Everyone heard about the Gamestop story, and how a multitude of retail investors acting together with the help of social networks forced enormous hedge funds out of a short position, and made them lose billions. Many observers, including one of Reddit’s co-founders, are presenting this as a healthy revenge of David against his oppressor Goliath. I am afraid very few of those who think about the implications can agree.
Just to be perfectly clear, neither I nor the portfolios managed by Graphene Investments have held any exposure to Gamestop or other stocks mentioned in this article, nor do we have any intention to hold one in the foreseeable future.
What happened?
Gamestop, a videogame retailer, has been struggling for many years. Sales were almost halved in two years, because players don’t need stores to buy new games (which are sold online) and the 2nd hand game business has been shrinking as developers included protections against resale. Yet, after years in a severe downtrend, its stock shot up 1750% in the last few weeks with no fundamental reason to justify that. A multitude of retail investors blindly followed simplistic Buy recommendations found on Reddit’s WallStreetBets and its likes. The rally forced several major investment funds to liquidate significant short positions in a “short squeeze” situation, thus contributing to a further rise in the stock.
Several other securities, ranging from AMC Entertainment to Bed, Bath & Beyond to Nokia, experienced similar situations, although with smaller magnitudes so far.
Is it a “revenge” of retail investors against powerful investment funds?
In 25 years managing US equities, I had many occasions to hold on to a long position in stocks that were being hammered just because a large short-seller had the right connections to convey his bearish views in the media. I know very well how it feels when the truth eventually emerges, if our analysis proves right and the “opponent” has to unwind his bet. However, when we, professional investors, get into that kind of fight, we don’t do it out of pride or to take a revenge, but because we spent a huge amount of time studying the company and digging into every detail, and we feel we have enough reasons to trust our investment case (… and yet, we often, make mistakes!). Here, it is true, Goliath lost and David won or, more accurately, David doesn’t know yet that he will lose too. David is this little amateur investor who thinks social networks’ gossips can replace expensive data sources, sophisticated models and hard work in fundamental research. He blindly followed the advice of unknown others, and may also have bought Etsy after Elon Musk tweeted that he liked the site. He was lucky so far and, at this time, he is considering to quit his job to become a professional trader before retiring in a paradise island within months. He doesn’t know that his father did the same 20 years ago after investing in America Online, 3Com and Alcatel… only to return to his job a few months later. David now has all his pension savings in a stock, which he bought at 15 times its real value, and which will soon return to that logical level. His new friends on the social network will have left the ship by then, to set up another scam on the bitcoin or another instrument.
Why does it matter?
If it were to last, this type of situation could be disastrous in multiple aspects. Notwithstanding that shocks like those incurred by certain funds in this story could certainly trigger a serious financial crisis if they were to repeat too often and hit randomly, a financial market is only attractive if it offers a sufficient degree of transparency and price efficiency. Insurers, pension funds, other institutions (and more generally all rational investors) will leave if they can’t be confident that the market is a reasonably logical environment. Retail investors will be left on their own to continue their experiments in this gigantic casino, but there will be many losers. Companies will miss a source of funding, investors one of the few asset classes offering high long-term returns without the constraints of a low liquidity, and active asset managers a wonderful playground to exercise their skills and generate value-added.
This is why, even though I was raised on principles that one should never wish others ill, I will make an exception today: I hope David (*) gets broke rather sooner than later, and goes back to his job. The more his illusions last, the more they will contribute to attract more naïve participants. Social networks already caused enough problems lately, and nobody wants to add a Ponzi scheme to the list.
HG – Jan. 28, 2021
(*) to all real Davids: please don’t take it personally !