Cast your mind back to January 2021 when multiple hedge funds and institutional investors had taken short positions against GameStop. They felt that the bricks and mortar retailer was becoming outdated in comparison to its online competitors and the ongoing effects of the Covid-19 pandemic had significantly reduced footfall in retail stores. Retail investors, who communicated through platforms including twitter and the subreddit r/wallstreetsbets piled into the stock.
When a heavily shorted stock experiences a large price increase, short sellers lose money and they did in a big way. The retail traders caused them to exit their short positions, which requires them to repurchase the stock at an inflated price. This increased buying that must occur in order to close short positions will push the price even higher. This circus caused the price of GameStop to rise from $19 to over $300 in just a 15-day period and soon afterwards, the term “meme stock” was born. The drama unfolded even more as US broker Robinhood blocked trading and a congressional hearing summoned some of the most influential financiers, and American retail investor “Roaring Kitty”, to explain what was going on.
For large parts of 2021, these stocks reached levels far removed from the facts of their fundamentals and the bull market supporting global stocks in 2021 that pushed equity valuation measures close to all-time highs. Warren Buffet once said, “only when the tide goes out do you discover who’s been swimming naked” and we are now seeing some scantily clad traders out in the shallows. In recent weeks, markets have been gripped by fears around inflation and changes to central bank policy. Their future actions will see reduced levels of economic support, which has been one of the key drivers behind the strong performance of equities over the past decade. Whilst major indices have seen significant drops since the start of 2022, meme stocks appear to have been hit hardest, GameStop is down 36% year-to-date whilst AMC has fallen 46% since the turn of the year.
Global lockdowns caused a large increase in the number of retail investors as people who were stuck at home sought to get in on the strong recovery in markets seen after the initial pandemic shock. According to figures from the FCA, over 7 million investment accounts were opened in the UK in the first year of the pandemic. The $1 trillion of new money put into the stock market in 2021 (a larger sum than the previous 20 years combined) was mainly driven by retail investors, and allowed supply chain issues, warning signs of higher inflation and ongoing uncertainty around the Covid-19 pandemic to be largely ignored as global equity markets soared to new all-time highs. However, as people begin to resume their normal day-to-day routines and household savings are now being spent elsewhere, retail trading volumes were seen to be dropping back below 20% of total market volume towards the end of 2021. The lack of retail investing has taken away the levels of support that elevated these stocks to their highs of 2021 and meme stocks may finally be taking notice of market fundamentals as well as wider macroeconomic issues, such as global monetary policy.
In normal market conditions, businesses that were underperforming or heading towards becoming obsolete would experience heavy short selling, just as AMC and GameStop were at the start of 2021. However, the intention of retail traders to short squeeze these positions and cause major losses for those on the other side of the trade has made some large investors wary of taking large public short positions for fear of being squeezed or facing backlash from the retail investing community. Andrew Left of Citron Research, a vocal short seller of GameStop, and his family received targeted online abuse and even death threats because of his short position. This demonstrates retail investing has significantly changed what previously was an important market mechanism.
In April 2021, the FCA announced that they were looking to strengthen rules around the classification of high-risk investments and to further segment the market for high-risk investments. Reasons behind this move were concerns around investors being able to easily access higher risk investments which do not reflect their risk tolerance and are unlikely to be suitable for them. Incredibly, FCA research demonstrated the lack of awareness of the risks behind investing with 45% of new self-directed investors not aware that losing money was a risk of investing.
Is the party over? Is the music stopping? The Russian roulette of meme stocks has certainly, and sadly, taken some victims but the circus will now likely just move elsewhere. Looking forward retail trading volumes have fallen; the macroeconomic environment has changed significantly and equity markets are preparing for significant central bank action and any of the meme believers may see their fortunes continue to unfold. However, the institutional investors have seen the power and influence held by retail traders and the incredible moves that can occur when small investors work together. Despite the headwinds, there remains a huge number of retail investors still active in the markets. Have we seen the last major retail trading event or will the members of r/wallstreetsbets and other trading groups once again show Wall Street and the world of finance just how easily they can level, and even dominate, the playing field or should we wait and see where the circus tent pitches up next?
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