The battle between retail investors and hedge funds burst seemingly out of nowhere last week, and many people have spent the weekend wondering how it would end.
The answer depends in part on two things: First, who will be first among the three group of actors — hedge funds shorting the handful of stocks, retail investors buying them and the intermediaries enabling both sides to trade — to surrender, especially if done through a disorderly unwinding of their book? Second, how will regulators and politicians react?
What has been colorfully, and not that inaccurately, labeled as the uprising of the little guys reflects the confluence of information platforms, data, and easy-to-use products and trading apps — all of which have been helping the more general phenomenon of democratizing finance.
Photo: Reuters
In addition to technology, big data and some relatively simple forms of artificial intelligence, the fuel also involved an accumulation of years of the everyday small investor feeling marginalized and disadvantaged by a finance establishment that appeared to have co-opted the US Federal Reserve and other agencies.
The catalyst — helped by the availability of cash and, in some cases, stimulus checks — came in the form of the discovery of a strategy in which the usual power brokers, led by the so-called smart money (the term historically used to refer to hedge funds), were significantly vulnerable. This strategy involved an ad hoc movement to buy the stocks of the most heavily shorted companies in the hope of triggering a short squeeze and forcing the bears to scramble and cover their positions.
It is a strategy that worked especially well in the case of GameStop Corp, where the accumulated shorts were equivalent to about 140 percent of the outstanding stock.
The hedge funds shorting were not the only ones exposed to what in markets is known as a pain trade. The intermediaries also found themselves under growing pressure, scrambling to safeguard their balance sheets and maintain prudential guidelines, being forced to cough up cash, draw on credit lines or both.
By the end of the week, all three actors were still in the game. Who will be knocked out first is far from straightforward.
Historically, small investors pushing up a handful of stocks would be at most risk of being picked off because of their limited individual capital, especially when squaring off against professional hedge funds. Under that outcome, the implications for the financial system would be relatively small notwithstanding the losses incurred by these investors.
Similar to a phenomenon that first came to global attention during the Arab Spring in the early 2010s, social media, and in this specific case Reddit, has enabled usually dispersed investors to become more of a strong collective force with a common purpose. To confront this new force and stay in the game, hedge funds have already been driven to raise cash to meet higher margin calls, with some also stopped out of their short positions.
This compelled a few of them to sell some of their long holdings, with the inclination to dispose of their most liquid ones. With that comes an element of market-wide contagion, the extent of which will depend on the strength of what, at least until now, has been a remarkable countervailing “buy the dip” conditioning.
Such damage to general asset prices, producing the worst week for the S&P 500 Index since October last year, pales in comparison to what would most likely happen if one of the intermediaries were forced into a disorderly deleveraging, whether it be a broker or central clearinghouse. If not handled well, this could have much broader effects, especially because the nonbank segment of the financial system has been in an unprecedented period of rapidly rising debt, leverage and risk-taking, aided and abetted by too many years of excessive policy reliance on experimental central bank measures, and regulatory and supervisory gaps.
Regardless of which of these scenarios plays out — and, to make things, even more interesting, they are not mutually exclusive — regulators and politicians can be expected to become involved in some capacity.
Harder to predict is what particular element they will focus on most; some can have competing effects on asset prices and market functioning. Among the targets could be small investor protection, investment suitability criteria, margin limits, possible collusion and price manipulation, and market structure.
What started out as a market curiosity — small investors taking on the Wall Street establishment using what had been periphery platforms too easily dismissed by the traditional market powers — has both broader origins and implications.
This is not just an epic David versus Goliath story that has attracted worldwide media attention. Potentially in play is the democratization of finance, tech-led disruptions to market hierarchy, the overall valuation of markets, regulatory and political responses, and the market structure itself.
Mohamed El-Erian is a Bloomberg Opinion columnist and president of Queens’ College, Cambridge; chief economic adviser at Allianz SE, the parent company of Pacific Investment Management Co, where he served as CEO and co-chief investment officer; and chair of Gramercy Fund Management.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
JITTERS: Nexperia has a 20 percent market share for chips powering simpler features such as window controls, and changing supply chains could take years European carmakers are looking into ways to scratch components made with parts from China, spooked by deepening geopolitical spats playing out through chipmaker Nexperia BV and Beijing’s export controls on rare earths. To protect operations from trade ructions, several automakers are pushing major suppliers to find permanent alternatives to Chinese semiconductors, people familiar with the matter said. The industry is considering broader changes to its supply chain to adapt to shifting geopolitics, Europe’s main suppliers lobby CLEPA head Matthias Zink said. “We had some indications already — questions like: ‘How can you supply me without this dependency on China?’” Zink, who also
Taiwan Semiconductor Manufacturing Co (TSMC, 台積電) received about NT$147 billion (US$4.71 billion) in subsidies from the US, Japanese, German and Chinese governments over the past two years for its global expansion. Financial data compiled by the world’s largest contract chipmaker showed the company secured NT$4.77 billion in subsidies from the governments in the third quarter, bringing the total for the first three quarters of the year to about NT$71.9 billion. Along with the NT$75.16 billion in financial aid TSMC received last year, the chipmaker obtained NT$147 billion in subsidies in almost two years, the data showed. The subsidies received by its subsidiaries —
At least US$50 million for the freedom of an Emirati sheikh: That is the king’s ransom paid two weeks ago to militants linked to al-Qaeda who are pushing to topple the Malian government and impose Islamic law. Alongside a crippling fuel blockade, the Group for the Support of Islam and Muslims (JNIM) has made kidnapping wealthy foreigners for a ransom a pillar of its strategy of “economic jihad.” Its goal: Oust the junta, which has struggled to contain Mali’s decade-long insurgency since taking power following back-to-back coups in 2020 and 2021, by scaring away investors and paralyzing the west African country’s economy.
RE100 INITIATIVE: Exporters need sufficient supplies of renewable energy to meet their global commitments and remain competitive, the economics ministry said Local export-oriented manufacturers, including Taiwan Semiconductor Manufacturing Co (台積電), require sufficient supplies of green energy to maintain their competitiveness and regulations already ensure that renewable energy development adheres to environmental protection principles, the Ministry of Economic Affairs said yesterday, as the legislature imposed further restrictions on solar panel installations. The opposition-led Legislative Yuan yesterday passed third readings to proposed amendments to three acts — the Environmental Impact Assessment Act (環境影響評估法), the Act for the Development of Tourism (發展觀光條例) and the Geology Act (地質法) — which would largely prohibit the construction of solar panels in some areas. The amendments stipulate that ground-mounted solar
RSS