and prospects of enhanced returns.

o   In parallel central banks may decide to limit QE and raise interest rates.

o   These dynamics may make alternative assets attractive (such as Commodities; as well as FinTech, Blockchain and ESG) beyond their intrinsic values.

An investment strategy which incorporates momentum stocks still has a certain validity. Playing meme-stocks (a la r/WSB) has its risks and rewards both significant. Yet, the discipline of: appropriate choice of stocks; use of equities and options as well as; productive trading are all the enduring characteristics of a robust investment portfolio.

Rage – fashion and fury

The current retail investor rage (in all its senses) of the r/WSB forum and its subscribers’ equity investments, mainly targeting heavily shorted US equities, could be the tinder of a broader revolution, however small. 

The reinforcing forces of sentiment-based valuations and Covid-19 restrictions have attracted a new set of retail equity investors in the US. The r/WSB inspired retail investors feel slighted by Society. In the last two weeks its membership has quadrupled to over 8.4 million subscribers.

It is part on the unfolding twists & turns of a digital take on an age-old story: reasonable expectations of a minority group being unreasonably and unjustifiably thwarted by the Establishment. It is a story-line worthy of MCU and Disney (not yet a restricted meme stock). In fact, the chosen metaphor of the 8.4 million w/WSAB Forum members is “Star Wars”. Pitting the just-cause inspired ‘Rebel Alliance’ of r/WSB investors against the ‘Dark-side’ and its manifest ‘Empire’ of Wall Street institutions. The seeming infantile communications mask an earnest, sophisticated and serious investing force.

Recently, an orchestrated group of the r/WSB members have employed successfully a classic investment ploy to drive value: the “short-squeeze”. With the GME stock, using a mix of equities and options, the share price skyrocketed from $20 a share to over $483 in the space of a week as the short squeeze was effected. As a result, in what might be one of the largest and quickest transfers of wealth, nearly $20 billion was transferred by the losing short selling hedge funds to shareholders, who themselves had invested about $100 million in GME stock.

The r/WSB cohort is jubilant in their success, in having beaten the “suits” of Wall Street at its own game.  

The Empire bruised, but no injured; has struck back; essentially blocking off the ability for the cohort to trade. The r/WSB members now feel unjustly thwarted to continue their successes

This institutional reaction has added insult to injury in the minds of the r/WSB forum investors. It has wider implications.

The bruised institutional short sellers hedge funds have rallied their formidable resources and forces. New capital has been found within days to shore-up beleaguered firms (such as Melvin Capital as well as Robinhood.com). Also, the market intermediaries of prime brokers and trading platforms have used self-serving arguments of: market fears, fiduciary responsibilities and legal protection to literally limit trading of certain stocks and investors; even for cash investors. These restrictions apply not only to meme stocks but the likes of Starbucks, BlackBerry, GM and Nokia. Any stock with a large ‘short’ position. Margin control might have been a more acceptable manner to reign in demand under the banner of ‘risk management’ (and self-interest). But even established Interactive Brokers have followed fellow minnow start-up, Robinhood.com, in blanket bans.

An abuse? To be determined. To quote Senator Elizabeth Warren: [recent trading] "raises troubling concerns about Robinhood.com’s relationships with large financial institutions that execute its trades".

The r/WSB cohort are crying “foul” with these restrictions, which seem against the spirit and letter of equity investing in US markets.

Dark…

Furthermore, the Brokers’ reactions are revealing the machinations of the obscure and arcane world of the financial systems.

Sophisticated trading strategies are being deployed by both sides. With share swings of 50% a day, a person observing the trading screen can see real-times the advancing green-bars of the buying cohort (“hold the line” …” buy the dips” ….” we like the stock”) are countered by successive red-bar hammer blows administered by the baited hedge funds shorts. ‘Ladder’ strategies all the way.  The short interest in GME declined from 140 to 50% in a matter of days as the hedge funds regrouped. Suggestions of synthetic options and definitional slight-of-hand by institutions are prevalent. Share price frenzy at GME, moves then to AMC, BBBY, BB, PLTR, etc; but stifled by (sudden and questionable) platform restrictions.

The role of the Depository Trust & Clearing Corp (DTCC) has been thrown in to sharp relief – it is the single central clearing organization for all equity trades. With the dramatic volatility of GME’s options (to over 700%) it asked for a daily increase from the intermediaries, from $26 to 34 billion. DTCCs role is clear, but what of “Dark Pools” and other related elements and aspects of the financial system that the general public are unaware, and the Media seldom report? It has the whiff of LIBOR, before it was beset by scandal, proven abuse and demise.

In the ‘fish-eat-fish’ culture of hedge funds traders it seems the Forum inspired short squeeze of GME allowed some venerable sharks to join. Analysis shows that in volume, the r/WSB investors were not in the top 10 group of investors for GME. A fact underscored by the volume and nature of options. Institutions shorting each other.

Despite the cries and actions, the Regulators have proven slow to act, and in the Forum’s posted opinions, protect. The Media, mindful of where their revenues are generated, echo established story arcs. The Politicians position themselves for sound-bites as they question the direct and indirect actions of all.

The dynamic has revealed the later potency of the Internet. It allows for access, speed and mobilisation. There have been claims and counter claims of hacks and bots. The site’s server even darkened for a day. Reddit and r/WSB are amongst the seven most visited Internet sites.

Each side landing bruising blows against the other, suffering set-backs. In its wake and conclusion, the protagonists may not be achieving the ends they imagined: nether short nor long term. Action leads to reaction to repression to abuse in a spiral of change. Revolutionary passions are fanned.

Democratization of finance and investing

It is a an ugly phrase and reflects the nature of the process. What is clear is that this r/WSB struggle is just another manifestation of the financial democratizing process which continues to accelerate. Is this greater access with greater voice for the masses or greater access to perpetuate a tiny incumbent base?

The latest example is the explosive growth of zero-cost investment platforms (such as Robinhood.com) which has attracted a new segment of Stay-At-Home GEN-Xs & -Ys. Many are tech-savvy, due to their generation-age as well as online gaming experience. Such means are giving them easy access (time & cost) and ‘credit’ to participate. From playing fantasy of “Counter-Strike” to real world Options contracts in GME with a flick of a switch. This sizable group of new retail investors (now representing 20% in daily equity volumes and more in any single stock) are trying to make the best of Covid-19 enforced restrictions as well as the continuing economic deprivations, some extending back from the Credit Crunch of 2009.

The Forum is not a pack of Jordan Belfort wolf-cubs; but they are drawn to the same ‘get-rich-quick’ prospects of the 1980s and 90s. Some of its members are professional traders themselves, and as well trained as any on Wall Street; others are very fast-learners. The Forum’s open source, sharing style and with investing idols (such as Musk-Palihapitiya-Wood-Cuban) contrasts with the secretive, furtive faceless institutions of Wall Street and their chosen figures of derision chosen from the ranks of at Citron, Melvin Capital and Citadel Securities.

The r/WSB cohort’s investments, equity and more importantly the use of options (in GME and other meme-stocks, such as TESLA/TSLA, Palantir/PLTR BlackBerry/BB, AMC to name a few) has added to the current market’s evolution. The increased use of options for the average US investor has increased from less than 20% to over 40% in the last twelve months. “Greek” is no longer a language of Europe, but financial parlance of an increasingly adept body of options investors; “thetas” abound in search of that elusive “gamma squeeze”.

The Forum’s strategies are sophisticated and given import by collective action. Last year, The Forum’s members out-invested Warren Buffet in his airline holdings. The TSLA and GME developments have emboldened the Forum further.

This saga reflects and reinforcing sentiment-based valuation of markets (such as TSLA). The ongoing Bull market and frothy valuations are a product of long-standing regulatory actions and political policies. These government edicts (such as QE mechanism, SPAC based IPOs) in addition to low levels of accountability for mismanagement are making available into the economy huge sums of money. The US stimulus cheques are likely to end up in this flow. These sums are being channelled into the equity markets as the concept of a ‘risk premium’ is further eroded by low/negative interest rates.

Is this drama leading to increased investor sophistication or frustration?

If nothing else, the successes of r/WSB short squeeze/momentum investing strategies has encouraged renewed interest in equity investing.

Revolution or Rumble

Some industry observers view the r/WSB developments as a side-show; an episode in the rough and tumble world of zero-sum equity investing. They cite investing mania, “irrational markets” and mention tulips. It will all blow over. More than likely with GME and AMC case but what about the broader horizon?

More thoughtful voices, such as Goldman Sachs, have raised a concern that if unchecked, the development could have significant negative repercussions on the structure and dynamics of the equity markets. To quote: “…if the short squeeze continues, the entire market could crash”. Other participants have opined that the GME gyrations reveal that the market structure is inappropriate and current practices need review. As experience shows a break-down may lead to a break with an untenable past. 

More difficult to predict are the effects of this unfolding drama on the interrelated elements of the financial markets. These elements include: asset prices; market functioning; small investor protection, investment suitability criteria, margin limits, role of prime brokers (of which there are a dozen or so); trading platforms and the nefarious links between them as well as possible collusion and price manipulation, and effects of the market structure itself.  

There will be losers, and the immediate ones are the marginal FOMO investors caught up in the hysteria of the last few weeks. These unfortunates have invested more than they can afford to lose at the absolute peak of the latest market prices. Some r/WSB have done well, very well. Even institutions, such as BlackRock have enjoyed the benefits of the short squeeze. Certain fund are reporting monthly returns of +15%. Some winners have made over 1000% return in the matter of weeks. The evidence shows that ‘for-free’ trading platforms make money for their investors., such as Robinhood.com. Although its recent steps may add to unnecessary costs and fines as well lessen its prospects with disgruntled clients.

The affected hedge funds, at the losing end of the short squeeze, have begun to exercise the considerable resources to protect returns and positions, by direct and indirect means. It is uncertain any will go bust. The current ‘de-grossing’ is a reaction to such a threat, with reverberations on broader allocations of investment.

It should be remembered that the Top 10% of Americans own over 88% of corporate bonds and equities; the bottom 50% less than 0.6% . A disparity that has increased over time.

Seemingly abused, thwarted and denied – that is how the r/WSB retail investors forum members feel. ‘Rebel Alliance’ under threat.

As some commentators have opined in reflective terms, that the French Revolution on Bastille Day started for a lot less than what some of the Forum’s member feel at the moment.

Angry, they are! A cohesive force that can rally, or are they spent?

This latest example of the Internet’s empowering and rallying ability of digital tribes is not being lost on the broader community of Internet controllers, governments and corporations.

Will the Forum members’ energies flow elsewhere, forcing a more general change or just dissipate? Another generation lost and segment of society disillusioned? Is the current r/WSB struggle a first-world indulgence or a reflection of something deeper and more enduring? Is this a US issue or one that transcends most real and virtual boundaries, globally?

Quo Vadis?

In the David story a single slingshot blow was enough, to slay the domineering Goliath.

This current r/WSB contest is not just the developments of GME or a handful of similar meme stock. It may well be a contest of attrition.

The r/WSB saga may reveal that the Forum’s subscribers are more than blowers of asset bubbles and mania investors; their ripples may well create longer lasting waves of change. Keep a ‘weather-eye’ and prepare accordingly.

For further information please feel to contact us at info@gatecapitalgroup.com.

RISK WARNING

The views expressed are those of the author alone – no advice nor recommendation is provided nor implied. Investing in any financial instrument carries risks. Your capital may be at risk. Certain investments maybe long term and may not be readily realisable. Please consider all risks before investing. Gate Capital Group Ltd is authorised and regulated by the Financial Conduct Authority (FCA Number 189170).