This article will seek to contextualise the story so far, present prominent players as well the mechanics underlying this debacle that Wall Street’s gilded investment mavens woke up to find themselves in the midst of and then provide some measure of an epilogue to an event that, while largely over, will likely continue to develop over the next few weeks.
Reddit is not like Twitter or Instagram. While prime users of the latter often use these platforms to position and monetise themselves as brands, Reddit is completely anonymous. Real names are seldom offered, profile pictures are considered to be anathema and discussions are structured into “subreddits”: groups where Redditors gather to discuss a vast variety of topics, from the mundane to the esoteric. Many of the most popular subreddits also have evolved their own vocabulary.One such subreddit is “wallstreetbets” (r/wsb) which describes itself thus:
The tool of choice for many of the r/wsb members and their allies was Robinhood.Note: Following an investigation of public records and social media posts, Reuters revealed on January 28, 2021 that deepf—ingvalue’s true identity is Keith Gill, a Chartered Financial Analyst formerly employed at Boston-based insurer MassMutual. TANSTAAFL (or “There Ain’t No Such Thing as a Free Lunch”) “Gospodin,” he said presently, “you used an odd word earlier–odd to me, I mean…”
Vlad Tenev (L); Baiju Bhatt (R). Image Credit: The Wall Street JournalUnlike traditional full-service brokerages that have higher commission fees but offer a wider range of services including market research and investment advice, Robinhood offers commission-free brokerage with no minimum account requirements. Users can also trade fractional shares — a piece of a single share as opposed to units of shares. As a result, Robinhood’s Total Addressable Market (TAM) is significantly larger and, on average, less knowledgeable about investing than the average customer of a full-service brokerage: the average Robinhood customer, for example, is 31 years old, while the average Charles Schwab customer is around 50. Rather than risk overwhelming its users by presenting them with data processed by professional trading tools, Robinhood keeps its information streamlined. Robinhood also significantly “gamifies” its app. New accounts receive a free stock — a single share of a company determined at random. While the gift is unlikely to be a stock of Apple or Tesla, new users reportedly have a 98% chance of receiving a stock valued at between $2.50 and $10. When account holders make their first deposit, they receive a congratulatory message saying that funds have been made available immediately so they can start trading, and so forth. This “gamified” approach is suggested as the reason why Robinhood gained 3 million new users in the first 4 months of 2020. “Pandemic day traders” traded nine times as many shares as E-Trade users and forty times as many shares as Schwab users during Q1 ‘20. They also traded eighty-eight times as many risky options contracts as Schwab users during that period. However, the media narrative of inexperienced investors making risky decisions due to “gamified” apps such as Robinhood has been largely debunked by the National Bureau of Economic Research (NBER). While some users did invest in exotic instruments during the initial months of the pandemic, Robinhood investors principally held stocks with large persistent past share volumes and dollar volumes, making them invest overwhelmingly in large rather than in obscure stocks. Robinhood’s impact on the US brokerage landscape cannot be understated. In October 2019 – following the success of the likes of Robinhood – Charles Schwab, E-Trade, and TD Ameritrade announced they would no longer levy commissions on ETF, options, and stock trading (which is now the norm). However, despite the rise of niche brokers and advisory services being made available to investors for (often) little to no cost, Robinhood ended 2020 with 13 million users. The company’s revenue comes from three main sources: interest earned on customers’ cash balances, selling order information to high-frequency traders (a practice known as “Payment for Order Flow” or “PFOF”) and margin lending. Now, the average Robinhood account is worth between $1-5,000. Prior to E-Trade’s acquisition by Morgan Stanley in 2020, the company’s average brokerage account was estimated to be worth around $69,000. Morgan Stanley’s average account value is even higher, at approximately $175,000. Given the vast difference in scales as well as the large numbers of small-scale investors using its services, it stands to reason that the first and last sources likely wouldn’t be massive revenue generators for the company. It was revealed by investigations by the U.S. Securities and Exchange Commission (SEC) and other parties that the company earned under half of its revenue in 2017 from PFOF, and roughly half in 2018. Notably, the company did not disclose this piece of information to its users until October 2018 – more than 5 years after it commenced operations. PFOF is certainly not unique to Robinhood; most full-service brokerages pursue this practice as well. PFOF has brokerages direct third parties known as “market makers” to execute trades on their behalf. In the case of Robinhood, the process would be:
However, while PFOF accounts for just 3% of Schwab’s revenues and 17% of E-Trade’s revenues, Robinhood remains heavily dependent on PFOF. It also bears mentioning that Robinhood currently commands one of the highest rates on equity trades of any brokerage, at 17 cents per 100 shares. By comparison, Schwab makes 11 cents per 100 shares.Robinhood’s “gamified” app with its fractional trading facility became one means through which the r/wsb members amassed their forces against the “Titans” of Wall Street. “HOLD THE LINE!” What started as a strategy to benefit from a short squeeze became a little more than that: it became a battle between two groups. The r/wsb members – by and large never really identifying as proletarians and never less than aspirational with regard to making money – saw their ranks of allies bolstered by those who grew up in the recession of 2008, i.e., a time when Wall Street received massive taxpayer-funded bailouts while ordinary Americans received little to nothing for the tragedies that unfolded in their lives for years. Many saw this as payback time. Many opened brokerage accounts for the first time. And they categorically refused to sell.
Memes like these helped rally the cause furtherStarting around November 2020, GME had been making a steady climb up the charts. Then, on January 21, Citron Research declares that GME should be worth around or less than $20 and mocked those holding the stock. By around January 25, the stock skyrocketed more than 1,200% to the near-$500 range in its highs. Melvin Capital, with its very large short positions, ends up losing 53% of its investment and has $2.75 billion in emergency funds injected into it by Citadel, its partners and Point72 Asset Management. This was reportedly lost as well. Melvin makes press statements claiming that they have covered their shorts by now. r/wsb is not convinced; they reason that the volumes traded weren’t high enough to cover all the shorts. Elon Musk – no ally of short-sellers – voices support to r/wsb. Stock prices rally upwards. On January 26, GME opened at $354 per share (up more than 1,550% from December 31). Billionaire investor and CEO of Social Capital Chamath Palihapitiya – a vociferous defender of r/wsb’s actions on GME – buys $125,000 worth of February $115 GME call options after asking his 1.3 million Twitter followers what to buy. GME soars more than 300% throughout the day. By January 27, brokers struggle to meet demand for GME. Meanwhile, Facebook disables the 157,000-strong “Robinhood Stock Traders” group founded by 23-year-old Allen Tran of Chicago. Discord bans the “r/WallStreetBets” server on grounds of hate speech. New groups on Facebook and new servers on Discord spring up almost immediately. On January 28, several brokers including Robinhood block or severely restrict trading activity on GME and other “meme stocks” (by now, almost 50 other stocks including AMC, BlackBerry, Nokia and Palantir experience similar behaviour due to “hold” actions; all of these companies have significant short interest). GME records a high of $483. Chamath Palihapitiya closes his position in GME and announces he’s now going to donate both the profits and principal to David Portnoy’s Barstool Fund for struggling small businesses. On January 29, Robinhood allows “limited buys” of “meme stocks”. GME surges again while the apps of brokers (including Robinhood) were downrated to 1 on the Play Store by hundreds of thousands of users. Google wipes these ratings off and restores their prior ratings. In retaliation, usage of DuckDuckGo – a rival to Google with significantly reduced tracking and monetization of user behaviour – skyrockets.
The boards of r/wsb lit up with messages like thisOn January 30, some Redditors booked a digital billboard in Times Square through TPS Engage (a Romanian startup) to run a 15-second ad ten times over for a total price of $18.71. This was the ad:
Billboard in Portland, Oregon on February 5, 2021GME went up 19.2% on February 5 relative to the previous day after rising as much as 77.6% earlier in the day. With their ability to buy the stock restored, many GME bulls took the opportunity to acquire more shares.
To set a constant reminder to Wall Street of what happened in January 2021 (and what, the Redditors promise, will keep happening), a fundraiser to take over billboards in Times Square (such as NASDAQ) for months during high traffic hours is underway. The $10,000 fundraiser is at almost 40% of its goal as of February 6, 2021“TL;DR” As Redditors repeatedly stated (often ad nauseum) that this wasn’t about money, this was about sending a message. The message was directed at Wall Street: they’re as vulnerable as the common man in the free markets that they so cherish. These Redditors, however, are a small part of a new generation of investors who – as opposed to those that are typically catered to by full-service brokerages – are seen to have a pronounced disinterest in index-based ETFs in favour of single stocks. In terms of strategies, there is an outsized interest in options contracts albeit with a solid interest in cash positions, i.e. stock ownership as well. It is also likely that they share a (best case) neutral opinion of Wall Street “Titans” or (worst case) have a deeply negative opinion. These investors are spread across the globe, as supported by the fact that similar actions were seen on the European and Asian GDRs of “meme stocks” as well as the US-listed stocks themselves. Interest in the GDRs or outright foreign ownership of US-listed stocks drove a number of “meme stocks” into the leaderboards of European brokerages in the end of 2020 and January 2021. The events of January 2021, on the surface, didn’t seem to add up to much, relative to other events in Wall Street. Analytics firm Ortex estimated on January 28 that Wall Street’s short-sellers have lost more than $70 billion in the year to date (YTD). Shorting GME was estimated to have cost $1.03 billion, while shorts on Bed, Bath & Beyond (a “meme stock”) were looking at a $600 million loss. However, it bears noting that the largest losses were estimated to be from Tesla, which tops the list of most shorted names (in value) with $47 billion worth of bearish positions, followed by fuel cell maker Plug Power. Neither Tesla nor Plug Power was a “meme stock”. Also, Ortex data showed that as of January 27, there were loss-making short positions on more than 5,000 U.S. firms (and not just “meme stocks”). Credit Suisse attributed this to the liquidity triggered by waves of monetary and fiscal stimulus and advised its clients that this liquidity is expected to increase after the next round of government stimulus. On February 1, Ortex revised its estimates of losses and reported that hedge funds have lost $12.5 billion on GME over January. Given that most short positions were likely centered around GME being worth less than $20 and GME (as of February 5, 2021) closed at $63.77 with after-hours trading pushing it to $66.31,it would be a fair assumption to make that some short positions on the likes of GME and other “meme stocks” were rolled forward via complex structured deals that might continue to bleed for a little while. In Europe, retail investors targeted the most shorted European names including Pearson and Cineworld, likely with the same strategy as with “meme stocks” in the US. Pearson shorts had estimated losses of $208 million, followed by Nokia at $205 million. Short-sellers booked US$28 million losses on their bets against Cineworld. However, attributing all of the $70 billion loss to the actions of r/wsb and their allies would be premature. It also bears noting that Wall Street is by no means a monolith that exclusively targeted the likes of GME with short positions. Richard Mashaal and Brian Gonic’s New York-based hedge fund Senvest Management LLC made $700 million after investing in GME in September 2020 and riding the wave until January 2021. The company reportedly became curious after a compelling presentation by its new CEO George Sherman and investor Ryan Cohen at an investment conference in January 2020. By October 2020, it owned more than 5% of the company. It exited its stake because of a tweet fired off by Elon Musk on January 26, which helped extend the short squeeze and sent GME surging another 157% when the market reopened the following morning. Seoul-based Must Asset Management had presented a rosy view on GME in a Bloomberg interview on March 2020 and held a 4.7% stake in the company as of April 2020. On January 25, however, CEO Kim Doo-yong told Bloomberg that the company’s view on GameStop have turned less bullish on account of the stock’s high volatility and more-than-ten times surge since March 2020. He also declined to reveal Must’s holdings in GME but instead stated that it has increased its stake in US-listed Kaleyra Inc (KLR) to 5.2%. PlusTick Administration in Charlottesville (Virginia), which runs a hedge fund managing about $120 million, gained 20% in January, mostly due to rallies in BlackBerry and Macerich which were both “meme stocks”. Similarly, New York-based hedge fund Mudrick Capital Management LP made $200 million on another “meme stock” AMC in the month of January 2021. The fund’s holdings were principally in AMC’s debt, which rallied in January’s final week as AMC’s share value soared. The fund additionally made about $50 million writing and promoting name choices on AMC and GME shares it owned. “It is not just little people on the long side here. There are huge players playing both sides of GameStop,” said Thomas Peterffy, chairman of Interactive Brokers Group to the Wall Street Journal on February 3. Reddit CEO Steve Huffman stated on February 1, “The big change I see coming is the fulfillment of the promise of the internet. What we’re going to see over the next 20 years is the democratization of economics, not just what we’re seeing on Wall Street Bets”. Hedge fund billionaire and Bridgewater Associates founder Ray Dalio said of the GameStop frenzy on February 3, “Is this a big thing? It doesn’t come close to these other big things. How should wealth be distributed? Why doesn’t capitalism achieve the goal of being good for most people and how do you engineer it that way, while increasing productivity and its efficiency? That kind of engineering is the big thing and I don’t think they’re paying enough attention to that.” Dalio had argued in 2019 that the economic system does not serve the interests of most Americans. He also said he believes in more protections for individual investors. Seemingly sympathetic towards the short-sellers’ predicament was Senator Elizabeth Warren of the ruling Democratic Party, who had long been touted by the media as being hawkish on Wall Street greed. “We need an SEC that has clear rules about market manipulation and then has the backbone to get in and enforce those rules,” said Senator Warren on January 27. “To have a healthy stock market, you’ve got to have a cop on the beat.” With regard to the short-selling “Titans” of the industry: Melvin Capital founder Gabe Plotkin, personally worth at an estimated $300 million, has seen his company lose 53% of its value due to its short positions in GME while in the midst of a $44 million plan to expand the 1935 Miami Beach house he bought for $12 million by replacing the adjacent property with amenity courts, a new 1,316-square-foot cabana, a children’s playground and open space. Some speculators opine that he likely would be hard-pressed right now to justify his expenses. Plotkin’s neighbours Dan Loeb (founder of activist hedge fund Third Point) and Cindy Crawford (veteran of many a magazine cover and fashion ramp) were not approached for comment by the media. Melvin Capital ally Point72 led by Steven A. Cohen slid 10% in January, according to a source with knowledge of the fund’s returns. Point72 declined to comment to the media. Citadel’s Melvin investment had an immaterial impact on its flagship multi-strategy hedge funds, according to a source, who added that it made up about 1% of the losses incurred by its Kensington Global Strategies Fund and 3% of the losses incurred by its Wellington Fund for January. Citadel declined to comment to the media. On January 29, outspoken activist short seller Andrew Left announced that, after 20 years, his company Citron Research will no longer publish ‘short reports’ on companies whose value may fall. Citron, he said, will focus instead “on giving long side multibagger opportunities for individual investors.” Activist short seller Hindenburg Research outlined a negative view of health-care software maker Clover Health Investments after four months of investigation on February 4. Hindenberg CEO Nate Anderson says his firm isn’t planning to give up short-selling any time soon. However, in light of the climate around short selling, Hindenburg isn’t currently short Clover Health stock. They simply state that their published research – which also accuses Chamath Palihapitiya of misleading investors about Clover – is meant to prove a point. Bibliography:
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