Even the Bears are Bulls
Friday, 29th January 2021
Markets versus Economics
There is an accepted wisdom that the share market reflects the economy. The theory is that economics is the best tool to use to forecast how the market “should” behave. When markets move too fast in either direction, the common refrain from market commentators is that the market isn’t trading “on fundamentals”.
This indicates that the said commentators and ‘analysts’ haven’t spent any effort to understand what drives the market in times that are considered irrational.
Recently, there has been an explosion in retail trading amongst a subreddit group that have taken on the large hedge funds and their short positions. Considering that Elon Musk is their hero and Tesla is often one of the most shorted stocks, this group has decided to buy the most heavily shorted stocks and thwart the short sellers.
One of the stocks targeted was GameStop, which is a US video game chain that jumped 1500% since the start of the year, based on the groups buying. This has caused a hedge fund to close their short position at a huge loss.
The madness has even caused an Australian Nickel explorer share price, with the same ticker code of GME, to double in price in the last week.
This is completely normal behaviour when markets morph into a bubble. The retail frenzy almost always occurs at the end of a bull run and the usual victims are those with the least amount of knowledge and experience.
One of the retail platforms called RobinHood has been forced to restrict any new purchases of GME and of course without the buying flow, the shares fell 50% in one day. RobinHood were simply restricting their risk to one stock as they have banking requirements and liquidity obligations to adhere to.
Calls for class actions against RobinHood and allegations of the platform siding with Wall St will fall on deaf ears. When actions of participants threaten the stability of an exchange, action will always be taken to protect the exchange.
In the 1970’s, the Hunt brothers attempted to corner the Silver market via the futures market and a potential short squeeze was thwarted by the Chicago exchange when they doubled margin requirements overnight. The Hunt brothers were too extended and they were forced to sell at any price which sent them broke. To learn more about the Hunt brothers, click here.
The Hunt brothers were not the only ones who tried to corner the market and failed. In 1994, a Japanese Copper trader controlled 5% of the world’s supply at one stage. Long Term Capital Management (LTCM) tried the same approach in the late 1990’s when they leveraged their cash positions by 300% to short US Treasuries and buy Russian bonds.
When Russia defaulted on their bond payments and the US increased their rates, LTCM required a bailout from the Fed and Wall St banks.
The lesson for investors is that when behaviour distorts markets to an extent such as GameStop, the risk is to the small investors, exchanges will always protect their business.
One of the measures to ascertain whether the market is in a bubble is to look at the activity of a cohort of fund managers that are traditionally conservative, with a healthy dose of bearish managers amongst them.
The National Association of Active Investment Managers (NAAIM) publishes the exposure of their members and the most interesting part is the behaviour of their most bearish managers.
Typically, these managers have a net-short position of 80%. However, 2020 has seen these managers reverse their view entirely to such an extent that they are now 75% net-long and leveraged to do so.
The chart below clearly shows the reversal in behaviour.