Every financial asset trades at a level that is related to the present value of its future expected cash flows. That is, unless buyers and sellers are interested in transacting for other reasons. Certain stocks like Gamestop, AMC, and Bed Bath and Beyond, which have boomed in the past few weeks, have become disconnected from the underlying reality which is – these companies are not in good shape. The big questions are (1) what’s happening, (2) is this market manipulation, and (3) are there potential impacts to broader financial markets.
Gamestop runs retail video game stores, it is not a place where consumers have been flocking over the past few years and even less so during the pandemic. It is losing money. Companies like this tend to attract investors who want to bet that the company’s stock will do worse, not better. Hedge funds are the biggest players who go “short” and bet the stock will go down. Recently there has been an online ‘viral’ phenomenon where regular retail investors have used online forums like Reddit to collaborate to buy stocks like Gamestop. They have targeted stocks that have a large number of hedge fund folks with short positions and have bought them at such a rate that the share prices have popped, causing hedge funds to cover their bets and driving the prices even higher. This is called a “short squeeze”, another example of such a squeeze was in 2018 with a company called Tilray. A short squeeze itself is not altogether abnormal market action, but the herd mentality and targeting of unhealthy companies with short interest is unique.
Is this market manipulation?
Leading into the next question, is this market manipulation? Yes, this is certainly a form of market manipulation. If this had been a coordinated effort by licensed professionals, traders, or brokers the SEC would deem it akin to a “pump and dump” scheme or another form of coordinated market moving manipulation – and there would be repercussions to those actors. Because it is largely retail traders who are participating it is harder to know how the SEC or other regulatory bodies will crack down on this, but surely there will be investigations.
Do we anticipate impacts to broader financial markets?
My opinion, I don’t think this signals a larger imminent threat to broader markets. We’ve seen in the latest earnings report out the past two weeks positive signs of economic recovery and corporate profit growth – good signs for the stock market and economic prospects generally and our outlook remains positive for 2021 (detailed market outlook piece coming next week – stay tuned).
I find it harder to believe that the mechanics of total global markets are as likely to be swayed or moved by the message boards – one stock yes, but there are a lot of different investment players and strategies globally, including large institutions, and many investments are in broad market indexes/mutual funds rather than individual stocks. Furthermore, not all stocks have short interest which these Redditors are targeting. Apple and Tesla notably have no short interest, and most do not have substantial short interest. In fact, the overall short interest of the S&P 500 is only 3.4% (chart below). I do think heavily shorted stocks may be susceptible to the herd, but that is less likely to significantly impact portfolios like those constructed at Artemis which do not invest in individual stocks and are based on globally diversified asset allocation.
This doesn’t mean there aren’t risks in the market or reasons why we might see pull-backs from time to time. That said, we think it is less likely to come from this odd trading situation than from other avenues such as challenges to vaccine development/distribution, new coronavirus strains, inflation, or missing global growth expectations as we recover from the pandemic.