What I thought would be a relatively straightforward tale of chaos in financial markets has turned into a much more complex and entangled matter. The more I look into the issue, the more I need to dig further and the more thorny the language becomes. To quote from The Economist’s Buttonwood “Those schooled in the idea of efficient capital markets will be puzzled by the latest goings on”[i]. Me being ‘schooled’ is certainly an overstatement, but puzzled I am! The puzzlement to which I refer is the shenanigans on Wall Street over the trading of stocks like GameStop and AMC.
I draw again from the words of Buttonwood to explain my bewilderment. “Picture a world in which there are two types of investor – fast and slow. The slow money investors are pension funds. They eschew short-term trading. When they enter the market it is in a measured way, to buy and sell when share prices look cheap or dear. The fast-money crowd are the hedge funds, which are happy to trade every day.” I guess I’ve always been more aligned to the pension fund way of thinking and want to see tangible fundamentals in an investment – a solid business case and clarity of cashflow and profitability. None of that came into the reckoning that unfolded as the price of GameStop skyrocketing by almost 30 times its value as at the beginning of January. Well perhaps that isn’t wholly true, but it seemed to be more on the short side where consideration of the fundamentals were taking place. Even without the impact of the pandemic, ‘physical’ retailing has faced the challenge of cheaper and more convenient online alternatives. Witness the empty high streets in lock-down and the fate of a ‘brick and mortar’ store is even more fundamentally challenged. This was obviously the thesis that the short-sellers bought into – that the fundamentals indicated the direction of the share price could head only south, notwithstanding a significant stake taken by one investor in late 2020 in the belief that business could be turned around.
But the fundamentals of the business are not what drove the spike in price. This is where the story becomes challenging to unravel; where Reddit forums – specifically r/wallstreetbets, ‘meme stocks’ and their rankings on Stonks News, ‘swarm trading’, and free/low-cost trading venues such as Robinhood unite to take on the hedgies and force a short squeeze. The combined might of the collective voices on forums wading in to buy stock and hence forcing those with short positions to capitulate and cover their positions, at a loss. Some of the figures are eye-watering. It is estimated that the cost to the hedge funds was some $ 6 billion.
There is something both exciting and scary about this event. The excitement is due to evidence of a democratisation of the financial systems – with information flow being cheaply available and low-cost trading combined via applications that facilitate ease of access to public markets. Stock exchanges no longer being the domain of the pin striped investment professional. Against that I find it scary that this ease of access can lead to large scale manipulation of the system, often resulting in losses faced by those who do not have a full appreciation of the risks or the wealth to sustain the loss. Indeed, reading through the numerous articles on the GameStop debacle there are many examples of individuals investing in the expectation that the price would rise and rise, only to lose out when financial gravity kicked in.
New innovations are undoubtedly going to challenge the orthodoxy and that is to be welcomed, but it is important that there are safeguards to balance the risks. To draw on Ben Graham’s quote at the beginning of this post, I hope the short-term voting noise that takes place will not to be the detriment of a robust weighing machine that provides for the asset growth of millions of long-term savers.
[i] The Economist, 6th-12th February 2021, p61.