Last week may go down as one of the weirdest weeks in investing history.
By now you have been made aware of the company Game Stop (GME:N). You’ve undoubtably been forced to look up what a short position and a “short squeeze” are and have collided head first into the meme fuelled online community of Wall Street Bets, the subreddit that lives for dangerous investments and may go down in history for the first market based populist uprising.
My first twig that something was going on came the week before last. I had investments in Blackberry (BB:TSX), a company that I had felt was undervalued and believed had made a successful transition into cyber security, a market sector I believe poised for long term growth. The ride had had not been fun. And then, all of a sudden the stock began going up. At first it seemed to be in response to a series of positive news stories; a settled IP legal case with Facebook, a new deal with Amazon for cloud services, and the sale of some 90 patents to Huawei. And then the stock took off. Within days a stock that had been languishing around $8 – $9 had suddenly doubled and was now looking to triple.
I was elated, until I read about Wall Street Bets (WSB), Game Stop, a hedge fund and how a number of stocks, including Blackberry, were being driven higher in an attempt to hurt a hedge fund. The story was fascinating but also terrifying. On Tuesday morning I exited Blackberry and began trying to understand what was going on.
The internet is a weird place, and far from creating a new universal society, it has instead hastened the growth of more insular and specialized communities. From the outside these groups can feel pretty alien. They have their own language, jokes and hierarchies and the subreddit Wall Street Bets is no different. But once you had pushed past the memes and lingo, it became clear the WSB, which is filled with amateur traders, had caught on to a risky move by a hedge fund called Melvin Capital. Melvin Capital had taken out large short positions on Game Stop, a legacy business that sold physical game cartridges in malls that was obviously struggling. The price of the stock had recently gone up following a new board member and announced plans for further restructuring. The traders at Melvin Capital believed the price of the stock over valued and had opted to short the stock (a method of betting on a future price decline by “borrowing” stock, selling it and buying it back within a set period of time). What the investors over at WSB understood was that the size of the short was too big, and that if they were to buy up all the available stock and hold it they could create a “short squeeze” in which the price of the stock climbs and the available supply of the stock falls, forcing potentially unlimited losses on those holding the shorts.
From here everything becomes extremely weird. It turned out the Wall Street Bets crowd wasn’t interested in making money as much as they were interested in crippling Melvin Capital. The trading platform that facilitated all of this, Robinhood, which prided itself on “democratizing trading” and offered no fees for doing trades, suddenly seemed to fold under the most minor of pressure to the request of another hedge fund to restrict retail trading on Game Stop, allowing only selling and no buying on Thursday. Suddenly members of Congress from across the political spectrum were tweeting and complaining about the restriction of trading regarding Game Stop and threatening to hold hearings into Robinhood’s practices.
On Friday limited purchases of Game Stop reopened, and much to the surprise of many, the commitment to “hold” did hold. While the price of Game Stop stock had fallen Thursday during the period only selling was allowed, the price decline reflected minimal volumes. On Friday morning the stock opened again above $300, and despite considerable volatility closed the week at $325 a share.
You’d be forgiven if you’re having a hard time following all the facets of this story, but from my vantage I’d like to share the 4 major issues this convoluted chain of events has created.
1.Populism and Democracy – Twitter and Reddit have been alive with excitement over screwing with a hedge fund, and its apparent that those engaging in the initial rally for GME are committed to undermining Melvin Capital, but the sharp response from Wall Street institutions that this represented some kind of illegitimate assault on the markets highlights the lack of interest in a “democratized” market. Like a lot of internet buzz about “making things more accessible” or “democratic”, when put into practice established institutions don’t seem to like the rabble actually having all that much power. Whether it’s a crowd sourced populist group of traders playing the other side of an over leveraged short position, or simply an online vote that wishes to name a scientific vessel “Boaty McBoatface”, efforts to open, engage and democratize previously closed off institutions seem to fail when it turns out the masses don’t share the goals or reverence of those institutions.
2. Hedge funds often describe themselves in terms of significant reverence and are self-styled “Titans of Wall Street”, but as a group hedge fund performance frequently falls flat. What hedge funds have been good at is risking other people’s money. The brashness and over confidence displayed by hedge fund traders is precisely how you end up with a short position worth 130% of the available stock of a company and squandering $5 billion in a week. Some may find “shorting” a controversial practice, but in reality it is a common and well understood strategy. But in the hands of hedge funds it can become predatory as efforts are made to sometimes game the system and force stock prices down unnecessarily.
3. The Robinhood trading app, which has become all the rage with DIY investors seemed to have its brand implode in the week, and it perhaps revealed far more about this business than anyone had wanted. Like Google or Facebook, where the service is “free”, people using the Robinhood trading platform were the product. Robinhood, legally but controversially, makes its money by “payment for order flow”, or by directing the orders to different parties for trade execution. This all gets pretty complex, but at its core those using the Robinhood app may have been paying fractionally too much for their trades, but when in the context of billions of trades it adds up to a substantial amount of money. The benefit of buying overflow is that high frequency trading algorithms can potentially front run those trades, which was the subject of the controversial Flash Boys book by Michael Lewis. Perhaps more nefarious was who was Robinhood’s primary purchaser of order flow; Citadel Execution Services, which is owned by Citadel LLC, which just bailed out Melvin Capital.
4.Much of this will end up bypassing the bulk of the population. The story is too weird, to convoluted and too specialized. It involves a cynical and anarchistic online community whose rallying cry is “WE CAN REMAIN RETARDED LONGER THAN THEY CAN STAY SOLVENT”, something that many will find repellent and will keep people from looking closer. What might make people pay attention is the money.
The apocryphal story of the famous investor receiving investment advice from the shoe shine boy right before the great crash has some modern parallels. Prices for stocks, some at all time highs, keep going up despite worrying fundamentals. Companies like Tesla, which have devout adherents, have bid up that stock so that the total company is worth more than all the other major car companies combined! This reeks of the beginnings of a mania, one that can only be made worse by a prolonged lockdown, low interest rates, and the use of social media to hype up a stock. The allure of easy money, embodied by the events surrounding Game Stop will only attract more investors that believe that they too can beat the market.
At the end of last week the number one app in Canada was the Wealthsimple Trade App, a similar low cost trading platform to Robinhood, while the Robinhood App itself remains highly popular south of the border.
The wind has been let out of the sails somewhat this week. Game Stop closed under $100 on Tuesday, and early hype that silver was going to be the next big WSB play seem to have fizzled also. Markets seem to have responded to this cooling of temperatures by resuming their positive direction, but the spectre of market mania looms over returns. Where we go next, I don’t know. But I do know that sensible investors should be watching this with concern. Whatever the merits of hunting hedge funds through crowd sourced market initiatives, the larger story remains one of deep concern, involving all the worst aspects of investing.
“Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI”.