Are we in the beginning stages of the next big short?
Disclosure: All opinions presented here are purely my own and do not represent my firm or anyone associated with it. This is not a recommendation. Do your own homework and due diligence before investing in anything.
First posted on my personal website (here)
I spoke about this in a previous post (here) but I have more conviction now that we’re at the beginning of the next big market correction.
I hope I’m wrong.
I’m a positive person by nature but I can’t help but think about what’s potentially happening in the stock market.
If you think about probabilities, this is more likely to happen than not.
It’s how you can be really successful, and also how you can lose everything.
Hedge funds are over-leveraged.
When they raise a fund, the amount of money they can use in the market goes up 5x.
For simplicity, if they have a 1 billion dollar fund, they can get 5 billion dollars worth of liquidity in the market. How do they do that?
They use leverage. One way they do this is by what’s called ‘buying on margin.’
A margin account is borrowed money from a broker that is used to invest in securities or stocks. Trading on margin amplifies gains but also amplifies losses.
Let’s use an example.
Say I buy $100 of a stock, using $50 that I own and $50 on margin. Now let's say the stock goes up to $200.
Instead of doubling my money, which is the case if you had originally put in the $100 from your own account, you quadruple it using margin. Your $50 investment turned into $200. 4x.
What if the stock drops to $20? In this case, the investor sells their stock at a loss of $30 and they must pay the broker the $50 for a total loss. A margin call. Because they are trading on margin, the investor lost more than they originally had.
Right now, there’s a large potential that a bunch of funds on leverage are going to get ‘margin called’ in the next few months.
Gamestop and AMC.
What retail has done in coordinating thousands, potentially millions of people, through the Internet, to all buy and hold the same stocks, is unbelievable. It’s the true power of the Internet. Individuals as a collective against institutions.
Gamestop and AMC are set for a short squeeze. What does that mean? The price for AMC could go up to $100-$200 dollars in the near term. It’s an $11 stock today. Look what happened to Gamestop. It went from a single-digit stock to $497 at its peak.
Hedge funds shorted Gamestop again at the peak, thinking they’d be able to pay back all their shares by driving the price down.
But retail has held their shares. If they continue to hold, that’s going to cause major disruption to the market.
If a short squeeze happens, hedge funds have to buy those shares to cover their short positions or risk going out of business. This assumes they can cover their shorts at reasonable prices. But what if the price of the stock goes to $500 or $1000? It is a massive amount of money that hedge funds won’t be able to pay back, creating a huge redistribution in wealth from hedge funds to retail.
When that happens, the market loses liquidity. Money disappears. All of a sudden the stocks that were the darlings of the world like Tesla, Apple, Amazon, Facebook, etc. are going to have significant chunks of shares being sold. Hedge funds have to cover their short positions and they do that by selling other stocks.
The average person is not going to understand what’s happening and why stocks across the board are dropping all of a sudden. By understanding the concept of loss aversion, they likely want to sell too to take their profits. This creates a downward spiral that could get ugly.
This could collapse the whole market because of naked shorting.
Funds can create shares out of thin air.
They can push it into the market so it looks like there’s more supply and therefore the price stays low. What if that supply doesn’t really exist? In Gamestop’s case, hedge funds were shorting 140% of the total float of the stock, which makes no sense.
This means if there are 100 shares available that the public can trade, and all of a sudden there are 140 shares that are short, those with short positions eventually have to buy up the shares available.
People online are speculating, based on rumours, that the short float is above 100% of available shares for AMC. If that’s true, and it’s a big if, you could have another situation like Gamestop.
Now, what if multiple stocks short squeeze at the same time?
Americans just got their stimulus checks. They’re ready to spend money. They have access to the market now like never before. They can coordinate through the Internet. If tons of individuals across the world coordinate their effort against hedge funds shorting companies, these guys are going to lose billions of dollars.
This is the game.
This is how the market works.
For every short, there is always going to be another long. What if the longs are suddenly thousands of individuals across the world acting in unison? We’ve never seen that before.
Hedge funds: you’ve used shorting to destroy companies. You’ve created fake shares in the market that didn’t exist. That’s fraud. How can you create things out of thin air? How can the SEC, what’s supposed to be a regulated body, not see what’s happening? I expect a lot of regulation in the next few years on naked shorting because people are going to want answers.
When billions of dollars disappear overnight or over a few weeks because of a short squeeze, a lot of rich people will not be happy. They will blame the system. They will blame Millennials. They will blame the Internet and Reddit and Robinhood.
Welcome to the game.
It’s unfortunate because the amount of money they play with in the market has trickle-down consequences. If billions of dollars of money start to disappear, people are going to get nervous.
Could the whole thing drop 10% in a day multiple times?
I think so.
When Gamestop had its short squeeze, the market crashed a bit, just a couple percent. On January 25, 2021, Gamestop (GME) closed at $76.79/share. The Nasdaq (QQQ) on the same day closed at $328.11. On January 27, 2021, GME closed at $347.51/share. The Nasdaq on the same day closed at $314.56. The Nasdaq dropped about ~4%. That was just one stock. What if multiple stocks squeeze at the same time? It could be a sign of things to come.
You also have the bond yield and inflation.
Institutions are slowly rotating out of equities and back into bonds. We’ve had tons of money in equities in the last several years because bonds didn’t offer any yields. Institutions had to put their money in high-yielding assets, which have recently been stocks because of low rates.
Inflation is a major concern. When people are vaccinated and back out partying and having fun and spending money, things are going to get pricier. Think about how much money was injected into the global monetary system by the US. Like 4+ trillion US dollars in the last year? Wut? That money didn’t exist before and has to get paid back eventually.
Inflation is a concern because when demand goes high, supply goes low. When supply goes low, things get more expensive. Given all the pent-up demand for people to want to do things, things are going to start to get pricier.
What does this all mean? There’s a potentially once-in-a-lifetime opportunity to ride the squeeze and turn against the market.
This is not a recommendation. This is just how I’m thinking and what I’m betting against.
What if I’m wrong? The market continues to go up, more money gets put into the system and the bubble keeps climbing.
But what if I’m right? Then this is a generational buying opportunity, exactly like ‘The Big Short’.
All of these conditions exist at the same time and all you need is a catalyst to set everything off.
AMC and Gamestop are what I think take the whole thing down.
Keep Going, You’re Doing Great