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.