By Normally I don’t write back-to-back market updates unless something particularly unusual has happened. Well, by now I’m sure you’ve read at least something about the unusual activity going on with GameStop, and what’s being pitched as individual investors bringing a professional hedge fund to its knees with a $3 billion loss after it shorted the video game retailer stock.
So, what is a short, you’re wondering? A short is when a share of stock is sold with the intention of buying it back at a cheaper price. It’s akin to selling your house to someone who’ll pay full market value because you think it’s overvalued, and you planning to buy it back after the market plunges.
In the case of GameStop, the people shorting it sold more stock than actually existed to be traded, a.k.a, the float. At which point individual investors in a chat room bought up those shares, and sent the stock skyrocketing, which caused hedge funds and other investors significant losses. Because of those losses, the hedge funds had to sell off shares of winning companies’ stocks, which sent the indices down.
Now, do short squeezes happen all the time? Yes. Are they always this big? No, but this isn’t the first time we’ve seen this situation, although it has been a while. I have no dog in this fight, but my opinion is that GameStop is a failed business, no matter how high their stock goes temporarily. As someone who has spent the majority of the last 21 years with the stock markets, it does concern me when it appears that there is outright speculation and unabashed manipulation of the markets taking place on a daily basis. That’s not to say that Wall Street isn’t also manipulating – personally I believe it happens all the time. But this is the first time people can remember a community of citizens sticking it to Wall Street.
What I’m interested in is, how many of those individual investors were actually other hedge fund managers using a chat board to wage war on their brethren? Only time will tell, but I don’t think I’m that far off. Of course by the time that’s known, the media will have moved on from this David vs. Goliath story.
One thing that has become apparent in this however, is that a large group of people have been getting stimulus checks, are reading Reddit, and with the availability of zero-commission trades, they’re making a bet much more than an investment. Of course, I’m the last person who will criticize someone for gambling – I’m the first person in line at Keeneland every spring and fall, so I’ll let someone else cast the first stone. But there is a big difference between this kind of speculation versus investing in a stock based on the merits and real growth opportunities of that business within the marketplace, planning to hold that stock for years and reaping the profits as a shareholder of that business. That’s what investors are doing with their hard-earned money to delay gratification and pay for college, buy a home, save for a rainy day (or a boat!) and create a retirement paycheck. Long term, this is what the market affords everyone, regardless of how much money you have.
What we’ve seen over the last couple of weeks is outright speculation. Nothing has changed in the value of GameStop, or AMC. They’re not growing, or buying back shares. As a long-term investment, they’ve been terrible, but in the last few weeks, they have proven to be great speculations. Typically, speculative bets made on companies with no significant growth tend to end poorly. That’s not advice, it’s just history.
Now the question becomes, do I have a problem with all this? The answer is, absolutely not! It’s just like speculating on property, or a lottery ticket, or Garbage Pail Kids and Beanie Babies. But let’s be sure to call it what it is – these people are not great investors. They are speculators, and like those who went west for the Gold Rush, this will also eventually end. Wall Street will adjust to where the edge is, and the edge that’s benefiting the speculators will disappear.
What I hope is that while this phenomenon runs its course, the speculators don’t cause damage to those who have invested in the markets for the long-term. The rug could be pulled out from underneath our feet, and people could suffer large losses that have nothing to do with the health or direction of the economy, the stimulus, the housing boom, etc., all because people decide to participate en masse to speculate and manipulate certain equities on an hour-by-hour and day-by-day basis. Per the industry jargon: Investor be warned.
Article by David Smyth, CLTC, Senior Partner at Family Financial Partners — a financial services firm in Lexington, Kentucky.
