Individual investors again piled into several niche stock market plays on Tuesday, prompting hedge fund short sellers to scramble to cover losing bets and driving a rally in shares of companies including GameStop and Etsy.
The surge in recent days — GameStop has risen to about $150 from $19 since Jan. 12 while BlackBerry Ltd. has shot up 170 per cent this year — has spurred concerns over bubbles in stocks that hedge funds and other speculative players had bet would fall in value.
To some on Wall Street, the moves have also begun to look symbolic of a stock market that may be overvalued at the end of a year dominated by floods of fiscal and monetary stimulus to ease the coronavirus crisis.
“This is hardly an environment where informed investors are transacting to establish price discovery,” said Mike O’Rourke, chief market strategist at JonesTrading.
Chasing tips from Reddit
The benchmark S&P 500 has gained more than 70 per cent since March, with analysts putting moves in share prices of several loss-making firms down to herds of amateur investors chasing tips from Reddit discussion threads or the private Facebook group Robin Hood’s Stock Market Watchlist.
Venture capital investor Chamath Palihapitiya said in a tweet that he had bought $115 call options on GameStop, a gaming and electronics retailer, on Tuesday morning after an exchange with Reddit founder Alexis Ohanian. Those give him the right to buy the shares at $115, should he choose to.
GameStop closed at $147.98, up about 92 per cent on the day and extending its winning streak to a fourth straight session.
In after hours trading in New York on Tuesday evening, the shares were changing hands at more than $200 a share.
Much of the action has centred around shares that have been heavily “shorted” by other market players — traditionally an area dominated by hedge funds.
Shares in Evotec, a Germany-based drug company, rallied eight per cent on Tuesday with three traders reporting that hedge fund Melvin Capital Management was closing its short positions after suffering losses on some bets.
Melvin previously held a 6.2 per cent short bet against Evotec, according to filings with the German regulator. The fund did not respond to requests for comment.
WATCH | Here’s how short selling works:
Short sellers typically bet against stocks of companies that they view as outdated in their business models or otherwise overvalued.
BlackBerry shares trade at a 12-month forward price to earnings ratio (P/E ratio) of 117.22, while online retailer Etsy has a multiple of 93.44. At that level, investors are paying $93 for every dollar of actual profit at the underlying company.
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By contrast, Apple Inc., the world’s most valuable publicly listed firm, has a 12-month forward P/E ratio of just 34.46. Etsy jumped as much as nine per cent on Tuesday after Tesla Inc. CEO Elon Musk, also often a focal point for social media-savvy traders, endorsed the company in a tweet.
Investor Andrew Left is as convinced as ever that GameStop is a dying business and its stock price will fall sharply.
Will it end badly? Sure. We just don’t know when– Thomas Hayes, Great Hill Capital
Left shorted the company’s stock when it traded around $40 a share and forecast publicly that it would tumble to $20 a share. He said on Tuesday that he was still shorting the stock.
“Will it end badly? Sure. We just don’t know when,” said Thomas Hayes, managing member at Great Hill Capital in New York.
“The most optimistic estimate from the street [for GameStop] is $30 a share, which would be pricing in perfection on all of the most bullish initiatives of the company.”