Where To Find The Next GameStop

What to make of this market? Violent swings up and down with r/wallstreetbets, Reddit message board users banding together with memes to send GameStop Corp. (GME) and hedge funds into a frenzied game of high-stakes chicken.

Hint: Wall Street is like the house in Las Vegas, they always win in the end. Not because they are more virtuous, they are not, but because they have far deeper pockets. Unlike the Reddit raiders, hedgies have access to billions and billions of free dollars. They can borrow damn near zillions of dollars at damn near no cost. Think Federal Reserve, maybe not directly without a banking arm, but indirectly from mutually beneficial existing relationships.

Here is the dirty secret, once the hedgies can get their hands on the money, they can leverage it up to 10 times (some as much as 40 times). That means, for every dollar they borrow, they can spend between $10 and $40. r/wallstreetbets can’t borrow like that and are at the mercy of brokerage margin and trading rules, as we saw last week. It’s not a fair fight.

Recent trading swings recalls Popeye The Sailor Man cartoons (fill in old man jokes here) but in reverse. His love interest, Olive Oyl, would be under water too long and Popeye would save her. Then to clear her lungs of water, Popeye would move her leg up and down like a lever while saying out with the bad (water) in with good (air). However, like in 2008, it’s out with the good to pay for the bad.

Overborrowing, outsized leverage and just flat-out stupid risk taking was at the root of the 2008 subprime crisis. We see remnants of that with recently volatility. When a firm gets a margin call because one or more of their positions suddenly moves against them, generating big losses, they need to create liquidity elsewhere to get their account(s) back in balance. More often than not, they need to sell other positions to move into compliance.

It’s a rock in the pond, it has a ripple effect. The circle of impacted portfolios grows wider, causing more selling… heavy selling makes stock prices drop, which in turn causes other accounts at other firms to get out of balance too. Then they need to unload holdings to get back in balance. It’s a waterfall effect of selling and you get big drops like we saw last week. It’s no coincidence that GME was down on a day the market was up to start of this week.

Wall Street won on Monday with the markets going deep green, but we expect the tug of war to linger for a few days/weeks before its over. In the meantime, the risk is to the downside with defined lines. If the NASDAQ can get to the better side of 13,600, then it should challenge its recent highs at 13,750ish. On the flip side, if the index closes below 13,000, then it’s probably headed towards 12,500. We won’t commit one way or the other until the market picks a side.

We are going to skip the SECTOR WATCH section this week. Considering the recent interest in highly shorted stocks with smallish floats (the amount of stock available for trading), we’ve put together the following list of stock with the largest short positions as a percentage of their floats.

Much like GameStop Corp. (GME), many of these names could “go to the moon” if the message board mafia turns their sites on any of the companies below. The stocks with the smallest floats and average daily volume would be the fastest of the rocket ships.

Rich Meyers
Investing Trends