Dash for Trash

Back in 2017, when I was working on my investment thesis, I made the observation that trading in Bitcoin is a little like trading in bankrupt companies. It's all about scarcity with no regards for utility. Little did I know back then that such trades would be popular by 2020. By early 2021, trading in trash is all the rage, with Game Stop up hundreds of percent in hours, outpacing the volatility of Bitcoin by leaps and bounds. However, none of this is irrational, as some commenters appear to believe. What's going on is perfectly rational in a world where interest rates are kept artificially low.

The rational behind the dash for trash is quite simple. Institutional investors have large short positions in such stocks in the expectation that they will go to zero. Due to cheap credit, such bets are more leveraged than they used to be, but still based on conventional metrics of value. However, with cheap credit available to all traders, there's an opposite position that can be taken without much cost. This is the bet on a short squeeze. If a heavily shorted stock is suddenly pushed higher in prize, weak hands will be forced to cover their positions by buying back the stock they sold. This drives the prize higher, allowing the engineers of the short squeeze to profit.

A short squeeze has the additional effect of extending the expected life of a company in trouble. The company can issue fresh shares, and it can borrow money based on its higher share prize. This further pressures short positions that often bet on bankruptcy dates. Even prudent short positions will need to readjust for a later bankruptcy date. In extreme cases, a short squeeze can end up making the troubled company the financial victor. Instead of going bankrupt, it prospers on the back of its new valuation. It can buy up a competitor, restructure its business, and start dominating its industry, as happened in 2008 with Volkswagen when Porsche took a controlling stake in that company.

But such windfalls are difficult to turn into lasting profits. Short squeezes are not a sign of health in the economy. Rather, its a sign of serious trouble. Interest rates are too low, and long term profitability is on its way down.

Hertz

By Raysonho @ Open Grid Scheduler / Scalable Grid Engine - Own work, CC0, Link