Broker Check

Reflecting on the Recent Craziness

February 04, 2021

Market activity involving a small number of stocks has certainly garnered a lot of attention in the media recently. At least for now, the frenzy has subsided a bit. However, these things are subject to frequent reversals and may take a while to play out.

What exactly is happening and what is a short squeeze?

Sometimes stocks with perceived challenged business models and balance sheets are what is called sold short.  Without going into a deep technical discussion, it involves making a bet that the stock will go down in value. Typically, this is done by hedge funds that specialize in this type of trading.

Short selling can be a dangerous game. If the price of the stock rises significantly, the position may require additional money as collateral. If the money is not put up, the position must be closed by buying the stock within hours, causing the stock to trade even higher. This can snowball, causing a feedback loop that results in extreme volatility called a short squeeze. Short squeezes are actually quite common. But, they usually are confined to small pockets of the market and occur and fade quickly.

Why is this time different?

This has taken a new twist. Several social media websites have gone viral with participants encouraging each other, in rapidly multiplying numbers, to buy a few small, speculative stocks with large short positions. This has led to short squeezes leading to large gains for some social media players and big losses for a handful of hedge funds. Over the weekend, trading in precious metals has also been involved.

How significant is this and how does this impact me?

While this will take time to play out, there probably won’t be much of a long-term impact. Stocks gyrating wildly and some hedge funds suffering big losses grab headlines. As mathematically based stewards of wealth, we look deeper than the headlines. We look at the numbers.

As of January 27th, the spotlighted stocks with the highest short positions, favorites of the social media crowd, made up just 0.17% of the value of the S&P 500. We doubt that many will feel sorry for the hedge funds that suddenly found themselves on the very wrong side of a squeeze. While one might wonder if hedge fund losses could result in some domino effect in the markets, the type of strategies involved here are only a relatively small part of the hedge fund world and less likely to cause a large-scale chain event.

Do we have a strategy around this?

People participating in either side of the social media crowd versus hedge fund frenzy certainly have this dilemma. We, however, don’t manage your portfolio like a distressed securities hedge fund, nor do we tout individual stocks on social media. The struggle between the social media side and the hedge funds is ongoing. If history is any guide, it is possible that there will be losers on both sides by the time this is over.

Famed investor, Warren Buffett once said, “There are no called strikes in investing.” For non-baseball fans out there, that means investors don’t have to take a swing at every dramatic issue that periodically comes along. As disciplined investors, we are free to avoid the murky corners of markets where strange and unexpected things are more likely to happen and instead focus on what really matters in your portfolio and your life.

We are here for you.

All that said, we are monitoring the situation and are taking it seriously. We take everything that might affect you and your portfolio that way. Through all of this and whatever else comes, we are here for you.