Seeing the hedge funds being squeezed is fun but it won't last | Nils Pratley

The squeezing of the hedge funds, or at least a few of them, is splendid entertainment. The pure bizarreness of the rise in GameStop’s share price since the start of this month – a 25-fold rise at the peak – beats anything seen in the dotcom mania at the turn of the century. But the lesson of 20 years ago should be remembered: when it looks easy for anybody to make quick money speculating in stock markets, the party is probably about to end.

This Reddit crew prefer a different narrative, naturally. For them, cranking up share prices and trying to create hell for short-selling hedge funds is about beating Wall Street at its own game. And give the traders credit, their loosely coordinated tactics worked like a dream at GameStop. The likes of Melvin Capital, the short-selling hedge fund forced into a bailout, never saw the rebel alliance coming.

But let’s not pretend the hedge fund industry is now in tatters or won’t learn from the experience. For starters, a large part of it doesn’t dabble in obscure video gaming retailers. Currencies, government bonds and interest rates are what excites the “macro” crowd. For short-selling hedge funds, the new power of Reddit’s traders (for as long as it lasts) probably won’t be viewed as an existential threat. It’ll be regarded as another factor to incorporate into strategies.

Stage one for the hedge funds was about taking bets off the table elsewhere to inspect the new landscape. Stage two may involve reading the Reddit breezes to get a possible edge. Indeed, when the dust settles on the GameStop saga, it would not be a surprise to learn that rival hedge funds joined the squeeze on Melvin and its co-travellers. Hedge funds also like to eat their own.

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The wider picture is that these unusual stock market events tend not to appear out of nowhere. The oddity this time is that the shares in the spotlight are those of struggling and half-forgotten companies – aside from GameStop, there’s AMC, the US cinema chain, and Nokia and BlackBerry. Back in 1999 and 2000, the speculation centred on new internet companies with little revenue. But the new version still looks like a familiar case of speculative excess that will end badly for many.

One common theme is fear of missing out. Redditers who had the nous to get out of GameStop in time will have made life-changing fortunes – they even publish their paper winnings with screenshots. The advertising is powerful but works best for the early-comers. Another ingredient is the notion that stock market risks have reduced. The rip-roaring recovery in share prices after last year’s initial Covid plunge helped on that front.

And a critical factor is access to leverage, or magnified bets. In the UK, spread-betting firms are doing great business – IG Group reported a 55% increase in active clients in its last half-year figures. In the US, retail investors are using futures and options, another way to increase the size of a punt.

“One of the surest signs that a bubble is close to bursting is when the retail investor piles in with leverage,” says Albert Edwards, at the investment bank Société Générale. “And if the retail warrior millennial mob are angry now, wait until they lose their shirts in any market collapse.”

He blames the US Federal Reserve for creating an environment in which stock market investors believe central bankers, dishing out cheap money, have their back. He’s usually a gloomster but he has a point. GameStop is so much fun it can’t last.


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