"People were bored, sitting at home with nothing to do, often no work to attend, and few things to spend their extra cash on. Self-directed punting around in the stock market was a reasonable way to pass the day. It is a cold heart that begrudges the success that some of these amateurs enjoyed last year in an equity rally that baffled many market veterans.
Inevitably, though, there will be painful losses for some naive investors when the bubble eventually deflates. It is a high-risk game — many of those caught out will be least able to afford it. But this is not just about their financial health. This has become a destabilising force in global markets." - Katie Martin, 'Reddit army is on the hunt for hedge fund scalps', The Financial Times
The Financial Times headline three days ago said it all and caught my attention:
Bubble signals flash red as bitcoin races to extremes and stocks surge
Exponentially ramped up stock rallies and wild speculation by have-a-go amateur investors are stirring fears among market veterans over a bubble to rival anything seen in the past century. Meanwhile the WSJ reported yesterday that Reddit’s popular WallStreetBets forum briefly went dark late Wednesday, stunning users who had been flooding the community with posts all week amid a frenzied stock rally. This has centered on a video gaming company called Game Stop with maybe millions of day traders on Reddit getting even with Hedge funds for trying to short Game Stop shares. ("Short" means they made bets - probably using a form of credit default swaps or other derivatives - to value GS shares below current market value. The gang on Reddit evidently got PO'd and decided to rally their investor resources and buy up GS shares leaving the short sellers in the tank)
A message on the forum’s landing page initially said WallStreetBets had been taken private by its moderators because of technical difficulties on an “unprecedented scale as a result of the newfound interest in WSB.”
WallStreetBets has been the subject of growing fascination and scrutiny as once-unpopular stocks ranging from GameStop Corp. to AMC Entertainment Holdings Inc. have drawn significant interest from individual investors, helping catapult their share prices to eye-popping highs. Much of the discussion surrounding these shares has originated on WallStreetBets and then was amplified across the internet.
But the Game Stop speculative frenzy and related ones (e.g. for electric vehicles like Tesla) are only part of what appears to be a mammoth emerging bubble, which - when it "bursts" may see blood all around from losses. This from the FT piece:
"After a dramatic rebound from the coronavirus crash last March, benchmark equity indices have toppled a series of records in the early days of 2021. Bitcoin, the most speculative bet of them all, has raced to extremes. Popular stocks such as Tesla continue to defy efforts at sober valuation.
Baupost Group founder Seth Klarman has warned that investors are under the impression that risk has “vanished”, likening them to frogs being slowly brought to the boil. GMO co-founder Jeremy Grantham has dubbed the rally since 2009 an “epic bubble” characterised by “extreme overvaluation”.
Fund managers are on alert for a pullback. “Timing the end of this frothiness is hard. It can go on longer than you think. I don’t see a huge move lower . . . But we have become more cautious,” said David Older, head of equities at Carmignac."
What gives? According to the FT, markets are "floating on an unprecedented wave of monetary and fiscal support, with yields near historic lows and investors — institutional and retail — sitting on piles of excess cash, outlandish patterns in stocks could persist for some time."
Where did all this cash come from if the economy is supposed to be in such a hole? From March through November, personal savings was $1.56 trillion higher than in 2019, a rise of 173 percent. Normally the savings rate bounces around in a narrow range, around 7 percent just before the pandemic. It spiked to 33.7 percent in April, its highest level on record dating to 1959.
Even as millions of individuals faced great financial hardship this year, 40 million losing jobs, Americans in the aggregate were building savings at a startling rate. It had to go somewhere. But where? Holding on to extra cash was one option — and sure enough, currency in circulation has spiked by $260 billion since February, a 14 percent increase. Deposits in commercial banks are also way up — by 19 percent since the first week of March.
To be sure, most of this money is from middle or upper middle class people who've been able to work from their home offices and still rake in the $$$. It's not from those laid off, obviously, or even grocery workers earning $12 an hour. In any case, with no place to spend their money - given all the businesses closed and online shopping losing its pizzazz - the locked- in are looking for gamier pastures.
For those who are comfortable with risk, there is investing in stocks, which helps explain the 16 percent rise in the S&P 500 for the year. After all, most casinos are shuttered and there's a dearth of other fun activities (cinemas) in the Covid lockdown era. For those comfortable with a lot of risk — and also into day trading - why not take advantage of the market’s momentum? Enter the Reddit Game Stop buy -up brigade on WSB, to teach those hedge fund honchos a thing or two. Well, when they're not buying a darling stock like Tesla or doing other option trading. Wait. Trading options? What's that?
Well, the market for stock options is where traders can place bets with brokers that a stock will rise or fall. Speculation in these markets has now reached a frenzied level not seen since the tail end of the dotcom boom two decades ago. That enthusiasm is having a growing influence over the regular stock market itself, and also prefigures a bubble if ever there was one.
Over the past year, and even during the deep uncertainty that flummoxed the market at the start of the pandemic, individual investors — often with little experience — have been pouring into the market. What has lured them varies: free trades, extra cash from relief payments or even an itch for action with most sports leagues shut down. Options trading hit a record in 2020, with some 7.47 billion contracts traded, according to the Options Clearing Corp. That’s a 45% increase compared with the previous record, set in 2018.
So how would options work in terms of the Reddit-based investor clique taking down the Hedge fund bosses, e.g. by going for Game Stop shares? Basically, the Reddit pro-Game Stop investor makes a bet the share price is going to rise so buys a call option at a brokerage firm. This contract gives the buyer the right — but not the obligation — to buy a stock at a given price at some point in the future. If the share price is higher on that date, the buyer can purchase the shares using the contract, then sell them for a profit.
Just as the buyer stands to benefit from a rising share price, the dealer who sold the contract stands to lose. Brokerage firms make money by charging fees on products, not by predicting where share prices go. So to hedge their risk on a given contract, they buy a calculated percentage of the stock they would be forced to sell if the buyer ends up making money on the bet.
But as the stock prices rise, brokers must buy more shares to keep their hedges in balance. And buying more shares helps push share prices up.
Apart from the Game Stop mania (share prices soared 800% in just the last week), a larger bubble looms and has many on the Street worried. In a note in mid-January, analysts at Absolute Strategy Research produced a checklist of bubble indicators, setting the rally in U.S. “growth” stocks in the same context as the boom and bust in Japanese equities in the 1980s, the more abrupt rise and fall of dotcom stocks in the late 1990s.
Common features include low interest rates, stock valuations that tower over earnings, runaway retail trading, and rapid accelerations in equity gains. On all these points, conditions look alarming. ASR points out that more than 10 per cent of stocks in the US blue-chip S&P 500 benchmark are 40 per cent or more above their averages of the past 200 days — a phenomenon seen only four times in the past 35 years. According to Ian Hartnett, co-founder of ASR. quoted in the FT:
“Clients are increasingly worried. There is career risk in the fear of missing out. People find a way to rationalize every bubble. They have to explain to a chief investment officer or to an investment committee why they have gone long here.”
Some also point to the explosion in trading by amateurs (such as in the Reddit Game Stop group) as a concern. Seen as flighty “weak hands” by fund managers, intolerant of losses and quick to exit bets, they have been on the ascendant as lockdown boredom encourages them to the commission-free trading offered by start-ups such as Robinhood. Americans were turning to stocks as “the casinos are closed [and] a lot of sports are shut down”, according to one stock maestro and bubble analyst quoted in the FT.
Even given the warning signs, investors are not staging any rush to the exits. In part this is because the surge in retail trading may be less troubling than it looks. Unlike previous episodes of retail trading exuberance, analysts and fund managers suspect that the bout may be more robust and less likely to saddle households with huge losses.
So yep, the stock market is near record highs, and optimism abounds among the more cash flush hoi polloi. Coronavirus vaccines are finally getting jabbed into arms. Interest rates are at historic lows. Meanwhile, investors expect the Democrats who control Washington to pour another couple trillion dollars of stimulus into the still struggling economy.
But bear in mind none of these factors is fixed, they are all variables subject to change. Republicans may halt the big Covid relief package in its tracks or cut it down to measly proportions (and neither of the moderate Dems - Manchin or Sinema - may sign onto budget reconciliation to get it passed). The virus may spawn a deadlier variant for which none of the vaccines work and lockdowns become permanent or nearly so. And, for whatever reason, the Fed is forced to jack up interest rates to 2 % or more.
Stay tuned.
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