The uprising of the US retail investors
It is difficult not read into this latest US retail investors’ revolt promoted by Reddit’s Wallstreetbets forum as some sort of socio-economic backlash from growing disparity in wealth distribution and what is blamed by masses to be the run-away capitalism that has only benefited the society’s elite. Fascinatingly, weeks after the civil unrest in Washington and President Biden’s promise to unite a divided nation, this microcosm seems to be achieving that unity as the energy and anger behind the recent civil unrest and support for Trumpism of the far right appears to have morphed with the ideology of Occupy Wall Street of the far left.
There are many who claim this is simply just part of the process of democratisation of the US stock market which began months ago and promoted by online brokers such as Robinhood. Others see this as the gamification of the market and another form of online betting phenomenon. They argue that with the pandemic keeping people at home and having initially diverted funds from sports betting last year, it is now an established gambling arena where the masses have united on social media to take down the house. Whichever way one looks at this movement, it is a force to be reckoned with as we have seen signs of it spilling over to other global markets including ours in Japan.
This said, we don’t think this engineered short squeeze that has led to huge losses by some hedge funds and forced liquidation of some of their long positions will ultimately have a long-lasting impact on markets. Although we have seen signs of market dislocation with growth stocks coming under pressure and even recently favoured value plays also being sold off, we suspect part of this sell-off has been due to markets looking technically overbought in the first place and this event has provided a good pretext to lighten up in the very short term. With over $4trn still sitting in US money market funds, with corporate earnings so far looking even better than the previous quarter and more Covid vaccines being launched soon to fight the pandemic, we view this sell-off as a strong buying opportunity.
Identifying shorting opportunities remain one of our core mandates
Although we have much sympathy for the retail investors on the Reddit forum, as an advisory firm partly focused on identifying short sell opportunities in the Japanese stock market, we have had mixed feelings about the recent events which have unjustly vilified shorting. To be sure, we have long viewed the buy-side practice of shorting stocks and subsequently writing negative reports on them for external consumption as nothing other than ‘front-running’ which on the sell-side is strictly forbidden by regulators, and for a good reason. Indeed, short sellers will now think twice before writing these research notes and then making them public which in turn makes them an easy target.
Other much needed regulatory changes to the practice will undoubtedly involve enforcing rules that will make sure that all the stock lending have been backed and secured by prime brokers, preventing more shares to be shorted than what there is outstanding. We have also always believed that the ‘Uptick Rule’ should be re-established to stop short sellers conducting ‘bear raids’ to push down stocks to force liquidations of long positions. Although this has not been a problem in the bull markets of recent years, we have regarded this rule as an elegant solution that mitigates risks and prevents short sellers to take advantage of poor market conditions.
However, we see nothing wrong with short selling itself and we are confident that the practice will prove highly lucrative along with long/short strategies in the coming years as liquidity driven rally is eventually exhausted and interest rates ultimately head higher. As contrarian advisors, we generally avoid crowded shorts and look for selling opportunities among more over-valued and over-loved names which we think face a potential derating based on such factors like growth maturing, structural or regulatory changes in their respective industry or those simply facing disruption risks. This will remain one of our core mandates.