In the seemingly never-ending saga that is the Reddit meme trading phenomenon, the next target that social media followers have on their sights is Invesco Mortgage Capital (NYSE:IVR) stock.
A mortgage real estate investment trust, the extreme dynamics of the novel coronavirus put IVR stock in very bad shape.
But Redditers are apparently attracted to bad news like a shark is to blood, which presents a strange bullish case for Invesco Mortgage Capital.
But before we get into the details, let’s back up for a moment and explain why IVR stock suffered so badly relative to other real estate-based investments. First, the basic mortgage REIT business model involves absorbing “short-term debt at a low interest rate, then buying mortgages at a higher interest and profiting from the margin.”
As soon as the coronavirus pandemic became a reality in the U.S., IVR stock cratered. However, that wasn’t necessarily because of the extremely low interest rate environment because the Invesco Mortgage REIT could also borrow at these low rates.
Therefore, the profitability margin roughly stayed the same.
No, the issue is speculation among market participants that eventually, benchmark interest rates will rise. I don’t think that’s an unreasonable assumption.
Moreover, such a circumstance brings up consequences. Key among them is that homeowners will not seek to refinance their mortgages at higher rates. And that’s the rub — mortgage REITs depend on short-term debt, which means replacement at higher rates.
Fundamentally, you can make the argument (assuming you believe the Federal Reserve will not try to keep rates artificially low) that IVR stock is in bad shape. If rates were to rise significantly, it will impede the underlying business model.
Not surprisingly, then, IVR stock has a relatively high short percentage of float. But that’s also where Reddit comes in.
Will the Market of the Apes Help IVR Stock?
Adopting the mantra of warfare — apes together strong — Reddit traders are on a mission. Impose as much pain as possible and attempt to restore some financial justice to the system. Under this ethos, these digital Robinhoods have won over the public, providing at the very least collective catharsis.
While a cursory look at the justification for their trades reveal a general lack of sophistication — and some might say rationality — there is one element that virtually all Redditers have latched onto: the short squeeze.
By deliberately bidding up heavily shorted stocks, this action forces bearish traders to cover their positions, which in turn drives up the price even more.
It can be incredibly lucrative, as we’ve seen with other meme stocks. But as we’ve seen with other meme stocks, it can be incredibly dangerous.
Will the trade pan out for IVR stock? Its short percentage of float is nearly 17% as of May 28. Certainly, bears have targeted IVR (and many would say for good reason based on economic principles), but sparking a sustained short squeeze is not guaranteed.
Further, what I’m more worried about this time around is that the Reddit crowd is moving against serious fundamental catalysts. Ultimately, I don’t know who is right in this argument about interest-rate trajectory. But if the Fed decides that it must turn off the spigot of cheap money, that might send IVR stock falling much more than it has.
The allure of course is that IVR is an excellent opportunity for a day trade. By squeezing the shorts, the equity unit could jump higher, irrespective of the underlying fundamentals. Once you’ve made your profits, you just dump the stock.
Of course, you might be dumping on your fellow apes but that’s a different story for another day.
Best for Conservative Investors to Stay Away
Though the short-term narrative for IVR stock does make sense, you really can’t trust social media traders to have your back. I mean, the movement went from saving companies on the brink of bankruptcy (a noble cause in some cases) to bidding up the equity units of private prisons.
That’s a sharp swing of morality that I didn’t see coming. To me, this confirms that if you were holding IVR, the apes in front wouldn’t think twice about cutting the rope behind. That just adds another level of variability to an already unpredictable situation.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.
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