Wall Street Cassandras Don’t Scare WallStreetBets Retail Army

A wild week on Wall Street ended as it began: with the retail army blowing up short bets, punishing hedge funds and minting small fortunes off the most-hated shares.

Following relentless promotion on Reddit’s WallStreetBets forum, GameStop Corp. surged 68% on Friday, taking its five-day gain to a staggering 400% as the S&P 500 Index fell 3.3%.

Shares of the video-game retailer had tumbled Thursday, when popular investment platforms including Robinhood began restricting trades. But the rally revived after the curbs were eased.

Something else that survived the week: the gaping chasm in sentiment between day-trading faithful who view GameStop as the emblem of their populist ransacking of Wall Street, and industry professionals who are convinced the bubble will burst.

“You can have this euphoria go on for a while, but some day people are going to put down the phone and get back to work. Then there’s going to be too many sellers and not enough buyers of that stock,” said Kim Forrest, chief investment officer of Bokeh Capital Partners.

Wall Street Cassandras Don’t Scare WallStreetBets Retail Army

To the pros, market history, research on crowded trades and basic logic all argue that this week’s Reddit-fueled mania is doomed.

In their view, GameStop’s valuation is simply unsustainable. The bricks-and-mortar retailer ended the week with a market cap of about $23 billion, up from $5 billion at the start of the week. Little about the company justifies the price, except the fact it is currently popular with the Reddit crowd.

“What I’ve seen happen with GameStop this week is the craziest thing I’ve seen in 27 years in the business,” said Norm Conley, chief executive officer of JAG Capital Management.

Researchers showed long ago that stocks whose trading is dominated by speculative retail investors “tend to be overpriced and earn significantly negative alpha.” And there are plenty of examples of equity bubbles collapsing -- some of them in the not-too-distant past.

In 2018, investors briefly went pot-stock crazy. Cannabis producer Tilray Inc. listed at $17 per share, and two months later hit an intraday peak of $300 -- an almost 1,700% increase. By the end of that year it was at about $70. It closed Friday at $18.10.

Popularity also doesn’t guarantee profits. One academic paper on the Robinhood phenomenon last year concluded that intense buying on the platform was linked to future negative returns.

“In every case I have observed, it’s ended badly,” Barry James, portfolio manager at James Investment Research, said of the retail investor frenzy.

Yet as of Friday, there was no sign of a bust. As went GameStop, so went other day-trader favorites. AMC Entertainment Holdings Inc. added 278% for the week and Koss Corp. advanced 1,800%. Meanwhile, the Dow Jones Industrial Average retreated, and the tech-heavy Nasdaq 100 shed 3.3% -- its worst week since October.

Wall Street Cassandras Don’t Scare WallStreetBets Retail Army

Barclays Plc’s Maneesh Deshpande wrote in a note that stresses from the short squeeze could continue, though risks of a “full-fledged contraction” remain low. However, he said, retail investors will remain a force to be reckoned with and will fundamentally alter market dynamics and investors’ business models.

And so the panic sweeping the kinds of trades favored by institutional investors continued to swell. The Goldman Sachs Hedge Industry VIP Exchange-Traded Fund (ticker GVIP), which tracks favored hedge fund picks, fell for the sixth time in seven sessions. It lost 4.1% this week.

Still, while any contagion risks from the retail bubble -- if that is what it proves to be -- look to be contained for now, worries persist.

“This is a very interconnected market,” said Steve Chiavarone, portfolio manager and equity strategist at Federated Hermes. “The best-case scenario is that the linkages are limited and this works itself out in a number of days. But there is the real potential that those linkages are more significant and may cause more disruption.”

©2021 Bloomberg L.P.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.