The writer is president of Queens’ College, Cambridge university, and adviser to Allianz and Gramercy
The retail investor “Reddit rebellion” has painfully been exposed to one of the big lessons of popular political uprisings — although that does not mean it will not return.
First, early gains won during the initial surprise attack on the established order are hard to maintain if the movement is leaderless, lacks staying power and is easily distracted. Second, the established order — supported in its “counter attack” by those wishing to minimise disorder and uncertainty — quickly reasserts its dominance. However, this reassertion tends to happen in ways that fail to deal with the uprising’s underlying causes. That leaves in place the roots of future disruptions.
The story of the uprising is now well known. Facilitated by efficient communication platforms, disposable funds and costless trading apps such as Robinhood, a young group of investors tried to beat hedge funds by exploiting the “pain trade”.
In this case, that meant squeezing large short positions held by hedge funds on a handful of stocks, such as GameStop. Scrambling to save themselves, these stressed funds had to raise cash by selling out of their long positions, which put pressure on the market as a whole.
The strategy worked extremely well, initially. However, sustaining it proved hard.
Retail investors’ ability to buy, a critical element in any short squeeze, was hindered by draconian limits on additional purchases imposed on them by trading platforms. This, in turn, was said to be a function of the requirements imposed on trading platforms by clearing houses.
The buying power of the rebellious investors was also distracted by talk of silver being their next “target” — a problematic approach given the silver market’s much larger size and its relatively low share of outstanding shorts. Finally, infusions of fresh capital stabilised the trading intermediaries and calmed the bloody-nosed hedge funds.
Indeed, by midday in New York on Wednesday, GameStop was down 70 per cent from the start of the week, while the price of silver was off 8 per cent from its week high. Hedge funds were back in command, with little pressure to cover their shorts. Many retail investors had become victims instead of predators. And the rest of the market went back to what it was doing before, seeking one record high after another.
All this exposed the structural disadvantages inherent to the retail investors’ strategy. It reminded me of two sayings I learned early in my career as an investment manager: “You have no friends on Wall Street,” and; “If you cannot identify the weak hand, it’s you and you shouldn’t be in this game.”
Even so, it would be very short-sighted to believe that markets have fully recovered from this event and remain immune to further disruption. That is because it illuminated several realities which, if not acted upon, could well assert themselves far more dramatically.
It revealed the persistent asymmetry between the establishment and the “little guys” who carry considerable personal and national debt and are rightly worried about their economic future. Their concerns are unlikely to get material relief anytime soon. Their sense of marginalisation and alienation will grow.
It exposed a number of regulatory and supervisory gaps. The authorities were caught asleep at the wheel, again. They now need to resolve a series of difficult and, in some cases, competing issues that range from investor protection to market collusion.
It uncovered systemic risk. Judging from the billions of dollars subsequently raised by Robinhood, the financial system came close to a market accident that could have triggered a disruptive “de-grossing” — the simultaneous deleveraging of financial balance sheets. Moreover, it played out amid excessive risk taking and the broad disconnect between finance and the real economy. Ramming that point home, the market’s reaction to having avoided an accident has been to take on even more risk overall.
This retail investor uprising was akin to too many grass roots political movements that promote greater inclusion and participation. It failed to maintain its momentum, and growing counter-pressures frustrated the uprising’s aim of disrupting the established order and democratising finance more.
What has not been crushed, however, are the underlying forces that propelled the uprising. In its aftermath, markets have reverted to their old behaviours, rather than internalise its lessons. This leaves open the possibility of more disruptions still to come.