Don’t think the Reddit/small investor phenomenon is going away. Prepare for much more instability

A few narratives are emerging from established financial commentators about the Reddit-Wall Street bets/small trader phenomenon. One is that traders are creating stock bubbles that will inevitably burst.  The other is the equity markets will return to more normality when the regulator intervenes. Both are wrong.

First, the Reddit message-board fueled small investors buying GameStop stock might have driven up the electronics retailer’s stock price to unbelievable highs. But it’s not been driven by speculation – at least not entirely. 

Even if the regulator can successfully stem the Reddit-enabled revolt of small investors, another insurrection in financial markets will emerge somewhere else very soon afterwards

The exercise is a calculated move against hedge funds from investors acting in unison to undermine an established part of the financial system. They want to force hedge funds into closing they short positions by forcing up share prices they are betting against.  If these traders profited in the meantime, this was only part of their plan.

Yes, inevitably, GameStop’s share price will relapse given the challenges the Texas-based retailer faces. Fundamentals should return to the market, and the tribe of small investors will move onto another target. But here’s the thing – effectively, small investors aren’t driven by greed in their endeavours. 

Instead, their motivation is to take on the hedge fund industry and its dominance in financial markets by betting against its short positions. As one commentator said, they have taken hedge fund managers hostage and they aren’t about to let go. And providers like Robinhood use technology which means investors can trade without paying commissions. 

If hedge fund managers aggressively short other stocks then expect small investors to go long, once more, to undermine these hitherto masters of the universe. Effectively, the small investor brigade has tasted victory, and they aren’t about to stop. 

In fact, some commentators suggest their efforts might signal the end of long-short hedge fund trading strategies for good, not least because short positions in smaller companies tend to be highly lucrative. If these small investor efforts continue, who knows what will happen?

Second, if the regulator attempts to dampen the Reddit/small investor phenomenon the process won’t be easy. Maybe even impossible. That’s because financial regulators will find it difficult to justify coming down hard on small investors. These investors will argue that the regulator is favouring the Wall Street establishment, and its attempt to make money out of an unpopular activity. The tribe of small investors will engender much sympathy from many if that comes to pass. 

Even if the regulator can successfully stem the Reddit-enabled revolt of small investors, another insurrection in financial markets will emerge somewhere else very soon afterwards. After all, it has only taken a few years for Exchange-Traded Funds to develop from a cottage industry into ownership of half the US market, disrupting a big chunk of the asset management industry. 

Two weeks ago, few investors had heard of these small investors, but they had heard of cryptocurrencies and in particular Bitcoin. The cryptocurrency phenomenon is another form of financial instability plaguing much of the established investment world thanks to technological advances.

The phenomenon goes away when the price of cryptos fall, but reappears in the public’s imagination when their prices go up as they have recently. The regulator in the form of US treasury secretary Janet Yellen has hinted regulation is around the corner for cryptos.   

But just as Yellen made her remarks, the Reddit trading phenomenon arose. The market, bolstered by the digital revolution’s empowerment, is moving so incredibly fast – and the regulator is finding it difficult to keep up with it all. 

Of course, we don’t precisely know when another disruptive trade will emerge like Bitcoin or the Reddit phenomenon. But it will and probably very soon.    

This is because the digital transformation of the world economy is much greater in its significance than just creating more and more unicorns and bolstering Big Tech – and it’s only beginning to get going. 

Expect digital platforms to emerge that will have an equally huge impact on global markets like Bitcoin and the current small trader revolution have had so far. According to experts, it will only be another 20 years before quantum computing throws everything into confusion by working out how the entire market works.

Of course, Big Tech will continue to benefit from the digital revolution – they own much of the revolution’s plumbing. But technology advancements will see new groups taking on well-known players, challenging the established order in all walks of life.

That might be of little comfort to investors looking for a bit of Warren Buffett-like long-term investment stability of yesteryear. But those who realize the current instability is here to stay will be better placed to take advantage of the market chaos of today…and beyond.