What happened this week with GameStop (GME), Reddit and Robinhood was shocking, unprecedented and unforeseen. Lost in the flurry though is that the craziness is very much a part of some elephant-in-the-room trends in this country.
I’ll explain what I mean in a moment, but first let me give you the bare bones of the story which includes everyone from Elon Musk to Congresswoman Alexandria Ocasio-Cortez, as well as hedge fund titans and the New York Mets. Here’s the precis: Over the past several weeks, a group of investors, often communicating on a Reddit community called Wall Street Bets, (WSB)—which has 6 million members and describes itself as “Like 4chan found a Bloomberg terminal illness”—bought shares in GameStop, the beaten down video game retailer.
A few saw promise in the company, but recently, mostly because word had gotten out that hedge fund Melvin Capital, among others, had shorted the stock (betting it would go down.) That the belief that they could make the stock go “to the moon” (how WSBers put it.) As demand for GameStop’s stock rose, (these investors bought options as well), so did its price, creating “a short squeeze,” which forces those who bet against the shares to buy in order to forestall bigger losses, sending the stock price even higher.
But something else was going on too. These newly-empowered investors insisted they were sending short sellers, hedge funds and Wall Street writ large, a message. They were tired of being on the wrong end of the proverbial investment stick. In other words this wasn’t just investing, it was about torches and pitchforks.
“It makes me think of Occupy Wall Street, in this case instead of protesting corporate greed, they were given the tools to participate in it,” says Doug Boneparth, president of wealth management firm, Bone Fide Wealth. These investors had figured out a Wall Street pain point: Ganging up on short sellers.
Some of these retail investors were buying these stocks on Robinhood, which famously bills itself as not-your-father’s brokerage-firm. That was fine until Robinhood and other brokers including Morgan Stanley’s E-Trade and Interactive Brokers restricted trading in some of these stocks on Thursday which caused universal howling. (Trading resumed yesterday.)
Everyone, even teenagers, has been going nuts over this story. It’s easy to see why. Over the past six months GameStop’s stock has gone from around $5 to almost $500. All of this has greatly impacted the markets too: This week total U.S. equities volume surged to a record, 23 times the average rate in 2020, and likewise total U.S. equity options volume, which surged to 10 times the 2020 rate.
That’s where things stand as of this morning. But as I said I think it’s more important to see this story within the context of bigger trends. Here are five of them.
On the evening of November 8, 1940, one Jesse Livermore went into the coatroom of The Sherry-Netherland hotel in Manhattan, where he typically had cocktails each day, and shot himself. Livermore, once a protege of J.P. Morgan, was a stock trader extraordinaire, a pioneer in short selling, as well as market manipulation. At one point Livermore was one of the richest people in the world, though he was in the red when he committed suicide. (His biography, “Jesse Livermore: Boy Plunger, The Man Who Sold America Short in 1929,” popular amongst Wall Streeters these days, makes for a fascinating read.)
I’m telling you about Livermore to make the point that crazy trading and traders have been around forever. The ways and means change, but beneath it all are fear and greed. 1929, 2000, 2008, and even March of last year. The order of magnitude varies, but the inevitability is ever present.
Action in the Reddit-fueled stocks somewhat resembled the 2000 tech bubble, but with at least one key difference. Investors then drove up the prices of Amazon, Cisco and yes, Yahoo, as well as Global Crossing and Pets.com. Sure there were day traders, but many investors believed these companies had real potential. The stocks being bid up today are the very opposite of that. Their businesses are fading at best and investors make no bones about that (which is why they are being shorted.)
“What [WSB investors are] doing is not investing,” Jaime Rogozinski, Wall Street Bets founder, told Yahoo Finance. “They're using the stock market like a casino in a very unapologetic way. They're not posting information about the fundamentals. They're posting funny videos on people to go ahead and risk the same. They're not investors.”
Is there systemic risk to the markets or even the broader economy in this madness? (This has to be in the Black Swan Hall of Fame, right?) It’s not clear. At its peak, GameStop’s market capitalization was $28 billion, likely a joke compared to the value of its business, but more importantly, only a little bit more than 1% of the value of Apple. (Add up all the other Reddit stocks and it’s still tiny versus the overall market.) That’s a good thing.
Still, long short hedge funds are unwinding their positions, (selling their long positions and ridding themselves of their short positions, reflected in the chart below.) And they’re doing so as much as they did during the bloodbath last March. Why? Because of the Reddit Revolution, but for other reasons as well which I’ll get to.
That means volatility will likely continue for a bit according to Michael Purves, chief executive of Tallbacken Capital Advisors. "I do think the contagion risk is real," Purves said. "Any stock that is heavily shorted is exposed to getting GameStopped."
“It's just another chapter in this ongoing book of excessive speculation,” says economist David Rosenberg. “And it’s not really a different crowd than who was buying Hertz’s stock when it declared bankruptcy last spring. One can argue that we have a grand new neophyte type of investor in the market. But I think a lot of the ‘rich man-poor man,’ investors, might be overplayed.”
“All manias die out,” Jeremy Siegel, professor of finance at Wharton School, told Yahoo Finance. “It will go back to fundamental value. It's the greater fool's theory. ‘I know it's not worth this, but I know someone else who is more foolish who will buy it from me at a higher price. I'm smart enough to get out in time.’ Obviously there will be a lot of people holding the bag at the end. They're going to be the losers.”
A changing of the guard
This January has lived up to its namesake, Janus, the Greek god of transitions. Each Wednesday this month in particular was momentous: insurrection, impeachment, inauguration and then insanity (with the stock market.)
I would argue that the impact of the changeover from Trump to Biden has been underestimated by investors. Sure there was talk of new sectors doing well, but to think we have this massive shift in politics and that the stock market wouldn’t react is naive.
“Just remember who the president is, it’s Joe Biden. Not Donald Trump,” says Rosenberg. “Donald Trump talked about the stock market throughout his presidency. Joe Biden doesn't care about the stock market as much.”
But how is this political realignment directly related to the market? Example: Many large hedge funds had terrific years in 2020, with names like Citadel, Viking, Third Point all up 20% and 30%. That, plus the new political environment made managers wary. “You ride your long/short positions as long as they work,” a trader told me. “When they begin to break, you move.” That’s what’s happening now. Add to that the promise by Biden and Treasury Secretary Janet Yellen to funnel hundreds of billions of liquidity (aka cash) into the system. That too is upending models.
Another data point here is the aforementioned brokerage firm Robinhood which held itself up as a democratizing force for investors. The narrative was almost literary. A firm called Robinhood replete with commission-free trading (it makes money off of margin trades) extracting money from rich hedge fund short sellers and disbursing it to lowly day traders.
But when the firm restricted trading in those stocks and later raised margin limits, it went from proletariat ally to “The Man” as fast as a flash crash. Robinhood’s rating on the Android store dropped to 1, and the company, which was set to IPO this year, drew down lines of credit reportedly worth a billion dollars. (One commentator wondered if Robinhood would later halt trading in itself if it became a target of WSB.)
“We know that customers were upset with the temporary restriction,” Robinhood CEO Vladimir Tenev told Yahoo Finance. “We've unrestricted it now and customers can buy these stocks. We stand with the people who are making their voices heard through the markets, and showing the world that investing is for everyone, not just for the wealthy and the institutions,” he added.
“Retail investors used to always be wrong,” says veteran Wall Street institutional trader Tiger Williams. “Not any more. Now you got 50 million of them all tied together and they really matter.”
If nothing else, this week showed that populism, heretofore manifested in politics has come to Wall Street. The folks on WSB are the financial cousins of Trump and Bernie supporters. They are sick and tired of a system they consider rigged against them. Understandable, because while hedge fund managers and investors racked up double digit gains, ordinary investors lost their jobs. Or as I heard of one Wall Streeter telling it: “2020 was bad for humans, but it was great for finance.” Guess who’s taking their revenge?
“There's a lot of pent-up aggravation at the financial services industry that's been brewing for the last 13 years,” WSB user Louis Rossmann told Yahoo Finance. Oh indeed.
Filling the Trump news void
“Trump’s gone away and now you people in the media need something to talk about,” said Williams.
Ah yes, Tiger, blame the media. Except that he has a point. With Trump off Twitter, there was indeed a news vacuum, now nicely filled by this story. The media didn’t really create this trading phenomenom, except for one giant often overlooked social media platform, and that is Reddit. If Twitter, Facebook and YouTube in part provided a social media means to the insurrection this month, Reddit did the same for this Wall Street tempest.
Of course violently and illegally invading the Capitol is no way equivalent to making money at the expense of hedge funds. And yet it would be wrong not to recognize parallel undercurrents. Simply put, people are mad at the elites in America.
Certainly other media have amplified and benefited from Reddit trading. Twitter’s stock, which dropped after it banned Donald Trump, bounced back from its mid-January low perhaps in part from this new surge in traffic.
Tweeting this story, you have hedge fund big shot and New York Mets owner, Steve Cohen, assuring his team’s fans that his involvement in this brouhaha would not affect the team. (Cohen shored up Melvin by investing $750 million.) Then provocateur and Barstool Sports founder Dave Portnoy got into it with Cohen, who was then supported by journalist Keith Olberman and so on. Elon Musk, who loathes short sellers came in on the side of the WSB crowd of course. “Get shorty,” he tweeted, which over half a million people liked.
But maybe craziest was an exchange between AOC and Sen. Ted Cruz. At 11:36 a.m. on Thursday the congresswoman tweeted her outrage over Robinhood blocking retail investors “while hedge funds are freely able to trade the stock as they see fit.” At 11:48 a.m., Cruz replied “Fully agree.”
This is so crazy that even AOC and Cruz agree? That lasted 58 minutes. At 12:46 p.m. AOC tweeted out: “I am happy to work with Republicans on this issue where there’s common ground, but you almost had me murdered 3 weeks ago so you can sit this one out.” Over three quarters of a million people liked that.
On Thursday night AOC went on Twitch, the gaming platform owned by Amazon, where she was joined by Reddit co-founder Alexis Ohanian. “...everyday people were finally able to proactively organize and get back at the folks that have historically had all the marbles on Wall Street and forced one hedge fund into an existential crisis,” AOC said. Over a million people tuned in.
Politicians know a hot button issue when they see it. Who needs Trump?
But seriously where is the government in all this? And what should it do?
First of all don’t worry, (or maybe worry) the Feds are coming. White House Press Secretary Jen Psaki told the media that “Our economic team, including Secretary Yellen is monitoring the situation.” And Sen. Elizabeth Warren weighed in: “We need an SEC that has clear rules about market manipulation and then has the backbone to get in and enforce those rules,” she told CNBC.
But weren’t those accused of market manipulation the Reddit traders, i.e., the little guys? Or maybe the manipulation was Robinhood and others restricting trading on Thursday? Unclear.
In fact the SEC said it was reviewing the matter. So too New York Attorney General Letitia James. And Ohio Sen. Sherrod Brown, incoming head of the Senate Banking committee, and Congresswoman Maxine Waters, who leads the House Financial Services Committee, announced they would hold hearings. Also at least 17 federal lawsuits have been filed against Robinhood. A handful of other brokers have been sued too.
But other than Robinhood, E-Trade, et al., restricting trading possibly being a problem, what really is actionable here? (And by the way, the brokers say they imposed restrictions because of potential problems with their clearing firms and capital requirements.) As for Reddit traders working in concert to corner stocks, that’s very hard to prove.
It’s true that our securities laws, last revamped in 1934, could use a close lookover. And looming even larger than Reddit traders bidding up a few dog stocks is Bitcoin and blockchain, which the SEC—not particularly active as of late—has only begun to act upon. “[The SEC has] an impossible task on their hands and I do wish them well, says WSB’s Rogozinski.
So what’s the upshot?
There will be hearings and litigation. And Robinhood, a friend of the retail trader until it became the enemy because of one decision on one trading day, will no doubt pay a price.
As for the mania, “I don’t think it’ll be this kind of craziness permanently,” says Jamie Catherwood, client portfolio associate at O’Shaughnessy Asset Management and founder of the financial history newsletter “Investor Amnesia.” “But I do think the broader concept of retail participation and democratization of finance is only going to increase.”
Meanwhile, those bigger trends: populism, politics, media obsessions and especially intermittent manias aren’t going anywhere.
This article was featured in a Saturday edition of the Morning Brief on January 30, 2021. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe
Andy Serwer is editor-in-chief of Yahoo Finance. Follow him on Twitter: @serwer.