Redditors’ declaration of war on hedge funds might be ugly, but it won’t break the system, pros say

A wild week on Wall Street ended in much the way it had begun, with day traders pouring money into a handful of troubled stocks as the broader market churned with volatility over vaccine worries, corporate earnings and short-sellers scrambling to regain their footing.

Retail investors — many newly minted, their exposure to the market facilitated by apps like Robinhood and their education limited to the raucous hive mind of Reddit message boards — continued to inflate the price of GameStop and other companies pegged by short-sellers for failure, such as AMC Entertainment and Bed Bath & Beyond.

Jan. 27, 202107:37

“This is the pure definition of speculation,” said Brian Vendig, president of MJP Wealth Advisors.

The pros acknowledged that some aggressive short-sellers could get burned beyond the point of recovery, or even that one or more hedge funds could collapse under the weight of the retail investor pile-on. Losses had already grown to nearly $20 billion in aggregate by the time the market closed on Friday.

“What’s been going on that’s leading to volatility is some institutions have to liquidate other positions to raise capital and cover their shorts,” said Jeff Buchbinder, an equity strategist at LPL Financial.

There’s no denying that some of these day traders have made serious money over the past several days, oftentimes at the expense of professional investors. The David-and-Goliath narrative has been stoked by braggadocious online gloating of small investors gleeful about, just for a moment, beating the pros at their own game.

While analysts said it would be foolish to entirely rule out the prospect that the spike in the stock prices of GameStop and its peers could trigger a market meltdown, they were in agreement that such an outcome was highly unlikely. For the retirement savers who aren’t treating investing like gambling, the smartest thing to do is just to ride out the market’s mood swings, they said.

“As far as spillover into the broader economy, I see extraordinarily low risks of that happening. This isn’t going to take down giants like JPMorgan or Bank of America,” said Mitchell Goldberg, president of ClientFirst Strategy. “This is an isolated event that is really small dollars compared to the overall market.”

The implications for long-term savers should be minimal, Goldberg said. “For your regular investor, this is a total and complete nonevent,” he said. “Investors should not let this throw them off their long-term goals. Investors have bigger things to worry about,” he added, referencing the rocky Covid-19 vaccine rollout and disappointing results of J&J’s highly-anticipated contender.

Vending pointed out that markets have sustained anomalies, hiccups and other weird behavior many times over the years. “Maybe this week some of the volatility is caused by this frenzy, but there’s always been something that’s caused investors a little bit of agita,” he said.

“When we think about the hundreds of millions of people who are investors, it’s still a small percentage of the overall market — but it is an indication that technology and communication can create adverse consequences,” Vendig said.

A far more likely scenario than a sustained selloff, market observers say, is that those hype-fueled valuations will implode and leave retail investors, including ones with little more than a rudimentary grasp of investing fundamentals, holding nearly worthless stock into which they might have sunk hundreds or even thousands of dollars.

Some pros criticized what they characterized as the “gamification” of Robinhood’s app-based platform. “Their investor base is younger and less experienced and a lot of people might not understand the potential losses that they may be facing,” Goldberg said.

“If people are looking at this more as entertainment value and not understanding that there’s a risk, there could be a very negative side to this,” Vendig said. “People are going to learn about what risk really means.”