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Esteemed Advisor

Doug Noland

Yet another week for the history books. For posterity: GameStop gained 400%, AMC Entertainment 278%, Express 235%, Siebert Financial 122%, Cel-Sci 75%, Novavax 74%, Vaxart 68%, Fulgent Genetics 60%, Vir Biotechnology 59%, National Beverage 54%, and Fossil 47%. Ominously, the VIX Index spiked to almost 38.

Retail vs. the Hedge Funds. David vs. Goliath. Main Street Beating Wall Street. The democratization of finance for all. A Bloomberg headline from December: “Robinhood Is Not Gamifying Markets. It’s Democratizing Them.” Social media instigating a bloody short squeeze upon the hedge funds. The first month of the new year begins with chaos in our Nation’s Capital and ends with market mania chaos – both manifestations of Acute Monetary Disorder. Society Out of Kilter.

Shorting and even so-called “squeezes” have been part of markets for centuries. From a 2008 Reuters article, “Short Sellers Have Been the Villain for 400 years”: “In 1609, a merchant contracted to sell shares in the Dutch East India Company in the future, sending the company’s share price into a plunge. A year later, the authorities imposed the world’s first ban on short selling.”

My first experience with a short squeeze was in 1991. I was working for a bearish hedge fund that had just wrapped up a bountiful 1990. The economy was sinking into recession, the banking system was in trouble, and the U.S. was heading into war. Prospects for our fund could not have appeared brighter. Then, seemingly out of nowhere, disaster struck. Short Squeeze.

We had a handful of positions both heavily shorted and illiquid. These were also shorted by the leading short hedge fund at the time that, trapped by the squeeze, was “blowing up.” Hedge funds had even invested in short hedge funds specifically to garner a list of short squeeze candidates. It was dog-eat-dog, ruthless, manipulative and bloody within the nascent hedge fund industry.

There was another brutal squeeze following the Fed’s Q4 1998 LTCM bailout – a squeeze that unleashed 1999 speculative blow-off “tech” Bubble dynamics. There was a decent squeeze that fueled record market highs after the Fed’s 2007 subprime blowup emergency measures. A big squeeze unfolded in 2009 after the Fed’s $1 TN QE-fueled market recovery. There were “mini” squeezes in 2011, 2013 and 2018.

Last March’s unprecedented Federal Reserve (and global central bank) crisis response unleashed a historic squeeze dynamic. Squeeze poster child Tesla surged about 700%, surely inflicting the largest ever losses from an individual company short position. The Goldman Sachs Most Short Index rallied over 200% off March lows, ending 2020 up more than 50%. The shorts came into 2021 significantly impaired and vulnerable.

The retail “Robinhood” online trading community strolled merrily into 2021 in the money, emboldened, and understandably overconfident. After all, the Fed last year rigged the “investing” game to ensure maximum payouts. Some during 2020 caught on to the market peculiarity that there’s no quicker way to post hefty trading gains than to be on the right side of a short squeeze. This week the Manic Crowd discovered this phenomenon – and what a spectacular mob scene erupted. I appreciate that the retail trading community especially despises the “unsophisticated” label after a year of capturing such heady trading gains. But, as a group, they have no idea the fire they’re playing with.

A well-known market pundit on Bloomberg Wednesday morning celebrated the retail traders’ defining success over the hedge funds. That the online trading community would profit from unwise and unwieldy short positions was nothing short of a marvel of Capitalism.

What we’re witnessing poses a risk to Capitalism – an out of control mania. The Madness of Crowds. I’ve been increasingly disturbed by the manic nature of online equities and options trading. These concerns have only been elevated by throngs of online traders partaking in a chaotic squeeze episode. Many must be inexperienced in such cutthroat market warfare and surely do not comprehend the risk.

Squeezes are pernicious market dislocations that ensure significant wealth transfers. There are big winners and losers – the ultimate game of chicken pitting greed versus fear. Some hedge funds will not survive this ordeal. Other funds will profit handsomely from the squeeze - and likely then turn their sights on exposed retail traders. There will be winners in the retail community – that will for years enjoy bragging rights for nailing the Great 2021 Squeeze.

I hope I’m wrong on this, but most will be losers. Before this is over, many will blow up their trading accounts and exit the casino in dismay – or worse. Short squeezes always have a pyramid scheme component. It’s musical chairs, and the velocity with which squeeze stocks eventually collapse will be a shock to many. There was outrage Thursday after Robinhood and other online brokers restricted trading in a limited number of stocks. Just wait until this Bubble implodes and there’s blood in the (Main and Wall) Streets. Trading systems were stressed this week by millions of buy orders. How will the system function under the stress of tens of millions of panicked sell orders? I’ll presume worse than March.

Things get crazy at the end of cycles. To what scale of craziness during the waning days of an epic super-cycle? From this perspective, it’s only fitting that Crowds of retail traders discover the short squeeze game – the ultimate speculation. It’s also a conspicuously late-cycle phenomenon. Indeed, ears were ringing this week from sirens blaring warnings of trouble ahead.