The short squeeze in heavily shorted names such as GameStop (GME) and others continued and accelerated this past week. The impact of that spread to the broader market as investors became concerned that losses at large funds could cause broader market selling. This entire GME saga has indeed morphed from a market-related event to one with broader news coverage. As such, we wanted to address the issue and clearly explain:

1. What’s happening
2. Why it matters to markets

What’s Happening: An Good Old-Fashioned Short Squeeze in a Modern Market.

This week, stocks just experienced their worst day in three months due to extreme volatility amongst some of the more heavily shorted stocks in the market (GameStop (GME), AMC Theatres (AMC), Nokia (NOK). Without getting into the messy details, the bottom line is that multiple hedge funds had extremely large short positions in these companies (and with good reason, the business prospects for these companies are challenged, to say the least).

But in testament to the power of the crowd, large groups of retail investors, mostly communicating via message boards and chatrooms on Reddit (a social news and discussion site), have been buying these heavily shorted stocks in hopes of creating a short squeeze and that’s exactly what’s happened. GME surged from a share price of $20 two weeks ago to more than $340 on Wednesday.

Why It Matters: Contagion.

Stocks such as GameStop usually don’t move markets, but as is almost always the case, fears of contagion are starting to impact the broad market. Specifically, as GameStop and other stocks go parabolic, markets are starting to get concerned that the losses being taken by larger hedge funds could turn into forced liquidation that hits all corners of the markets (that’s part of what happened yesterday).

Often times, in a market environment that we’re currently experiencing, the number one short term risk to stocks is investor complacency. Well, that complacency (which is expressed in the mismanagement of risk) is now being corrected. And if that investor complacency is further shaken, then we could see a negative feedback loop develop where declining prices cause more investors to lock in gains/reduce risk, causing a potential pullback.

Bottom line, the GameStop fiasco has hit investors’ confidence, and given markets are stretched and investors complacent, it could cause some short-term volatility.

The Good News.

We don’t see this saga as a bearish gamechanger because the fact remains that the four pillars of the bull rally remain intact:

1. Historic Fed accommodation
2. Historic fiscal stimulus
3. Vaccine optimism
4. No double-dip recession

Often times, our emotions can lead us astray, especially when we combat a heightened media and endless news cycles. When this happens, remember to point your thoughts toward your overall financial plan and try to view these events in full context.