wolf of wall street on steroids.
“People don’t buy stock; it gets sold to them. Don’t ever forget that.” — Jordan Belfort, The Wolf of Wall Street
For market participants, these are among the most interesting times we’ve seen since the 2000 tech bubble. downtrodden companies such as Gamestop, AMC entertainment Holdings, blackberry, bed bath & beyond Inc., Tootsie roll Industries and even Twinkie-maker Hostess brands Inc. have suddenly seen their share prices explode higher in the past few weeks, rebranded as “meme stocks” and bid up by a new breed of retail investor. Gamestop has been the poster boy for this resurgence and has seen its share price skyrocket as much as 20 times higher this year alone, boosting its market capitalization to us$25 billion and making it larger than companies such as Suncor.
In our opinion, what is happening is similar to the pump-and-dump schemes of the past that were made famous in the 2000 film boiler room or the 2013 film Wolf of Wall Street. The strategy is to establish a large position in relatively unknown or unloved name and then stir up interest by cold calling people with an exciting made-up story, an “insider tip” or secret strategy in order to pump up the price.
This time, however, the scheme is running on steroids, with applications such as Tiktok and reddit making it possible to reach millions of people almost instantaneously. While they are manipulating the typical desire to get rich quick, the move is also taking advantage of the pandemic, with a plethora of young people suddenly finding themselves with more time on their hands and government stimulus cheques and free-and-easy access to trading applications like robinhood.
This has even been carried into the options market, where last Wednesday more than 38 million call options traded, the most ever recorded in one day.
The difference from the pump and dumps from the past is that they are targeting poorly run companies with large short positions on them so that when they rally it causes forced coverings resulting in a huge spike in the share price. Interestingly, we wonder if it all started with Tesla which rocketed in part due to the massive short-covering that cost sellers more than $40 billion in losses last year.
Overall, this strategy has been so successful that Goldman Sachs’ 50 most heavily shorted stocks are up an astounding 80 per cent in the past 12 months.
All of this is wreaking havoc on hedge funds and so if you happen to have a u.s. long-short fund in your portfolio you may want to check in to see how they are navigating this environment. The problem with short selling is that the downside is unlimited unless some risk controls are put in place. Therefore, times like these will weed out the good managers from the bad.
Another important takeaway is that this activity isn’t reflective of the entire market. Former BNN host Frances Horodelski said it perfectly in her newsletter last week when she noted, “remember, this is a very small corner of the market. Normal things are happening.”
While these meme stocks make for great headlines we don’t think this means the broader market is in a bubble, as many of the top stocks within the S&P 500 are also backstopped by strong fundamentals, such as revenue and earnings growth. They also have little influence, as last Wednesday when some of the meme stocks were rocketing, the S&P 500 sold down 2.5 per cent.
We are keeping a close eye on things as this could change especially since the ongoing short-covering is the largest since early 2009 following the end of the Financial Crisis. In particular, we are watching to see if this spreads into other more meaningful segments of the market as it appears contained for now. According to a report by barclays PLC strategists, and cited in bloomberg, the most heavily shorted companies this year amount to less than 0.001 per cent of the us$43-trillion stock market. However, today’s action in silver markets could be a sign that this is spreading to more impactful and meaningful areas of the market.
Overall, we would expect things will eventually return to normal in a post-covid world, just not yet in 2021. In the meantime, if you’re playing these inflated meme stocks whether it be Gamestop or even the much larger names like Telsa, just make sure you’re not the last one standing when the shorts are done covering, the bots have ceased their turbo-promoting, the billboard signs are taken down and the music stops.
Martin Pelletier, CFA, is a portfolio manager at Wellington-altus Private Counsel Inc. (formerly Trivest Wealth Counsel Ltd.), a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax and estate planning.