Dead cat trampoline
If you want to understand the story of why a bunch of Redditors have used Gamestop shares to squeeze a load of profitability out of a couple of hedge funds you could do worse than to read the 1994 Wired article about the time the Usnet newsgroup alt.tasteless invaded rec.pets.cats, by Josh Quittner. A horde of "little guys" invading the protected territory of a handful of stodgy, entitled billionaires and hedge fund managers could be the Internet's origin story. For example: bitcoin.
In brief, for those who've missed the breathless coverage: the "troubled" retail chain Gamestop. whose share price opened 2021 at around $17 and which dropped as low as $2.57 during 2020, suddenly spiked (briefly) last week to $483. The technical explanation is that this is an extreme version of a short squeeze, a vicious spiral in which a company's rising share price forces traders who have bet that it will go down scramble to cover their losses before they can escalate further.
Rule of thumb: when your get-rich-quick strategy appears on CNBC, it's time to cash out.
Calling Gamestop "troubled" is polite. Offline retail in general and particularly malls, where Gamestop outlets are located, are struggling. The company's revenues slid badly in 2019. That December - still 2019 - the best suggestions for recovery were to leverage the company's 5,600 physical locations to create experiences that can't be replicated online and to build its own line of products while it waited for the launch of new game consoles to goose its business. *Then* came the pandemic and its shutdowns to accelerate the spiral downwards. The company seems unlikely to be able to mount a comeback. Terrible for its employees, terrible for the malls and towns that depended on sales and other taxes, terrible for other local dependent businesses, but an opportunity for short sellers who get their timing exactly right.
In January, a Reddit group (subReddit Wall Street Bets) spotted that short sellers' commitments amounted to more than double the number of outstanding Gamestop shares and correctly recognized that they were looking at a spring-loaded slingshot. Ordinary retail investors can't, individually, buy enough to set a squeeze in motion, but a crowdsourcing, coordinated through an online forum, could indeed move the needle. The Redditors were also aided by 2019's industry-wide elimination of commissions on retail stock trades, which makes very small trades newly viable. The persistence of friction-inducing costs is why the Reddit scenario is unlikely to be replicated in the UK: British brokers still charge commissions on trades and the government adds stamp duty.
The markets are broken, short seller Carson Block tells Julia LaRoche at Yahoo Finance, in response to this incident. Like many over the last four years, he notes the widening gap between fundamental value and market pricing, between the real economy in which millions of Americans were struggling to afford rent even before the pandemic and the market, where 84% of the value is held by 10% of Americans, a level of inequality seen in England in 1966. This is not good news. WallStreetBets may be a messenger telling us that things are worse than we thought, but decades of underlying trends have fueled today's overpriced market: the extraordinarily low interest rates since 2008, the lack of alternatives for small, ongoing savings, the decades of replacing pensions with shares-filled 401(k) plans, and most recently Trump's tax cuts. The result is distorting the entire economy and robbing working Americans of a decent living.
Much of the Reddit action centered on Robinhood, a brokerage that markets itself as democratizing finance. At Slate, Alex Kershner says no: Robinhood's retail investors are the product, and Robinhood's real customers are Wall Street's market makers, who pay for the privilege of executing its stock orders. This arcane subject is best explained by Michael Lewis in Flash Boys. Because of the way it reduced friction for small-time retail traders - free commissions, instant access to deposited money, margin trading - Robinhood contributed to the volatility, but it's not really the story by itself. It is merely the last stop on a decades-old journey toward making it possible for retail investors to take risks previously limited to people who could provably afford the losses. The good side of that approach is to protect ordinary people from losing their homes; the bad side is to reserve the biggest profits for people who don't really need them.
If past decades are any guide, breaking those protections will hurt people. On Monday, February 1, Gamestop dropped 75%; on Tuesday it dropped 60%. On Wednesday, it rose slightly - about 2.5% in what experienced investors would call a "dead cat bounce", as Thursday saw it drop another 42%. Price Thursday night: $53.33. No one who bought at $483 will get their money back. As Farhad Manjou warns at the New York Times, in the end the house always wins. In the long term, fundamentals *should* matter. because the value of having the market in the first place isn't to make people rich but to help channel investment to viable businesses. If it doesn't fulfill that function it's time for real reform.
Illustrations: Chart of Gamestop's share price for the three months ending close of business February 4, 2021 (from Big Charts.
Wendy M. Grossman is the 2013 winner of the Enigma Award. Her Web site has an extensive archive of her books, articles, and music, and an archive of earlier columns in this series. Stories about the border wars between cyberspace and real life are posted occasionally during the week at the net.wars Pinboard - or follow on Twitter.