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Market Voice: GameStop, Bitcoin and Brexit

Ron Leven
Ron Leven
Professor of Economics at Duke University

In February’s Market Voice, we analyse what the GameStop price surge could mean for short selling in the long-term; compare the recent Bitcoin rally with the previous rally in 2017; and survey the impact so far of Brexit on the UK economy and markets.

  1. The surge in price in GameStop made headlines in the financial markets, but what are the long-term implications for short selling? Refinitiv’s StarMine provides some clues.
  2. The price of Bitcoin recently topped $48,500. How does this rally compare with the previous Bitcoin rally in 2017?
  3. Since Brexit, the UK equity and currency markets have been stable, and January retail figures indicate that it has not had a negative impact on consumer sentiment.

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GameStop price surge analysed

The GameStop price surge and collapse these past weeks has generally garnered more attention than it deserved.

Even at its peak price, GameStop represented less than a 10th of a percent of total market capitalisation and other than creating stress on the broker Robinhood and outsized gains and losses for the individual investors abroad it had no significant effects on the general market.

That said, we think the nature of the short holdings estimated by StarMine, available in Eikon, provides some interesting lessons that may have broader implications.

Refinitiv Eikon: Turbocharge your analysis of the financial markets with the ultimate set of tools

Figure 1: GameStop shorts as percentage of outstanding (top) and market price (bottom)

GameStop Shorts as percentage of Outstanding (Top) and Market Price (Bottom)
Weekly Close Data. Source: Eikon

Figure 1 shows the weekly closes of the market price for GameStop in the lower pane and the total number of outstanding shares held short as a percentage of total shares is shown in the upper pane.

This data is available with a lag, so the last date in the table is for 4 February. Because the same share of stock can be borrowed and sold multiple times, there is no theoretical limit on short interest. This is why the chart could report that in the weeks prior to the price surge, short interest hit 107 percent of total outstanding shares.

Based on StarMine’s estimates, the situation was even more extreme as shorts got above 120 percent of free float (i.e. excluding shares that are not accessible to the market).

Short exposure of this magnitude is quite exceptional.

By comparison, even at the peak of market bearishness on Tesla, short interest never got significantly above 25 percent of total shares. Even the shorts in AMC, which was caught up in a squeeze simultaneously with GameStop, did not get much above 30 percent of the float.

Indeed, StarMine had rated GameStop as the most vulnerable to a short squeeze of any stock in the market. It is easy to see how total shorts exceeding the value of the market created a massive price response as these positions were reversed.

Implications for short selling

The GameStop gyrations are being discussed by market regulators.

Short sellers will be under scrutiny by the House Financial Services Committee on 18 February. Representative Maxine Waters, who heads the committee said: “We must deal with the hedge funds whose unethical conduct directly led to the recent market volatility, and we must examine the market in general and how it has been manipulated by hedge funds and their financial partners to benefit themselves while others pay the price.”

It is unlikely that short selling will be banned because the existence of shorts can actually be a source of stability.

In normal market conditions, shorts are a source of support as they buy back their position on market downturns and can also provide resistance to excessive market euphoria. But the possibility that investors will now seek out other companies with aggressive short exposure to manufacture a GameStop-like squeeze creates pressure to introduce some type of restrictions.

For example, there may be a case for limiting total outstanding shorts, e.g., half of the outstanding would remove extreme vulnerability and rarely pose as a serious constraint.

In the meantime, investors considering establishing shorts – especially for thinly traded companies like GameStop – would be well served to monitor the StarMine short estimates reported in Eikon to avoid being on the wrong side of the next squeeze.

Watch: Eikon – The ultimate set of tools for analyzing financial market

Is it déjà vu all over again for Bitcoin?

Elon Musk’s announcement that Tesla is putting $1.5 billion of its reserves into Bitcoin sparked a rally this week to new highs close to $49,000.

When Bitcoin first broke $20,000 in 2017, there were concerns that the market was going into bubble territory and was bound to fail. Although Bitcoin is now more than twice the prior peak, there seems to be relatively little focus or concern on Bitcoin overvaluation. Part of this may be the benefit of the existence of short-sellers discussed above.

In 2017, there was no practical way to sell Bitcoin short, creating the possibility of a one-sided market where bears were side-lined and which abetted the emergence of bubble conditions.

It is probably not a coincidence that, as shown in Figure 2, a peak emerged shortly after a futures contract started trading, creating a convenient vehicle to sell short.

With an established vehicle for shorting, there is less concern that the bears are being kept out of the market. One similarity of the two rallies are rumours that illegitimate issuance of Tether, another crypto-currency that is purportedly tied to the U.S. dollar, is being used to fuel the Bitcoin rally. To date, the claims remain unsubstantiated. However, if it proves true, this could create a major setback for the Bitcoin rally.

An important difference in the two Bitcoin rallies is also shown in Figure 2. Gold remained range- bound during the 2017 rally, but is now the bellwether having gone into a major rally early last year.

Figure 2: Bitcoin spot and futures price and gold

Bitcoin Spot and Futures Price, and Gold. GameStop, Bitcoin and Brexit
Source: Eikon

The source of the strength in both Bitcoin and gold are apparent in Figure 3.

The green line shows how the Fed’s aggressive response to the COVID-19 contraction has led to an explosive growth in the supply of money. The inflation expectations embedded in the 10Y Tips market collapsed in the early stages of the market shut-down but reacted to the growth in money supply to rise to the highest level of expected inflation in three years.

Both the rally in Bitcoin and gold are direct reactions to the rise in inflationary expectations.

Figure 3: Bitcoin, M1 growth and inflation expectations

Bitcoin, M1 growth and inflation expectation
Source: Eikon

Inflation and the Bitcoin rally

In last month’s Market Voice, we discussed that it is unlikely inflation will rise materially this year but that does not necessarily negate the basis for the Bitcoin rally.

The inflation expectations in Figure 3 are for the average over the next ten years, so this year’s inflation level is not critical. The near-zero opportunity cost of holding cash is also supportive, so we would expect the gains to be maintained while the Fed remains in this expansive monetary state.

That said, an extension of the Bitcoin rally appears to reflect the rise in inflation expectations and the price of gold, so a further extension above this level would start looking like a speculative bubble.

Brexit more bark than bite

Whereas there was unanticipated volatility in the Bitcoin and GameStop markets, UK markets have been surprisingly stable following Brexit.

There have clearly been delays and disruptions to flows of goods across the border, but the feared severe shortages of key goods and industrial inputs have, so far, not emerged.

It is too early in the year to get a clear fix on the performance of the real economy but, as shown in Figure 4, retail sales, one of the few January releases available, is supportive.

The UK sales have a similar pattern as the United States, plunging at the onset of COVID-19, and snapping back over the course of the year. Both are now back at the pre-COVID-19 pace of growth, so there does not appear to be significant negative Brexit fallout on consumer sentiment.

Figure 4: U.S. vs UK monthly Y/Y retail sales growth

Figure 4: UK vs U.S. Equity Market Performance
Source: Eikon

How has Brexit impacted equity and currency markets?

The UK equity markets also seem to be taking the departure from the European Market in their stride. As shown in Figure 5, the FTSE has been trading in a stable range versus the U.S. market for the past three years. The relative value of the two markets has hardly budged since the end of the year.

This is also true for the financial industry, which is key because the London banks are a sector that is particularly vulnerable to business disruptions as EUR business transfers to the Continent.

Figure 5: UK vs U.S. equity market performance

UK vs U.S. Equity Market Performance
Source: Eikon

Currency markets are showing a lack of concern on the post-Brexit UK economy, which is important as cross-border trade and capital flows are the sector that is most exposed to Brexit related disruptions.

As is shown in Figure 6, the GBP sold off sharply early last year in the early stages of COVID-19, but started recovering late last year ahead of Brexit and the rally has extended into the new year. The GBP is now at its strongest level versus the USD in almost three years.

Implied volatility, which is an assessment of future disruptions, is also benign (note the chart shows GBPUSD implied volatility versus USDCAD implied volatility to filter out any COVID-19-related effects on global markets). Implied volatility began sinking last year as the GBP rallied, and is now back within the ranges that prevailed in 2018. The options markets suggest that post-Brexit will remain a non-factor for the months ahead.

Figure 6: GBPUSD spot and relative 3M implied volatility

GBPUSD spot and relative 3M implied volatility
Source: Eikon

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