GameStop: easy peasy, short squeezy
It’s a story that has everything – Wall Street, gamers, politics… even the real ‘Wolf of Wall Street’ has weighed in. A group of retail investors, largely from the 8.2 million (and counting) members of the Reddit forum r/wallstreetbets (r/WSB), banded together to drive up the value of GameStop*, a heavily shorted gaming and electronics retailer with a seemingly outdated business model.
From the start of 2021 to 27 January, shares of GameStop soared by 1,745%. More modest but still spectacular increases have also been seen from a host of other stocks popular with this community.
But what caused all the commotion? Let’s take a look at who has been buying these shares and why, and what impact this could have on wider markets and our portfolios.
The who, the how and the why
Let’s start with the platform which retail traders have been using to communicate these trade ideas. Reddit is a self-described “network of communities based on people’s interests”. Patrons engage in anything from discussing politics, through to playing Fortnite, or sharing animal memes. The site houses a number of forums or ‘subreddits’ discussing such topics, one of which is r/WSB, which has seen a surge in new members in recent weeks. In fact, at the time of writing, the five fastest-growing subreddits are all finance related, of which r/WSB is number one.
Of the members who have spoken publicly, many appear to be American males in the millennial age bracket who have held a strong disdain for the financial sector (stemming from the Global Financial Crisis) and hedge funds in particular. Within the hedge fund community, short sellers appear to have caught the ire of these individuals more than any others. In fact, as at 26 January the 50 most shorted stocks in the Russell 3000 had increased in value an average of 33% since the start of 2021, driven upwards by retail flows pouring in.
How were retail investors able to do this? In recent years there has been a huge proliferation in trading apps and websites targeted at the casual investor, giving these investors much greater access to markets than ever before. I know my social media feeds are flooded with advertisements for these platforms. Couple that with the fact that we are living through a pandemic. Huge swathes of people are unemployed or underemployed, and the US has largely chosen to deal with this by putting cash directly in people’s pockets. For some, there are not many options for spending it at present. People have more cash at their disposal to be able to engage in this activity and more time to complete at least some research. One reason that the same level of activity is not being seen in Europe is that authorities have chosen to provide income replacement through furlough schemes rather than lump sum payments to all.
Now to the ‘why’. In 2020, an investor on r/WSB identified that a significant proportion of GameStop’s stock was being shorted. This information is publicly available; in fact, representatives from hedge funds often appear on finance shows to discuss their short positions. The investor asserted that if the subreddit’s members could combine resources, they could drive the stock price up and force short sellers out of their positions, sending the stock higher in the process, also known as a short squeeze. This is without regard for the fundamentals of the stock, but it is worth noting that many Reddit users are gamers themselves, so they are buying what they know and like. In addition to purchasing regular shares, r/WSB investors discussed entering the position via options, also a new phenomenon for retail investors. This has enabled them to gain leveraged exposure to GameStop. It has also meant that investment banks writing the options have had to buy the stock themselves to hedge their positions, which has taken the stock even higher.
This once again shines a light on the rising influence of social media and increasing wealth inequality on western society in recent times. Over the past year, we have seen large-scale protests across the US and much of the world, growing adoption of non-traditional news media sources, a rise in negative attitudes towards vaccines, the growing influence of conspiracy theories, an attempted coup at the US Capitol, and now the rise of the retail trading activist. Not all are directly linked, but the thumbprint of social media can be seen right the way through.
The effects on wider markets and portfolios
So far the effect on the wider equity market has been limited. The data suggest that the pickup in trading activity is only from a subset of the retail market and that private wealth client flows into equities have not increased. The focus of the participating investors has been on individual small-cap stocks rather than the wider market. Given there is less market capitalisation in these areas, the smaller volumes these investors tend to trade can have a larger impact on prices. Despite the fact that Big Tech is popular among casual investors, it arguably has a lower weight in the retail-investor space than in the S&P 500 given the sheer size of these companies. In theory, these investors’ flows might be able to impact certain sectors, but so far the effect has been marginal in the sectors we hold.
However, it is worth noting that the trading volume in some of these stocks has been increasing. On 27 January, the volume traded in GameStop was higher than in Apple*, which suggests the impact could spread to the wider market if the focus switches. For example, we have seen a brief surge in silver prices as chatter in r/WSB about the precious metal has grown in recent days. This is noteworthy given the size of this precious metal’s market is over $1 trillion. Additionally, towards the end of January there was some volatility in the wider market, which could well have been caused by short sellers having to exit some of their other positions at short notice in order to buy GameStop and other names to close out their shorts.
All of this poses some potentially challenging questions for regulators over what action to take. We could see greater regulation placed on the retail trading platforms after they decided to suspend selling on several affected stocks last week, action which created an unlikely and very temporary alliance between Democratic congresswoman Alexandria Ocasio-Cortez, Donald Trump Jr, and Republican senator Ted Cruz, who all tweeted their disapproval. Greater restrictions could be placed on retail investors’ access to certain instruments, or on the nature of discussions on internet forums. Alternatively, restrictions could be placed on short selling, or there could be a removal of the requirement to publicise information on short positions. Only time will tell, and regulators will be wary of the law of unintended consequences.
Increased retail participation in equity markets is a typical side-effect of bull markets and of bull markets overshooting into bubbles, as investors who were around for the dotcom bubble will tell you.
At this point in time, we believe the increased involvement of retail investors is a positive for markets. So far it seems that only a subset of retail investors is involved but there remains potential for increased participation. We note that valuations and sentiment appear to have reached slightly elevated levels in recent months, but we believe equities still appear attractive relative to government bonds in this historically low interest-rate environment.
This, in addition to the promising economic backdrop, in our view presents supportive conditions for equities moving forwards. However, we will continue to monitor developments and look for any signs of investor excess.
*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.