17 March 2021
By John Husselbee, Co-Fund Manager WS Verbatim Portfolio Growth Funds
Investment stories rarely make the front pages – beyond intermittent ‘billions wiped off in single day’ headlines – so it has been fascinating to watch events surrounding US firm GameStop, several hedge funds and an army of social media-fuelled day traders in recent weeks.
In a plot straight out of television’s Billions – which charts the market-manipulating misadventures of hedge fund mogul Bobby Axelrod – we have seen hordes of traders take to discussion board Reddit and hatch stock bets in an attempt to spark a short squeeze and attack hedge funds. US firm GameStop has seen much of the activity, with the struggling video game retailer among the heavily shorted stocks to see its share price rocket and then fall away as amateur investors piled in. The fact trading in this company and several others was restricted on certain platforms – one, in another TV-worthy twist, named Robinhood – has added fire to the prevailing story of plucky outsiders versus the privileged elite.
Now the dust has settled for the most part, it is worth examining what the fuss was about and whether it might signal wider changes in investment. While it seems an exaggeration to claim social media has changed stock markets and trading forever, as some commentators have, there are clearly developing trends we need to consider.
To cover off that first term in the headline, stonks is an intentional misspelling of stocks that originated with an internet meme; a picture of a man in a suit, standing in front of numbers, alongside a big, orange arrow. It became synonymous with the frenzied trading in GameStop, highlighting the growing ‘gamification’ of investing, with so many people stuck at home during lockdowns and turning to day trading to relive boredom.
GameStop is a US retailer of physical video games but with a growing trend towards downloading and stores shut during lockdowns, the business is facing a challenging future. Understandably, this has seen its shares subject to growing short interest from hedge funds.
Over recent weeks, however, the stock became the poster child for Reddit users, particularly on the WallStreetBets community, looking to squeeze these short sellers, with a surge of buying driving huge share price growth. Around 20-30% of flows in the US are from so-called mom and pop traders and, while this is usually spread across the market, social media was able to focus much of this volume on to a few names. As a result, over the course of just 16 days in January, GameStop shares rocketed from under $20 to nearly $350, growth of over 1,300%, leaving a number of hedge funds – which borrow shares in the expectation of them falling in value – facing billions in losses.
This short squeeze passed quickly, however, with many hedge funds rushing to cover their positions and the shares declined just as precipitously, plummeting back towards the initial price at the start of February. Meanwhile, other shares favoured by the Reddit warriors have also experienced notable price jumps including Bed Bath & Beyond, AMC Entertainment and Blackberry, with commodities such as sliver also targeted.
These price changes have been so extreme that several major discount brokers and platforms imposed freezes on certain stocks, largely sparked by spiking margin requirements, and faced criticism from market participants and politicians alike, especially as hedge funds could continue trading. As stated, this has fuelled the ongoing David versus Goliath narrative and, while interesting, this debate, as well as the fundamental ethics of shorting stocks, are beyond the scope of this article. One counterpoint to consider, however, is that if a group of ‘professional’ investors formed a group with the express purpose of touting and bidding up out-of-favour stocks, they could expect a fairly rapid visit from law enforcement.
What we do need to consider is how much this activity could affect our Multi-Asset funds and whether it will increasingly become part of financial markets? The first of these is much easier to answer: within the portfolios we manage, there are no underlying funds that participate in short selling so recent and future short squeezes should have no adverse impacts.
Taking a longer term, broader view is more challenging and there are a few points to consider. First, short squeezes are not uncommon, with Volkswagen briefly becoming the most valuable company on the planet in 2008 for example. The difference in the latest bout of activity is the ‘retail’ nature of the investors driving it, with social media and forums enabling rapid, widespread sharing of ideas and a range of platforms allowing anyone to trade immediately and cheaply. With a small amount of money and a simple app on your phone, literally anyone can be a day trader.
For a long time, short squeezes were the preserve of professional investors but this has clearly changed in the world of social media and discussion boards. We would also point to the current strain of anti-establishment thinking in the US and Covid-19 as exacerbating these trends; on the latter, many people have been furloughed or lost their jobs in the pandemic and are looking for ways to make ‘easy’ money, with a large amount of the stimulus cheques given to US citizens flowing straight through phones and into stock markets.
One point to recognise is that stocks like GameStop are relatively few and far between, needing to meet two criteria necessary for an effective short squeeze. The first is that the stock is relatively easy and cheap to borrow for the purpose of shorting; the second is that there is a low free float number of shares to trade. The fact the company does not have many freely available shares to buy and sell, and many of those are locked up in long-term funds, means it is not that difficult to bid up the price if you are looking to hurt hedge funds.
As an industry, investment has been slow to change over recent decades, keeping to the basic model of ‘professionals’ telling investors where to put their money. Social media is revolutionising this relationship, as it has in so many other facets of life, and whether this is seen as positive or negative likely depends on which side of the democratisation versus gamification line things ultimately fall.
Either way, it will be important to monitor how the narrative around stock markets and investment evolves in these increasingly important communication channels over the years ahead, especially as the world continues to emerge from the shadow of Covid-19.
The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. The contents of this article should not be construed as advice and is for information only. Individual stock selection should only be performed by suitably qualified advisers.