Like many naughty amateur active investors [1] who should know better, I watched the movie The Big Short [2] with popcorn, envy, and a grin.
Oh how I wished I was one of the movie’s heroes.
One of those quirky, semi-Aspergic, single-minded and misanthropic hedge fund managers who spotted the fatal flaws in the system that precipitated the Great Financial Crisis.
And who then profited mightily from all the mayhem.
After all, I’m quirky and I might be at home somewhere on the spectrum.
Why shouldn’t I be paid billions for being a single-minded misanthrope who watches share prices instead of football games?
I’d be played by Christian Bale, natch.
You can have Steve Carell.
In truth though, a lot has happened since The Big Short came out in 2015.
And most of it happened this week.
Today it’s hedge fund managers who are watching in awe and fretting about what amateur stock traders will do next.
Specifically about whether said retail traders are about to blow up their hedge funds.
In this moment it’s the little guys [3] who are the (anti) heroes of the movie.
Don’t stop me now
By now many of you will have heard of the poster child for this revolution – GameStop.
That’s ‘poster child’ in the sense of an official warning that you’re about to be electrocuted, nuked, or biologically poisoned if don’t get the hell away.
And that’s ‘GameStop’ as in the US video game retailer that’s listed on the New York Stock Exchange.
As opposed to ‘GameStop’, the safe word that’s stammered by hedge fund managers through their ball gags when they’ve taken enough of a beating.
Here’s a graph of GameStop’s share price action recently:
[4]Kind of hard to read, right? Looks almost flat – until you spot that cliff on the right hand side.
Surely that’s where the action is?
Fair enough. Here’s a chart of GameStop’s share price just year-to-date:
[5]No, that’s not much better.
It’s probably easier if I tell you that GameStop began 2021 priced at less than $18. As I type it’s now around $325.
That’s roughly an 18-fold increase in less than a month.
It’s up nearly 10-fold since this time last week.
Wow.
Game for a laugh
An innocent, easily fooled person who believes that human beings and markets always behave in predictable, simply modeled ways – an economics professor, say – might suppose GameStop has enjoyed some kind of super-fortunate change in its business model since the Monday before last.
Perhaps GameStop found all its stores were located on top of gold mines?
Or it’s recovered a password to a lost wallet stuffed with Bitcoin?
Or it’s devised a way to jam Internet access for everyone forever, so people have to traipse to a GameStop shop to buy a disc in a box like it’s 1999?
No, no, no.
In a reality so unlikely [6] it has even seasoned market watchers rubbing their eyes, re-reading the ingredients list on that Kombucha they’ve been mainlining in their lockdown home offices, and deciding that they really need to get out more, mutant virus or no mutant virus – what’s happened is that thousands of members of a Reddit subforum called WallStreetBets [7] have engineered perhaps [8] the greatest short squeeze of all-time1 [9], transforming GameStop from a potentially doomed video game retailer from another era valued at $2bn into a potentially doomed video game retailer from another era valued at $22.5bn.
And brutalised several hedge funds [10] along the way.
And turned some of the Redditors into multimillionaires [11]:
[12]At least for now.
Wall Street frets
Surprisingly to those just tuning in, none of this interruption to normal programming is entirely new.
The gleefully anarchistic punters who populate WallStreetBets have been getting themselves noticed as they chase their favourite stocks via the free trading app Robinhood since at least the beginning of the pandemic.
And the subReddit was amusing itself in spectacularly reckless style for years before then, as this amusing video history recounts:
Monevator has even linked to several relevant stories about all this retail action in our Weekend Reading links over the past year.
Admittedly it’s been more the stuff of opinion columns and wonky commentary.
As opposed to something being of interest [13] to the White House:
[14]There’s also nothing new about the mechanism by which the Redditors drove up Gamestop’s share price – the fabled short squeeze – either.
You can read about this sort of thing in Jesse Livermore’s 1923 classic Reminiscences of Stock Market Operator [15].
And if you run a hedge fund I suggest you do, because more than 100% of GameStop’s shares were sold short when WallStreetBets came calling.
Yes, more than the entire issued share capital had been sold short by sophisticated and amply remunerated market participants.
Which is rather surprising, even without a horde of Redditors at your gate.
If you wonder what happens when the music stops and more shares are sold short than exist, ask any seven-year old who has played musical chairs.
It might save you having to ask your billionaire hedge fund mates to bail out your hedge fund to the tune of $2.75bn [16].
Alternatively, read Matt Levine’s vintage take for Bloomberg [17].
Levine goes into all the detail – and he’s writing about the little squeeze before the big squeeze – but the gist is:
…that these two factors—a short squeeze and a gamma trap, if you like—combined to push the stock up rapidly on Friday. Something started the ball rolling—the stock went up for some fundamental or emotional or whatever reason—and then the stock going up forced short sellers and options market makers to buy stock, which caused it to go up more, which caused them to buy more, etc.
Matt Levine, 25 January 2021, Bloomberg
Talking of hedge funds, while some stock watchers now call for regulators [18] to step in to stop uncouth youths from stiff arming honest, hardworking capital market oligarchs, the reality is hedge funds have been ripping each other to shreds with orchestrated takedowns for about as long as hedge funds have existed.
Rival funds were probably in the mix alongside the Reddit money pushing up GameStop.
Heck, George Soros and Stanley Druckenmiller – and a bunch of other funds that piled on – broke the Bank of England [19] with what was effectively a short squeeze on Sterling in 1992.
And you didn’t see the Queen running to the regulator whining that meanie hedge funds were trashing the value of her coin of the realm then, did you?
No, like any good market player, Regina1926 just logged into an AOL chatroom via Buck Palace’s dial-up and conceded she’d been pwned.
Flows before pros
Perhaps at this point you’re wondering what the hell you’ve been doing with your life?
Why you have been steadily trickling £500 a month into a balanced passive portfolio [20] in an ISA when you could have been whooping it up on Robinhood? Or at least on Freetrade [21], the UK’s equivalent?2 [22]
The game has changed, right? The power is now in the hands of the little guys – provided there’s enough of them.
As Bloomberg’s Tracy Alloway puts it, today’s market is favouring flows before pros [23].
And retail punters are the ones with their hands on the money hose.
Not so fast.
I know, I know. It seems a lot of fun to ride meme stonks by going YOLO on calls like a pure autist with his eyes only on the tendies, diamond hands clenched tight, barely bothering to do any DD on the way to the moon!
(Translating from WallStreetBets-ease: It sure looks like it would be an enjoyable – not to mention profitable – enterprise to invest every penny of one’s capital into buying call options on a popular stock represented by an amusing image posted on Reddit, just like a gifted but somehow limited mathematical savant would, refraining from selling any of your securities, and focusing only on the six- or seven-digit returns to come rather than being bogged down with due diligence on said stock, all the while looking forward to some delicious chicken nuggets as a reward.)
But if you want to make easy money, do something hard [24].
We’ve seen this movie before. If following Internet posters into hot stocks was a sure route to enrichment, the Dotcom Bust would have been left with a different name.
We will, we will, rock you
I don’t begrudge the WallStreetBets crowd their fun. It’s been a miserable 12 months, so get it where you can I say.
I may be an active investor for my sins, but I’m not a hypocrite.
I understand the thrill of punting like this (it certainly isn’t investing).
Only with money you can afford to lose, ideally.
Otherwise fine, let’s see this run for a while. I’m enjoying the show.
Right now the day-traders are scanning the lists of the most-shorted stocks in the market in their hunt for new targets.
Some such stocks (sorry, ‘stonks’) are already seeing their prices rise.
Perhaps traders and investors have begun to buy in anticipation of the WallStreetBets eye of Sauron alighting upon them.
Or maybe sophisticated shorters are bailing, covering their shorts, and putting an ‘Out to Lunch’ sign on their door. And who can blame them.
The blast radius is expanding. I even noticed a relatively obscure German battleground stock called Grenke was up 16% yesterday. It’s hard to imagine that’s on the typical Redditor’s radar.
Short fall
This can’t last forever, though. And I don’t even mean regulation.
GameStop isn’t worth $22.5bn. It just isn’t. The company should try to raise capital while it can at this price, because it won’t stay here.
It seems a poor short to me – originally the epitome of a crowded trade, it also has net cash, a billionaire cheerleader [25], and while you wouldn’t want to start today with a load of shops in malls, games aren’t exactly a fading force – but nevertheless, it won’t be the new Amazon anytime soon.
Eventually fundamentals and prospects will – at least vaguely, in the hand wavey look-into-my-eyes way of the stock market – be reasserted.
That’s not to say a precise intrinsic value will be reflected in the stock price.
But something within – oh, I don’t know – say 200% of what it’s worth.
And you really don’t want to be holding the bag on the way down to there.
Eventually you’ll run out of greater fools [26] to sell to.
Flashy mobs
What I haven’t got much time for is all the FinTwiterrati [27] proclaiming Something Must Be Done, This Isn’t Capitalism Dear Boy.
There’s talk of a disorderly market. Of the breakdown of true price discovery. Of big losses to come in the aftermath.
But as I said, hedge funds have been taking advantage of opponents caught offside forever.
Why shouldn’t retail traders have a go for a change?
Perhaps the only thing that’s truly different is the risk tolerance of the newbies.
A hedge fund that’s short a particular stock can’t afford to see its assets go to zero. It has a fiduciary duty, as well as more practical limits on its losses.
But the WallStreetBets army? They have a cavalier attitude to losing money at the best of times.
Perhaps the mathematics of tens of thousands of coordinated punters being ready to lose $100-10,000 does change things a little bit.
Maybe new risk controls are needed at funds. Maybe the mechanics of options trading need a rethink. Perhaps there will be regulatory tweaks – whether advisable or not.
But that’s something for the zero sum [28] traders to figure out among themselves.
Personally I think the market will take care of it – in brutal fashion – eventually.
The rest of us are best off watching with a bag of peanuts from the gallery. Or at the most having a flutter with some fun money.
I’m an active investor. But I’m the old-fashioned sort who expects to see long-term gains achieved over a few years, or even a few months.
At least a few weeks!
I don’t expect to get rich in an afternoon. Day trading [29] is not and has never been a profitable way to wealth for nearly all who try it.
Bet on the horses. Bet on ‘stonks’, if you must.
But invest for the long-term in stocks.
My unexpected piece of the Gamestop action
Here’s a fun postscript.
I thought I’d be ending this article bemoaning that I wished I had some GameStop shares. Simply so I could sell them.
Well, it turned out I did own some GameStop shares!
It’s around this time every week that Freetrade [21] tells me if anyone followed my affiliate link [21] to bag their free share for signing up via my referral – granting me a bonus share in the process.
Imagine my surprise when I fired up the app to see if anything had come in – only to discover my single largest holding on the platform was GameStop.
[30]It wasn’t my number one holding last week. It wasn’t even yesterday.
Truth be told I hadn’t even known I owned any GameStop shares. (I typically just let my free bonus shares be.)
But there they were. Two of them! Awarded to me when they were priced at less than $5.
Now priced at $330. Up around 70x.
Freetrade handily reminded me that GameStop had been on a bit of run:
[31]What to do next? Should I evaluate the prospects for GameSpot’s future like a serious investor?
Cling onto my shares in a mini-me version of a WallStreetBets’ YOLO trade and ride the company to the moon – or to zero?
Reader, I hit hammered the sell button:
[32]A huge shout out to whoever signed up to Freetrade and randomly granted me this windfall.
And I’ll add something that nobody has said for most of the past five years…
…I hope you got a GameStop share, too.
Sign up to Freetrade via my link [21] and maybe we’ll both get another free share that’s going to the moon. No promises, mind.