Market Update – A Breakdown of the GameStop Stock Saga, Trading, and More
On Wednesday, January 27th, while watching Bloomberg TV, the media person provided some statistics on the “stocks hated the most are rising” describing the stocks that had a large amount of short interest were actually climbing the fastest. The stocks mentioned were GameStop Corporation (GME), AMC Entertainment Holdings, Inc. (AMC), and a few others. The report said that a group of investors on Reddit – a social news aggregation site, were buying shares of companies that have a lot of short interest, to squeeze large investors.
Short interest is an investment strategy that can be used to profit from an investment at a lower price than what it is currently. The strategy entails borrowing shares of a company, then selling them. If the price goes down, then the investor purchases them (for the lower price) and delivers the borrowed shares to the purchaser (for the higher price). Short selling involves risk, because if the shares do not go down in price, eventually the investor has to return the borrowed shares, and the price risk is limitless. GameStop (see figure 1) had been trading at prices between $4 and $20 per share until a group on the Reddit site started talking about the short squeeze and an opportunity to make a lot of money. This caused a large amount of purchase orders, which drove the stock price up significantly – over $468 per share by Thursday, January 28th.
Early Thursday morning, KVEW News requested an interview about this “whole stock market thing” because at that time, some of the large brokerage firms were halting trading in the security. This caused some sort of political statement being spun that the “big guys” of wall street were restricting the “little guys” from making money. The short version of my comments to the local news channel was that what is happening is interesting, but that it has happened before, that the regulators will watch for fraud, and investors should watch it – from a safe distance.
If you got in your time travel pod and set the dial for 1998, you would have seen companies like Yahoo and AOL had things called “chat rooms.” You may remember these unregulated rooms where people could say what they wanted to each other on various topics. Social media has since cut the technology for these rooms by using different conversation techniques, but inside some of these chat rooms, investors would get together and talk about stocks, because, well, it is fun to make money in the stock market. In the stock market there are no limits to how much money can be made, and sometimes people in chat rooms might be experts and possibly even have inside information on particular companies. Be assured that the Securities and Exchange Commission (SEC) kept tabs on these chat rooms, and yes, even shut down some illegal activity. Sometimes information provided in chat rooms would move a stock price up or down. According to Yahoo!Finance, “the busiest day on Yahoo Finance’s message board in 1998 was just short of 12,000 messages. The difference this time around is the scale – the r/WallstreetBets subreddit boasts about 8 million users and some daily threads pulling in upwards of 99,000 comments.” Another big difference between now and then is trading costs. Back then, some equity trades were advertised as low as $29.99, and eventually dropped to $9.99. Currently, a lot of brokerage firms offer free equity trades, which essentially eliminates the cost barrier for anybody to trade equities as often as they want.
As an investment professional, we are taught to look for companies that have a low price relative to their value. Efficient market theory tells us that the price of a security reflects everything that is known about a security (except inside information). We do not have a team of analysts trying to determine the proper prices of individual securities, but for a security like GameStop, which has traded under $5 per share less than 6 months ago, it is not very probable the company is worth over $460/share. My best analogy of this price discrepancy is a Ponzi scheme; the investors who paid for the stock early on, then ran up the price, are going to make a lot of money. The investors trying to jump on the band wagon later in the game will learn a valuable lesson, which is paying 100 times what it was worth 6 months ago, might be a bad idea.
One of the topics surrounding this activity covered by the press was the action that some brokerage firms took to limit trading in these securities, reportedly hurting the “little guy,” and some investor lawsuits against some of the brokerage firms. Charles Schwab, Inc., TD Ameritrade, and other brokerage firms made adjustments to some trading requirements in a few of the securities that had increased trading activity. Their reasons for doing that can be found on their individual websites. I am sure there is more behind the scenes in their trading, legal, and compliance departments that helped them arrive at their decisions.
How This Might Impact You
If you are wondering if your portfolio has GameStop in it, it does. Cory Briggs, MBA, CFP®, AIF®, Wealth Advisor and our Investment Committee Chairperson, said that GameStop is a small cap stock, and it is represented in some of the funds we use for the small cap allocation in client portfolios. The total exposure is 0.01% up to 0.15%, so not a significant amount. Mutual fund companies like Vanguard and DFA have flagged these securities which means they may change their trading strategy by not automatically adjusting them in their mutual funds to reflect current prices. This might be a factor in some index funds, for example: if a security has a weighting in the index with a price of $4 per share, it will have a higher weighting in the index with a value of $460 per share. This might cause a true index fund to have to purchase it at the higher price to retain the index weighting. Mutual fund purchases responding to this price change could exacerbate the increasing price problem causing their investors a great disservice in the long run.
So, what is the answer? Price manipulation is not legal activity and will be stopped. However, what constitutes manipulation? An important question likely to be addressed by our courts and legislators. Most of our securities laws were instituted in 1933 and 1934, when stock tips were delivered by word of mouth. They were not designed to address potentially millions of people taking coordinated action that causes security prices to change.
Conclusion
The bottom-line is acting on chat room advice is speculative behavior and not based on company fundamentals. A much better strategy is to establish long-term goals, build a diversified portfolio designed to achieve those goals, and rebalance as necessary. You might hear about somebody who made 300% on GameStop, but likely will not hear the rest of the story.
If you want more information, or are curious about it, please contact your Petersen Hastings advisor.
Sincerely,
Scott A. Sarber, CFP®, AIF®
CEO & President