Morning Jog

The Percolator

If you are wondering whether the stock market is in a bubble, you are not alone. After all, that is the only rational question to ask seeing the completely irrational behavior taking place in some parts of the market.

While I do not believe there is a systemic, market-wide bubble (yet), we are already in bubble of talking about bubbles.



The world is awash with capital and it is flowing into all parts of the financial markets, the narrower the market segment the more pronounced the impact. SPACs, the blank check companies previously confined to a dusty corner of the stock market are now a must-have accessory for sports team owners and celebrities, with one launched every hour. Trading volume in penny stocks is off the charts. And no retelling of today’s excesses is complete without mentioning Dogecoin – the cryptocurrency created with the sole and explicit purpose of a joke which now commands a $9 billion market cap, valuing it somewhere between Western Union and Under Armour.

Commission free trading, plenty of time at home in front of a computer screen and record household savings (see here) sparked a boom in retail trading that shows no signs of abating. While the speculative trading frenzy in SPACs, penny stocks and heavily shorted names is undeniable, these segments are simply not big enough to pose material risk of contagion.

We saw a glimpse of what happens when institutions are pulled into the fray two weeks ago. As the Reddit army of traders pushed popular short names to new highs, hedge funds were forced to cover their short positions. To keep their overall market exposure in balance, they sold popular long names as well, in a process delightfully called De-Grossing. The overall reduction in market footprint was of historic magnitude, but it was only a small hiccup for the broad equity market.



Short squeezes on small cap stocks hyped up on Reddit are a fascinating sideshow, but they have little impact on the broad equity markets, dominated by the Tech behemoths, or on the real economy. Vaccine progress and fiscal and monetary policy are the headliners.

A few thoughts on the GameStop saga.

If any day traders get into trouble with the DOJ, the media companies should offer to cover their legal bills. You could not script a better drama. Hedge fund villains, an army of Robinhood renegades and the perfect Venn diagram intersection of social media, finance, and technology.

I will not go into the umpteenth rehashing of the story, but I do see a few winners coming out of this:

  • Hedge Funds. Years of outflows from actively managed funds going into passive index funds has increased intra-stock correlations – stocks were moving up or down in unison, with low dispersion in performance. That is a tough environment for traders, who benefit from high dispersion and high volatility. Today’s retail investors, moving single stocks up or down 10% in a day are a gift for the pros.
  • Ben Mezrich, who got an advance for a story that writes itself.
  • Keith Gill, the 34-year-old investor responsible for the thorough and impressive analysis on GameStop who inspired an army of day traders to follow him in a short squeeze on Melvin Capital. No matter that his GameStop position fell from $48 to $22 million in the span of a few days (before he wisely stopped posting a daily screenshot of his account balance) and that he is now subpoenaed by securities regulators. For a brief period, he experienced what it is like to be a hero, worshipped by millions.(1)
  • Citadel Securities, the number one market maker in retail order flow, accounting for 46% of volume traded by retail investors. Citadel executes trades placed on Robinhood and other trading platforms, making a fraction of a penny on each trade, that last year added up to $6.7 billion in trading profits. The casino always wins.
  • And lastly, first time investors. We haven’t heard many stories of day traders taking on credit card debt or using their life savings to hop on the bandwagon of moonshot stocks; I’m sure there are instances but hope those are few and far in between.

For most newbies, there is nothing like experiencing the euphoria of greed and the despair of fear firsthand to get an appreciation for how the market works. No textbook or a YouTube tutorial can teach you about your own behavior during those critical moments, that make us self-aware as investors. Trading is like tequila. You hear cautionary tales from your friends, but until you have that ONE NIGHT with it in college, you won’t learn the lesson. And it is better to learn the lesson in your 20s than in your 50s, when you have a lot more to lose.

Seeing some rocket ship emojis replaced with snails on the Reddit message boards – an homage to playing the long and slow investing game – is a sign that the lesson was not lost on at least a few.

Cheers,
Alex

Alexander Bass CFA, CFP®
Managing Director
Chief Investment Officer
Nucleus Advisors

 

 

 

(1) https://www.wsj.com/articles/keith-gill-drove-the-gamestop-reddit-mania-he-talked-to-the-journal-11611931696

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