Market Perspectives

Reddit vs. the Hedge Funds: Anatomy of a Squeeze

The start of 2021 marked a sharp increase in speculative trading.  Video game retailer GameStop has been the poster child for this mania, gaining over 1,700% from year-end through January 27th, before falling sharply on January 28th—fueled by Reddit’s r/WallStreetBets community.

Year-to-date (YTD) through January 27th, the Goldman Sachs “Highest Short Interest” basket gained 52.1%.  The basket includes the 50 stocks in the Russell 3000 Index with market capitalizations greater than $1 billion that have the highest percentage of short interest, as measured by float.  By contrast, the Goldman Sachs VIP basket, which includes the 50 stocks that appear most frequently as top 10 holdings of hedge funds, declined 3.0% YTD.  The high short interest basket does not even include GameStop, providing a clear example of the breadth of this short squeeze dynamic. (It’s important to note that these are small companies and exposure within hedge fund portfolios will vary considerably, as will fund returns.)

On January 26th and 27th, GameStop was the most actively traded U.S. stock, with more than $20 billion in turnover—far exceeding mega cap names such as Tesla, Apple, and Microsoft.

The sharp gains in names like GameStop were caused by technical distortions called gamma squeeze and short squeeze.

Earlier this week, long/short hedge fund Melvin Capital was squeezed out of its short position in GameStop, and required an infusion of $2.75 billion from hedge funds Citadel and Point72 to shore up its balance sheet.

The GameStop battleground pitted Melvin Capital and prominent short-seller Citron Capital against traders from Reddit’s r/WallStreetBets community.  The “Redditors” were cheered on  through Tweets by prominent figures such as Tesla CEO Elon Musk and venture capitalist Chamath Palipathya, which further fueled the trading.

The movements in GameStop and other heavily shorted stocks show the impact of social media on the markets.  To be clear, the moves have been a function of a temporary imbalance in the supply and demand of shares.  This technical phenomenon is completely divorced from any change in company fundamentals.  Investors should ignore this speculative market action and keep an eye on their long-term objectives.

Indices referenced are unmanaged and cannot be invested in directly.  Index returns do not reflect any investment management fees or transaction expenses.  All commentary contained within is the opinion of Prime Buchholz and is intended for informational purposes only; it does not constitute an offer, nor does it invite anyone to make an offer, to buy or sell securities.  The content of this report is current as of the date indicated and is subject to change without notice.  It does not take into account the specific investment objectives, financial situations, or needs of individual or institutional investors.  Information obtained from third-party sources is believed to be reliable; however, the accuracy of the data is not guaranteed and may not have been independently verified.  Performance returns are provided by third-party data sources.  Past performance is not an indication of future results. © 2021 Prime Buchholz LLC 

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