Something strange is happening on Wall Street

Something strange is happening on Wall Street, or at least to a number of individual stocks, which are getting caught up in a battle between a bunch of Reddit day traders and investors and Wall Street hedge funds. Shares in GameStop (GME) surged another 92% on Tuesday to almost $148, with after-hours trade pointing to shares opening up another 42% higher later today. Other companies’ shares are going through the same weird price action. Shares in AMC Entertainment rose 12% yesterday but shot 66% higher in after-hours trade. BlackBerry, Bed, Bath and Beyond and Nokia are among some of the stocks being bid up.

Now even the likes of Elon Musk, Chamath Palihapitiya and Jon Najarian are getting involved. Lists of stocks being shorted by hedge funds are being circulated online and appear at risk of coordinated efforts to bid up these ailing names by the Reddit crowd. It’s a pile-on and there is no telling what other stocks could be next. Luck be to you if you are sitting on the next ‘stonk’ in the firing line.

Among the many aspects of this story that are strange, what is so unusual is the peculiar vigilante morality of the traders pumping the stock on /r/wallstreetbets. They seem hell-bent on taking on Wall Street, they seem to hate hedge funds and threads are peppered with insults about ‘boomer’ money. It’s a generational fight, redistributive and all about robbing the rich to give to the millennial ‘poor’.

What it is demonstrably not about is searching for value. Or at least, whilst there have been fundamental cases on GME put forward by one or two users, the vast majority it seems are working to YOLO (you only live once) their life savings, (or their parent’s) on a stock that they hope will go to the moon.

The problem it seems to me is that they are all working to artificially bid up the price of the security in question. This raises problems about potential securities fraud and specifically market manipulation. Bloomberg’s Matt Levine makes an excellent observation about the possibility of SEC action on this and whether or not the Redditors are carrying out what the regulator might see as an illegal short squeeze. In short, he thinks it could be seen as dodgy, or could be ignored. It’s up for debate still. But is it covert enough to be classed as market manipulation? The argument – that it’s ok because everyone on Reddit knows the game and are in it for fun – I don’t think holds water when we are talking about capital markets in which not all of us are paid-up /r/wallstreetbets members. I would hardly class this as the smooth functioning of financial markets and the SEC will be starting to pay attention.

Which brings me to the other aspect that concerns me is the idea that everyone will win – or at least everyone in their crowd will win. It’s presented as an open goal and all the believers will hold until payday comes.  For every buyer bragging on the way up, there is a seller. For every seller taking profits at the top, there is a ‘schmuck’ buying at the top. Now, this is fine, the Reddit crowd says, if the schmucks are the hedge funds covering their shorts. And not just them: for many Redditors, it’s a badge of honour to have bought at the top. This is weird, to say the least, and hardly the basis for sound investing. Redditors are told to simply hold to force up the price even further. But this is not sustainable forever; it is reasonable to expect that at some point you will want to realize some profits, so you will need to sell. Who do you sell to? Well it cannot always be hedge funds covering shorts – no doubt it will be your peers in the crowd playing the game. When the music stops, someone, or several thousand people, will be left with the bill to pay as the security’s price collapses with no bid coming through on the market.

The Reddit mania is a greater-fool, pure beggar-thy-neighbour trade pure and simple. It is pump and dump cleverly masked by the preachy moralizing about fat cats, boomers and suits. Users are knowingly conspiring to force up the price of an asset well beyond any reasonable expectation of its fundamental value. It’s presented as an attack on the boomer hedge funds, but at its core, it relies on someone else being prepared to pay an even higher price for the security. Nothing short of the Greater Fool Theory in action and ends only one way.

Elsewhere, stocks in Europe were mixed in early trade ahead of the Federal Reserve meeting later today. Shares in Microsoft rose 3% after-hours following a bumper earnings card which further builds the case for a strong tech-led earnings rebound. Today we have earnings from Tesla, Apple, Facebook and Boeing.

The Federal Open Market Committee (FOMC) convenes today for its first meeting of 2021, with some new faces (not least Janet Yellen at Treasury) but the same old problems facing the Federal Reserve as it seeks to steer the US economy out of the pandemic. The statement is released at 19:00 (GMT), followed by the press conference with Chair Jay Powell at 19:30.

Not a lot has materially changed since the December meeting, when the Fed provided updated forecasts on the economic trajectory. Vaccines and stimulus support a bullish case for recovery longer term (eventually things will pan out) but near-term risks to the outlook are elevated (vaccines could be slower to reach people, governments may be reluctant to ease restrictions as quickly as we’d hoped back in November + scarring). The one major change of course is the arrival of Biden in the White House. We also have some greater clarity around the stimulus package being discussed and around vaccines (albeit not all positive).

Economic outlook: Whilst the longer-term outlook remains solid enough and perhaps a little firmer given greater clarity around the fiscal side of things and vaccines, near term softness presents risks and calls for the Fed to remain very dovish and hammer home its willingness to remain as accommodative as necessary for as long as required. Recent deterioration in the labour market supports the thesis that the Fed will be disinclined to even signal it is thinking about taking its foot off the pedal. Moreover, whilst there is hope the stimulus-vaccine cavalry are riding to the rescue later this year, there is no immediate boost from these and, if anything, it could take longer to benefit from these than first expected during the rotation trade of Nov-Dec. Whilst the holiday (Thanksgiving + Christmas) rise in cases is easing, clearly there is just not enough visibility yet about the pandemic for the Fed to sound anything other than cautious about the near-term outlook. The Fed will be mindful about scarring to the economy long term, but this only cements the case for greater accommodation today.

Nonfarm employment growth is stalling

Nonfarm employment growth is stalling

 

Financial conditions remain loose and present little by way of a problem for the Fed right now. The recent rise at the long end of the yield curve seems to be down to expected reflationary trends in 2021 and beyond, so is not a major worry. In the last day the yield on 10s has retreated to a three-week low, giving the Fed even less to think about. AIT implies an acceptance of higher inflation anyway, so I’d expect the Fed to remain very relaxed even if/when CPI and PCE prints push up in the coming months.

Financial conditions remain loose

Financial conditions remain loose

 

Breakevens outpacing nominal yields

Breakevens outpacing nominal yields