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PODCAST: Short squeeze vs. freshly squeezed

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PODCAST: Short squeeze vs. freshly squeezed

By: Dean Dorton | February 10, 2021

How does the power of social media relate to the recent short squeeze in the stock market? Why have the U.S. markets been on the rise over the past year? Matt Parks, wealth advisor at Dean Dorton Wealth Management, joins host Justin Hubbard on this episode to answer these questions and more.

Unhinged Podcast

Episode 17

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Transcription

Justin Hubbard:
Today, I sit down for a conversation with Mr. Matt Parks. Matt is a wealth advisor at Dean Dorton Wealth Management. Matt attempts to help me understand the difference between a short squeeze and freshly squeezed, why the U.S. markets have been on the rise over the past year, and he forces me to read you the following disclaimer: All information contained on this podcast episode is for informational purposes only and does not constitute investment advice in any form.

So please listen, enjoy, but just don’t spend your money based on anything we say.

Okay. The wise, the wonderful, the charmingly good-looking Matt Parks; welcome to the show.

Matt Parks:
I think that might’ve been some few false allegations there, but we’ll roll with it. Thank you. Good to be here.

Justin:
Allegations. Well, okay. Okay. All right. You’re in the wealth management world, the investing world, and it is January the 28th, and it’s an odd time across the markets. For those of us who are not astute to the financial markets, we’re learning what a short squeeze is. So what the heck is going on?

Matt:
It’s crazy. I don’t know. The initial thing with GameStop, I guess started three weeks ago or so significantly. And it’s a group on Reddit that have decided they’re going to take on some of the biggest Wall Street hedge fund guys, and it’s a David versus Goliath. And as of right now, David’s been winning.

Justin:
So some of the things that I’ve said, that you’ve got the power of social media is connecting these people with a unique interest. And basically that interest is: if you’re a conspiracy theorist, maybe their interest is to really take on some of these hedge funds and cause some pain, but maybe they’re also just in it to make a lot of money at someone else’s expense. And so Reddit is the platform of choice. I believe there’s also similar groups formed on Twitter. We’re seeing how social media can come together and really just impact society. Some people are calling it the democratization of the markets, which is an interesting take on it.

Matt:
Yeah. It’ll be interesting to see how it plays out as to whether or not there’s any type of allegations for market manipulation, that kind of thing. But as of right now, there’s either one argument that yeah, it’s just an investing club who decided, “We think the short positions on certain stocks are too heavy, and so we’re going to go the opposite way and bet against it,” and it’s working, they’re squeezing out, and they’re making profits. And on the other hand yeah, it’s that story of just, “Hey, let’s see what can happen,” and markets are working out efficiently, and if it plays out to the end eventually it could correct itself and it will correct itself. And there’ll be people left with nice profits. There’ll be people left that lost their shirt.

Justin:
Yeah. I guess the term squeeze, what does that mean in this context?

Matt:
In very general or overarching terms, the short sellers, they’ve borrowed a stock from someone, gone and sold it at a particular price, and then are looking to buy it back at a cheaper price later on because they’re banking that the stock’s going to go down. And then they return it to the person they borrowed for and they’ve got a profit from the difference. And so the squeeze comes when somebody holding the short position realizes the stock is running up and, “I’m just going to cut my losses and get out.”

So in order to cover that, they’ve got to go and buy shares. So they buy and that demand drives the price up a little bit more. And so then another short seller says the same thing. And you just get this sort of network type of thing that eventually there’s so much going on with that, that it creates a squeeze where it just shoots the price up because so many people are trying to cover it. And somebody who’s holding the stock, these Reddit WallStreetBets guys, if they’re longing the stock, then they’re going to have some nice profits from it if they can get out in time, I guess.

Justin:
So essentially, it’s basic economics, supply versus demand, but you’ve got the demand being squeezed for two different reasons.

Matt:
Yeah, exactly. And so some of the stuff going around is the mantra of this group is, “We can stay stupid longer than they can stay solvent,” so as long as they can hang on, the short sellers are going to have to cover at some point because they got to answer to their investors and whatnot. And even the press secretary for President Biden now was asked about it yesterday, and they said, “We’re monitoring the situation.” So there’s I think a lot more parties involved now than what anyone foresaw two weeks ago when they all said, “Let’s resurrect this 2002 mall game store from the dead.”

Justin:
Well yeah, I saw somewhere that GameStop had announced that it might be to at least pay kids 15% of the value of the game that they’re trading in for.

Matt:
Okay.

Justin:
So there’s some hope for the children out of this.

Matt:
Yeah. And I think the initial thing that started all of this was the stock was heavily shorted. It got a small pop in value because a particular person joined the board of GameStop who had some; I forget, I mean I’ve seen it in a headline, I didn’t read a significant… But it was somebody with prior experience, business experience, who was a big enough name that it got the attention of a few people. And so that kind of jumped the initial. And I think it’s just one of those things of how do you know what tweet’s going to go viral or whatnot. But this was the thing that happened to get some traction in that group. And now we see it with AMC, Bed Bath and Beyond. I saw last night, Tootsie Roll was up 60% after hours. I mean, it’s just go pick something from your childhood and there could be something happen here soon.

Justin:
So I mean, I know there’s no way of knowing just as there was no way to predict this, but is this just going to fizzle out, you think?

Matt:
I mean, I would think it has to, at least on a per stock basis. Markets, as we are seeing right now, can be very inefficient in the short term. But usually over the long term, they’re efficient. They are priced to reflect all the available information. And so if there’s no future in GameStop as a company, and as the ability to generate earnings, pay cash to investors; then people are eventually going to sell. Everybody’s getting in at this point, just hoping that somebody is going to get in at a higher price than they are. And so eventually that’s going to turn and it can happen rapidly. And then, like I said, some people are going to be left there with considerable losses.

Justin:
Well, we saw this a few years ago back with Bitcoin, right? When everyone was going online to the various Bitcoin exchanges or Bitcoin services with their fancy new credit card and running up credit card debt for something that they had no concept of what it really was. And I think finally some of the exchanges, if that’s the correct word, Coinbase and perhaps some others, said no, no longer accepting credit cards. And even back then you still had the banks. There was a conspiracy theory that all this is the banks, they’ve stiff-armed the Bitcoin people because they don’t believe in Bitcoin and they’re afraid of not being able to be paid in full.

Matt:
Exactly. They say history repeats itself, so it’s just we’re seeing it in a different area now. But yeah, definitely the case with Bitcoin a few years ago, and there were people who, again, who it worked out for great because they got in at the right time and then they finally decided to sell. And there’s other people who lost a considerable amount with no ability to repay the credit card debt they had taken on.

Justin:
Well, let’s jump off the headlines for a second, if we can. And let’s just pull back a little bit and just look at the market overall over the past 12 months. The market is up considerably, despite the fact that you had a huge drop back in, I guess, the first quarter of 2020. We’re in a pandemic, still record, a significantly large unemployment rate. We’ve had social unrest, we’ve had a contested presidential election, a run off for the Senate, we have a new president. And yet the market keeps going up.

Matt:
Yeah. An eventful year, the market went up, right? That’s all there is to it.

Justin:
I mean, there’s probably a whole generation of investors at this point who don’t understand that the market can go down.

Matt:
Yeah. That’s probably true. Yeah. It’s interesting to say the least, I think there’s a couple things at play or a few things at play, and some of them track with historically the way markets have worked, and some others are new uncharted waters, I guess I’ll say. One thought is that markets are operating ahead of the economy. Markets are forward-looking, whereas the economy obviously is what’s going on today. So when we saw the sell-off in February and March of last year, one, there was a lot of uncertainty. And markets hate uncertainty even more than they hate bad earnings or whatever that may be. The uncertainty is what drove to so much panic, so much flight to safer assets out of equities, that kind of thing. But because the market’s forward looking, what the current value of the market is, is oftentimes not going to reflect what’s really happening today in the economy. It’s also considering what is expected to happen going forward, because really the value of a stock is ultimately the value of its future earning stream.

And so when you then have to try and find the value of that stock today, there’s only a little bit of that value that relates to the next six months of earnings or the next year of earnings. And so markets are looking out thinking if this is going to be a fairly quick recovery, then we’re almost back to where we were. There’s going to be a little bit of a blip. And obviously when you look company specific, there’s been companies who have done very poorly, their stocks have, and they’ve stayed down. But overall the market’s reacting to the fact that if we can get a vaccine and the economy begins to return to normal, there’s going to be a lot of pent up demand for goods and services that people weren’t buying during the pandemic. And so we could see a pretty quick return and then the economy is off and doing well. So I think that’s the historical part of the way markets operate that provides an explanation for why the market’s up, even though the economy is still struggling.

But I think there’s also factors that you’ve got a group of new traders, new investors, who through Robinhood and some of these other sites really weren’t involved in trading prior to the pandemic. And so that was something that everybody’s staying at home, the government sent them checks, and a lot of people said, “All right, well, here’s something I can do. So let’s day trade, or let’s at least just buy some stocks,” whatever stock you’re hearing about, or that kind of thing. So there is some new forces at play. And then additionally, just capital is cheap. Interest rates are low. And so there’s not a lot of other alternative investments for a decent rate of return. And so to try and get a decent rate of return, a lot of people would say, “I’ve got to go to the stock market.” So there’s a willingness to pay a higher premium to buy that, I think, for a good amount of people. And like you said earlier, ultimately economic supply and demand, that demand is driving some prices up.

Justin:
Yeah. That’s interesting, you were talking about how markets are our future looking. So let’s say as a society, the vaccine has been rolled out to hundreds of thousands of people each week, so maybe we’re to the point of getting back to some form of normal. So once then that demand for the supplies and the goods is met, people have bought their whatever; would your expectation be then that the market maybe doesn’t go down, but maybe just pans out a little bit and holds steady?

Matt:
Potentially. I’d say what will drive what markets do this year won’t be whether news is good or bad, whether on the effectiveness of the vaccine or the demand, it’s all going to be is it better or worse than what we expected? And so if there’s an expectation that the vaccine is going to get rolled out roughly in this timeframe, and it’s going to be 90-95% effective, so the experts are saying, by July, most things are going to be returned back to normal. That’s all going to get priced in to the current price of those assets or those stocks almost immediately.

And so yesterday, the stock market sold off considerably. And a lot of that was due to there was information coming out about delays with vaccine rollouts or lower supply getting that to certain states, that kind of thing. And so that’s the market reacting immediately to that. And it all will hinge on is the news better or worse than what we expected it to be, not so much is it just good or bad news. Because you could have bad news, and as long as it’s a little bit better than what was expected, you’ll see markets go up. And so it’s just all a reaction to what was priced in initially. And so that’s one of the difficult things, is trying to fully know or understand what really is priced in. But that’s what I would see going forward is, it’s just going to be a response to do we outpace or underpace what the expectations.

Justin:
Yeah. Okay. I’d never heard or thought of it that way. So in some ways, the market rewards moral victories. So if you expect a drop, but the drop isn’t as severe, then it’s a gain.

Matt:
Yeah. Because the expected drop should already be priced in.

Justin:
Yeah. Versus if your favorite sports team, you expect them to lose by 20 and they lose by 10. Well, that’s really kind of worthless.

Matt:
Exactly. You could think of it as your team lost the game, but you still covered the spread.

Justin:
Yeah, I guess that’s what it holds up to.

Matt:
Which the way markets are going right now, there’s a little bit of equivalence to that gambling notion, I think.

Justin:
We are not condoning gambling. So relax.

Matt:
No.

Justin:
But speaking of gambling, let’s talk about cryptocurrencies. So over the holidays I sat and watched Bitcoin hit $40,000 per something, I don’t know for what. But what is this phenomenon of cryptocurrency and what should we average investors know about it?

Matt:
Yeah. Well, I’m not an expert in it by any means, but in general, cryptocurrency, it’s a decentralized virtual currency, so a different option than a fiat currency or a government backed currency, that’s basically backed by the network that it runs on and the blockchain technology that it operates on. So some people look at it as an investment in the technology. Some people look at it as an investment just in the future of where currency is going. Other people, it’s entirely speculative in nature, and you ought to use the same money to buy that if you’re going to that you would take to the casino, because there’s just as good odds of it working out okay for you.

Justin:
Yeah. Well, you partner that with the government going trillions and trillions of dollars further into debt, it definitely raises concern for inflation, and a way to, like you said, hedge against inflation. So lastly let’s real quick; inflation, why aren’t we seeing it? Or are we seeing it, we just don’t recognize it?

Matt:
Yeah. I think we are seeing it in one sense. We’re not necessarily seeing it in consumer price inflation, but we’re seeing asset price inflation. And so what I referenced earlier, just the cheap, easy money that is available now, we’re seeing significant rises in stock market prices. In most markets, we’re seeing a pretty decent increase in residential real estate prices at least, commercial’s another story. But we’re seeing asset price inflation. So I think it’s not that we’re not seeing it at all, and that printing more money and pumping more money into the economy is just not causing inflation. It’s just that people right now are limited in what they can spend because of shutdowns and lockdowns and travel restrictions. And so that new money is getting funneled into either just general savings, but also in investment, and it’s driving those prices up. It’s sort of a two sides of the same coin, traditionally consumer prices is what’s thought of as inflation. They’re just not seeing it there.

Justin:
But don’t we eventually have to?

Matt:
Yeah. I mean, I think we will. I think it’s a slower process, and the Federal Reserve is positioned in a way where once they do start to see them reaching the inflation target, which is 2% roughly, little more than two, and they’ve indicated they’re going to let it slide and that’ll be fine. But if it starts to continue to creep up, then they will act to adjust interest rates, to adjust the amount of bond buying that they’re doing. They’re purchasing a ton of bonds right now, they have been in the past. And so I think just the way that they can adjust will hopefully not allow inflation to get too out of hand. Now, that’s yet to be seen whether or not that can happen and it can be fine with the amount of money that’s already been put into the economy. But as of now, it seems like most of it’s going into assets as opposed to chasing goods and services and driving the price of that up.

Justin:
Is it fair to say that as long as money is in circulation and it’s spending fast, we can take some hope in that, that it’s not just spending; that represents an active economy, active opportunities to pursue, and places hopefully investment and re-investment in our infrastructure, as well as into our people and just our overall economic motors?

Matt:
Right. Yeah. I mean, definitely a little bit of inflation is good and just overall inflation that is good. Another thing with the Federal Reserve purchasing these bonds and basically putting money into the economy through banks; banks have to keep so much more on hand now than they did pre 2008 financial crisis kind of thing. So when you hear about $3 trillion has been pumped into the economy, I think not all of that money is making it out to consumers. A lot of it’s sitting on banks’ balance sheets. And so that helps keep things depressed, it helps keep banks liquid and able to lend, so that yes, as you said, we can continue to keep a healthy economy going and allow for businesses to continue to borrow and flourish and invest and that sort of thing.

Justin:
Well that’s a high note, so that’s a good place to end.

Matt:
Exactly. There you go.

Justin:
Matt, thank you for coming on. It’s been a privilege, it’s been fun, and let’s do it again.

Matt:
Sounds good. Thank you for having me.

Your Host

Justin Hubbard
Justin HubbardAccounting & Financial Outsourcing Director

With Guest

Matt Parks
Matt ParksWealth Advisor, Dean Dorton Wealth Management
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