It is tempting to see GameStop’s soaring stock as merely the result of clownish behaviour in a chat room. That would be a mistake.
4 min
GameStop is the platonic ideal of a stock bubble.
A combination of easy money, a real improvement in the company’s prospects, technical support from a short squeeze and a mad rush to get rich or die trying pushed stock in the retailer up 64-fold from late August to Wednesday’s close. Anyone who has held on for 10 days made gains of more than 10 times their money.
It is tempting to see GameStop as merely clownish behaviour in a chat room having some amusing effects on a stock few care about. That would be a mistake.
Sure, the wildly popular Reddit group Wall Street Bets—slogan: like 4chan found a Bloomberg terminal—is full of childish chat. Several users report that they have bet their parents’ pension fund on GameStop or that the boss’s daughter has bought in. There are plenty of calls for the stock to go to $1000 or more (it started the year at $18.84).
But GameStop’s soaring stock—and similar moves in BlackBerry, Nokia and others—is a bubble in microcosm, with lessons for those of us worrying about froth elsewhere in the market.
GameStop’s rise started with some genuine good news, just as bubbles always do. Ryan Cohen, who built up and sold online pet-food retailer Chewy, started building what is now a 13% stake for his RC Ventures in GameStop last year. He pushed for the staid mall-based seller of videogames to improve its internet sales. This month he joined the board.
Mr Cohen’s arrival means GameStop at least has a chance of joining the 21st century. From the first disclosure of his stock purchases in August up to the end of November the shares tripled, helped too by the improved prospects for the vaccine-driven reopening of the economy.
Along the way, some private investors latched on to the stock, helping its rise, and it became an item of discussion on Wall Street Bets, or r/WSB as it’s known.
This month the stock moved into the pure speculative phase, producing several daily jumps of 50% or more, and fundamentals were abandoned. Many cheerleaders on r/WSB stopped even making the pretense of arguments about Mr Cohen’s chances of turning the company around. Instead, there were two justifications for buying: wanting to get in on the price action to avoid being labelled, in the abusive parlance of the forum, a “retard” who missed gigantic profits, and the self-fulfilling prospect of hurting the large numbers of short-sellers.
As the late economist Charles Kindleberger put it: “There is nothing as disturbing to one’s well-being and judgment as to see a friend get rich. Unless it is to see a non-friend get rich.”
The scale of trading in GameStop shares is as extraordinary as the daily gains in price, suggesting widespread disturbance to people’s judgment. On Tuesday, $22 billion of shares changed hands, more than in Apple, the world’s largest company, and double GameStop’s market value. Adam Smith, the founder of economics, called speculative manias “overtrading,” and this is what they look like.
The hope of getting rich is only part of what’s inflating the bubble. Kindleberger argued that speculative manias needed innovative sources of financing, and the private traders on r/WSB have one: the shift last year to make trading in options free on Robinhood and several other platforms.
Options, like other derivatives, allow traders to use implied leverage to boost their bets, similar to borrowing money. In the same way that Japan’s bubble in the 1980s was fueled by cheap mortgages, and low Federal Reserve rates combined with collateralised debt obligations to support the housing bubble of the 2000s, the bubble in GameStop is aided by an increase in the money supply of private stock traders. Stimulus checks from the government can’t hurt, either.
Bubbles also frequently have support from technical factors that prevent the asset from being priced correctly. In the late 1990s, many dot-coms had a small float available, and none for short-sellers, making it hard or impossible for those who doubted the story to have their views expressed in the share price.
In GameStop, there are plenty of short-sellers, but they are making things even worse. The stock is caught in a vicious short squeeze. Short sellers had borrowed and sold more than 100% of the stock outstanding, as some was borrowed again. As the price rose, at least some of the hedge funds bought back shares to prevent further losses, so pushing the price up even further.
The most obvious parallel here is to K-Tel, the TV retailer of compilation tapes and the Veg-o-matic food processor, among other things. It announced in 1998 that it was moving online, prompting a jump in the shares that turned into an extraordinary short squeeze. K-Tel’s appropriately named public relations representative, Coffin Communications, gave this wonderful justification to the Washington Post: “Which do you think has more likelihood of success, a pure start-up that has never sold a product, or one like K-Tel that has been in business for 35 years?”
It turned out the answer was a pure startup, and K-Tel’s shares collapsed—but not before they had soared from $3.34 to more than $35 in under a month.
The difference with GameStop is that the r/WSB mob is actively engineering a short squeeze, discussing the pain they hoped to inflict on the short sellers and encouraging buyers not to cash in their profits.
Because there are so many shares that need to be repurchased by short-sellers, this offers an exit route for those who sell. But not everyone can do this, and those who are left holding the stock when demand eventually evaporates will watch the price plummet as it reverts back to something closer to what is justified by the company’s profit potential, just as K-Tel did.
Warren Buffett attributed to his mentor, Ben Graham, the line that “in the short run, the market is a voting machine—reflecting a voter-registration test that requires only money, not intelligence or emotional stability—but in the long run, the market is a weighing machine.”
The absence of emotional stability on r/WSB is obvious and has worked out beautifully for buyers of GameStop so far. But when the stock is weighed, many will be found wanting, as they always are in bubbles.
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Wall Street’s hottest momentum trade has reversed sharply, as former winners tumble and heavily shorted stocks surge.
3 min
Wall Street’s hottest trade has gone ice cold.
For years, it paid off to buy stocks that were rising in price—and bet against struggling shares. The momentum trade was especially profitable this year, as investors piled into hot stocks including Micron Technology, Nvidia, Advanced Micro Devices and other artificial-intelligence darlings while wagering against those likely to be hurt by the embrace of AI.
The S&P 500 Momentum Index soared 44% in the second quarter, its best quarterly performance on record, and it surged 133% over the past five years, nearly double the broad market’s performance.
Mega funds and rookie investors alike piled into the trade, some using leverage and options contracts in an effort to amplify their returns, propelling the underlying shares higher.
“It is a self-fulfilling prophecy,” said Matthew Tym, managing director at Cantor Fitzgerald, of the trade.
Suddenly, the trade is a loser. The momentum index has tumbled more than 9% since July 1, lagging behind the S&P 500’s 2.8% gain. The index—which tracks stocks in the S&P 500 based on a “momentum score”—is on track for the biggest quarterly underperformance in 25 years. July was the second-worst month for the momentum trade in around 40 years, according to Bank of America estimates; the only month worse was April 2009, in the teeth of the global financial crisis.
Hedge funds that bought momentum shares while shorting low-momentum stocks suffered even more. At the same time, a basket of the most popular stocks held by hedge funds tracked by Goldman Sachs recorded its biggest one-month underperformance in July relative to the S&P 500 in more than 20 years, according to the bank’s analysts.
Momentum trading is based on a rather simple observation: Investments that go up tend to keep outperforming; those that underperform often remain laggards. This kind of trading might seem too simple a stock-picking strategy to work. Yet it often has.
“For decades, it didn’t take a lot of sophistication to run a momentum strategy and make a decent living at it,” says Agustin Lebron, senior researcher at EquiLibre, a trading firm.
Part of the reason: It takes a while for corporate and other information to spread to various investors, so they slowly build positions, producing buying momentum.
“A huge pension fund can’t flip around its positions in a day,” says Lebron. “Behavioral biases also account for some of the effect, as well—people tend to sell their winners too early and hold losers too long.”
Fans of the strategy point to the human tendency to extrapolate from past results—and chase investment returns—noting that momentum patterns have been evident in markets for decades, even centuries. They also say that some of the worst months for momentum strategies are during longer periods of outperformance.
Some have been doing the trade by buying the strongest investments in a sector while shorting the weakest; others lean in to rising markets or asset classes. Still others use a quantitative approach or turn to banks or others who sell ways to make distinct wagers on momentum as a “tradable factor” or a “thematic basket.”
The fans remain believers. “Any strategy has disappointing periods,” says Antti Ilmanen, global co-head of the portfolio solutions group at AQR Capital Management.
The surge in Moderna and other biotech stocks helped crush the momentum trade. These shares were among the most heavily shorted in recent years, but positive news on a cancer vaccine from Moderna and Merck sent those stocks flying, crushing some quant and other hedge funds. Moderna is up around 150% so far this month.
These traders had an especially rough day on Aug. 19, which Goldman Sachs told its clients was the worst day for “systematic long-short managers” in more than two years. About half of the losses were because of momentum trades, the bank said.
Some traders have begun to short, or bet against, the very stocks that propelled the momentum trade earlier this year. Net short positions in futures tied to the Nasdaq-100 index among speculators recently climbed to some of the highest levels of the past two decades, according to data from the Commodity Futures Trading Commission.
The about-face is a sign of how markets have become more treacherous for investors, even as indexes keep climbing. Part of the issue: the recent meltdown of Situational Awareness, a hedge fund that had piled into some of the most popular momentum shares, including chip stocks. After a period of market tumult, Nvidia shares rocketed almost 9% after its earnings, showing how quickly sentiment can shift.
Some investors say the run-up in share prices driving tech stocks higher reminds them at times of the dot-com frenzy decades ago.
Mike Ogborne, the founder of San Francisco-based Ogborne Capital Management, said he has grown more cautious on technology stocks and is keeping more of his portfolio in cash than he typically does.
And he is nervous about the surge in spending by technology giants and quarterly capital expenditures that keep rising.
“It is a little bit like Cinderella and the clock striking midnight. You don’t know when midnight is going to come around,” Ogborne said. “They don’t send a memo around telling you when the capex cycle is over.”
