“I meant no harm. I most truly did not.

But I had to grow bigger. So bigger I got.

I biggered my factory. I biggered my roads.

I biggered my wagons. I biggered the loads

of the Thneeds I shipped out. I was shipping them forth

to the South! To the East! To the West! To the North!

I went right on biggering… selling more Thneeds.

And I biggered by money, which everyone needs!”

– Dr. Seuss


Be Concerned.  Be Very Concerned. 

Jay and Janet overcooked the goose.  When derivatives and passive investment control the value of stocks, we’ve put the proverbial cart before the horse.  How many cliches can I hit you with before you stop reading?

Investing is supposed to be about giving money to entrepreneurs to create future growth.  

That is not what is happening right now. The regulators are probably all sitting around a large oak table right now, discussing how to go about unwinding the excess they’ve created.  GME, BB, AMC, SKT, PBI, GSX, NOK… The list goes on of irrational stock movements. 

Here is the Catch-22:

Because of all the unfunded public pensions, if Jay and Janet decide to slow the ponzi scheme, states won’t be able to pay firefighters, teachers & policemen the pension they promised.  On the flip-side, if they keep the ponzi scheme going, then it’s basically admitting that the free-market is dead.  Let’s dig in…

What Exactly is Happening Today?

Megacorporations have been cornering the market and gathering assets for a generation. Vanguard, BlackRock, Fidelity, State Street, Invesco etc. have been hoovering up most of the shares outstanding in a large portion of the stock market in the name of diversification for the client.

These megacorporations end up constricting the float of available shares because they’ve created some of the most scalable businesses in history.  As the largest shareholders in the country, they serve as the foundation of value from where everything is built.  

On the surface, they’ve been creating cheaper avenues for people to invest in the market but recently they crossed some sort of maginot line where the side effects have really messed up market structure.  WallStreetBets was just the one to exploit this with buying calls and creating the ultimate gamma/short squeeze.

The passive ETFs only sell underlying stocks when there is an outflow from the ETF.  Since Jay and Janet decided to pump the market full of monetary and fiscal steroids, there is no incentive for anyone to sell anything anymore.

At least not yet. 

Will You Get to GameStop Already!?

Below is a list of the largest holders of GameStop Corporation. It’s all the usual suspects.

If any active manager was holding GME at $350 dollars, they would sell it immediately.  Meanwhile, passive funds are mandated to hold that position and not sell until there’s an outflow.  In fact, as the market cap of GameStop rises, more incremental dollars will flow into ETFs that are market cap weighted.  This is the self-reinforcing cycle we touched on a couple days ago.

Where it All Gets Sticky

After the big passives, the second largest pockets of capital in the equity market are long/short ‘market-neutral’ funds.  If the Vanguards and BlackRocks are the aircraft carriers of the stock market, the long/short funds are the jet fighter pilots. 

These are funds like Citadel and Millennium who manage $35 billion & $40 billion respectively.  Their whole value proposition is that whether the market rises or falls, they will still make money. 

So how do they do this? In its simplest form, these funds buy 100 shares of a stock like AAPL and short 100 shares of a stock like GME.  The idea is to make sure that AAPL goes up higher than GME. 

In fact, if they are really good at making sure AAPL goes higher than GME, they can borrow money from their prime broker and “lever” up.  Instead of only buying and selling 100 shares of AAPL & GME, they can buy 600 shares of AAPL and short 600 shares of GME.  As long as AAPL keeps outperforming GME, things are copacetic and they just juiced their returns 600 percent.

The problem in the marketplace right now is that the volatility of all these single stocks like AMC and GME is BLOWING OUT to a level we’ve never seen before.

If a market neutral fund is short a stock like GME, they are forced to cover those 600 shares short and simultaneously sell their 600 shares of AAPL. 

In simplicity, you are losing money on both your longs & your shorts and could potentially face the dreaded ‘margin call’ where you are forced to de-lever.

Their entire business model is obsolete if this continues to happen!

The Read-Thru

If Jay and Janet keep the pedal to the metal on MMT, then the WallStreetBets crowd will make a mockery out of the capital markets and create gamma squeezes across every low float stock, running over Ken Griffin and Izzy Englanger in the process. 

If Jay and Janet pull back on the MMT, then you have a riot from every teacher, policeman, firefighter and public employee in the country as stocks fall and their pensions dry up. 

My guess is Jay and Janet won’t have the chutzpah to pull back the reins and Vanguard will end up owning the entire market.  I’ll probably have to jump back in, but for now I’m happy to let the dust settle and sit in mostly cash.

I just went to 75 percent cash in all my public equity and digital assets for now.  I sold a good chunk of FEB puts in GME at a 25 strike price and I’d be happy to own it there.  If GME hits $25 dollars in the next month that means the world is imploding and money is worthless anyway because Vanguard, BlackRock & Fidelity were all forced sellers.

It all goes back to the hubris of growing too large and scaling things.  At some point there are side effects.

For today, that means a deleveraging that’s taking everyone to the cleaners..

Longer term is there any question that cryptocurrency is a better system at this point?

  • Blockworks
    Senior Editor
    Tyler Neville is a Senior Editor at Blockworks who covers the convergence of the macro finance community and crypto communities. He writes Blockworks daily newsletter and was a former buy-side equity and derivatives trader for a decade.