The Downsides of the GameStop Short Squeeze
Revenge of the Reddit Retail Traders
GameStop, a failing American video game merchandiser, has been caught in an ideological David and Goliath battle between individual retail traders and their institutional Wall Street counterparts. The battle takes place in an unusual arena — the New York Stock Exchange — with Redditors using the company’s share price as their weapon of choice, pulling off what is likely to be remembered as the short squeeze of the decade.
The Big Short
There are two ways to make money on a stock — a trader can buy it if they think its price will rise, or short sell it if they think its price will fall. It’s usually the large institutional investors like Wall Street hedge funds that short sell stocks. They do this by borrowing shares of a company they think is likely to have a decline in stock price — due to weak fundamentals or otherwise — and selling the borrowed shares at the current market price. They then buy the shares at a later time when the price drops in order to return it to the borrower and profit off the difference in prices.
The caveat is that if the stock price goes up instead of down, the short seller is then “squeezed” out of their short position, because they then have to buy the stock at a higher price than they sold it for in order to return it to the borrower — leading to a loss.
Hedge funds favoured GameStop as a short sell, since the brick-and-mortar video game retailer made a loss of $795m in 2019, and probably several hundred more in 2020. However, thanks to the recent boom in retail traders, the stock is now up over 300% for the past week as of writing, putting the hedge funds in a serious short squeeze which cost them billions of dollars.
We Are The 99%
The retail traders aren’t motivated by company fundamentals, but rather by a sense of rage against the institutional investing elites. Their primary motive for purchasing the stock was to send the price up in order to stick it to Wall Streeters who were betting on the stock’s demise. Their rage is visceral, stemming from the resentment towards the 1% who are perceived as having largely profited off the misery of the pandemic. The fact that the stock market continues to go higher while the economy remains down in the doldrums further illustrates the disparity between Wall Street and Main Street.
Individual retail investors — who largely used the social media site, Reddit, to discuss their coordinated “investment” in GameStop — have long felt a sense of disregard from the mainstream investment world. While some have joined in the GameStop frenzy merely to be a part of the hype, others are there to send a message to institutional investors that there are new players to the game. Perhaps the most poetic detail of the story is that the stock belongs to a company whose slogan declaims, “Power to the Players”. The writers of Billions themselves couldn’t have conjured such a saga.
A Pyrrhic Victory
But alas, there are downsides to the punishing short squeeze of hedge funds merely for the sake of schadenfreude. The market manipulation of GameStop’s stock by maverick investors only serves to adulterate the integrity of the capital markets.
Contrary to popular belief, the stock market isn’t purely a casino for the rich. It’s a mechanism for efficiently allocating capital in society. Ideally, innovative companies that help propel society forward should be the ones that easily get funding from investors who believe in their mission and trust that they can remain profitable as years go by.
Buying a company’s stock in order to weaponize the price against a hedge fund out of hate only serves to distort the market’s fair pricing mechanism while debasing its more noble use as a distributor of capital towards innovation. Merely treating the stock market as a tool for gambling is simply not a productive use, and certainly doesn’t serve to improve society.
Further, while retail and institutional investors appear balkanized, with the latter provoking the indignation of the masses, perhaps not all the hate is entirely warranted. Most institutional investors aren’t from the elitist billionaire class, but are merely pension or insurance funds meant to benefit the working class. If the resentful attacks towards institutional investors continue, it would eventually be a case of retail investors sinking the ship they’re on just to kill the captain.
But perhaps most significant of the downsides is that GameStop simply does not have the fundamentals to support such a high stock price, and eventually people will start selling the stock again — resulting in losses for those that bought in at the highs.
No can say when exactly this will end, but the end surely won’t be pretty.
But for now, Power to the Players, indeed.
