Weekly Roundup, 1st February 2021 – Gamestop

None of the commentary below is financial advice. I am not a lawyer, and I am not familiar with the detail of US trading regulations, since I am a UK investor. As always, DYOR.

We begin (and end) today’s Weekly Roundup with a look at the GameStop episode.

The story so far

1. Some short sellers (often described as hedge funds) drove down the price of an ailing US video-game retailer called GameStop (GME) in the hope of profiting from the share price fall.
2. Short-sellers borrow stock that they don’t own and sell it, in the hope of buying it back cheaper in the future.
3. Some Redditors (see below) noticed that the shorts held more than 100% of the stock float, and attempted to engineer a short squeeze by buying the stock – if they held the stock, the shorter would need to pay up to close their positions.
4. A lot of this buying and price support involved options and cheap platforms like Robinhood.
5. It’s not clear that a short squeeze has been achieved – since there is still a large short interest in GME – but the stock price has rocketed.
6. One of the hedge funds had to be refinanced and one of the shorters vowed never to issue another short dossier.
7. The “leader” of the Reddit insurrection is now up by $33M.
8. Platforms and brokers have been limiting trades in GME (and a slew of similar stocks that the Redditors have latched on to).
9. US politicians have got involved, with unclear implications.
10. Other stocks with large short positions have also been targeted, and are showing good returns in 2021.
11. Silver is now also in the game, with significant price increases in the last few days.

Reddit

I’ve been a member of Reddit for almost 15 years now, and I even run my own subreddit.

• But I haven’t spent much time on the r/wallstreetbets subreddit.
• One of the nice features of Reddit – which it shares with Twitter – is the ability to tailor what you see and (until recently) to avoid sponsored product.

Over the years, the level of debate on the site has steadily deteriorated. (( This mirrors the decline of standards of the wider internet over the last 35 years ))

• This decline has rapidly accelerated since the pandemic began.

One plausible explanation is that the furlough schemes, stimulus checks and the suspension of sports during the first round of lockdowns lead to a migration of sports gamblers to stocks.

• There’s no way to prove this, but the growing fame of Dave Portnoy and Barstool Sports is supporting evidence.

And the isolation of lockdown has no doubt increased the need of many people to feel that the belong.

• The recent rise of commission-free brokers offering leverage to investors with not much in the way of resources has also contributed to “perfect storm” conditions.

The early targets of these new Redditors/”investors” were tech stocks like Tesla, Zoom and NIO.

• But now we have reached level two of the game.

The key point is that these guys are not “retail investors” who need protection.

• They are gamblers and the true retail investors need protection/separation from them.

Greed vs anger

I’ve parked the debate on whether the wider market is in a bubble for now, but as John Authers points out, bubbles are normally driven by greed, and it seems that the GameStop action is in part driven by anger.

• A lot of people – possibly including quite a few who weren’t around at the time – are convinced that the banks blew up the system in 2008 and were rewarded with bailouts rather than being punished with jail sentences. (( I was working in one of those banks at the time, and I see things a little differently – the problem began with government-sponsored drives to lend money to people who were unlikely to pay it back and was compounded by incentives which pushed several sets of people to sell loans and “loan sausages” and pass on the downside risk ))

But the current targets of the mob are not the people who were involved in the 2008 crisis.

It’s pointless to attempt to police people’s feelings, so I will simply point out that this different motivation offers the possibility that this particular bubble might play out differently from those that have gone before.

Of course, angry Redditors are not the only people pushing up the GME price – they probably don’t have the financial clout.

• And the more experienced players might lead to a more traditional end-game.

Hedge-funds and short-sellers

The target of the anger is ostensibly the hedge fund short sellers which originally drive down the price of GME (and ended up borrowing more than 100% of the outstanding equity).

• Hedge funds and short-sellers are not the same things and each group can be subdivided into many flavours.

I like hedge funds and short-sellers.

• Hedge funds offer uncorrelated returns, which help me to lower my portfolio volatility and improve my Sharpe ratio.

Short-sellers are part of the price discovery process and are far more likely to uncover fraudulent accounting than they are to drive a healthy company into oblivion.

• And sick companies have to die so that they can be rep[laced with something better.

Shorters were even the heroes of the last crisis (see “The Big Short”). (( Another hat-tip to John Authers here ))

• And shorting in general is useful for risk management and diversification.

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So the bogeymen are not quite what the Redditors think they are.

• But this probably doesn’t matter, since both terms are largely shorthand for “rich people.”

In the same way that an alcoholic is someone who drinks more than you do, a  rich person is someone who has more money than you.

• My note here is that it would be hard to have healthy capitalism without some very rich people.

It’s the price of admission.

Suspensions

There’s also a lot of anger at the trading platforms who suspended or restricted trading in the key stocks during critical periods.

I’m a supporter of the idea that people should be able to do what they want with their own money but in many cases, these suspensions will have involved other people’s money.

• Experienced investors will be familiar with “close only” leverage markets.

Trading involves a chain of counter-parties and any of them can decide at any time that they don’t want to take on more risk.

• We all want ordered liquid public markets, but a dying retail stock whose price has been inflated by a factor of 100 is not the right place to make this argument.

Generations

The third target of anger is the older generation – boomers. (( Disclosure: I qualify as a boomer under most definitions, though being right at the tail end of a large “generation” makes you feel that your peer group hasn’t had much influence over it ))

I’m not sure when this envy of the store of wealth accumulated by older people originated – it certainly wasn’t a thing when  I was in my twenties, despite a more serious recession than any seen since.

• I wanted to find out how older people had managed it, not to destroy them

But houses prices have gone up a lot since then and DB pensions have been replaced with the inferior DC version. (( In the US in particular, many DB pension schemes appear insolvent – it will be interesting to see if benefits are maintained at the expense of younger generations ))

• We have also seen the rise of wokery and protections from name-calling (and worse) on the basis of race, sex/gender, sexuality, body size/shape and disability.

But old people are not protected, nor – as we have seen from many of the reactions to pandemic lockdowns – universally valued.

• So it looks as though intergenerational strife is here to stay.

Market abuse

The Redditors are certain that the platforms are conspiring with the billionaires and hedge funds to manipulate free markets.

• It’s true that Robinhood’s business model includes selling order flow to market makers and high-frequency traders, some of which will be hedge funds.

But this didn’t start this month.

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Other commentators feel that using a bulletin board to mobilise an army of small investors is also market abuse.

• I think that this is a grey area and that market abuse is largely in the eye of the beholder.

r/wallstreetbets is a public forum and experienced investors should be aware that they can’t believe anything that they read on the internet.

• The forum is also transparent about the fact that GME isn’t really worth $300 a share – this isn’t a traditional “pump and dump”.
• It’s also decentralised and not pyramidal, which means this isn’t a regular Ponzi or MLM.

At the same time, the market is being manipulated, in the sense that the GME price has completely separated from the fundamentals. (( One side issue in all this is why GME management haven’t issued more shares – perhaps the price has become so disconnected that a placing could no longer be achieved; the directors might also think about buying another company in a stock swap ))

• But then, so has the Tesla price, and that one is in the S&P 500.

End game

As noted above, the price of GME is now far above the true (“intrinsic”) value of the stock.

• So people will in aggregate lose money from here, though some will make out like bandits.

Sadly, some of the smaller players are likely to be wiped out entirely.

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Longer-term, the risk is yet more regulation of what retail investors are allowed to do.

• The balance between freedom and protection is never easy, but the real issue is that rules designed to protect the vulnerable are usually applied to everyone.

I like having the ability to access leverage and to use options.

• So I hope that access via some self-certification for sophisticated investors like me will remain.

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I’ve run out of time and space for today.

• I’ll try to get back to the usual Weekly Roundup format next week if Reddit will let me.

Quick links

I have just three for you this time:

1. The Economist wondered whether Boeing can fly without government help
2. Musings on Markets had its third 2021 data update on currencies, commodities, collectables and crypto
3. And Alpha Architect asked What exactly is the Quality Factor?

Until next time.