Shorting squeeze will happen again: Billionaire stock picker and Platinum Asset Management founder Kerr Neilson

The ‘vagueness of the links among the participants has allowed this crowdsourced spectacle to scrape by the protections’ afforded market participants.

Stock-picker Kerr Neilson described the recent short squeeze as a “spectacular occurrence”. Picture: Hollie Adams/The Australian

The short squeeze battle between day traders and institutional investors is a “spectacular occurrence”, but the root problem is nothing new, according to legendary billionaire stock picker and Platinum Asset Management founder Kerr Neilson.

In a note to clients, Mr Neilson, who stepped down from the investment team at Platinum last year and sits on its board as a non-executive director, warned the ­recent phenomenon that has gripped markets will recur even as regulators attempt to restrict such activity through new trading rules and margins.

“It is indeed a spectacular occurrence and reflects the democratisation of access to information and to markets facilitated by the internet,” he said.

“The vagueness of the links among the participants has allowed this crowdsourced spectacle to scrape by the protections afforded market participants against stock price manipulation.”

The so-called “Reddit rebellion”, which took off last month, pushed an army of amateur investors towards underwhelming stocks including GameStop, AMC, BlackBerry and Bed, Bath and Beyond, with the aim of punishing hedge funds that had shorted the stocks.

Shares in New York-listed GameStop bounced 68 per cent on Friday alone, reaching $US325 as retail investors pushed back on the hedge funds. The video game retailer’s stock was trading at $US18 at the start of the year.

“The clever aspect is the understanding by its leaders of the effects of attacking crowded short positions,” Mr Neilson said of the instigators of the short squeeze ­attack.

“They would have understood the technical aspects that such disruption would unleash.

“Namely, in the first instance, the reversal of a price trend would activate trading rules where a fund is obliged, because of its internal guidelines, to cover a short position once a share price moves up by a preset percentage.”

By closing off short positions and buying back shorted shares, the upward trend is amplified.

“At this point, the option traders chime in to cover exposed contracts that they have written in those shares, again adding to the squeeze. And lastly, financial ­in­ter­mediaries offering exchange-traded funds or index-based products suddenly find themselves grossly underweight what were hitherto insignificant constituents of their universe,” Mr Neilson said. “They too need to buy to redress their implicit short position.”

The root problem was nothing new, he said: “Total consensus is dangerous, something a contrarian fund manager is highly alert to,” he told clients.

“Reading these accounts may fill some with a degree of satisfaction regarding the comeuppance of the established order and the emergence of a fairer world, but sadly this event highlights the dangerous experiment of central bank balance sheet bloating. It also highlights the new world of instant mass communication.”

It also reflected the growing sense of injustice in established systems and the “imperfections” of government action to remedy the issues with short-term fixes.

The result of cheap money and government handouts was the ­ordinary punter now “having a go”, Mr Neilson said. “These are interesting (and dangerous) times when risk is regarded as a game.”

The sense of injustice in the old world order was likely to lead to the phenomenon recurring “even as the authorities try to flatten this waterbed of discombobulation with changes to trading rules and margins,” he warned.

He said alongside the frenzy in the shorted stocks, the maturing of the internet was also fuelling frantic activity in crypto currencies. “The skyrocketing price of ­bitcoin has acted as a giant flywheel to gear up innovations among third-generation crypto applications where participants are rewarded with coinage for their support as originators, coders, network enhancers and so on,” Mr Neilson wrote.

With a market value of over $US600bn, bitcoin was head and shoulders above others such as ethereum and ripple, he noted.

“What any of them is worth is still a wild guess but one should be extremely cautious and open-minded before disregarding these coinage-funded markets.”