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Markets’ Biggest Drop Since October; Hedge Funds Lose Billions Thumbnail

Markets’ Biggest Drop Since October; Hedge Funds Lose Billions

In an extraordinarily wild week, the Dow (-3.3%), NASDAQ (-3.5%), and S&P 500 (-3.3%) all fell sharply for the week, exhibiting its largest weekly decline since October.  Meanwhile, taxable bonds were flat, but tax free muni bonds had a great week, gaining at least 0.5%, and extending its 4-month rally.  For the month of January, the Dow and S%P 500 are down about 1% - 2% and the NASDAQ is up about 1%.  The tech-heavy NASDAQ is being led by strong corporate earnings reports by technology companies, as we are currently in the thick of corporate earnings season with reports mostly exceeding expectations.


Of course, the news from last week was dominated by short squeezing of hedge funds by large volumes of retail (ordinary) investors.  So what actually happened?  Well, hedge funds are firms who manage large amounts of money from wealthy investors, and they have the ability to invest in ways that retail mutual fund investors cannot.  One way is that they “short sell” stocks.  That means they are actually selling stocks they don’t own, and later buy them at the market price.  They are “betting” that the stock(s) will go down.  For instance, if they shorted GameStop (GME) when it was at $20 per share and the stock drops to $12 per share, they buy it at $12, sell it at $20, and make $8 per share.  But what if the stock jumps to $100 per share?  They have to buy it at $100 and sell if at $20 and take a giant $80 loss.  So, through a viral message initiated through the social media Reddit, retail investors bought GME (and several other stocks) to drive the price up to almost $500 per share, and the hedge funds lost billions of dollars in a mere few days.  Needless to say, that has sent a ripple effect that will likely result in class action lawsuits and actions by the SEC to prevent this from happening again.  This has settled down a bit, but the impacts are not over yet.


So, the real news was masked by the phenomenon above.  And the real news was that there really wasn’t any news, except for favorable corporate earnings reports.  Thus, it seems that the market drop last week was initiated by massive selling of stocks owned by the hedge funds in order to generate the cash they needed to buy all those stocks they shorted.  Then, once stocks start selling, it can generate automatic (program) selling, and the dominos begin to fall.  Otherwise, there were no real fundamentals to support a market drop like that last week, suggesting that we may see a rebound, all other things being equal.


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