Carson Block: The 'Stonk' Bubble Poses Significant Global Risks

BY TYLER DURDEN

THURSDAY, FEB 11, 2021 - 11:21

Authored by Carson Block of Muddy Waters, published originally in FT

The recent boom and bust of GameStop shares is a wake-up call to policymakers that world markets and economies are precariously positioned, and pose serious risks to political stability.

The US is patient zero for this sickness and as the US goes, so too will much of the world. GameStop illustrates clearly that capital markets are driven by flows and investor positioning, rather than by the underlying fundamentals of businesses.

The primary causes of this market dysfunction are the prevalence of passive investing and leverage enabled by low-interest rates. The combination has resulted in grotesque distortions of capital allocation while further bifurcating society into haves and have-nots.

The increasingly obvious fact is we do not know whether the government will be able to perpetually bail out markets. With interest rates already hovering around 0 per cent, the traditional levers of monetary policy may not be able to rescue markets and prevent another depression.

The effort to squeeze short-sellers took GameStop’s share price well beyond any rational fundamental valuation. It soared by 23 times within 11 trading days as those who had bet the price would fall were forced to buy shares to cover their obligations.

One factor that made the GameStop squeeze so profound was passive ownership. About one-quarter of the available shares were owned by passive investors. These funds run on autopilot. As new money comes in, it is allocated to keep a constant balance among a specific combination of individual stocks or other assets. As GameStop’s price rose to ridiculous heights, those passive funds were almost certainly buying to maintain their balance.

These same phenomena are a big part of the Tesla stock story. Ever-rising share prices that have no basis in fundamentals have birthed yet another meme, “Stonks!”, which is feeding frenzied retail speculation.

The distortion of prices caused by the growth of passive has only recently been fully understood, thanks to the work by Michael Green of Logica Funds and a growing number of academics.

More:

https://www.zerohedge.com/markets/stonk-bubble-poses-significant-global-risk