GameStop is a story that has dominated US equity markets particularly over the last couple of weeks. The company is an unloved video gaming retail chain. Being unloved, Hedge Fund Melvin Capital established a significant ‘short’ position in the stock i.e. a bet that the share price would fall. Hedge Funds being short stocks is not unusual but by using the options market Melvin was forced to disclose its position and therefore made itself a target.
An eagled-eyed Reddit user called Stonksflyingup was not the only one to spot Melvin’s position, but they might have been the most prescient. In an October 27 video posted on the WallStreetBets message board — titled “GME Squeeze and the Demise of Melvin Capital”, using GameStop’s three-letter stock market ticker — the Redditor used a scene from TV show Chernobyl to portray Melvin as a nuclear reactor that would blow up when its bet against GameStop went wrong. Within six months, half of Melvin’s $13bn fund had been wiped out.
The David-and-Goliath narrative of the events, in which retail investors organised on Reddit overwhelmed the short-sellers who had bet against GameStop, has captured the imagination far beyond Wall Street had been a favourite target of short-sellers for some time. But Melvin took a disproportionally large trading position: Melvin’s options position had grown to 5.4m shares over the third quarter, according to the regulatory disclosure 13F published on November 16, even as the share price had risen by 135 per cent, to $10.20. This left Melvin vulnerable to a ‘short squeeze’. Why did Melvin left itself so exposed and why it didn’t reverse out of the trade earlier?
The higher the short interest, the higher the risk, since if everyone rushed to exit their positions at once, a sudden surge in demand to buy back stock would push the price up further — a classic short squeeze. “That’s the part where the retail people got it right, to their credit”.
GameStop shares became detached from the reality of its business prospects. The posts about Melvin on Reddit became more frequent as traders on the forum declared war on the hedge fund as “the real greatest short burn of the century”.
As Reddit day traders, using the Robinhood trading App, and others piled in, long time short sellers like Melvin had to decide which way to jump. Those who got out their positions before the end of the year, as the stock soared towards $20, suffered heavy losses — but not as heavy as those who waited until the middle of January, when the founder of Chewy.com joined GameStop’s board promising to bring it into the digital era, after which the share price went parabolic. The temptation to stay the course was obvious, since GameStop shares had become detached from the reality of its business prospects and would one day tumble. But with the level of short interest going up, not down, the risks were mounting.
Meanwhile, investors started trying to squeeze short sellers out of other popular positions, too, such as the cinema chain AMC, the tech group BlackBerry and more. Many of Melvin’s shorts sustained losses in the melee politics When Melvin was forced to exit their bet against GameStop last week and crystallise its losses, the shares peaked at $483 on the day, a rise of 11,000 per cent since the second quarter of last year. Melvin took an emergency cash injection of $2.75bn from two other hedge funds — $750m from Cohen’s Point72 Asset Management and $2bn from Ken Griffin’s Citadel — to deal with the losses and top up the fund. It had lost 53 per cent of the $13bn it was managing at the start of January over the course of just one month!
US and global equity markets remains buoyant having their best week since last November as vaccines get rolled out around the world and markets supported by the imminent prospect of Joe Biden’s $1.9 Trillion economic stimulus plan which became even more likely after Friday’s release of January US Non-Farm Payrolls data showing the US economy creating a paltry 49,000 jobs last month as it struggled through the latest surge of coronavirus infections. The weakness of the US jobs market has been one of the main catalysts for Biden’s drive to enact the $1.9tn economic stimulus plan during his first weeks in the White House.
European stocks have also benefitted from the prospects of a global recovery beyond Covid.
US bond yields have been creeping up (prices lower) on the back of the stimulus plan and potentially higher inflation prospects with the 10-year yield at 1.15 yield-to-maturity having spent much of 2020 below 1%.
Oil prices have risen to just under $60 per barrel for Brent crude. That took the international marker to its highest level since February last year, just before a plunge sparked by the pandemic.
Gold prices remain fairly soft at $1,800 per ounce (down from $2,050 highs) as it is losing some of its ‘safe haven’ attraction in an economically rebounding world.
The US Dollar: Analysts are
wavering in their conviction that the dollar will continue to weaken as a more
optimistic outlook about the US economy challenges a key driver of the
greenback slide. The US currency fell 5 per cent in the final two months of
2020, and many investors and analysts were expecting further declines in 2021.
But after a weak 2020 the US Dollar is finding support with the prospects of a 2021/22
US economic recovery and prospects of firmer interest rates.
The British Pound prospects continued to rally last week following a unanimous vote by the Bank of England’s Monetary Policy Committee on Thursday to keep its policy rate at 0.1 per cent and maintain the size of its bond-buying programme. But it was the guidance on UK negative rates — that the UK is unlikely to move to negative interest rates that allowed the pound to restart its move higher. Sterling now at a recent high of $1.3700