CIO explains why the billions of shares traded on shorted companies amount to little more than modern pump and dump schemes
Meme stocks are making a comeback. In shades of the 2021 GameStop rally, online investors revolving largely on the r/wallstreetbets page of Reddit have shown that they can and will throw their weight around on the markets. This time the meme rally began with two companies traded heavily on Tuesday: Kohl’s and Opendoor. Both companies were heavily shorted, much like GameStop was, and a compelling narrative of taking from the rich to give to the poor motivates extremely online retail investors to pile into the stocks, resulting in huge trading volumes, sudden runs up in value, all followed by a huge crash back down to earth.
Josh Sheluk sees these runs as little more than a new age pump and dump scheme. The CIO and Portfolio Manager at Verecan Capital Management explained that behind any veneers of wealth redistribution and ‘sticking it to the man’ are a few people making a lot of money off of retail investors they convinced to buy a stock. Sheluk outlined the risks that these meme stock rallies introduce for ordinary investors and their advisors and why they are now simply a fact of modern markets that advisors need to watch out for.
“This is a story that's that goes back as long as time. There are lots of people that worked through the 80s and 90s in the discount brokerage era that will tell you firsthand stories about these pump and dump schemes that happened with penny stocks and small cap stocks and stocks on the TSX Venture,” Sheluk says. “If you go back and read some of the literature and research that was done back to the South Sea bubble as early as the 1700s you can hear elements of this same thing happening. This idea, fundamentally, is nothing new. It's just happening through a different medium, which is social media and the internet, and in a more significant and quicker way than anything in the past.”
What makes the meme stock rallies more notable, and arguably more dangerous, is the fact that they can move huge volumes of shares. Over one billion shares of Opendoor were traded on Tuesday, before the stock lost over 23 per cent of its value on Wednesday. Kohl’s had fallen 16.5 per cent on Wednesday after briefly doubling on Tuesday.
Sheluk’s view is that these sudden Reddit-induced meme rallies are now a fact of the market that advisors need to be aware of. He rejects the idea that this moment is particularly vulnerable due to summer’s lower trading volumes or the relative dearth of marginal institutional capital entering US equity markets. Instead, he argues that advisors need to prepare themselves and their clients for the reality of these seemingly random pops occurring.
The fact of meme stock rallies is not an exclusively bad thing for investors, however. Sheluk notes that if a client happened to hold one of these stocks in their portfolio prior to the rally, it could be a windfall, at least in the short-term. The real risk occurs when a client comes to their advisor and says they want to get in on the rally.
“The challenge as advisors, and the potential risk as advisors, is trying to rationalize that type of behaviour with clients and make sure that they stay grounded and stay disciplined with their investment their investment process and approach,” Sheluk says. “Because I think as it becomes more prevalent, it's going to be harder and harder to push back on it.”
Different business models can empower advisors to manage clients’ FOMO (fear of missing out) differently. Sheluk notes that his firm operates as discretionary portfolio managers and fiduciaries, which means they don’t take direction from clients on individual stock purchases and would never make a purchase based on the logic of a meme stock rally. If a client is dead-set on participating, they’ll encourage them to use a self-directed account to make that purchase.
While Sheluk and Verecan’s advisors are empowered to respond with a hard no, he notes that from a client relationship standpoint offering a less directly confrontational response can be helpful. He and his team try to ensure clients understand why they’re not buying into the meme rally. They work to ensure a degree of collaboration and buy-in is maintained, even if the client walked into their office fully caught up in the hype.
Whatever approach advisors choose to take in this environment, Sheluk emphasizes how important it is for advisors to understand meme stocks now as a fact of life on the market.
“I think these types of schemes are going to continue evolve and change, especially as technology changes,” Sheluk says. “It's something that, as long as time, has probably been a bad idea for people and it continues to be a bad idea.”
