This week’s epic frenzy in the market’s most shorted stocks could be portending a near-term top and impending correction. Here’s why.
The best word to describe this week might be manic.
Reddit’s WallStreetBets forum mobilized retail traders this week into some of the market’s most unloved and heavily shorted names, pushing them far higher in a short squeeze amid wildly volatile trading.
The poster child for this frenzy: GameStop (NYSE: GME).
Exactly a week ago, GameStop shares closed at $43. It closed at $76.79 on Monday, $147.98 on Tuesday, $347.51 on Wednesday, and on Thursday jumped as high as $492.02 before closing the day down -44% at $193.60.
But investors beware, the speculative wave could be signaling a near-term top.
Julian Emanuel, head of equity and derivative strategy at BTIG, said this week that the surge of options buying and frothy trading in high-flying stocks including GameStop is looking very similar to the period leading up to the dot-com bubble crash in 2000. And if the market behaves the way it did back then, we could see the S&P 500 run up to a lofty 5,047 before the bull market ends and it all comes crashing down, though he’s not forecasting quite such a surge.
“We don’t see any signs yet, concrete signs, of a medium term trading top, but this type of volatility leads us to believe that similar to 1999 to 2000, you could get a 10% to 15% pullback at any time,” Emanuel said. “From what we see right now, the level of speculation leads us to conclude the typical retail investor is as bullish in the aggregate as we have seen in over 20 years. With valuations where they are now, that is the recipe for potentially rapid, albeit temporary, set back in the market.”
Emanuel isn’t the only one warning of trouble in the short term.
Investing legend Richard Bernstein said this week that retail investors will pay a big price for getting caught up in speculative trades, pointing to excessive euphoria in the market from naive traders.
“Bubbles show up in a number of different formats, and this is a classic,” Bernstein said. “You’re basically playing with fire. …Trading volumes are up pretty dramatically. We really have a bubble going on in that half of the market. If you’re worried about what’s going on… you should be a seller.”
Bleakley Advisory Group chief investment officer Peter Boockvar is also calling this week’s action “another epic parabolic bubble.”
“Let’s break down the investment strategy: Find the most shorted stocks, buy calls, write about it, buy the stocks and jam it higher,” Boockvar said in a research note, adding that it always ends “the same way, and that is a pop in that bubble and a crash right back to where the stock started from. We’ve seen this in the history of markets. [In the] 1920s, they had these stock pools where people got together and manipulated stocks.”
“We’re in 1999 again,” Boockvar added. “I just don’t know which part of that year.”
And as history repeats itself, Morgan Stanley CEO James Gorman warns that retail traders who spurred this week’s speculative frenzy could be in for a nasty surprise.
“There are a bunch of people that are in for a very rude awakening at some point here,” Gorman said at the Future Investment Initiative conference in Saudi Arabia. “I don’t know if it is going to happen tomorrow, next week or in a month, but it will happen.”