I hope you and yours are keeping well.
GameStop found themselves hitting the headlines in recent days as their share price surged to dizzying highs, before falling back sharply. Read on for a summary of what happened and what the implications could be.
As widely reported in financial and mainstream media last week, GameStop - a consumer electronics store that looked destined to be another retail casualty - saw its stock price propelled to unthinkable heights, after retail traders turned the company into an online sensation.
At the end of last year, GameStop traded at around $10 a share. By mid-January, it stood at $42. On Thursday, the share price surged to over ten times that, before falling back sharply. This meteoric rise was instigated on social media site Reddit by members of the ‘WallStreetBets’ forum. Their plan is simple: find stocks that are the target of intense short-selling, then coordinate on buying that stock to force up the price and cause a ‘short squeeze’, catapulting share prices upward.
The growing trend is wreaking havoc on short sellers, most notably hedge funds. Melvin Capital, which took out a large position against GameStop, was pushed to near-insolvency after losing billions in its short positioning. The ‘short squeeze’ phenomenon occurs when short sellers - essentially those betting that a particular share price will go down - are forced to close their positions and buy the underlying stock. Hedge funds are notorious for using short-selling to generate huge profits (and at times, equally huge losses), as it suits the ‘no-holds-barred’ investment style that most play by.
So why have large numbers of retail investors decided now is the time to coordinate their actions via internet chat rooms to punish hedge funds (and make a healthy profit in the process)? The media is describing the WallStreetBets phenomenon as not just a get-rich-quick scheme, but a virtual protest movement. A “War on Wall Street” and “Stock Market Insurrection” have made headlines, while comparisons have been drawn to the Occupy movement and Black Lives Matter. Some have even gone as far as to lump in the Reddit investors with Trump supporting rioters, with one outlet suggesting that, after attacking the US capitol, the disgruntled public are now attacking capitalism.
In reality, for many in the flash buying mob, this is just another timely and profitable bandwagon bet. For some however, there are also some non-financial motivations for the mass buying. Getting one over on the politically unpopular hedge fund ultra-high-earners, is always a nice bonus for the anti-establishment investor.
What this highlights is the growing voice – and importance – of individual retail investors. The volumes they trade may be small, but when coordinated en-masse via internet forums, they have the power to move individual share prices almost at will. With the pandemic leaving many with rising cash savings and barred from many everyday activities, activist day trading can seem mightily appealing.
It also exposes real problems for hedge funds in particular. Fund managers may hope that forums like WallStreetBets are banned or regulated for their role in potential ‘market manipulation’, but short sellers at large hardly have much of a leg to stand on here, politically speaking. Hedge funds and short sellers, after all, are the stereotypical ‘bad guys’ when market manipulation gets talked about, given their past success in banding together themselves to accelerate and ultimately profit from the demise of a seemingly doomed company for their own benefit and that of their investors.
In the short run, we are likely to see more incidents like this and suspect these new market dynamics will lead to some risk aversion from short sellers. Hedge funds in particular are likely to be buying more cover for their positions.
In the long run however, some of the biggest risks are to uninformed amateur investors, who jump on the bandwagon too late, or simply back the wrong bandwagon, without understanding the implications. As with any gamble, sooner or later your luck runs out and a share price with poor fundamentals, boosted to such heights by nothing other than speculation, is likely to come crashing back to earth again once rational resumes.
So many of you will not doubt be wondering what impact has for our client portfolios? The answer is (perhaps unsurprisingly) ‘not a lot’. Our portfolios are diversified to the point where even a single shareholding rarely amounts to much more than 1% of the total portfolio. They are professionally managed with the objective or controlling risk, so leave the casino-style investing to the internet traders and hedge funds.
