During Burns season, I'm often reminded that my plans 'gang aft agley'. As last-minute Christmas presents for two of my sons, I tried to combine financial education with some light parental psychology. My eldest got a funded Robin Hood account to help him understand how the stock market works. He's the 'Steady Eddie' of the siblings, and I figured he'd build a portfolio through diligent research. His younger brother is more a rebellious free spirit who's been evangelising about cryptocurrency for years. So, he got a digital wallet containing a fraction of a Bitcoin to teach him about volatile asset classes disconnected from the real economy. You can probably see where this story is heading.
By the end of last week, Steady Eddie had disappeared down the Reddit rabbit hole and doubled his money by trading incessantly, while Anarchy Boy had a nice return, but hadn't made a single trade. Like almost everyone else who works in finance, I've been left asking the question 'what just happened?'
The centre of the vortex is, of course, GameStop, the 40-year-old unprofitable video game retailer whose 5,000 stores are a staple of suburban American malls. They've played the same role for American teens that HMV on Union Street in Glasgow played for me. Somewhere to meet friends, browse without buying, and feel that you're with your people. Obviously not the best pandemic business model.
The tabloid version of the last two weeks is that rebel gamers organised via an online forum to start buying GameStop and defeated the evil empire of hedge funds betting against the firm. Against the odds, the rebels drive the stock to dizzying heights and blow up a couple of Wall Street Death Stars. Cue dancing Ewok memes, a cohort of unlikely millionaires, regulatory knee-jerking, congressional investigations, and the possibility that the way the stock market works just radically changed.
Of course, like all tabloid stories, the reality is a lot more complicated. The rebels didn't just stumble on the Death Star plans last week. Financial Jedi and Sith have been facing off over GameStop for a while. Eighteen months ago, and pre-COVID, a bunch of hedge funds concluded that GameStop was doomed by a combination of downloads and ecommerce. They shorted the stock, meaning they sold borrowed shares they didn't own planning to buy them back later at a lower price, allowing them to return the borrowed shares and make a profit. In the summer of 2019, short positions were already a multiple of the regularly traded GameStop share volume. Just like the second Death Star looming over Endor, the very existence of these short positions amplified the sense of impending doom for GameStop.
Meanwhile, on the rebel side in 2019, there's a guy on the WallStreetBets subreddit proudly showing off his portfolio of long-term options that only pay off if GameStop rallies. He's relentlessly mocked for wasting his money until this Luke Skywalker is joined by the Yoda of contrarian investing, Michael Burry. Burry had a starring role in The Big Short
movie as an investor who predicted the American subprime mortgage crisis and made a killing from it. Burry invested but also advised GameStop management on how to reverse the slide that had seen the stock drop from over $30 in 2016 to a low of around $3. In the summer of 2020, Burry was joined by activist investor Ryan Cohen who has a good track record in ecommerce. Cohen invested $76m at an average price of $8 per share and joined the board.
So far, so normal. Contrarian investors think they can turn around a poorly managed company and make some money in the process. It's the way equity investing is meant to work, and what I hoped my son would learn about. A stock price reflects the consensus around the future value of a business, with the price going up if there are more bulls than bears. By early January, the bulls were winning and GameStop had climbed to around $20. That's when things got weird.
WallStreetBets has been around since 2012 and had almost two million members by the end of 2020. It's a male-dominated, meme-fuelled, lightly-moderated, generally nihilist free for all, whose members revel in the casino-like nature of the markets and where the favoured game is high-risk options trading. Whether you win big or lose everything, you post screenshots to the site and take whatever plaudits or abuse comes your way.
Until two weeks ago, WallStreetBets was like one of the zombie herds on The Walking Dead
, a bunch of testosterone-fuelled risk takers milling around a fragmented set of discussion topics and occasionally someone gets lucky. Exactly the type of retail investors that professionals have always looked down on and fed off. Then suddenly, within days, the herd develops a collective consciousness and the hive mind gets laser focused on attacking the hedge funds shorting GameStop.
The price of GameStop then decouples from anything to do with the actual business. The stock soars to nearly $500, fluctuates by hundreds of dollars a day as buy and sell waves surge through the market and GameStop quickly becomes a spectator sport that dominates not only the financial but also the broader news cycle. Instead of being a claim on the future profits of a struggling specialty retailer, the stock becomes a Bitcoin equivalent, a financial token whose value is determined solely by technical market dynamics and collective sentiment.
It's also clear that the rebels didn't just get lucky. They'd studied the Death Star plans and figured out exactly where the fabled exhaust port led. The mechanics of a short position are that as the price climbs, the short investor will typically minimise their losses by buying the stock and giving it back to the people they borrowed it from. The higher the price, the more they need to buy, which in turns drives both the price and their losses up in an amplification cycle known as a short squeeze.
On the other side, because the rebels were using lot of call options (the right to buy a stock at a certain price in the future), a rising share price also forced the traders who sold them the calls to buy stock to cover their positions, creating a second positive feedback loop called a gamma trap. So, hit the exhaust port with enough buy trades and you can set off a chain reaction in the establishment Death Star resulting in a Mandalorian
-inspired wave of 'this is the way' memes on Reddit.
The rebels know that some of their number will take their profits (like my son), so the reaction needs more buyers to sustain it, making publicity gold dust. Last week, WallStreetBets exploded to over five million members and had over 270 million page views on Friday alone. This highly energised army also diversified their short seller attacks by piling into other 'vintage stocks' like AMC Movie Theaters and Blackberry, cheered on by Elon Musk among others.
Burry and Cohen thought GameStop was undervalued, while the Redditors simply didn't care about the economics of the underlying business and were just focused on torching the shorts. So, the last couple of weeks have been a perfect storm in which a natural geek affinity for GameStop (it wouldn't have worked with a ball bearing manufacturer), plus an understanding of the short-sellers vulnerability to coordinated action, got supercharged by a collective attitude reminiscent of Todd Beamer on the hijacked United Flight 93 on 9/11, rallying fellow passengers to take back the plane with a cry of 'let's roll!'
To borrow another movie analogy, the climax of the classic western Chisum
has John Wayne outgunned in his attempt to save Billy The Kid, so he stampedes a herd of cattle through the barricades in the town to even the odds. Chisum
understood the Newtonian physics of cattle; that a herd in motion will stay in motion. The hive mind at the centre of the GameStop phenomena came to the same conclusion. Effectively organise the masses around a just and profitable cause and they're unstoppable. By yesterday, the masses had started to move on and GameStop was down to around $100, mostly because the hedge funds have taken their losses and capitulated, with short positions down from well over 100% of the free float in mid-January to under 38% on Monday.
How does it end and what does it mean? I frequently hark back to screenwriter William Goldman's Hollywood observation that 'nobody knows anything'. The hot takes over the last week have ranged from this being a populist economic movement that will destroy Wall Street as we know it, to claims that the Redditors are just cannon fodder and that, despite killing Supreme Leader Snoke, they're already being manipulated by the real Sith Lords of finance. As every Star Wars
fan now knows, just because you blow up the Death Star it doesn't mean you've killed the Emperor. While the Redditors got the coverage, there's clear evidence that the aristocrats joined the revolution last week with wadges of institutional money piggybacking on and profiting from the populist buying frenzy.
What's clear is that, whether it's positives like Tahir Square or malignant conspiracies like QAnon, the organising power of mass digital communication is immense. Frankly it's surprising that it's taken so long for the original physical 'Occupy Wall Street' movement to evolve into this besieging online army. Last week was a great example of what my friend Professor Mark Blyth of Brown University calls 'Angrynomics' catalysed by a combination of pandemic boredom, righteous indignation, and free trading apps. What's also certain is that no hedge fund will be grandstanding about their short positions anytime soon.
As this drama plays out, there will inevitably be casualties when true believers are left holding the bag and prices reconnect with economic reality. Those left exposed on the front lines will suffer evictions, divorces, and suicides because they 'stuck it to the man' using their student loans, mortgage payments, and maxed out credit cards. Or maybe in the spirit of William Goldman, GameStop will hit $1,000 next week as the next round of government stimulus cheques gets channeled straight into 13 million Robin Hood accounts and the remaining short sellers get squeezed into bankruptcy. That would justify much dipping of chicken fingers in champagne, a traditional WallStreetBets celebration.
Gary Gensler, the new US Securities and Exchange Commissioner, hadn't even moved into his office last week. He's clearly going to have a busy time figuring out whether this democratisation of finance is a good thing or a bad thing, whether digitally coordinated stock buying is illegal, and ultimately do the rules governing the market need to change. Until then, may the Force be with Red(dit) Squadron as they form up for another run down the Wall Street trench, targeting their populist proton torpedoes on the exhaust ports of the billionaires.