Every once in a while, something happens in the financial markets that captures the imagination not just of investors but of the general population as well. While there has been no shortage of interesting stories in the market this year, the battle for GameStop is at the top of the list. Shares in GameStop, the brick-and-mortar video game retailer, which could until recently be purchased for considerably less than the trade-in value of an old Mario Kart game, soared to $483 last week before crashing back to $90 at the time of this writing. The tale has all the elements of a Hollywood script—the plucky underdogs, the detestable rich guys who have all the advantages, the noble quest, and more than a dollop of social commentary. The elevator pitch is basically a modern-day Trading Places. My understanding is that there is already at least one film project in the works. Of course, the screenwriter may have to rewrite the ending—it looks as though it will not be a happy one for all but a few. Not so much Louis Winthorpe and Billy Ray Valentine enjoying both the lobster and the cracked crab somewhere in the islands, but hot pockets in mom’s basement for a long, long time. YOLO indeed, Randolph. Indeed.
The Reddit avengers have moved on; they’re now tilting at windmills in the silver market. It probably won’t be long until most of them meet the same fate as the villainous Duke brothers met trying to corner the market for frozen concentrated orange juice—“turn those machines back on!”
I have long held a belief that the best investments are often the most interesting stories, but I may have to amend my position. GameStop was clearly a good investment for a handful of individuals, but it will prove to be a mouthful of ashes for many others, although I suppose I have to allow for the possibility that many of them may have had non-economic motives—such is the state of the market. We have to give credit where credit is due; the early investors who spotted an opportunity to engineer a short squeeze put their capital at risk and earned massive rewards. A keen-eyed retail trader noticed that a number of large investors had placed levered bets that the price of GameStop shares would fall. These large investors were “short” GameStop.
Shorting GameStop was not exactly a novel idea; it’s no secret that the company has struggled for years as the video game business moved increasingly online and away from dingy corners in shopping malls. It is the type of position in which a short seller would have relatively good odds of making perhaps not a killing but an okay return. Many persons shorting stocks aren’t even trying to make a lot of money; they’re just hedging their long positions, or even just using the proceeds from the short sales to finance their long positions. At any rate, there aren’t too many large investors out there who would go to great lengths to buy GameStop hand over fist.
There were, however, a few small ones. And what’s clear is that the market was not prepared for what could happen when small investors harnessed the power of social media.
GameStop shares had been a great performer during 2020, up more than 200 percent, enough to begin to attract some attention on online investor forums. But when members of the Reddit group WallStreetBets began to focus on GameStop, and when they learned who was on the other side of their positions (in their eyes, Mortimer and Randolph Duke), the price action began to go truly bonkers.
The fundamental risk with short selling is that while stocks can only fall to zero, they can theoretically go infinitely higher. Even if the possibility is small, it does exist. One can imagine the confusion and then the horror experienced by the risk-management team at Melvin Capital and other hedge funds upon realizing they were being squeezed, not by the likes of Carl Icahn but by an army of breathtakingly profane bandanna-wearing punters, many using the Robinhood trading platform, who saw themselves not only as a market force but as a social force with moral power.
Doubtlessly, some were just in it for kicks. I mean, the whole premise was absurd. But as days passed, it became more of a crusade, and that was a fatal mistake. Wall Street is the wrong place to take a moral argument.
Human beings are hardwired to engage in the following behaviors: attempting to identify patterns, assigning meaning to the world around them, and moving with the herd. I think each of these behaviors is actually related to the others and each of these is abundant in the GameStop saga.
What started as a clever observation and a legitimate opportunity for a small group of astute humans suddenly attracted the pattern finders, the meaning-assigners, and the herd. GameStop shares were no longer shares in a real company; they were lines in a chart and soon, bullets in a social war against the entrenched interests of society.
Everybody who has completed the 9th grade knows that every tragedy has hubris at its core—the minute GameStop transformed from a good trade into something else, it was doomed. The other side covered its bets and the trading platform seemingly betrayed the rebel alliance.
Hedge funds such as Melvin Capital covered their positions. Painful, and perhaps even mortal, but the positions were covered nonetheless. When these motivated buyers left the market, the laws of supply and demand were not suspended.
Robinhood, the online trading platform popular especially popular with young investors and traders, was built to handle online trading, even leveraged online trading, but not a jihad against institutional investors. In fact, perhaps unknown to its legions of “clients,” Robinhood earns money not from commissions and trading fees, but by selling its retail order flow to large institutions. Frankly, I am a little surprised the practice is even legal—Robinhood’s clients are actually its products; it’s not wholly inaccurate to say Robinhood is the Facebook of Wall Street. Just like Facebook, Robinhood is “free” to its users. And just like on Facebook, if you can’t figure out why the product is free, then the product is almost certainly you. The online crusaders who thought they had ridden into battle with Robinhood had actually ridden in alongside Braveheart’s Robert The Bruce.
But let’s assume for a moment that Robinhood is the best trading platform in the world with the best execution—there is still virtually no way it could have handled what would happen with GameStop.
From February to December 2020, trading in GameStop amounted to about 6.5 million shares per day, exactly what was traded as recently as January 8. By January 13, daily volume was 145 million. On January 22, almost 200 million shares traded. The stock price peaked on January 28 at $483 before falling in a matter of a few hours to about $112. Multiply the elevated stock price by the some healthy fraction of the trading volume and consider how many billions of dollars in losses Robinhood users sustained on the trip from $483 to $112. When Robinhood restricted trading in GameStop and other YOLO names, it wasn’t doing it out of paternalism, it was doing it to save itself. That’s because Robinhood was on the hook for the losses its customers couldn’t pay, and with that much volume and that much volatility, it seems rather implausible there were no such losses. The company has raised $3.4 billion in the last week.
How much capital will the self-anointed “stampeding retards” be able to raise this week? What did they prove? That they are willing to bankrupt themselves protesting the social inequities that exist in today’s society? Perhaps they figured they might as well do it themselves instead of waiting for health care expenses or pandemic-related unemployment to do it for them. Perhaps they did not care either way; there was more than hint of nihilism, or at least dark humor, to the whole affair.
These are dark issues to contemplate but it doesn’t take a psychology degree to understand how most of the world must feel, on the outside looking in, with no bailouts, no quantitative easing propping up their net worth, and a growing suspicion that something valuable has been stolen from them. It would be a scientific experiment that would make the Duke brothers blush to study whether people being forced to stay home and watch markets driven higher by stimulus could be enticed to throw their own stimulus checks at the very people and institutions against which they rail.
If there is a point to all this (and it is entirely possible that there is not) it’s to stay focused. Stocks are pieces of real companies, nothing more. They’re not blips on a screen, they’re not trading sardines, and this is not Trading Places.
On the other hand, perhaps this has gotten a bit heavy for a Hollywood ending. I’m not sure it will test well in focus groups. Get me rewrite. Let’s put Clarence Beeks in a gorilla cage and hit the beach with Jamie Lee Curtis instead. And remember:
“It was the Dukes, it was the Dukes!”
Any opinions are those of Burke Koonce and not necessarily those of Raymond James. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Burke Koonce is a financial advisor at Raymond James & Associates, Inc., member New York Stock Exchange, member SIPC. www.raymondjames.com/burkekoonce