Why the Games Should Stop With GameStop.
6 min read
Socially, none of us like to "miss out." Missing out on a good time because of a prior obligation is one thing, but it stings when it comes to making money. We all know someone that 'would've played in the NFL' if they hadn't torn their ACL in 8th grade, or 'went on to play in the Major Leagues' if they didn't have the sun in their eyes catching a pop-fly that one time in high school.
Similarly, in my career, I've heard countless times, "If I only would've held onto my Amazon stock" - unfortunately, the reality is that they didn't and missed out on a great money-making opportunity. This FOMO (Fear of Missing Out) can get investors into trouble as it stimulates the desire to "catch up" to a forgone opportunity. As you can imagine, this creates an issue. Taking outsized risks doesn't always yield outsized returns.
As I sit on the airplane home returning from my honeymoon and scroll through social media, I felt compelled to buy the Delta in-flight wi-fi. The amount of bandwagon jumpers is astonishing.
“If everyone is thinking alike, then someone isn’t thinking”
My pre-retiree demographic of clients seem to be especially susceptible to this recent cultural FOMO. Remember, there isn't a way to cut corners to get rich. When you hear tales of home runs hit on individual stocks, you have to remember that the losers don't write the history books. Only the extreme minority of those who knock it out of the park share their secret sauce with the world - which, by the way, is often a result of more luck than skill. Because hey, if I can, so can you! Just a word of caution to not view these stories through rose-colored glasses.
Before diving in, most of my clients understand that the stock market has a way of transferring money from the impatient to the patient, and good things come to those that wait. As such, these topics I typically avoid. My clients and I usually adopt the "not my monkeys, not my circus" mantra. However, the buzz from all age groups I've talked to is too significant to avoid discussion.
Gaming Gamestop.
To describe what is going on with Gamestop, we need first to recognize one fundamental fact. When you buy a stock, you own more than just a piece of paper or a number on a screen. You own a real company that employs real people, that seeks to make real money. To that extent, in 2019, Gamestop lost half-a-billion dollars - before the pandemic! Today's astronomical stock price of $GME makes it a company with a market cap larger than Carnival Cruises, Kellogs, Under Armour, or Dominos.
I mean, c'mon, who will buy a video game in a brick and mortar location for much longer? The latest generation of the Xbox & Playstation consoles now offer a "digital-only" option, meaning you can't put a physical disc into the machine at all! In my opinion, Gamestop has inevitably headed the way of Blockbuster.
All that being said, the stock market this week said, "hold my beer," and put the "FU" in the fundamentals of Gamestop's stock price.
So what’s actually going on?
Bob Seawright concisely summarizes the logistics of what is happening.
The formula requires stocks with a small float, light trading volume, a substantial short position, and an army of "investors" willing to buy the name relentlessly. The buy orders eventually cause the shorts to cover their positions by buying more shares, which instigates a self-reinforcing vicious circle: The short-covering causes the price to rise, which, in turn, causes more shorts to cover, and further price appreciation, eventually bringing the market to its knees.
This feedback loop is a classic short-squeeze, but the WallStreetBro Reddit Group's added wrinkle is the use of options and the leverage provided thereby exacerbating the price action. It's called a "gamma squeeze." Those who hedged the call options they had sold by buying the underlying stock increased the pressure."
To break down some of the jargon, shorting a stock means you believe the price will go down. A few large hedge funds had this belief with Gamestop. As far as shorting goes, I don’t believe in it. For me, it seems un-American to bet on someone else's failure. It's akin to taking the under on a basketball game, and I don't know anyone who wants to watch a game without much scoring. Instead, I'd rather my assets play a role in a company's future success and growth, create jobs, improve the economy, and help consumers.
Basically, individual investors are pooling together and driving up the price of certain stocks more susceptible to manipulation. Whether it is manipulation or not is something the SEC has stated they are monitoring. My opinion is that unless the United States goes the route of China or Russia with government-regulated internet, the reality is that humans are going to communicate. Technology has a way of accelerating things, and this is no different.
Rich vs. Poor Narrative
The narrative of retail investors working together to "stick it to the man" is a bit farfetched. Just the same as the small money, don't think for a second that big money isn't on both sides of the trading too.
“Investing is a zero-sum game. To buy a stock, someone else has to be selling. You are betting you know the company better than the person that is selling it to you.”
While the recent activity has caused some pain for a few big players short the stock, the reality is that when this inevitably ends, there will be many retail investors left holding the bag, not just the shorts getting squeezed.
Think of it as a multi-level marketing company or pyramid-scheme. Only the people who got in early enough with multiple sales reps underneath them make the real money. When the steady stream of buyers subsides, so will the stock price.
In my opinion, the lasting impact of this frenzy is simply the optics that should be on hedge fund leverage. Should funds have the ability to use leverage to short a company? To go long, 10x a company's performance? Is this healthy for efficient markets to operate? I anticipate these questions coming under more scrutiny in the future. The idea swirling about social media that this is the poor taking from the rich may be a bit farfetched in the market's overall scope. Sure, it has made some significant funds sweat it out. Instead, the silver lining may be simply the need for a more in-depth conversation as we advance. Many policymakers are already calling for this.
What I think will happen.
Some timeless stock market wisdom: the stock market can remain irrational longer than you can remain solvent. A few hedge funds caught on the wrong side of this exuberance are feeling exactly that.
Chief Economic Advisor for Allianz, Mohamed El-Erian, once coined the phrase "tourist money," whereby thinly traded markets are flooded with foreign investment (think third-world type markets) which can severely distort the actual internal economics and dynamics of that particular environment. At the first sign of trouble, the assets are yanked out, leaving a vacuum in their wake.
Today's "tourist money" white-knuckling its way upwards will eventually come to an end. Unfortunately, it will have real-world consequences, just as it often does for any thinly-traded market.
As a disclaimer, this isn't sour grapes for me, as I don't have any skin in the game nor plan to initiate any positions in any of these 'tourist money' targets of today's Reddit community/retail investors.
FOMO & you.
Sitting on the beach this week during my honeymoon, I had the pleasure of eavesdropping on a conversation between a college student, his father, and his grandfather. Phrases like "I doubled down," "I hit that one," and "I went all in" were prevalent across all three generations. As I listened, I imagined the same dialogue occurring at a blackjack table in Detroit's Greektown Casino. So if playing the odds are your thing - then let's looks at some real eye-opening probabilities.
Let's say you are of the mad-money mindset and want to take a flyer nonetheless?
“Hey, it's just $5,000 - I could retire sooner! Pay off my student loans quicker, buy a bigger house, etc.! Shoot, even if I go down in flames and fail spectacularly, it's only $5,000.”
Here is the best-kept secret in investing, come in, close the door. Are you ready? Investing isn't supposed to be exciting if done correctly. To achieve the highest probability of a successful outcome, it should be similar to watching paint dry or grass grow.
For example:
$5,000 invested in the S&P 500 ETF, $SPY in January 1991 through the end of January 2021 would've grown to over $65,000. The annual return comes out to an average compound growth rate of close to 10%. Play with the math yourself here.
So if the next 30 years resemble anything close to the last 30, you could 13x your money. There is never a guarantee that past performance will yield similar future results, but the key is that slow and steady wins the race. With investing, reliability is more important than speed.
The risk of being wrong in the long term far outweighs the reward of being right in the short term. Meaning, you don't just lose $5,000 if you are wrong today; you lost $65,000 in hypothetical opportunity cost tomorrow. As such, my FOMO skews more long term than short term.
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
In closing, most folks don't realize that they still will be able to meet their financial goals by remaining above the fray of this week's buzz. Hopefully, this helps you make heads or tails of what you should do or not do in this case. A long term perspective is the most surefire way to create and sustain wealth. After all, he who laughs last laughs the loudest.
My job is to provide advice that puts my clients in the best position to be successful. Similarly, many of us also understand that if we exercise and eat healthier, we will eventually lose weight. No doctor has ever been excited to sell a cast, they provide advice, and it is up to you how to proceed.
The only game worth playing is the long one. The ball is in your court.
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