This post was originally published on this site
https://content.fortune.com/wp-content/uploads/2023/08/GettyImages-457462091-e1691336100526.jpg?w=2048
Dan Loeb is hardly the first Wall Street titan to lament how meme stock traders have made short selling a perilous endeavor. But that Loeb, who runs the hedge fund Third Point LLC, did so now is what’s interesting.
The meme crowd, it turns out, is back at it again, driving up stocks and burning short sellers just like they did back in the wild early days of the pandemic. Tupperware Brands Corp., Nikola Corp. and Yellow Corp. have spiraled higher, sticking short sellers in the process with some $435 million in losses over the past two months. Loeb, while seemingly untouched by those sudden market swings, made it clear in a letter this week to his clients that his days as a big gambler against individual stocks are over.
“Fundamental analysis is increasingly taking a back seat to monitoring daily option expiries and Reddit message boards, as evidenced by the numerous short squeezes and manipulations of heavily shorted stocks such as AMC and Gamestop in 2021 and others this year,” Third Point LLC’s chief executive wrote. “While we have not abandoned short selling, we continue to reduce our single name short exposure in favor of market hedges and short baskets.”
One short seller after another was burned by the meme-stock crowd back in early 2021 as amateur investors banded together on forums like Reddit’s WallStreetBets to bet against Wall Street pros who had bearish positions in the likes of GameStop Corp. and AMC Entertainment Holdings Inc. It was a time of excessive speculation, visible also in the froth around blank-check IPOs and the frenzy in digital currencies.
That strategy bore less fruit as the overall market turned south in 2022 and pros took extra care to mask their short positions. But it’s come roaring back in recent weeks, as the AI-fueled tech rally started to spread to the broader marker and speculative furor kicked up.
Take Tupperware. The maker of food-storage containers staged an unlikely eight-fold stock rally over two weeks despite warnings its business is teetering. For Yellow, the trucking company expected to file for bankruptcy, a three-day rally catapulted shares higher by 584%. Nikola Corp., the troubled electric vehicle maker, a 400% in shares jump hit short investors to the tune of roughly $350 million in paper losses at one point, data from analytics firm S3 Partners showed.
The seemingly random booms lay bare a risk to investors betting against stocks popular with retail traders. Those sudden pops can leave money managers with short positions exposed to big losses.
“The ability to have your price whipped around you, on the long or short side, is like never before,” says Peter Atwater, an adjunct professor of economics at William & Mary. “The speed at which the crowd can assemble, target and move is unprecedented.”
The latest barrage from the Reddit crowd only adds to the peril for short sellers, a group of investors that often comes under fire for taking negative stances on companies. The U.S. Justice Department launched a criminal probe into short selling by hedge funds and research firms with both the Securities and Exchange Commission and Justice Department going after hedge funds for running “short and distort” campaigns.
Read more: Short Seller Andrew Left Lives in Fear of the Feds at His Door
Distressed drugstore chain operator Rite Aid Corp. seemed to capture the attention of meme traders on Wednesday, spiking as much as 68% when a record 57 million shares changed hands. The company attempted to attract the meme spotlight last year, setting up a virutal event in an effort to appeal to the amateur crowd.
Short selling has always come with the threat that the bearish thesis won’t pan out or will take longer to play out than an investor can afford to wait. It’s only in the past two years that the threat of getting squeezed by an internet mob has emerged. For Loeb, that’s more than enough to signal a permanent change in the landscape.
“The short selling environment is much more challenging than it has been historically,” he wrote. Third Point has “increased diversification and reduced position sizes of single name shorts, limiting our vulnerability to short squeezes.”
