The angry online mob that hopes to watch hedge funds endure a long and painful financial death could end up rattling everyday investors along the way.
If the movement gains more steam, it has a shot at impacting some names you might never imagine, maybe even a stock like Detroit-based Rocket, should traders move on from GameStop and other names to new heavily shorted stocks.
Speculators will be trying to guess what the next GameStop or AMC Entertainment might be, according to Sam G. Huszczo, a chartered financial analyst in Southfield.
“What company could these crowd-sourced day traders target next?” he asked.
And that’s precisely why the Securities and Exchange Commission, as well as Congress, must treat the latest stock market volatility fueled by vitriol seriously.
Manic market gains in some stocks — including GameStop, BlackBerry, AMC and Bed Bath & Beyond — occurred this year, showing how the power of social media can inflame investors.
While many will celebrate the winnings of small investors, the risks go up when speculative fever spikes.
The problem in the long run is that outlandish stock prices won’t be sustainable based on earnings and a company’s business outlook. As many know too well, you could be looking at all-out panic when that social media bubble bursts.
Why does it matter if a stock is heavily shorted?
The Reddit rallies are being driven by chatter that centers on stocks with high interest from short sellers.
Short sellers, including hedge funds, are betting that a battered stock, such as the video game retailer GameStop, will go down even further and they’re hoping to make money as the stock falls in value.
The WallStreetBets users are mounting a counterattack by buying stock in GameStop and others to drive up those stock prices to cause the hedge funds to take on huge losses.
As the buying picks up by the social media traders, short sellers must enter into the market to buy the stock to cover their short positions and avoid losing even more money.
Some formerly down-and-out stocks, such as GameStop and BlackBerry, aren’t the only stocks with a high level of short seller interest, though.
What’s going on at Rocket?
Rocket Companies, the parent of Quicken Loans and Rocket Mortgage, has a 40% short interest exposure, according to S&P Capital IQ, a data division of S&P Global.
It means that 40% of the outstanding shares have been sold short by investors looking to make money when the price of the stock declines, which is a significant number according to experts.
Short sellers lose money when the stock price goes up.
Rocket launched an initial public offering in the summer.
Rocket stock — ticker symbol RKT — began trading on the New York Stock Exchange on Aug. 6 when the stock closed at $21.51 a share — up $3.51 a share, or 19.5%, from the IPO price of $18.
Back on Sept. 2, Rocket closed at a high of $31.31 a share. But the stock has since pulled back.
On Friday, Rocket closed at $21.36 a share, up 5 cents, or 0.23%. Rocket started Friday up in double-digits in pretrading and was up 10% early Friday.
“Following the gain, CEO Jay Farner had a word of caution for short sellers: be careful,” according to a report Friday by Benzinga, a Detroit-based investment news outlet.
“You might want to rethink your position if that’s how you are playing it,” Farner said. “We’ve got a great track record and a lot of exciting things we are working on.”
Rocket founder Dan Gilbert, Farner and the leadership team continue to own 95% of Rocket.
Rocket has gained 10.3% since its close of $19.35 on Jan. 6.
IPOs don’t always keep climbing higher
The IPO market has been superhot for some but short sellers would be betting that Rocket was going to tumble in value.
David Sowerby, managing director and portfolio manager for Cleveland-based Ancora Advisors, said one might speculate on a variety of reasons behind the short seller interest in Rocket.
Rocket stock has not closed below its $18 a share IPO price but it hasn’t been soaring much since the initial IPO spurt. Its low point was $18.23 a share on Oct. 30.
With the stock having risen so much in the initial days after the IPO, Sowerby said, short settlers took an interest in Rocket.
This past week, short sellers had to cover their positions by buying the stock and they drove up Rocket’s price. At one point this past week, Sowerby said, Rocket had risen 25% from the low to the high in trading during the day.
Sowerby noted that there’s an ongoing uncertainty by the market about whether Rocket should be valued close to a traditional mortgage player, leading to a more conservative stock price, or as a financial technology company, which would drive the price higher.
In addition, he said, if interest rates do rise, mortgage companies like Rocket would see pressure on profit margins.
Boone Bowles, assistant professor of finance at the Mays Business School at Texas A&M University, said short sellers could be betting that sustained low interest rates will not spur demand for mortgages.
“Rates have been low for months now and those folks motivated to refinance have probably done so already, so future refinance demand may be low,” Bowles said.
In addition, Bowles said, short sellers could be viewing large parts of the stock market as being overpriced now for several weeks, if not months.
The GameStop episode, Bowles said, has shown a stark example of how wildly prices can move away from any semblance of fundamental value. Other stocks could be out there, he said, that are priced with too much optimism.
A Rocket spokesperson did not immediately respond to a request for comment.
Yet, if a social media trading frenzy envelops Rocket — which is not the case now — the stock could go higher, simply based on momentum trading.
“You could see a pop in Rocket, not related to an improvement in underlying fundamentals but rather due to a desire by short sellers to flatten their position or get out of their negative position,” said Sam Stovall, chief investment strategist at CFRA Research in New York.
How does this GameStop game work?
Like GameStop, a stock must have a high level of short interest exposure for this online trading game to work.
Stovall said the social media traders can be viewed like locusts descending on a tree top. One doesn’t know what tree they’d land on next but they’ll create a similar kind of havoc on one tree after the next.
The next target, though, would continue to be stocks with high levels of short interest.
Not all stocks are attracting the interest of short sellers.
The Standard & Poor’s 500 index, based on a simple average, has 2.7% in short interest exposure, Stovall said.
General Motors currently has 1.4% short interest, he said, while Ford Motor has 2.4%.
By contrast, Stovall said, you’re looking at short interest exposure of 83% for National Beverage and 53% for Tanger Factory Outlet Centers.
GameStop has a 131.8% short interest exposure.
In general, buyers playing the social media trading game might target companies with short interest exposure that’s one-third or higher, Stovall said.
The trading game hit a major roadblock Thursday, of course, after the popular app Robinhood and other online brokerages shut down the buying feature for certain hot stocks, preventing people from buying more GameStop, BlackBerry, AMC and other stocks, contributing to falling stock prices.
GameStop fell 44% on Thursday to close at $193.60 a share. But the stock rally resumed Friday, as GameStop gained $131.40 a share, or 67.87%, to close at $325 after Robinhood allowed limited buying of stocks like GameStop, AMC and others.
AMC closed at $13.26 a share Friday, up $4.63 a share or 53.65%. AMC had closed at just $1.98 a share on Jan. 5.
How far this whole thing goes is anybody’s guess. But it’s clear that it doesn’t end with GameStop. And make no mistake, while it may be fun to talk about the big winners, there will be losers.