The GameStop Explosion is More Virtual than Reality By: Gabriel PotterMBA, AIFA® 2021.02.01

I have been a lifelong gamer, so when GameStop started showing up on my newsfeed – I didn’t think too much of it at first.  Longtime readers of our content will know that I popped into a GameStop store a few years ago to see how the chain was faring, which I wrote about here:  https://westminster-consulting.com/Media/Blog/changing-the-game.  In short, GameStop built itself up selling electronic goods, but it is easier than ever to simply sell and distribute data from the convenience of your mobile phone, video game console, or personal computer.  So, GameStop is clearly struggling to reidentify itself in a digital distribution world.

I was not alone in these observations.  Everyone knew the retail environment had been changing for years, and that change was accelerated because of the pandemic.  The market environment was so unfavorable that the company had attracted the unwanted attention of short sellers, who were actively betting that the stock price would go down. 

There are dozens of articles online that have explained what happened to GameStop’s stock, how short selling works, and how hedge funds got smashed.  Here is a good recap from the Associated Press - https://apnews.com/article/gamestop-stock-surge-explained-fb377363d1b04809706619a6bcc9e549.    In summary, the short sellers made money for a while betting against GameStop.  However, they overextended their bet against it and promised to deliver more shares than there were actual shares in the marketplace.  So, when short sellers had to deliver the promised shares, they would have to buy it no matter WHAT the price was.  The Wall Street Bets community on Reddit figured out how to collaborate on a short squeeze against the hedge funds making these over levered bets.  One such hedge fund, Melvin Capital, has taken huge losses (-53% in January) from the GameStop bet before leaving the position.

The whole incident is being portrayed in the media as the little guys (the small investors at Wall Street Bets) winning a fight against the corrupt big guys (the hedge funds).  This narrative is further compounded by the actions of online brokers, Robinhood, which provided the marketplace for small-investors and was popular among millennial day-traders.  Robinhood received some negative backlash because they are allegedly protecting the corrupt short sellers by limiting margin purchases of GameStop stock.  Now the SEC and Congress are getting pulled into the fray to review these actions.

While tempers are high, and trading is frenzied (GameStop stock has been traded more than any other S&P stock this week), it is important to take a step back and realize how much this has to do with the fundamentals of our economy – absolutely nothing.  GameStop’s business fortunes are not going to materially change based on this action.  They could be selling video games or tulips, and it wouldn’t matter because the ridiculous bubbles of asset pricing have no impact whatsoever on real world commerce.  The stock is getting pumped up today as a way to extract money from exploitable short sellers, but in the long term, GameStop stock will eventually reflect its real-world earning power, which is still down in the dumps.

The fight here is between speculative bettors, so it’s disingenuous to think of this as good-guys versus bad-guys, at least not in terms of actually helping the economy grow through prudent investment. Investors aren’t involved with this chicanery.  Investors focus on whether to go long on a stock, to buy it or avoid it.  Investors focus on the long-term prospects of the company and how that is reflected by its stock price.  There is a reason these strategies (like short selling) are generally limited; it is because these strategies are risky and filled with huge potential losses.  This market turmoil will have an impact on the of trading rules of leverage, the definition of collusion, the duty of SEC, and regulation of markets during volatility.   For most investors, however, this blow up is interesting but ultimately just theater. 

 

 

 

 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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