GameStop merchants might power hedge funds to vary their funding ways

Traders work on the trading floor of the New York Stock Exchange.

NYSE

Retail investors have outsmarted smart money, and the war between Reddit merchants and hedge funds seems to have left an indelible mark on Wall Street.

For large investors or hedge funds short of individual stocks, some of those positions have been besieged by a large cohort of small investors, many of whom use a Reddit forum.

The idea of ​​a short is that the holder of the position makes money when the stock price falls, but when it rises investors have to buy the stock themselves, and all of this activity can push the price even higher, resulting in a short push. GameStop was the flagship of this trade, and when investors bought the covered stocks and shorts it hit $ 483 on Wednesday. It gained 400% in the last week alone, closing at $ 325 on Friday after a week of volatile trading.

After the midweek high, the stock moved in the opposite direction. Its high was more than halved on Thursday afternoon and it closed at $ 193.60, a 44% decline. This caused pain for investors who bought in at higher levels and wanted to get out or were forced. But on Friday it resumed its upward trend.

Leo Grohowski, CIO at BNY Mellon Wealth Management, said the hedge funds were disruptors on Wall Street 30 years ago, but now they are being disrupted.

“There’s a lot going on in what’s going on. I don’t think it’s a one-time bias,” he said.

Rich Repetto, senior research analyst at Piper Sandler, said the movement of investors using social media forums and online trading was similar to the impact Covid had on the workplace when employees were working from home. The trading phenomenon has increased and accelerated during the pandemic as people are stuck in their homes. As with working from home, many will eventually go back to their old routines, but some changes are permanent.

“We have different behavior now. Will the trade be that high?” Said Repetto. “Maybe not, but we’re not going back to 2019. We have a whole new generation that was brought to market through apps.”

Wall Street has seen some impact as well. For one, Citron Research announced on Friday that it will no longer publish research information on its short positions, ending a 20-year practice.

GameStop isn’t just an investor favorite on the WallStreetBets Reddit forum. Investors have bought dozens of nicknames, including Blackberry, Nokia, and Koss. AMC Entertainment is another company that fell 50% on Thursday but fell 54% to $ 13.26 on Friday. Short stocks fell Thursday after Robinhood, Interactive Brokers, and others restricted trading and increased margin requirements on GameStop, AMC, and other heavily truncated names.

Brokers clear deals through a clearinghouse that could look for more capital for the quick deals coming from small investors. Brokers who are not capitalized well enough could suffer huge losses if investors are suddenly wiped out.

Robinhood CEO Vlad Tenev told CNBC that his company restricted trading of 13 stocks on Wednesday as part of an internal decision to manage operational risk to protect the company and its investors. He said the decision was made based in part on the SEC’s net capital rules and clearinghouse deposits that brokers are required to adhere to.

The temporary moves taken by the brokers angered investors and received criticism from far and wide by lawmakers, including a rare deal between Rep. Alexandria Cascio-Ortez, DN.Y. and GOP Senator Ted Cruz from Texas. Robinhood raised $ 1 billion from investors overnight, in addition to $ 500 million drawn through lines of credit for trading stocks like GameStop. Tenev said the move is proactive and not because of liquidity issues.

“This has been an unprecedented activity focused on a select few names, and it really is the first time I’ve seen where social media and financial services have overlapped in this way,” Tenev said on CNBC Thursday evening.

Some market pros also expect events to shed new light on short trading, a long-standing Wall Street strategy, but critics point out how it targeted companies whose businesses have been damaged by Covid.

This week’s frenzied trading resulted in billions of stocks switching hands, and it could change the dynamics of the stock market as well. Market professionals say hedge funds could be cautious about putting on shorts and instead create positions in the options market that would take on the role of short.

Individual investors have grown to around 20% of the market since their youth as retail has soared during the pandemic. The fee-free trading offered by Robinhood and other online brokers has fueled the trend, as has a stock market that has risen virtually significantly since the March low.

“I think the big picture at 40,000 feet is that this opens up retail. Whether sustainable or not, retail is driving valuation of certain stocks,” Repetto said. “I think the increased retail activity will stay here at some level.”

Repetto said the trend should benefit online brokers like Robinhood, TD Ameritrade and Schwab. The impact on hedge funds is still unclear.

“I have had no question in the past few days that hedge funds were doing a small risk assessment and reviewing their short positions to see if they had stocks with high short positions that could potentially be impacted by social media,” she said Repetto said.

But the phenomenon of a mass of small traders working together could transform the market. Dan Deming, managing director of KKM Financial, said retail investors have managed to find inefficiency in the market and move forward en masse.

“Some of the longer-term strategies that have worked for a long time are now being challenged, at least in the short term,” Deming said. He expects hedge funds to replace some strategies with options trading.

“To some extent, the population of the market is evolving and it is again a combination of technology that meets a need and finds a home in the investment community,” said Deming. “Market participants feel a little more encouraged than they used to be in getting in and out of positions. Information is on a much more even playing field. It seems like investors become traders to some extent.”

Steve Massocca, CEO of Wedbush, said Reddit investors had come across a winning strategy and he found some of the names they invested in were good stocks.

“We found Tootsie Roll ridiculously cheap and a well-run business. Some of those names have been massively undervalued,” he said. “Not GameStop, but other names that the Reddit folks were looking for that had big shorts, buying stocks that we thought were great value. Tanger Factory Outlets was fined terribly for Covid, but the deal is actually not bad. “

Massocca said his firm’s quantitative analysis two years ago showed that betting against shorts would be the wrong trade. It wasn’t great a year ago, but he found that things have changed in the past six months. He bought into shorted B&G Foods, owners of Green Giant, Accent and Ortega, and sold it when it came out in the mid-30s. It was down 8.6% to $ 37.51 on Thursday.

The short squeeze in hedge funds resulted in some selling of long positions on Wednesday, which helped to drive the market sharply lower. But it bounced back on Thursday and the Dow rose nearly 350 points. Stocks went down Friday morning as some of the short names rose.

Evercore technical analyst Richard Ross said Thursday he did not expect any impact on the broader market, although GameStop trading also hit the SPDR S&P Retail ETF XRT, causing the ETF to become volatile.

“The bullish backdrop for stocks is strong, intact, and so much bigger than GME. If the latter stops rising, the former will not fall and the massive early reversal of XRT and GME against the most overbought values ​​in history for the ETF ,” he wrote.

BNY Mellon’s Grohowski points out other examples of disorders such as: B. Carpooling and home rentals.

“It is thought-provoking that the very stable financial market participation might change,” he said. “We’re going to talk about the profitability of long-short managers. This is a wake-up call to liquidity, profitability, and it’s all in our dictionary this week and we weren’t expecting it.”