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Trading , Stocks

What the GameStop Circus Says About Market Sentiment

Are You Ready for Life Under the Big Top?

by Murray Gunn
Updated: February 12, 2021

Adapted from an EWI Currency Insights column

It's a sign of just how historic a top this is going to be.

The Fed meeting would normally have been the major talking point in markets a couple weeks ago but there was really only one thing everyone was looking at. Yes, the incredible short squeezes in stocks.

GameStop (GME) gets the headlines but a number of others were squeezed higher such as Bed Bath and Beyond Inc. and AMC Entertainment Holdings. At the start of January, GME was trading at $18 a share. It printed $483 before tumbling. On the face of it, the sudden advances in these stocks were due to forced buying by funds that were holding large short positions. There's also the so-called gamma effect whereby market makers have to buy more and more stock in a rising market to hedge option contracts that have been sold to investors.

But what's really behind it is much more fascinating.

These "reddit board" retail traders that have been credited (or blamed) for the explosions in the stocks give us an interesting insight into current psychology. Some commentators have stated that this is a revolution in financial markets, where the retail traders get to boss around the institutions. The retail traders are angry, people say, and want to "stick it to the man." We disagree. It's not a revolution. They're not railing against the system, they're embracing it.

What many of these retail traders think they are doing is punishing institutions for being short a stock. That's a sign of extreme bullishness. "What d'ya mean you're short?! Don't ya know stocks can only go up?!"

This episode is also a classic sign of incredible excess liquidity sloshing around the markets. A click on your mouse and you can be leveraged to the hilt in a second.

And it is a quintessential display of retail herding behavior of course. "Join the message board crowd or lose out!"

Excess bullishness, excess liquidity and retail herding behavior. These are all attributes of exuberance seen at historic stock market tops.

Two of the most famous short squeezes came over a hundred years ago. In 1901 it was Northern Pacific Railway, and in 1907 it was United Copper. Both squeezes are still remembered because they occurred just before major crashes in the stock market.

We'll see if the GameStop squeeze follows the same script.

Get to know the real ringmaster of the markets

Who's in charge of the market's moves -- Reddit traders, hedge funds, Congress, the Fed? Nah. They're just along for the ride. Discover what truly moves markets -- and how you can stay ahead of dramatic changes -- with the Financial Forecast Service.

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